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As filed with the Securities and Exchange Commission on January 6, 1998
FORM 10/A
AMENDMENT NO. 3
General Form for Registration of Securities
Pursuant to Section 12(b) or (g) of
the Securities Exchange Act of 1934
Pennsylvania Manufacturers Corporation
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2217932
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(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
The PMA Building
380 Sentry Parkway
Blue Bell, Pennsylvania 19422-2328
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215) 665-5046
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Securities to be registered pursuant to Section 12(b): None
Securities to be registered pursuant to Section 12(g) of the Act:
Class A Common Stock, par value $5.00 per share
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(Title of Class)
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Introductory Note
This Form 10 Registration Statement contains certain forward-looking statements
that involve risks and uncertainties. Such statements can be identified by the
use of forward-looking terminology such as "may," "will," "should," "expect,"
"anticipate," "believe," "estimate" or "continue," or the negative thereof or
other variations thereon or comparable terminology. The Company's actual results
could differ materially from those projected in the forward-looking statements
as a result of certain of the factors set forth elsewhere in this Registration
Statement, including, but not limited to "Management's Discussion and Analysis
of Financial Condition and Results of Operations" included in Item 2 of this
registration statement. The factors that could cause actual results to vary
materially include, but are not limited to, the following: 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 claim liabilities; adequacy and
collectibility of reinsurance purchased by the Company; and natural disasters.
Investors should not place undue reliance on any such forward-looking
statements.
Item 1. Business
Company Overview
Pennsylvania Manufacturers Corporation (the "Company" or "PMC") is an insurance
holding company formed in 1982 as a Pennsylvania corporation. The Company's
principal executive offices are located at The PMA Building, 380 Sentry Parkway,
Blue Bell, Pennsylvania, 19422-2328, and its telephone number is (215) 665-5046.
The Company operates in two principal segments, property and casualty primary
insurance through Pennsylvania Manufacturers' Association Insurance Company
("PMAIC") and other affiliated insurance companies (the "Property and Casualty
Group"), featuring workers' compensation coverages and related services, and
property and casualty reinsurance through PMA Reinsurance Corporation ("PMA
Re"). The Property and Casualty Group writes workers' compensation and certain
other lines of commercial insurance primarily in nine contiguous jurisdictions
in the Mid-Atlantic and Southern regions, utilizing the PMA Group trade name.
The domestic insurance subsidiaries through which the Property and Casualty
Group writes its insurance products and which share results through an
intercompany pooling agreement are referred to herein as the "Pooled Companies."
PMA Re emphasizes risk-exposed, excess of loss reinsurance and operates in the
domestic brokered market. The Property and Casualty Group and PMA Re are
sometimes collectively referred to herein as the "Insurance Subsidiaries." A.M.
Best & Company ("A.M. Best") has currently assigned an "A- (Excellent)" rating
to the Pooled Companies and an "A+ (Superior)" rating to PMA Re. At December 31,
1996, the Company had total assets of $3.1 billion and shareholders' equity of
$425.8 million. Unless otherwise specified in this registration statement,
dollar amounts set forth herein with respect to the Company are presented in
accordance with generally accepted accounting principles ("GAAP").
After a period of rapid growth in the late 1980's, the Company's consolidated
total net premiums written declined from $705.8 million in 1991 to $443.5
million in 1996. 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 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
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business and, commencing in 1993, rate reductions associated with workers'
compensation benefit reform laws. Management believes that recent initiatives it
has taken and workers' compensation reforms enacted in recent years 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. Between 1992 and
1996, 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. 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.
The composition of the Company's statutory net premiums written for 1996 was as
follows:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Net premiums written % of total
-------------------- -----------
<S> <C> <C>
Workers' compensation...................... $198,198 44.3%
Other commercial lines..................... 84,781 19.0%
-------- -----
The Property and Casualty Group............ 282,979 63.3%
PMA Re..................................... 164,053 36.7%
-------- -----
Total...................................... $447,032 100.0%
======== =====
</TABLE>
The Company is in the process of establishing a separate excess and surplus
lines company and has hired Ronald S. Austin as President and Chief Operating
Officer of that division. Management anticipates that the excess and surplus
lines company will primarily write multi-line business consisting of primary and
excess commercial general liability, professional liability, excess automobile
and certain property exposures.
The Property and Casualty Group
Background and Recent Developments
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. 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 $456.4 million in 1992 to $283.0 million in 1996.
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 loss adjustment expenses ("LAE"). The adverse
development arising from workers' compensation had reduced earnings by a
cumulative $251.6 million between 1992 and 1995. Such adverse development mainly
related to Pennsylvania workers' compensation business from accident years 1987
through 1991. As the claims data from these accident years have matured, the
impact of the disability and medical benefits available to claimants before the
passage of reform legislation in 1993 and 1996, coupled with the economic
conditions that had existed during the disability periods, has become more
apparent. As a result, the developed losses have exceeded management's prior
estimates. The reform legislation enacted 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
since 1991 have had and continue to have a beneficial
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effect on the Company's accident year loss ratios. The strengthening recorded
for asbestos and environmental claims is 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 loss development technique for environmental
claims. After strengthening the asbestos and environmental reserves, the
Property and Casualty Group's survival ratio is 8.8 years. See "Loss Reserves"
below. The impact of the loss reserve strengthening and restructuring charges
taken for the expense initiatives discussed below reduced the Pooled Companies'
statutory capital and surplus to $250.4 million at December 31, 1996.
In late 1996, the Property and Casualty Group began a commutation program
designed to reduce the outstanding Pennsylvania workers' compensation claims
from accident years 1991 and prior. 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 law, all such commutation agreements must be approved by the
individual claimant and the Pennsylvania Workers' Compensation Board. The number
of open claims for accident years 1991 and prior are expected to decline as a
result of this program. Management believes that the commutation program should
reduce the possibility of further adverse development on accident year 1991 and
prior reserves, although there can be no assurance that the level of
commutations will have a significant impact on the future development of the
recorded reserves.
In late 1996 and early 1997, the Property and Casualty Group initiated several
expense reduction programs. A voluntary early retirement program ("VERIP") was
offered in December 1996. Of the 84 employees eligible to participate in the
VERIP program, 49 opted to participate. Additionally, the Property and Casualty
Group announced a plan to consolidate field operations, which are presently
conducted in seven full-service branch offices located in Pennsylvania, New
Jersey, Maryland, North Carolina and Virginia. After such consolidation is
completed, there will be three regional service centers located in Valley Forge,
Pennsylvania, Harrisburg, Pennsylvania and Richmond, Virginia, which will
encompass staff underwriting functions, certain processing activities and claims
adjusting. The other offices will be converted into satellite offices that will
mainly have a marketing presence as well as line underwriting functions. In
conjunction with these expense initiatives, as well as the write-off of certain
accounts receivable, the Property and Casualty Group has recorded $29.9 million
of non-cash restructuring charges in 1996. See "Item 2. Management's Discussion
and Analysis of Financial Condition and Results of Operations."
The Property and Casualty Group is presently renewing its emphasis on 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 expenses, because acquisition costs are lower for workers'
compensation than other lines of commercial insurance. In Pennsylvania, the
Property and Casualty Group will seek to expand and retain more of its premium
base in territories which 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 existing marketing territories
(specifically, North Carolina and Virginia) has also improved in recent years.
In addition, the Property and Casualty Group intends to expand into certain new
territories. In 1996, the Property and Casualty Group began writing business 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 the territories. 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 territories. However,
no assurance can be given that the Property and Casualty Group will be able to
accomplish the above marketing plan.
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.
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Effective January 1, 1997, the Property and Casualty Group has reduced its
retention on commercial casualty lines of business to $175,000 from $500,000.
The Property and Casualty Group has established two internal run-off operations
to reinsure certain obligations associated with workers' compensation claims for
the years 1991 and prior of the Pooled Companies for statutory accounting
purposes. The results of the internal run-off operations are included in the
GAAP financial results of the Property and Casualty Group. See "PMA Insurance,
Cayman Ltd." and "MASCCO" below.
Business Written
The following table sets forth certain information on the Property and Casualty
Group's statutory net premiums written for the years indicated (the statutory
information presented below does not differ materially from amounts determined
in accordance with GAAP):
Years Ended December 31,
------------------------
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Workers' Compensation.............. $198,198 $236,742 $267,033 $342,184 $373,261
Commercial Auto.................... 35,224 39,834 38,984 48,108 49,065
Commercial Multi-Peril............. 35,108 40,659 31,123 27,306 20,805
General Liability & Umbrella....... 8,204 11,370 12,691 16,788 12,799
Property & Other................... 6,245 8,511 3,320 324 420
-------- -------- -------- -------- --------
Total.............................. $282,979 $337,116 $353,151 $434,710 $456,350
======== ======== ======== ======== ========
</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 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
(1995), the Property and Casualty Group is the second largest private writer of
workers' compensation insurance in Pennsylvania and between the fourth and
twelfth largest writer of workers' compensation insurance in the remaining named
jurisdictions listed in the table below. 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" below. The following table sets forth certain information with
respect to the statutory direct workers' compensation business written by
jurisdiction for the years indicated (the statutory information presented below
does not differ materially from amounts determined in accordance with GAAP):
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Years Ended December 31,
------------------------
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Pennsylvania....................... $134,171 $142,234 $169,448 $224,067 $230,504
New Jersey......................... 17,995 24,388 31,287 47,745 55,132
Virginia........................... 17,449 26,395 29,938 31,545 28,112
Maryland........................... 11,406 17,993 14,391 15,318 19,878
North Carolina..................... 8,195 14,035 11,649 21,216 22,313
Delaware........................... 7,545 5,763 4,831 4,274 3,481
Other.............................. 5,403 7,889 4,864 7,165 8,830
-------- -------- -------- -------- --------
Total.............................. $202,164 $238,697 $266,408 $351,330 $368,250
======== ======== ======== ======== ========
</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. The law
also reduced the minimum wage replacement benefit to injured workers, introduced
a credit for unemployment compensation 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 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 benefit offsets; (iii) further increases the time frame for
directed medical treatment; (iv) addresses certain inequities in the average
weekly wage calculation; and (v) increases the ability of employers to
demonstrate that injured workers have earning capacity.
To date, Act 44 has had a favorable impact on medical loss costs in Pennsylvania
and Act 57 is expected to have a positive impact on indemnity loss costs. In
recognition of these developments, in the respective first years following the
enactment of Act 44 and Act 57, the average manual rate level in Pennsylvania
decreased approximately 10% in 1994 and approximately 25% in 1997. In addition
to the workers compensation reforms which have taken place in Pennsylvania,
there have been reforms enacted in various other states in which the Property
and Casualty Group does business. A 1996 law in North Carolina reduced medical
treatment fees for treating injured workers by 11%. Reform legislation enacted
in New York in 1997, which reduced employers exposure to third-party
counterclaims, provides certain safety credits, increases fraud prevention, and
reduces certain benefit levels, is expected to reduce workers compensation
claims expenses by approximately 20% based on industry studies. These reforms
are generally expected to have a beneficial impact on the Property and Casualty
Group's claim costs in these states. 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, which have declined
as follows:
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<TABLE>
<CAPTION>
Estimated Undiscounted
Accident Year Pure Loss Ratio
------------- ---------------
<S> <C>
1990 100%
1991 86%
1992 80%
1993 64%
1994 64%
1995 63%
1996 63%
</TABLE>
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" below. Set forth below is percentage information on the
voluntary workers' compensation direct premiums written by product type for the
policy years indicated:
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992 1991 1990 1989
----- ----- ----- ----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Rate-sensitive products........ 57% 52% 50% 54% 53% 54% 60% 73%
Loss-sensitive products........ 30% 34% 39% 40% 46% 46% 40% 27%
Alternative market products.... 13% 14% 11% 6% 1% 0% 0% 0%
---- ---- ---- ---- ---- ---- ---- ----
Total 100% 100% 100% 100% 100% 100% 100% 100%
==== ==== ==== ==== ==== ==== ==== ====
</TABLE>
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. The dividends,
which are recorded as a separate line in the Company's consolidated statements
of operations, are calculated based upon an insured's actual loss experience as
compared to the Company's estimate of the insured's loss experience at certain
points in time. Generally, losses associated with an insured's policy are valued
initially at six months after policy expiration and annually thereafter for a
period of two years. The Company utilizes dividend paying policies to encourage
loss control on the part of its insureds and as a marketing product to attract
business. Since the late 1980s, the Property and Casualty Group has reduced its
proportion of rate-sensitive products from over 70% to approximately 57%. With
the enactment of regulatory reform in several jurisdictions in the Property and
Casualty Group's marketing territory, the Property and Casualty Group is more
interested in this type of business and may write more rate-sensitive accounts
in such jurisdictions in the future.
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.
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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 off-shore 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.
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 Property and Casualty Group's current marketing jurisdictions, except
Pennsylvania and Maryland. In these two states, separate governmental entities
write all of the workers' compensation residual market business. In 1996, the
Property and Casualty Group wrote $8.3 million of residual market business,
which constituted approximately 4% of its voluntary net workers' compensation
premiums written. Based upon data for policy year 1996 reported by the National
Council on Compensation Insurance, the percentage for the industry as a whole
was 16%.
Commercial Lines
The Property and Casualty Group writes property and liability coverages for
larger and middle market accounts which 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. In addition, effective January 1, 1997,
the Property and Casualty Group has reduced its retention on commercial casualty
lines of business to $175,000 from $500,000. See "The Company's Reinsurance
Ceded" below.
Home Office and Field Operations
As of June 30, 1997, 234 employees worked in the home office located in Blue
Bell, Pennsylvania, and 628 employees were assigned to field offices located
throughout the Property and Casualty Group's marketing territory.
Senior executives, financial operations, management information systems, human
resources, actuarial services and long-range planning teams are headquartered in
the home office. The 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.
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The field organization currently consists of three branch offices in the major
marketing areas in Pennsylvania and branch offices in each of Maryland, New
Jersey, Virginia and North Carolina as well as 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. The Property and Casualty
Group is in the process of reorganizing the field office functions. The seven
branch offices will be consolidated into three regional service centers located
in Valley Forge, Pennsylvania, Harrisburg, Pennsylvania and Richmond, Virginia,
which will encompass staff underwriting functions, certain processing
activities, and claims adjusting. The other offices will be converted into
satellite offices.
Distribution
The Property and Casualty Group distributes its products through approximately
20 employees and approximately 240 independent brokers and agents. The employees
are generally responsible for certain business located in Pennsylvania. For the
year ended December 31, 1996, these employees produced $51.6 million in direct
premiums written, constituting 17% of the Property and Casualty Group's direct
business. The brokers and agents write business throughout the marketing
territory. In 1996, the top ten brokers and agents accounted for 20% of the
Property and Casualty Group's business, the largest of which accounted for not
more than 4% 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's independent agents and brokers are compensated
on a commission basis, with different commission rates applying to different
lines of business. Certain of the the Property and Casualty Group's larger
agents and brokers also participate in incentive commission arrangements,
whereby additional commission amounts are paid for business that is underwritten
by the the Property and Casualty Group in excess of certain predetermined profit
and volume targets. Other than the Property and Casualty Group's internal sales
force, the Company has no fixed payment arrangements with any of its producers.
During the last several years, the Property and Casualty Group has analyzed the
business produced by the brokers and agents. Based upon this review, the
Property and Casualty Group reduced the broker and agent force from
approximately 370 in 1989 to approximately 240 currently. The Property and
Casualty Group monitors several statistics with respect 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 relationships with former brokers and agents were
terminated for a variety of reasons, including lack of profitability of a
terminated producer's book of business, absence of the types of accounts that
the Property and Casualty Group wants to write and lack of commitment by the
producer to the Property and Casualty Group's customer service program. The
current distribution network generally consists of large regional 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
branch office. It also identifies specific types of business that must be
referred to home office underwriting
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specialists and actuaries for individual pricing, including large accounts over
a specified dollar limit and alternative market workers' compensation products.
Underwriters and risk-control professionals in the field work as a team with the
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 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 preferred provider networks consisting of medical
practitioners 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. Finally, an automated program is used 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 also employs in-house attorneys who represent customers in
workers' compensation cases and other insurance matters.
The Property and Casualty Group has a separate formal anti-fraud unit. The anti-
fraud unit investigates suspected false claims and other irregularities and
cooperates with regulatory and law enforcement officials in prosecuting
violators.
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.
9
<PAGE>
Chestnut Insurance Company, Limited
Chestnut Insurance Company, Limited ("Chestnut") is a Bermuda insurance company
that was formed in 1982 as a wholly owned subsidiary of the Company. From 1992
to 1995, the Pooled Companies entered into aggregate excess reinsurance
arrangements with Chestnut that reduced the statutory discount on loss reserves
for the Pooled Companies. Chestnut is included in the Property and Casualty
Group's GAAP results.
Effective as of December 31, 1996, PMA Insurance, Cayman Ltd. assumed all of
Chestnut's liabilities, and $314.5 million of cash and other assets were
transferred from Chestnut to PMA Insurance, Cayman Ltd. Chestnut is currently an
inactive company.
PMA Insurance, Cayman Ltd.
PMA Insurance, Cayman Ltd. ("PMA Cayman"), a wholly owned subsidiary of the
Company, was incorporated in Grand Cayman, and had no material operations until
1996. Following the assumption of the business formerly written by Chestnut, as
well as reserves under a stop-loss reinsurance agreement with the Pooled
Companies, PMA Cayman has $335.4 million in total assets and $334.4 million in
total reserves at year end 1996. Substantially all of PMA Cayman's assets are
held in trust for the benefit of the Pooled Companies. PMA Cayman is included in
the Property and Casualty Group's GAAP results.
Mid-Atlantic States Casualty Company
Mid-Atlantic States Casualty Company ("MASCCO") is a Pennsylvania insurance
company and a wholly owned subsidiary of the Company. Prior to 1997, 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 (the
"Commissioner"), MASCCO withdrew from the pool 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 this agreement, the Pooled Companies transferred to MASCCO $131.3
million of loss reserves for known claims for death or permanent injury, which
reserves were supported by $131.3 million of investment grade United States
Government and corporate obligations. Additionally, an $11.0 million capital
contribution was made to MASCCO. MASCCO is included in the Property and Casualty
Group's GAAP results.
Pursuant to a surplus maintenance agreement between PMC and the Commissioner,
MASCCO is required to discount its reserves at no more than 5%, maintain a
maximum reserve to surplus ratio of 8:1 and continue to invest its assets only
in investment grade securities.
PMA Re
Background
PMA Re is primarily a treaty reinsurer of domestic property and casualty
business that operates in the brokered market. The Reinsurance Association of
America (the "RAA") reported that as of December 31, 1996, PMA Re was the
seventeenth largest professional reinsurer in the brokered market and the
twenty- third largest professional reinsurer in the United States market based
upon statutory capital and surplus.
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.
10
<PAGE>
In the five-year period ended December 31, 1996, PMA Re has expanded its premium
base without changing its underwriting standards. From 1992 to 1996, PMA Re
reported premium volume growth which exceeded that of the overall reinsurance
industry. During such period, PMA Re's net premiums written have increased
71.4%, while it is estimated that the reinsurance industry grew 54.6% in the
same period based upon information published by the RAA. Management believes
that the expansion of PMA Re's premium base has been attributable to several
factors. First, PMA Re's volume has been impacted by industry trends that have
tended to increase the demand for reinsurance. Specifically, much of the growth
that has occurred in the primary insurance market in recent years has been
attributable to regional and niche companies. Typically, these companies demand
more reinsurance than their larger counterparts. Second, there has been growth
in primary industry segments in which PMA Re specializes, such as excess and
surplus lines. Third, management believes that PMA Re has benefited from the
greater selectivity by ceding companies which have restricted the number of
reinsurers with which they will transact business.
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.
Reinsurance Products
The following table indicates PMA Re's gross and net premiums written by major
category of business:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
-------- --------- -------- -------- --------
Gross Premiums Written (1)
<S> <C> <C> <C> <C> <C>
Property.......................... $ 63,325 $ 63,693 $ 36,592 $ 28,217 $ 20,477
Casualty.......................... 143,991 128,736 107,001 94,482 93,965
Other Lines....................... 842 (63) 837 1,854 1,118
-------- -------- -------- -------- --------
Total............................. $208,158 $192,366 $144,430 $124,553 $115,560
======== ======== ======== ======== ========
Net Premiums Written (2)
Property.......................... $ 41,240 $ 45,440 $ 23,929 $ 18,407 $ 10,676
Casualty.......................... 122,008 107,382 88,585 82,016 83,894
Other Lines....................... 805 (62) 837 1,854 1,118
-------- -------- -------- -------- --------
Total............................. $164,053 $152,760 $113,351 $102,277 $ 95,688
======== ======== ======== ======== ========
</TABLE>
(1) In 1996, gross premiums written include $3.5 million of facultative
reinsurance, comprised of the following: property, $1.1 million; casualty,
$2.3 million; and other lines, $0.1 million.
(2) In 1996, net premiums written include $1.1 million of facultative
reinsurance, broken down as follows: property, $0.5 million; casualty, $0.6
million; and other lines, less than $0.1 million.
Casualty Business
In terms of net premiums written, casualty business has increased at a compound
annual growth rate of 9.1% in the five-year period ended December 31, 1996, and
casualty business accounted for 74.4% of net premiums written in 1996. The
following table indicates the mix of casualty business by class on the basis of
net premiums written:
11
<PAGE>
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994 1993 1992
-------- -------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
Umbrella........................ $ 40,307 $ 51,558 $38,743 $34,189 $34,898
Errors and Omissions............ 19,866 7,149 7,281 4,033 4,117
General Liability............... 11,702 7,460 8,936 8,665 8,845
Medical Malpractice............. 7,411 6,835 6,355 6,657 6,795
Directors' and Officers'........ 6,210 4,586 4,156 1,815 1,853
Miscellaneous Liability......... 12,811 10,350 6,006 3,690 3,767
Auto Liability.................. 17,056 13,032 10,134 12,616 11,439
Workers' Compensation........... 6,645 6,412 6,974 10,351 12,180
-------- -------- ------- ------- -------
Total........................... $122,008 $107,382 $88,585 $82,016 $83,894
======== ======== ======= ======= =======
</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 1994, the growth in other liability was mainly
attributable to excess and umbrella business, as PMA Re added several
significant programs. In 1995 and 1996, PMA Re began to decrease 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 38% of in force casualty treaty
business.
Property Business
Property business has increased at a compound annual growth rate of 30.4% in the
five-year period ended December 31, 1996, and accounted for 25.1% of net
premiums written in 1996. Much of PMA Re's growth in property business occurred
in 1995 and 1994, with increases in net premiums written of 89.9% and 30.0%,
respectively. Such growth 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's net property
writings declined in 1996 by 9.2% as a result of PMA Re's purchase of more
retrocessional protection and increased ceding company retentions for certain
coverages.
PMA Re has generally de-emphasized catastrophe coverages. As of December 31,
1996, catastrophe business accounted for approximately 6.8% of property premiums
in force. Typically, PMA Re requires that property programs contain per
occurrence limits and/or have limited catastrophe exposure due to the location
of the insured values or the nature of the underlying exposures. As of January
1, 1997, PMA Re maintained catastrophe retrocessional protection of $46.0
million excess of $2.0 million. Management believes that its catastrophe
retrocessional coverage is adequate to protect PMA Re against its probable
maximum loss from a significant catastrophe. See "Underwriting" and "The
Company's Reinsurance Ceded" below.
Facultative Reinsurance
Facultative reinsurance is a form of reinsurance coverage which 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 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: (i) to
12
<PAGE>
cover unusual risks; (ii) to cover high hazard risks; (iii) to protect a ceding
company's net retention and/or treaty reinsurers; (iv) to obtain additional
capacity beyond that provided by a company's treaty reinsurers; (v) to cover
risks excluded under a company's treaties; and (vi) to cover risks under a
company's new line of business.
There are some facultative products which 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.
In November 1995, PMA Re commenced writing facultative reinsurance. Although the
amount of net premiums written from facultative business has been relatively
insignificant through 1996, it is anticipated that facultative reinsurance will
be a source of premium growth in the future. PMA Re will offer 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
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. PMA Re's brokers that accounted for more than 10% of the
gross premiums in force as of December 31, 1996 were as follows:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Broker Gross Premiums in Force Percentage of Total
- ------ ----------------------- --------------------
<S> <C> <C>
Aon Reinsurance................... $50,501 22.7%
E. W. Blanch...................... 42,714 19.2%
Guy Carpenter & Company........... 34,942 15.7%
Sedgwick Re....................... 22,731 10.2%
</TABLE>
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 December 31, 1996, PMA Re had 157 unaffiliated clients, with no individual
client accounting for more than 8% of gross premiums in force.
Underwriting
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
13
<PAGE>
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 occurrence limits for property
coverages and requires that the underlying insured values not be catastrophe
exposed. Also, PMA Re does not emphasize 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 not focused on 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, 1996:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Insured 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.
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.
14
<PAGE>
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.
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 Property and Casualty Group carries excess-of-loss per occurrence
reinsurance for: $103.5 million over a net retention of $1.5 million on workers'
compensation and $49.5 million over a net retention of $175,000 on other
casualty lines; $2.0 million per occurrence on automobile physical damage and
$19.5 million per risk ($28.5 million per occurrence) on property claims over
its combined net retention of $500,000. A property catastrophe program with a
per occurrence limit of $15.0 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 $9.5 million over a net retention of
$500,000 and purchases facultative reinsurance for certain other risks.
PMA Re has its own ceded reinsurance program. The maximum gross lines that PMA
Re will write are $2.0 million for property covers and $7.5 million for casualty
covers. Net retentions on any one claim are $500,000 for property covers and
$1.5 million for casualty covers.
PMA Re maintains property catastrophe retrocession programs in an aggregate
amount of $46.0 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 $1.25 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
$12.5 million in excess of $2.75 million per occurrence and a workers'
compensation retrocession program with limits of $53.0 million in excess of $2.0
million per occurrence.
Also, PMA Re maintains aggregate protection up to $22.3 million in excess of
$190.0 million for the current accident year.
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 Pennsylvania.
15
<PAGE>
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.
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 at December 31, 1996, the related adjustments could have a
material adverse impact on the Company's financial condition and results of
operations.
The Company's losses and LAE have been impacted by significant loss reserve
strengthening for the Property and Casualty Group, partially offset by favorable
development for PMA Re. The components of the Company's incurred losses and LAE
for prior accident years are as follows:
(dollar amounts in millions)
<TABLE>
<CAPTION>
1996 1995 1994
------- ------- -------
The Property and Casualty Group:
<S> <C> <C> <C>
Workers' compensation.................. $110.0 $ 54.7 $ 13.2
Asbestos and environmental............. 60.4 23.4 4.6
Other losses and LAE................... 21.0 (11.6) 0.8
------ ------ ------
Total.................................. 191.4 66.5 18.6
PMA Re................................... (28.6) (15.0) (15.0)
Other.................................... (6.7) -- (3.2)
------ ------ ------
Total.................................... $156.1 $ 51.5 $ 0.4
====== ====== ======
</TABLE>
16
<PAGE>
The following table shows the composition of changes in the reserves for losses
and LAE for the past three years:
Years Ended December 31,
------------------------
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Balance at January 1..................................... $2,069,986 $2,103,714 $2,150,665
Less: reinsurance recoverable on unpaid losses and LAE... 261,492 247,856 218,695
---------- ---------- ----------
Net balance at January 1................................. 1,808,494 1,855,858 1,931,970
Losses and LAE incurred, net:
Current year........................................... 323,069 357,787 352,025
Prior years............................................ 156,074 51,491 366
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)............................... 57,480 13,300 50,478
---------- ---------- ----------
Total losses and LAE incurred, net....................... 536,623 422,578 402,869
---------- ---------- ----------
Losses and LAE paid, net:
Current year........................................... (72,194) (71,126) (71,965)
Prior years............................................ (438,427) (398,816) (407,016)
---------- ---------- ----------
Total losses and LAE paid, net........................... (510,621) (469,942) (478,981)
---------- ---------- ----------
Net balance at December 31............................... 1,834,496 1,808,494 1,855,858
Reinsurance recoverable on unpaid losses and LAE......... 256,576 261,492 247,856
---------- ---------- ----------
Balance at December 31................................... $2,091,072 $2,069,986 $2,103,714
========== ========== ==========
</TABLE>
The following table shows how the Company's losses have been paid and reserves
re-estimated over time, compared to the liability initially estimated:
17
<PAGE>
Consolidated Loss and Loss Adjustment Expense Development
(dollar amounts in millions)
<TABLE>
<CAPTION>
1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
I. Initial estimated liability
for unpaid losses and LAE
net of reinsurance
recoverables: 995.0 1,246.1 1,457.4 1,632.2 1,734.6 1,824.3 1,941.0 1,932.0 1,855.9 1,808.5 1,834.5
II. Amount of reserve paid, net
of reinsurance through:
- one year later........... 238.2 305.2 322.3 444.6 470.8 490.5 442.4 407.8 398.9 437.6 --
- two years later.......... 415.5 504.4 601.1 771.5 842.0 848.8 779.1 746.1 763.7
- three years later........ 551.2 691.8 825.9 1,042.6 1,133.8 1,127.0 1,066.8 1,055.9
- four years later......... 674.5 834.0 1,011.4 1,258.0 1,353.1 1,364.9 1,329.2
- five years later......... 788.5 955.8 1,165.8 1,421.4 1,539.4 1,585.4
- six years later.......... 844.3 1,063.1 1,283.8 1,553.1 1,715.1
- seven years later........ 917.6 1,143.3 1,380.1 1,684.6
- eight years later........ 977.7 1,214.0 1,478.9
- nine years later......... 1,030.7 1,288.2
- ten years later.......... 1,090.5
III. Re-estimated liability, net
of reinsurance as of:
- one year later........... 1,034.8 1,280.1 1,468.3 1,696.0 1,795.3 1,966.8 1,998.1 1,932.3 1,907.4 1,964.6 --
- two years later.......... 1,079.5 1,303.9 1,511.9 1,742.5 1,949.9 2,067.5 2,006.5 1,982.5 2,073.4
- three years later........ 1,080.9 1,339.1 1,553.3 1,876.0 2,034.1 2,081.5 2,060.6 2,163.9
- four years later......... 1,102.3 1,358.5 1,607.3 1,938.2 2,040.8 2,134.8 2,258.2
- five years later......... 1,119.4 1,368.4 1,651.5 1,935.1 2,123.0 2,302.0
- six years later.......... 1,123.5 1,391.1 1,648.7 1,985.3 2,273.3
- seven years later........ 1,141.5 1,392.8 1,684.2 2,098.2
- eight years later........ 1,148.1 1,425.4 1,783.6
- nine years later......... 1,167.4 1,503.9
- ten years later.......... 1,254.0
IV. Indicated deficiency: 259.0 257.8 326.2 466.0 538.7 477.7 317.2 231.9 217.5 156.1 --
V. Net liability - December 31, 1,932.0 1,855.9 1,808.5 1,834.5
Reinsurance recoverables 218.7 247.9 261.5 256.6
Gross liability - December 31, 2,150.7 2,103.8 2,070.0 2,091.1
VI. Re-estimated Net Liability 2,163.9 2,073.4 1,964.6 1,834.5
Re-estimated reinsurance
recoverables 188.4 232.8 265.4 256.6
Re-estimated Gross
liability 2,352.3 2,306.2 2,230.0 2,091.1
</TABLE>
The columns in the above exhibit are not mutually exclusive. For example, if a
reserve established in 1986 for a claim incurred during that year had been re-
estimated during 1988, the re-estimate would be reflected in the table for each
of the statement years from 1986 and 1987 during calendar years 1988 through
1996. 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.
The 1996 aggregate workers' compensation adverse development was allocated
$102.0 million to Pennsylvania and $8.0 million to all other states in the
Company's marketing territory. 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 and 1994, 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
18
<PAGE>
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; 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 $54.7 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.
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. Also, during 1996, management undertook efforts to reduce
its exposure to claimants from the pre-1992 accident years through a more formal
commutation program.
In 1993, Pennsylvania enacted Act 44, which introduced medical cost containment
measures and provided for the 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. As previously noted, in 1996,
Pennsylvania enacted Act 57, which included various additional controls and
limitations on disability and medical benefits in Pennsylvania. In addition to
regulatory reforms and management's re-underwriting of the book of business, the
loss ratios have been favorably impacted by the shift to loss-sensitive and
alternative market products. Such impact is reflected in the improvement since
1990 in the workers' compensation accident year loss ratios (losses recorded for
the year the event occurred expressed as a percentage of the premiums earned for
that year), as the following chart indicates:
19
<PAGE>
Workers' Compensation Undiscounted Accident Year Pure Loss Ratios as of December
- --------------------------------------------------------------------------------
31, 1996
--------
<TABLE>
<CAPTION>
Accident Years Loss Ratio
-------------- -----------
<S> <C>
1990 100%
1991 86%
1992 80%
1993 64%
1994 64%
1995 63%
1996 63%
</TABLE>
In addition, management is taking 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
is expected to continue 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 $17.8 million in the fourth quarter
of 1996 to commute workers' compensation indemnity claims. Savings associated
with these claims were consistent with management's expectations. The savings
that have been generated by the commutation program were included in
management's projected 1996 loss reserves. As a result of the commutation
program, it is expected that investment income for the Property and Casualty
Group will be less in 1997 than in 1996, as the cash flow associated with the
commutation payments should reduce the Property and Casualty Group's average
assets available for investment. It is also expected that the number of open
claims for accident years 1991 and prior should decline as a result of this
program. This reduction in open claims should reduce the possibility of 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 the recorded 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 is the result of a detailed analysis of loss and LAE reserves associated
with asbestos and environmental liability claims completed in 1996. 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 its loss reserves in 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
20
<PAGE>
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 losses were as follows:
Years Ended December 31,
------------------------
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves................................. $ 27,611 $13,969 $12,913
Incurred losses and LAE............................ 62,854 22,482 6,424
Calendar year payments for losses and LAE.......... (10,410) (8,840) (5,368)
-------- ------- -------
Ending reserves.................................... $ 80,055 $27,611 $13,969
======== ======= =======
Net of reinsurance:
Beginning reserves................................. $ 23,443 $ 8,168 $ 7,700
Incurred losses and LAE............................ 39,427 21,826 5,834
Calendar year payments for losses and LAE.......... (9,570) (6,551) (5,366)
-------- ------- -------
Ending reserves.................................... $ 53,300 $23,443 $ 8,168
======== ======= =======
</TABLE>
The Company's environmental-related losses were as follows:
Years Ended December 31,
------------------------
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves................................. $20,134 $20,952 $26,129
Incurred losses and LAE............................ 22,143 3,516 (2,150)
Calendar year payments for losses and LAE.......... (6,651) (4,334) (3,027)
------- ------- -------
Ending reserves.................................... $35,626 $20,134 $20,952
======= ======= =======
Net of reinsurance:
Beginning reserves................................. $20,134 $20,952 $26,129
Incurred losses and LAE............................ 21,109 3,516 (2,150)
Calendar year payments for losses and LAE.......... (6,651) (4,334) (3,027)
------- ------- -------
Ending reserves.................................... $34,592 $20,134 $20,952
======= ======= =======
</TABLE>
21
<PAGE>
Of the total net asbestos reserves, $6.8 million, $6.7 million, and $5.4 million
related to established claims reserves at December 31, 1996, 1995, and 1994,
respectively, and $46.5 million, $16.7 million, and $2.8 million related to
incurred but not reported losses at December 31, 1996, 1995, and 1994,
respectively. Of the total net environmental reserves, $12.5 million, $10.3
million, and $13.7 million related to established claims reserves at December
31, 1996, 1995, and 1994, respectively, and $22.1 million, $9.8 million, and
$7.3 million related to incurred but not reported losses at December 31, 1996,
1995, and 1994, 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. See Note 3 to the
Consolidated Financial Statements for additional detail on asbestos and
environmental loss reserves.
In 1996, the Property and Casualty Group's other commercial lines experienced
reserve strengthening of $21.0 million, as compared to a reserve release of
$11.6 million in 1995. The reserve strengthening was principally due to a re-
estimation of LAE 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, other than asbestos and
environmental claims. 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.
In addition to loss and LAE reserve adverse development, the 1996 calendar year
loss ratio was impacted by a net $15.1 million accretion of discount on workers'
compensation loss reserves. In 1995, losses and LAE incurred were impacted by a
$35.0 million reduction of unpaid losses and LAE related to changing the rate at
which workers' compensation unpaid losses are discounted for both SAP and GAAP.
The Property and Casualty Group's Pennsylvania-domiciled insurance subsidiaries
increased such discount rate from 4.0% to 5.0% in 1995, which was permitted and
approved by the Pennsylvania Insurance Department. Loss reserves on other lines
of business as well as LAE reserves for all lines of business are not
discounted.
PMA Re has reported favorable development of unpaid losses and LAE of $28.6
million in 1996 and $15.0 million in each of 1995 and 1994. 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, 1996, the Company's loss reserves were stated net of $75.0
million of salvage and subrogation, of which $65.8 million related to the
Property and Casualty Group allocable to the following lines of business:
workers' compensation, $61.9 million; commercial automobile, $1.4 million;
commercial multi-peril, $1.0 million, and all other lines, $1.5 million; the
anticipated salvage and subrogation was $9.2 million for PMA Re. Incurred
salvage and subrogation reduced (increased) losses and LAE by ($0.6) million,
$9.5 million and ($3.9) million in 1996, 1995 and 1994, respectively. In 1995,
the Property and Casualty Group implemented new automated programs to track and
collect amounts due for salvage and subrogation. These programs increased
collection of amounts due for
22
<PAGE>
salvage and subrogation by $5.1 million in 1995 as compared to 1994. 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 typical 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.
Investments
The Company's investment policy objectives are to (i) seek competitive after-tax
investment income and total return, (ii) maintain very high-grade asset quality
and marketability on all investments, (iii) maintain a 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 and non-investment grade fixed-maturity investments. The Company's
portfolio does not contain any significant concentrations in single issuers
(other than U.S. Treasury obligations), industry segments or geographic regions.
The Company's Board of Directors is responsible for the Company's investments
and 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
Company's Executive and Finance Committees of the Board of Directors meet
periodically with the investment advisers to review the performance of the
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. The Company's capital not allocated to the Pooled Companies,
MASCCO and PMA Re 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
December 31, 1996, 1995 and 1994:
(dollar amounts in millions)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
Carrying Carrying Carrying
Investment Value Percent Value Percent Value Percent
- ---------- ----- ------- ----- ------- ----- -------
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. Government
agencies.......................... $1,602.8 70.8% $1,666.3 67.9% $1,050.8 45.4%
Obligations of states and political
subdivisions....................... 76.5 3.4% 435.9 17.8% 841.8 36.4%
Corporate debt securities............ 372.8 16.5% 128.8 5.2% 45.6 2.0%
Mortgage backed securities........... 74.0 3.3% -- -- 179.2 7.7%
Equity securities.................... 0.3 -- 10.9 0.4% 17.5 0.8%
Short-term investments............... 135.0 6.0% 214.1 8.7% 178.4 7.7%
-------- ----- -------- ----- -------- -----
Total (1)............................ $2,261.4 100.0% $2,456.0 100.0% $2,313.3 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
(1) As of December 31, 1996, the market value of the Company's total investments
was $2,261.4 million.
The following table indicates the composition of the Company's fixed maturities
portfolio at carrying value, excluding short-term investments by rating as of
December 31, 1996, 1995 and 1994:
23
<PAGE>
(dollar amounts in millions)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
Carrying Carrying Carrying
Ratings (1) Value Percent Value Percent Value Percent
- ----------- ----- ------- ----- ------- ----- -------
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities and AAA..... $1,882.4 88.5% $2,025.5 90.8% $1,749.2 82.6%
AA................................... 95.8 4.5% 174.1 7.8% 329.3 15.6%
A.................................... 147.9 7.0% 31.4 1.4% 38.9 1.8%
-------- -------- -------- -------- -------- --------
Total................................ $2,126.1 100.0% $2,231.0 100.0% $2,117.4 100.0%
======== ======== ======== ======== ======== ========
</TABLE>
(1) Ratings as assigned by Standard and 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.
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 December 31, 1996. 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)
<TABLE>
<CAPTION>
Carrying Value Percent
-------------- -------
<S> <C> <C>
1 year or less......................... $ 110.8 5.2%
Over 1 year through 5 years............ 525.5 24.7%
Over 5 years through 10 years.......... 661.2 31.1%
Over 10 years.......................... 754.6 35.5%
Mortgage backed securities............. 74.0 3.5%
-------- -----
Total.................................. $2,126.1 100.0%
======== =====
</TABLE>
The following table reflects the Company's investment results for each year in
the three-year period ended December 31, 1996:
(dollar amounts in millions)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Average invested assets (1)......... $2,366.8 $2,395.8 $2,350.9
Net investment income (2)........... $ 133.9 $ 139.4 $ 138.7
Net effective yield (3)............. 5.66% 5.82% 5.90%
Net realized investment gains....... $ 3.0 $ 31.9 $ 47.5
</TABLE>
(1) Average of beginning and ending amounts of cash and investments for the
period at carrying 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.
As of December 31, 1996, the duration of the Company's investments was
approximately 5.6 years and the duration of its liabilities was approximately
4.9 years.
Competition
The domestic property-casualty insurance industry consists 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
competes 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
24
<PAGE>
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 and PMA Re 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 concern turn-around time for underwriting submissions,
information flow, 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 as compared to its
competitors.
Management attempts to design products which meet the needs of clients in the
Company's markets. In recent years, the Property and Casualty Group has
developed products which reflect the evolving nature of the workers'
compensation market. Specifically, management has increased its focus on
rehabilitation and managed care to keep workers' compensation costs lower for
the employers. Additionally, 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." Management continues to review
new product opportunities for both the Property and Casualty Group and PMA Re.
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- (Excellent)" rating to the Pooled Companies and an "A+ (Superior)" rating
to PMA Re. According to A.M. Best, its ratings are based on an analysis of the
financial condition and operating performance of an insurance company as they
relate to the industry in general. These ratings represent an independent
opinion of a company's financial strength and ability to meet its obligations to
policyholders. These ratings are not shareholder ratings, however, and do not
represent an opinion as to the value of the Company's stock. No assurance can be
given that these ratings can be maintained by the Pooled Companies and PMA Re.
Regulatory Matters
General
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.
PMA Re 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 Insurance Subsidiaries are authorized and regulated in all jurisdictions
where they conduct insurance business. Inasmuch as the Pooled Companies and PMA
Re are domiciled in Pennsylvania, however, the Pennsylvania Insurance Department
exercises principal regulatory jurisdiction over them. 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
25
<PAGE>
their agents, the approval of policy forms and related material and, for certain
lines of insurance, the approval of rates. Property and casualty reinsurers are
generally not subject to filing or other regulatory requirements applicable to
primary 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 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. The Pennsylvania Department of Insurance last conducted
examinations of the Pooled Companies and PMA Re as of December 31, 1992. 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 the Pooled
Companies or PMA Re. 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.
Insurance Holding Company Regulation
The Company and the Insurance Subsidiaries are subject to regulation pursuant to
the insurance holding company laws of Pennsylvania. The Pennsylvania 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 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
for such acquisition of control. Pursuant to the Pennsylvania 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 Commissioner,
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 of any acquisition of control of an insurance company, the proposed
acquirer must file with the Commissioner 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 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 Insurance Subsidiaries to
the Company.
26
<PAGE>
Restrictions on Insurance Subsidiaries Dividends
The principal source of funds for servicing debt of the Company and paying
dividends to shareholders of the Company is derived from receipt of dividends
from the subsidiaries. Under the Pennsylvania insurance laws, the Pooled
Companies and PMA Re may pay dividends only from unassigned funds (surplus), as
reported in the statutory financial statement filed by them with the Insurance
Department for the most recent annual period. As of December 31, 1996, the
Pooled Companies and PMA Re reported unassigned funds (surplus) in the amount of
$272.7 million. Subject to such constraints, any of the Pooled Companies and PMA
Re may declare and pay non-extraordinary dividends subject to certain notice
requirements to the Commissioner and extraordinary dividends to stockholders
subject to certain notice and approval requirements by the Commissioner. Under
Pennsylvania law, an "extraordinary" dividend is any dividend or other
distribution which, together with other dividends and distributions made within
the preceding twelve months, exceeds the greater of (i) 10% of such insurer's
surplus as regards policyholders as shown on its last annual statement on file
with the Commissioner; or (ii) statutory net income for the previous year.
Payment of extraordinary dividends is permissible only if the Commissioner has
approved the payment of such extraordinary dividends, or if the Commissioner has
not disapproved the payment of such extraordinary dividend within thirty days
from the date the Commissioner receives notice of the declaration of such
dividend. In addition to the foregoing standards, following the payment of any
dividends, the policyholders' surplus of the insurance company must be
reasonable in relation to its outstanding liabilities and adequate for its
financial needs. The Commissioner may bring an action to enjoin or rescind the
payment of a dividend or distribution by any insurance company that would cause
its statutory surplus to be unreasonable or inadequate under this standard.
For the years ended December 31, 1996, 1995 and 1994, the aggregate cash
dividends paid by the Pooled Companies and PMA Re were $53.6 million, $71.5
million, and $34.0 million, respectively. None of the dividends paid was
"extraordinary" for purposes of the Pennsylvania insurance laws. For 1997, the
Pooled Companies and PMA Re collectively are permitted to declare and pay
dividends to the Company in the aggregate amount of $51.9 million, subject to
the notice requirements on dividend declarations and payments. In accordance
with its plan of operation filed with the Pennsylvania Insurance Department,
MASCCO must maintain a ratio of unpaid losses and LAE to policyholder surplus of
no more than 8:1. As of December 31, 1996, MASCCO was in compliance with such
requirements.
Risk-Based Capital
The National Association of Insurance Commissioners (the "NAIC") has adopted
risk-based capital ("RBC") 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%
PMA Re and each of the Pooled Companies had ratios in excess of 200% as of
December 31, 1996. As a result of the Property and Casualty Group's 1996 loss
reserve strengthening (See "Loss Reserves" above), the ratios for the individual
Pooled Companies range from 230% to 210%.
RBC requirements for property/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
27
<PAGE>
phase-out of non-tabular reserve discounts previously taken for workers'
compensation reserves. The discount phase-out has increased by 20% in each year
since 1994, ultimately phasing out 100% of such discount by 1998. As a result,
this phase-out negatively impacts the RBC ratios of companies which write
workers' compensation insurance and discount such reserves on a non-tabular
basis relative to companies which write other types of property/casualty
insurance. Management believes that it will be able to maintain the Pooled
Companies' RBC in excess of regulatory requirements through prudent underwriting
and claims handling, investing and capital management. However, no assurances
can be given that developments affecting the Property and Casualty Group will
not occur, 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.
Employees
As of June 30, 1997, the Company had approximately 990 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.
28
<PAGE>
GLOSSARY OF SELECTED INSURANCE 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.
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.
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 respect to an accumulation of
29
<PAGE>
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
which write predominately long-tailed
liability risks will have a higher combined
ratio than those companies writing
predominately property risks.
Direct reinsurer, direct
underwriter, direct writer........A reinsurer that markets and sells reinsurance
directly to its reinsureds without the
assistance of brokers.
Excess and surplus lines..........Surplus lines risks are those risks not
fitting normal underwriting 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.
Gross premiums written............Total premiums for direct insurance and
reinsurance assumed during a given period.
30
<PAGE>
Incurred but not reported
("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.
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.
Net premiums earned...............The portion of net premiums written that is
recognized for accounting purposes as income
during a period.
31
<PAGE>
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.
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.
Primary insurer...................An insurance company that issues insurance
policies to the general public or to certain
non-insurance 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, in consideration of a premium paid
to it, 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.
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;
retrocessionaire..................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.
Semi-automatic 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
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<PAGE>
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.
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 or policyholder's
surplus; statutory capital
& surplus.........................The excess of admitted assets over total
liabilities (including loss reserves),
determined in accordance with SAP.
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 reinsurer's process of reviewing
applications submitted for insurance coverage,
deciding whether to accept all or 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 premiums.................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 which
are refundable to policyholders if an
insurance or reinsurance contract is canceled
prior to expiration of the contract term.
33
<PAGE>
Item 2. Financial Information
<TABLE>
<CAPTION>
(dollars in thousands, except share and per share data) 1996 (1) 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Consolidated Results
Net premiums written.......................... $ 443,475 $ 489,876 $ 466,502 $ 536,987
============== ============= ============= =============
Premiums earned............................... 420,575 484,952 466,534 547,407
Net investment income......................... 133,936 139,355 138,719 153,842
Net realized investment gains................. 2,984 31,923 47,521 69,798
Service revenues.............................. 9,189 5,106 3,380 1,321
-------------- ------------- ------------- -------------
Total revenues........................... $ 566,684 $ 661,336 $ 656,154 $ 772,368
============== ============= ============= =============
- ----------------------------------------------------------------------------------------------------------------------------------
Components of Net Income
Pre-tax operating
(loss) income (6):
The Property and Casualty Group.......... $ (219,619) $ (4,305) $ 3,893 $ (1,153)
PMA Re................................... 42,783 39,443 33,703 33,511
Corporate operations..................... (490) (13,414) (6,686) (885)
-------------- ------------- ------------- -------------
Total pre-tax operating (loss) income before
interest expense; ....................... (177,326) 21,724 30,910 31,473
Net realized investment gains................. 2,984 31,923 47,521 69,798
Interest expense.............................. 17,052 18,734 13,051 11,650
-------------- ------------- ------------- -------------
(Loss) income before income taxes and
cumulative effect of accounting changes.. (191,394) 34,913 65,380 89,621
(Benefit) provision for income taxes.......... (56,060) 10,783 8,130 21,324
-------------- ------------- ------------- -------------
(Loss) income before cumulative effect of
accounting changes....................... (135,334) 24,130 57,250 68,297
Cumulative effect of accounting changes,
net of related tax effects (2)........... - - - 14,119
-------------- ------------- ------------- -------------
Net (loss) income............................. $ (135,334) $ 24,130 $ 57,250 $ 82,416
============== ============= ============= =============
- ------------------------------------------------------------------------------------------------------------------------------------
Per Share Data
Weighted average shares:
Primary (3).............................. 23,800,791 24,709,031 24,650,741 24,470,024
Fully-diluted (3)........................ 23,800,791 24,934,579 24,650,741 24,470,024
(Loss) income before cumulative effect of
accounting changes, net of related tax
effects:
Primary (3).............................. $ (5.68) $ 0.98 $ 2.32 $ 2.79
Fully-diluted (3)........................ (5.68) 0.97 2.32 2.79
Net (loss) income per share:
Primary (3).............................. (5.68) 0.98 2.32 3.37
Fully-diluted (3)........................ (5.68) 0.97 2.32 3.37
Dividends paid per common share............... 0.32 0.32 0.32 0.28
Dividend paid per Class A common share........ 0.36 0.36 0.36 0.32
Shareholders' equity per share (4)............ 17.86 25.53 22.10 22.23
- ------------------------------------------------------------------------------------------------------------------------------------
Financial Position
Total investments............................. $ 2,261,353 $ 2,455,949 $ 2,313,261 $ 2,374,208
Total assets.................................. 3,117,516 3,258,572 3,181,979 3,197,909
Reserves for unpaid losses and LAE (5)........ 2,091,072 2,069,986 2,103,714 2,150,665
Long-term debt (7)............................ 204,699 203,848 203,975 194,836
Shareholders' equity (4)...................... 425,828 609,668 524,862 534,383
- ------------------------------------------------------------------------------------------------------------------------------------
GAAP Ratios for Insurance Subsidiaries
The Property and Casualty Group:
Loss ratio............................... 158.2% 92.5% 90.1% 96.3%
Expense ratio............................ 51.6% 32.1% 32.0% 25.1%
Policyholder dividend ratio.............. 6.1% 4.8% 4.6% 3.5%
-------------- ------------- ------------- -------------
Combined ratio........................... 215.9% 129.4% 126.7% 124.9%
============== ============= ============= =============
PMA Re
Loss ratio............................... 73.7% 74.6% 74.7% 80.6%
Expense ratio............................ 30.2% 29.5% 33.3% 29.4%
-------------- ------------- ------------- -------------
Combined ratio........................... 103.9% 104.1% 108.0% 110.0%
============== ============= ============= =============
</TABLE>
<TABLE>
<CAPTION>
(dollars in thousands, except share and per share data) 1992
- -------------------------------------------------------------------------
<S> <C>
Consolidated Results
Net premiums written.......................... $ 552,038
==============
Premiums earned............................... 700,207
Net investment income......................... 164,302
Net realized investment gains................. 70,633
Service revenues.............................. 305
--------------
Total revenues........................... $ 935,447
==============
- -------------------------------------------------------------------------
Components of Net Income
Pre-tax operating
(loss) income (6):
The Property and Casualty Group.......... $ (52,532)
PMA Re................................... 35,190
Corporate operations..................... (654)
--------------
Total pre-tax operating (loss) income before
interest expense: (17,996)
Net realized investment gains................. 70,633
Interest expense.............................. 12,542
--------------
(Loss) income before income taxes and
cumulative effect of accounting changes.. 40,095
(Benefit) provision for income taxes.......... (671)
--------------
(Loss) income before cumulative effect of
accounting changes....................... 40,766
Cumulative effect of accounting changes,
net of related tax effects (2)........... -
--------------
Net (loss) income............................. $ 40,766
==============
- -------------------------------------------------------------------------
Per Share Data
Weighted average shares:
Primary (3).............................. 24,406,445
Fully-diluted (3)........................ 24,406,445
(Loss) income before cumulative effect of
accounting changes, net of related tax
effects:
Primary (3).............................. $ 1.67
Fully-diluted (3)........................ 1.67
Net (loss) income per share:
Primary (3).............................. 1.67
Fully-diluted (3)........................ 1.67
Dividends paid per common share............... 0.24
Dividend paid per Class A common share........ 0.28
Shareholders' equity per share (4)............ 19.34
- -------------------------------------------------------------------------
Financial Position
Total investments............................. $ 2,329,242
Total assets.................................. 3,142,821
Reserves for unpaid losses and LAE (5)........ 2,163,181
Long-term debt (7)............................ 185,684
Shareholders' equity (4)...................... 468,105
- -------------------------------------------------------------------------
GAAP Ratios for Insurance Subsidiaries
The Property and Casualty Group:
Loss ratio............................... 113.8%
Expense ratio............................ 19.4%
Policyholder dividend ratio.............. 4.3%
--------------
Combined ratio........................... 137.5%
==============
PMA Re
Loss ratio............................... 78.6%
Expense ratio............................ 27.8%
--------------
Combined ratio........................... 106.4%
==============
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
(Unaudited) (Unaudited)
Three Months Ended June 30, Six Months Ended June 30,
(dollars in thousands, except share and per share data) 1997 1996 1997 1996
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Consolidated Results
Net premiums written.................................. $ 98,389 $ 96,336 $ 248,271 $ 243,780
=============== =============== =============== ===============
Premiums earned....................................... 114,451 102,226 222,401 220,163
Net investment income................................. 32,612 32,511 68,459 65,931
Net realized investment losses........................ (680) (1,412) (1,931) (469)
Service revenues...................................... 2,490 2,264 5,038 4,012
--------------- --------------- --------------- ---------------
Total revenues................................... $ 148,873 $ 135,589 $ 293,967 $ 289,637
=============== =============== =============== ===============
- -----------------------------------------------------------------------------------------------------------------------------------
Components of Net Income
Pre-tax operating (loss)
income (6):
The Property and Casualty Group.................. $ (8,703) $ (2,545) $ (8,412) $ 1,166
PMA Re........................................... 9,274 9,479 22,094 18,537
Corporate operations............................. (701) (187) (909) (1,226)
--------------- --------------- --------------- ---------------
Total pre-tax operating (loss) income................. (130) 6,747 12,773 18,477
Net realized investment losses........................ (680) (1,412) (1,931) (469)
Interest expense...................................... 3,888 4,358 8,222 8,830
--------------- --------------- --------------- ---------------
(Loss) income before income taxes and extraordinary
item............................................... (4,698) 977 2,620 9,178
(Benefit) provision for income taxes.................. (5,218) (139) (2,657) 2,433
--------------- --------------- --------------- ---------------
Income before extraordinary item...................... 520 1,116 5,277 6,745
Extraordinary item, net of related tax effects (7).... - - (4,734) -
--------------- --------------- --------------- ---------------
Net income............................................ $ 520 $ 1,116 $ 543 $ 6,745
=============== =============== =============== ===============
- -----------------------------------------------------------------------------------------------------------------------------------
Per Share Data
Weighted average shares:
Primary.......................................... 24,416,467 24,768,390 24,467,194 24,921,105
Fully-diluted.................................... 24,416,467 24,768,390 24,467,194 24,921,105
Income before extraordinary item, net of related tax
effects............................................ $ 0.02 $ 0.05 $ 0.21 $ 0.27
Net income per share.................................. 0.02 0.05 0.02 0.27
Dividends paid per common share....................... 0.08 0.08 0.16 0.16
Dividend paid per Class A common share................ 0.09 0.09 0.18 0.18
Shareholders' equity per share........................ 17.40 22.87 17.40 22.87
- -----------------------------------------------------------------------------------------------------------------------------------
Financial Position (as of June 30, 1997 and 1996)
Total investments..................................... $ 2,067,828 $ 2,280,525
Total assets.......................................... 3,085,640 3,166,809
Reserves for unpaid losses and LAE.................... 2,052,791 2,018,142
Long-term debt........................................ 203,049 196,632
Shareholders' equity.................................. 415,120 543,663
- -----------------------------------------------------------------------------------------------------------------------------------
GAAP Ratios for Insurance Subsidiaries
The Property and Casualty Group:
Loss ratio....................................... 95.9% 93.1% 95.4% 90.4%
Expense ratio.................................... 44.3% 40.2% 40.1% 37.1%
Policy holder dividend ratio..................... 4.9% 4.1% 4.8% 4.1%
--------------- --------------- --------------- ---------------
Combined ratio................................... 145.1% 137.4% 140.3% 131.6%
=============== =============== =============== ===============
PMA Re
Loss ratio....................................... 70.7% 65.6% 73.1% 72.8%
Expense ratio.................................... 35.5% 40.1% 30.6% 32.5%
--------------- --------------- --------------- ---------------
Combined ratio................................... 106.2% 105.7% 103.7% 105.3%
=============== =============== =============== ===============
------------------------------------------------------------------------------------------------------------------------------
</TABLE>
35
<PAGE>
(1) Operating results in 1996 were impacted by approximately $221,300,000 of
special charges related to reserve strengthening and expense initiatives for
the Property and Casualty Group. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" below.
(2) In 1993, the Company recognized an after-tax net benefit of $14,119,000
resulting from the adoption of SFAS No. 109, "Accounting for Income Taxes,"
($21,500,000 benefit), and SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions," ($7,381,000 after-tax charge).
(3) For the year ended December 31, 1996, common stock equivalents were not
taken into consideration in the computation of weighted-average shares as
these common stock equivalents would have an anti-dilutive effect on the net
loss per share.
(4) In 1994, shareholders' equity was increased $45,343,000 related to the
adoption of SFAS No. 115, "Accounting for Certain Investments and Debt and
Equity Securities." See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" below.
(5) Total assets and unpaid losses and LAE have been restated for 1992,
reflecting the adoption of SFAS No. 113, "Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contracts," and the
resultant reclassification of reinsurance recoverables on unpaid losses and
LAE as assets.
(6) Pre-tax operating income (loss) excludes net realized investment gains.
(7) In March 1997, the Company refinanced substantially all of its long-term
debt which resulted in a $4,734,000 extraordinary loss, which was recorded
in the first quarter of 1997. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" below.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
Years Ended December 31, 1996, 1995 and 1994
The following section provides a discussion of the financial results and
material changes in financial position for the Company for the years ended
December 31, 1996, 1995 and 1994. The balance sheet information presented below
is as of December 31 for each year indicated. The statement of income
information is for the years ended December 31 for each year shown. The term
"SAP" refers to the statutory accounting practices prescribed or permitted by
the Pennsylvania Insurance Department, and the term "GAAP" refers to generally
accepted accounting principles.
Results of Operations
The Company consists of PMC, an insurance holding company, and its subsidiaries.
PMC operates in two principal segments, property and casualty primary insurance
and property and casualty reinsurance. The Property and Casualty Group writes
workers' compensation and other lines of commercial insurance primarily in the
Mid-Atlantic and Southern regions of the United States, utilizing The PMA Group
trade name. PMC's reinsurance business conducted through PMA Re, which
emphasizes risk-exposed treaty reinsurance, operates in the domestic brokered
market.
In the discussion below, pre-tax operating (loss) income is defined as (loss)
income from continuing operations before income taxes, but excluding net
realized investment gains. Operating revenues consist of all of the Company's
revenues, except net realized investment gains.
36
<PAGE>
Consolidated Results
The table below presents the major components of net (loss) income:
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Pre-tax operating (loss) income.............. $(194,378) $ 2,990 $17,859
Net realized investment gains................ 2,984 31,923 47,521
--------- ------- -------
(Loss) income before income taxes........... (191,394) 34,913 65,380
(Benefit) provision for income taxes......... (56,060) 10,783 8,130
--------- ------- -------
Net (loss) income............................ $(135,334) $24,130 $57,250
Per Primary Share:
Net (loss) income............................ $ (5.68) $ .98 $ 2.32
========== ======= =======
Per Fully-Diluted Share:
Net (loss) income............................ $ (5.68) $ .97 $ 2.32
========== ======= =======
</TABLE>
The following table indicates the Company's pre-tax operating (loss) income by
principal business segment:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
The Property and Casualty Group.............. $(219,619) $ (4,305) $ 3,893
PMA Re....................................... 42,783 39,443 33,703
Corporate operations......................... (490) (13,414) (6,686)
--------- -------- -------
Pre-tax operating (loss) income before
interest expense........................... (177,326) 21,724 30,910
Interest expense............................. 17,052 18,734 13,051
--------- -------- -------
Pre-tax operating (loss) income.............. $(194,378) $ 2,990 $17,859
========= ======== =======
</TABLE>
In 1996, the Company's operating results were impacted by a pre-tax charge of
$221.3 million ($143.8 million after tax), or $9.30 per share ($6.04 per share
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. The charge
consists of the following:
(dollar amounts in millions)
<TABLE>
<CAPTION>
Strengthening of unpaid losses and LAE:
<S> <C>
Pre-1992 workers' compensation...................................... $110.0
Asbestos and environmental.......................................... 60.4
Other lines of business............................................. 21.0
------
Total reserve strengthening......................................... 191.4
Premium balances written off and increase in allowance for
doubtful accounts................................................. 17.5
Change in depreciable lives for computer equipment.................. 4.8
Accrual of costs related to early retirement plan................... 7.6
------
Total pre-tax charge................................................ $221.3
======
</TABLE>
37
<PAGE>
On a consolidated basis, in 1996, the Company reported a pre-tax operating loss
of $194.4 million ($8.17 per share) versus pre-tax operating income of $3.0
million ($0.12 per fully-diluted share) in 1995. As a result of the
aforementioned charge, the Property and Casualty Group reported a pre-tax
operating loss of $219.6 million in 1996, as compared to a pre-tax operating
loss of $4.3 million in 1995. Such operating loss in 1996 was partially offset
by pre-tax operating income reported by PMA Re of $42.8 million as compared to
1995 when PMA Re reported pre-tax operating income of $39.4 million. The
increase in PMA Re's pre-tax operating income reflects higher premium volume,
improved underwriting results and higher investment income. Corporate operations
reported a pre-tax operating loss of $0.5 million in 1996 versus a $13.4 million
pre-tax operating loss in 1995. The improvement in the operating results of
corporate operations is due mainly to the fact that 1995 was impacted by an $8.4
million write-down 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, mainly reflecting lower average debt balances and
the pay-down of higher coupon debt. In 1995, pre-tax operating income decreased
from $17.9 million ($0.72 per share) in 1994 to $3.0 million ($0.12 per fully-
diluted share). Such reduction related mainly to an operating loss of $4.3
million recorded by the Property and Casualty Group, resulting primarily from
loss reserve strengthening of $66.5 million, partially offset by a $35.0 million
impact of increasing the discount rate on workers' compensation reserves from
approximately 4.0% to 5.0%. In addition, corporate operations were impacted by
the aforementioned $8.4 million write-down of certain properties owned by the
Company. Interest expense was $5.7 million higher in 1995 versus 1994, mainly
due to higher average debt balances and higher interest rates. Net realized
investment gains were $3.0 million, $31.9 million, and $47.5 million in 1996,
1995, and 1994, respectively. The declining levels of net realized gains
reflected lower levels of realized gains on sales of equity securities, as the
Company has reduced its investments in equity securities in the last three
years. In addition, the fluctuating interest rate environment has generally
lowered realized gain activity in the three-year period ending December 31,
1996.
The Property and Casualty Group Results of Operations
In 1996, the Property and Casualty Group accounted for 63.9% of the Company's
operating revenues. Summarized financial results of this segment are as follows:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
Net premiums written:
<S> <C> <C> <C>
Workers' compensation....................... $ 189,338 $233,145 $260,882
Commercial lines............................ 90,084 103,971 92,269
--------- -------- --------
Total....................................... $ 279,422 $337,116 $353,151
========= ======== ========
Net premiums earned:
Workers' compensation....................... $ 176,380 $243,175 $270,922
Commercial lines............................ 92,221 102,432 90,202
--------- -------- --------
Total....................................... 268,601 345,607 361,124
Net investment income......................... 82,455 92,275 96,683
Service revenues.............................. 9,189 5,106 3,380
--------- -------- --------
Operating revenues............................ 360,245 442,988 461,187
--------- -------- --------
Losses and LAE incurred....................... 424,900 319,644 325,211
Acquisition and operating expenses............ 138,709 110,906 115,404
Policyholder dividends........................ 16,255 16,743 16,679
--------- -------- --------
Total losses and expenses..................... 579,864 447,293 457,294
--------- -------- --------
Pre-tax operating (loss) income............... $(219,619) $ (4,305) $ 3,893
========= ======== ========
GAAP loss ratio............................... 158.2% 92.5% 90.1%
GAAP combined ratio........................... 215.9% 129.4% 126.7%
SAP loss ratio................................ 125.7% 77.3% 85.5%
SAP combined ratio............................ 175.6% 115.1% 120.1%
</TABLE>
38
<PAGE>
Premium Revenues
Premiums for the Property and Casualty Group have decreased in recent years.
Between 1996 and 1995, net premiums written decreased 17.1%, and between 1995
and 1994, net premiums written decreased 4.5%. Direct premiums written for
workers' compensation decreased $36.5 million and $27.7 million in 1996 and
1995, respectively. Direct premiums written for the other commercial property
and casualty lines decreased $9.3 million in 1996 relative to 1995 and increased
$10.4 million in 1995 relative to 1994. Reinsurance premiums assumed increased
$0.8 million between 1996 and 1995 and decreased $1.7 million between 1995 and
1994. Reinsurance premiums ceded decreased $10.4 million in 1996 relative to
1995 and $2.3 million in 1995 relative to 1994. Net premiums earned decreased
$77.0 million between 1996 and 1995 and $15.5 million between 1995 and 1994.
The decline in premiums from 1994 to 1996 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 past three years, the Property and Casualty Group reduced workers'
compensation premium volume in those states in the Property and Casualty Group's
marketing territory that generally have had unfavorable regulatory environments
in terms of rates and benefits. As a result, the Property and Casualty Group did
not renew certain accounts due to inadequate profit potential. In addition,
competition and manual rate levels affected workers' compensation premium
volume. Intense competition caused rates for certain accounts to be unattractive
relative to the risks assumed. Rather than match the price merely to retain the
volume, the Property and Casualty Group declined to write the accounts. In terms
of manual rates, average rate levels declined 7.0%, 3.0%, and 10.0% in 1996,
1995, and 1994, respectively. The rate decreases had a substantially lower
proportional impact on premiums written, as the Property and Casualty Group had
reduced its dependence on rate-sensitive business during 1995 and 1994.
Workers' compensation premiums also declined during the three-year period as a
result of the enactment of workers' compensation 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 1980s, the Property and Casualty Group has reduced
its proportion of rate-sensitive products from over 70% to approximately 57%.
With the enactment of regulatory reform in several jurisdictions in the Property
and Casualty Group's marketing territory, the Property and Casualty Group is
more interested in this type of business and 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 1996, such adjustments reduced gross premiums written by $6.1
million, including retrospective policy returns of $23.2 million and audit
premiums billed of $17.1 million, while in 1995 such adjustments increased
premiums written by $13.1 million, including retrospective policy returns of
$13.8 million and audit premiums billed of
39
<PAGE>
$26.9 million. This decrease in premium adjustments billed in 1996 relative to
1995 is primarily due to two factors: (i) the lower amount of billed audit
premiums, which is attributable to more adequate estimation of risk exposures
and resultant estimated premium at the inception of the policies; and (ii) the
increase in retrospectively rated premiums returned to insureds, resulting from
the favorable loss experience in more recent accident years in workers'
compensation. The increase in 1995 relative to 1994 relates mainly to the fact
that, as loss data matured on retrospective policies for previous accident
years, the Property and Casualty Group was able to recover additional premiums
from such policyholders. As the Property and Casualty Group has expanded this
type of business since 1989, proportionately more policies have mature loss
data, resulting in more premium adjustments.
Under retrospectively rated policies, the Property and Casualty Group receives
an up-front provisional premium which 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 $59.0 million,
$85.0 million and $104.0 million of the Property and Casualty Group's workers'
compensation premiums were derived from loss sensitive products in 1996, 1995,
and 1994, 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
employee job classification. The Company determines its initial estimate of
annual premium based on payroll records and job 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.
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 in the voluntary market, and the assignments are accomplished
either by direct assignment or by assumption from pools. In 1996, the Property
and Casualty Group's direct assignments, which are included in direct written
premiums, decreased $15.3 million relative to 1995, and decreased $8.7 million
in 1995 as compared to 1994, reflecting generally lower premium volume in
workers' compensation for the Property and Casualty Group, as well as conditions
in the voluntary market.
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 of 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.
During 1995 and 1994, the Property and Casualty Group expanded writings of
commercial lines of business other than workers' compensation, such as
commercial auto, general liability, umbrella, multi-peril and commercial
property lines (collectively, "Commercial Lines"). Direct premiums for
Commercial Lines increased $10.4 million in 1995 to $114.2 million. While the
Property and Casualty Group expanded these lines in 1995 and 1994, the growth
had been less than management anticipated. Market conditions have been extremely
competitive in these lines, and management has refused to compromise
underwriting standards merely to increase volume during the three-year period.
Due to these competitive conditions, in 1996, premium volume in Commercial Lines
declined $9.3 million relative to
40
<PAGE>
1995, to $104.9 million. On a going-forward basis, it is anticipated that
Commercial Lines premiums will decline on a net basis due to a lower net
retention for such lines, as well as the Property and Casualty Group's planned
emphasis on workers' compensation products.
Ceded premiums decreased $10.4 million in 1996 as compared to 1995 and $2.3
million in 1995 as compared to 1994. In 1996, the rate of decrease in ceded
premiums was less than the decrease in direct premiums due to the increased use
of facultative reinsurance for specific uses in Commercial Lines. In 1995, the
rate of decrease in ceded premiums was less than the rate of decrease in direct
premiums, mainly due to the expansion of Commercial Lines. Typically, the
Property and Casualty Group buys more reinsurance covering these lines than the
workers' compensation line.
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 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 because 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 three years in the
period ended December 31, 1996:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Estimated retrospective policy
adjustments related to current
accident year.......................... ($18,767) ($12,941) ($17,334)
Revision of estimate of retrospective
policy adjustments related to
prior accident years................... (9,888) (4,845) (6,552)
Retrospective policy adjustments paid.... 23,155 13,786 22,886
Uncollectible write-off.................. (5,000) -- --
-------- -------- --------
Total.................................... ($10,500) ($ 4,000) ($ 1,000)
======== ======== ========
</TABLE>
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.
The 1996 reduction reflects improved loss reserve development in the prior three
accident years. This improvement in loss experience reduced the estimated
amounts of premium that will be billed for the retrospectively rated policies
written during these years. The decrease in 1995 as compared to 1994 was due to
overall reduction in premium volume and to the increased amounts of
retrospective premium billed in the period.
41
<PAGE>
Losses and Expenses
The following table reflects the components of the Property and Casualty Group's
combined ratios, as computed under GAAP (1):
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Loss ratio............................................. 158.2% 92.5% 90.1%
----- ----- -----
Expense ratio:
Amortization of deferred acquisition costs........... 19.7% 15.5% 15.3%
Operating expenses................................... 31.9% 16.6% 16.7%
----- ----- -----
Total expense ratio.................................... 51.6% 32.1% 32.0%
----- ----- -----
Policyholders' dividend................................ 6.1% 4.8% 4.6%
----- ----- -----
Combined ratio-GAAP.................................... 215.9% 129.4% 126.7%
===== ===== =====
</TABLE>
(1) The combined ratio computed on a GAAP basis is equal to losses and LAE, plus
amortization of deferred acquisition costs, plus operating expenses, plus
policyholders' dividends, all divided by net premiums earned.
In 1996, the Property and Casualty Group's loss ratio was impacted by $191.4
million of reserve strengthening for unpaid losses and LAE of prior accident
years as compared to loss and LAE reserve strengthening of $66.5 million in 1995
and $18.6 million in 1994. The loss and LAE reserve strengthening was associated
with the following lines of business:
(dollar amounts in millions)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Pre-1992 workers' compensation............... $110.0 $ 54.7 $13.2
Asbestos and environmental................... 60.4 23.4 4.6
Other lines of business...................... 21.0 (11.6) 0.8
------ ------ -----
Total reserve strengthening.................. $191.4 $ 66.5 $18.6
====== ====== =====
</TABLE>
The 1996 aggregate workers' compensation adverse development was allocated
$102.0 million to Pennsylvania and $8.0 million to all other states in the
Company's marketing territory. Of the $102.0 million, the allocation by year is
as follows: prior to 1987: $16.0 million; 1987-1991: $101.0 million; and 1992
and subsequent years: ($15.0 million). In 1995 and 1994, 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; 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,
42
<PAGE>
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 and 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.
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. Also, during 1996, management undertook efforts to reduce
its exposure to claimants from the pre-1992 accident years through a more formal
commutation program.
In 1993, Pennsylvania enacted Act 44, which introduced medical cost containment
measures and provided for the 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. As previously noted, in 1996,
Pennsylvania enacted Act 57, which included various additional controls and
limitations on disability and medical benefits in Pennsylvania. In addition to
regulatory reforms and management's re-underwriting of the book of business, the
loss ratios have been favorably impacted by the shift to loss-sensitive and
alternative market products since 1990. Such impact is reflected in the
improvement since 1990 in the workers' compensation accident year loss ratios
(losses recorded for the year the event occurred expressed as a percentage of
the premiums earned for that year), as the following chart indicates:
Workers' Compensation Undiscounted Accident Year Pure Loss Ratios as of December
- --------------------------------------------------------------------------------
31, 1996
--------
<TABLE>
<CAPTION>
Accident Years Loss Ratio
-------------- ----------
<S> <C>
1990 100%
1991 86%
1992 80%
1993 64%
1994 64%
1995 63%
1996 63%
</TABLE>
In addition, management is taking 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
is expected to continue 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 $17.8 million in the fourth quarter
of 1996 to commute workers' compensation indemnity claims. Savings associated
with these claims were consistent with management's expectations. The savings
that have been generated by the commutation program were included in
management's projected 1996 loss reserves. As a result of
43
<PAGE>
the commutation program, it is expected that investment income for the Property
and Casualty Group will be less in 1997 than in 1996, as the cash flow
associated with the commutation payments may reduce the Property and Casualty
Group's average assets available for investment by as much as $100 million in
1997, though the actual reduction is dependent upon the total level of
commutations and the timing of the related payments. It is also expected that
the number of open claims for accident years 1991 and prior should decline as a
result of this program. This reduction in open claims should reduce the
possibility of further adverse development on the recorded reserves, although
there can be no assurances that the level of commutations will have a
significant impact on the future development on 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 is the result of a detailed analysis of loss and LAE reserves associated
with asbestos and environmental liability claims completed in 1996. 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 its loss reserves in 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 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.
44
<PAGE>
The Company's asbestos-related losses were as follows:
Years Ended December 31,
------------------------
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves................................. $ 27,611 $13,969 $12,913
Incurred losses and LAE............................ 62,854 22,482 6,424
Calendar year payments for losses and LAE.......... (10,410) (8,840) (5,368)
-------- ------- -------
Ending reserves.................................... $ 80,055 $27,611 $13,969
======== ======= =======
Net of reinsurance:
Beginning reserves................................. $ 23,443 $ 8,168 $ 7,700
Incurred losses and LAE............................ 39,427 21,826 5,834
Calendar year payments for losses and LAE......... (9,570) (6,551) (5,366)
-------- ------- -------
Ending reserves.................................... $ 53,300 $23,443 $ 8,168
======== ======= =======
</TABLE>
The Company's environmental-related losses were as follows:
Years Ended December 31,
------------------------
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves................................. $20,134 $20,952 $26,129
Incurred losses and LAE............................ 22,143 3,516 (2,150)
Calendar year payments for losses and LAE.......... (6,651) (4,334) (3,027)
------- ------- -------
Ending reserves.................................... $35,626 $20,134 $20,952
======= ======= =======
Net of reinsurance:
Beginning reserves................................. $20,134 $20,952 $26,129
Incurred losses and LAE............................ 21,109 3,516 (2,150)
Calendar year payments for losses and LAE......... (6,651) (4,334) (3,027)
------- ------- -------
Ending reserves.................................... $34,592 $20,134 $20,952
======= ======= =======
</TABLE>
(Included in such reserves are reserves for PMA Re of $2,907,000, $2,635,000 and
$1,056,000 (net) at December 31, 1996, 1995 and 1994, respectively.)
Of the total net asbestos reserves, $6.8 million, $6.7 million, and $5.4 million
related to established claims reserves at December 31, 1996, 1995, and 1994,
respectively, and $46.5 million, $16.7 million, and $2.8 million related to
incurred but not reported losses at December 31, 1996, 1995, and 1994,
rspectively. Of the total net environmental reserves, $12.5 million, $10.3
million, and $13.7 million related to established claims reserves at December
31, 1996, 1995, and 1994, respectively, and $22.1 million, $9.8 million, and
$7.3 million related to incurred but not reported losses at December 31, 1996,
1995, and 1994, 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 Property and Casualty Group 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,
45
<PAGE>
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. See Note 3 to the
Consolidated Financial Statements for additional detail on asbestos and
environmental loss reserves.
In 1996, other commercial lines experienced reserve strengthening of $21.0
million, as compared to a reserve release of $11.6 million in 1995. The reserve
strengthening was principally due to a reestimation of LAE 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.
In addition to loss and LAE reserve adverse development, the 1996 calendar year
loss ratio was impacted by a net $15.1 million accretion of discount on workers'
compensation loss reserves. In 1995, losses and LAE incurred were impacted by a
$35.0 million reduction of unpaid losses and LAE related to changing the rate at
which workers' compensation unpaid losses are discounted for both SAP and GAAP.
The Property and Casualty Group's Pennsylvania-domiciled insurance subsidiaries
increased such discount rate from 4.0% to 5.0% in 1995, which was permitted and
approved by the Pennsylvania Insurance Department. Loss reserves on other lines
of business as well as LAE reserves for all lines of business are not
discounted. As premium volume has been reduced in recent years, the accretion of
the discount has had a more significant impact on the calendar year loss ratios
recorded, as there is a lower premium base over which to spread the effect of
the accretion.
The 1996 expense ratio was adversely impacted by several factors that occurred
in 1996. There was a $22.5 million increase in write-downs and valuation
adjustments for the Property and Casualty Group, including:
(dollar amounts in millions)
<TABLE>
<S> <C>
Accrual of costs for voluntary early retirement program...................... $ 7.6
Change in depreciable lives for computer equipment........................... 4.8
Premium balances written off and increase in allowance for doubtful accounts
(excluding $5.0 million of retrospective premium write-offs)................. 10.1
-----
$22.5
=====
</TABLE>
In connection with a plan to reduce its overall level of indirect underwriting
expenses in 1997 and beyond, the Property and Casualty Group initiated a
Voluntary Early Retirement Program ("VERIP") in December 1996. Eligibility to
participate in the VERIP was contingent upon the employees' ages and years of
service with the Company. Of the 84 employees eligible to participate in the
VERIP, 49 employees opted to participate. The accrual at December 31, 1996 is
primarily comprised of additional pension and medical accruals and severance pay
in connection with the VERIP.
The Property and Casualty Group also reassessed its estimate of useful lives for
its mainframe computer equipment, and changed the depreciable lives of such
assets from five years to three years. The effect of this adjustment was to
increase 1996 depreciation expense by $4.8 million.
46
<PAGE>
As part of its ongoing review of premium balances due from agents and insureds,
the Property and Casualty Group wrote off, and reserved for, $17.5 million in
premium balances receivable in 1996, an increase of $15.1 million as compared to
1995. The increase in this write-off is mainly due to a change in the collection
assumptions on accounts that have been referred to attorneys.
As a result of the aforementioned charges, the GAAP expense ratio increased by
8.4 points in 1996 as compared to 1995. The GAAP expense ratio also increased by
2.6 points due to the increase in sales of alternative market products, which
have much lower, if any, net premium, and due to loss-based assessments, which
do not vary with earned premium. The other 8.5 points increase in the GAAP
expense ratio is primarily due to operating expenses not decreasing
commensurately with the decrease in net premiums earned.
The GAAP expense ratios remained fairly stable between 1995 and 1994; the
expense ratios recorded were 32.1% and 32.0% in 1995 and 1994, respectively.
While total expenses decreased from 1994 to 1995, the decrease in premium volume
more than offset the expense reduction. In addition, the change in the mix of
business toward alternative market products and self-insured services, which
have much lower, if any, net premium caused expenses to represent a larger
proportion of net premiums earned.
The policyholder dividend ratios were 6.1%, 4.8% and 4.6% for the years ended
December 31, 1996, 1995 and 1994, respectively. The ratios have increased over
the three-year-period, mainly 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 of the most recent three
underwriting years has improved relative to the years prior to this period, the
Property and Casualty Group has incurred higher policyholder dividends.
Net Investment Income
Net investment income decreased 10.6% and 4.6% in 1996 and 1995, respectively.
The reductions were attributable mainly to lower average investment balances,
resulting from the pay-down of loss reserves from prior accident years and
decreasing premium volume. In addition, the planned acceleration of paid losses
in 1997 associated with the Property and Casualty Group's commutation strategy
has caused the overall maturity of the investment portfolio to decrease,
resulting in a lower average interest rate for invested assets at the end of
1996 related to 1995. The aforementioned commutation strategy is expected to
lower investment income in 1997 related to 1996, as average invested asset
balances are expected to be in lower in 1997.
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: Pennsylvania Manufacturers' Association Insurance Company;
Manufacturers Alliance Insurance Company; Pennsylvania Manufacturers Indemnity
Company; and MASCCO. Effective December 31, 1996, MASCCO was removed from the
pooling arrangement. As part of a plan to reduce the amount of indemnity
reserves from accident years 1991 and prior in the Pooled Companies, certain
workers' compensation reserves were transferred to MASCCO.
The results of the Company's foreign insurance subsidiaries are not included in
the SAP results. The Company's foreign insurance subsidiaries include:
Pennsylvania Manufacturers International Insurance Limited ("PMII"), a Bermuda
subsidiary engaged in reinsuring alternative market products offered by the
Pooled Companies, Chestnut and PMA Cayman. Up to December 31, 1996, Chestnut
primarily reinsured certain obligations of the Pooled Companies. At December 31,
1996, Chestnut transferred the assets and liabilities associated with such
reinsurance arrangements to PMA Cayman. Under such intercompany reinsurance
arrangements, PMII and PMA Cayman, in 1996, and PMII and Chestnut, in 1995 and
1994, assumed from the Pooled Companies the following amounts:
47
<PAGE>
(dollar amounts in millions)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Premiums earned............................ $ 40.9 $26.9 $19.8
Losses incurred............................ 120.9 71.7 33.1
Commissions................................ -- 1.7 0.9
</TABLE>
In addition to the above, 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
Insurance Company and other affiliated 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.
PMA Re Results of Operations
In 1996, PMA Re accounted for 35.6% of the Company's operating revenues.
Summarized financial results of this segment are as follows:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Net premiums written........................... $164,053 $152,760 $113,351
======== ======== ========
Net premiums earned............................ $151,974 $139,345 $105,410
Net investment income.......................... 48,676 45,166 42,068
-------- -------- --------
Operating revenues............................. 200,650 184,511 147,478
-------- -------- --------
Losses and LAE incurred........................ 111,937 103,947 78,750
Acquisition and operating expenses............. 45,930 41,121 35,025
-------- -------- --------
Total losses and expenses...................... 157,867 145,068 113,775
-------- -------- --------
Pre-tax operating income....................... $ 42,783 $ 39,443 $ 33,703
======== ======== ========
GAAP loss ratio................................ 73.7% 74.6% 74.7%
GAAP combined ratio............................ 103.9% 104.1% 108.0%
SAP loss ratio................................. 73.7% 74.6% 74.7%
SAP combined ratio............................. 104.4% 105.5% 108.2%
</TABLE>
Premium Revenues
In 1996 and 1995, net premiums written increased 7.4% and 34.8%, respectively.
In 1996, the increase was primarily the result of increased participation on
reinsurance treaties with existing clients and writing of additional layers and
programs with current clients. To a lesser extent, new ceding clients have also
contributed to PMA Re's growth during 1996. Such increases were partially offset
by premium reductions resulting from the current trend of larger ceding
companies increasing their retentions.
The increase in 1995 was attributable to an increase in the demand for
reinsurance as well as increased participation on reinsurance treaties with
existing clients. The increased demand was due to several industry trends such
as the growth of regional and niche companies that have greater needs for
reinsurance and strong growth in certain primary industry segments in which PMA
Re specializes, such as excess and surplus lines.
The following table indicates PMA Re's gross and net premiums written by major
category of business:
48
<PAGE>
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995
1996 1995 1994 Change Change
---- ---- ---- ------ ------
<S> <C> <C> <C> <C> <C>
Gross Premiums Written:
Casualty lines........................ $143,991 $128,736 $107,000 11.9% 20.3%
Property lines........................ 63,325 63,693 36,592 (0.6)% 74.1%
Other lines........................... 842 (63) 838 -- ----
-------- -------- -------- ----- ----
Total................................. $208,158 $192,366 $144,430 8.2% 33.2%
======== ======== ======== ===== ====
Net Premiums Written:
Casualty lines........................ $122,008 $107,383 $ 88,585 13.6% 21.2%
Property lines........................ 41,240 45,440 23,929 (9.2)% 89.9%
Other lines........................... 805 (63) 837 -- --
-------- -------- -------- ----- ----
Total................................. $164,053 $152,760 $113,351 7.4% 34.8%
======== ======== ======== ===== ====
</TABLE>
PMA Re's net casualty premiums written increased 13.6% and 21.2% in 1996 and
1995, respectively, for a 17.4% compound annual rate. The growth in 1996 and
1995 is attributable to the expansion of several programs covering specialty
business, which includes professional liability, directors' and officers'
liability, and other coverages written on a surplus lines basis.
PMA Re's property business decreased 9.2% during 1996 and increased 89.9% during
1995. The decrease in 1996 is primarily attributable to higher ceding company
retentions and competitive pricing conditions in a soft reinsurance market.
During 1995, PMA Re was able to increase property premiums through expansion of
several property programs; these programs encompassed such lines as auto
physical damage, inland marine, and certain specialty property coverages written
on a surplus line basis. The programs written by PMA Re contain per occurrence
limits and/or are not considered significantly catastrophe exposed, either
because of the locations of the insured values or the nature of the underlying
properties insured.
In November 1995, PMA Re commenced writing facultative reinsurance. During 1996,
this new line of business contributed 1% to total net premiums written. It is
anticipated that the facultative operations will be a source of premium growth
for future years.
Net premiums earned increased 9.1% and 32.2% in 1996 and 1995, respectively.
These increases both correspond to the increase in net premiums written.
Losses and Expenses
PMA Re's combined ratios have remained fairly stable from 1994 through 1996,
with a slight decreasing trend. 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 GAAP combined ratios:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Loss Ratio............................................ 73.7% 74.6% 74.7%
------ ------ ------
Expense ratio:
Amortization of deferred acquisition costs.......... 24.7% 24.2% 26.3%
Operating expenses.................................. 5.5% 5.3% 7.0%
------ ------ ------
Total expense ratio................................... 30.2% 29.5% 33.3%
------ ------ ------
Combined ratio-GAAP................................... 103.9% 104.1% 108.0%
====== ====== ======
</TABLE>
49
<PAGE>
For the past three years, PMA Re's loss ratios remained fairly stable,
decreasing to 73.7% in 1996 from 74.6% and 74.7% in 1995 and 1994, respectively.
Favorable development on prior years' unpaid losses and LAE was $28.6 million in
1996 and $15.0 million in both 1995 and 1994. The lower loss ratios are also
largely attributable to the trends in PMA Re's mix of business toward contracts
written on a pro rata basis and other contracts containing ceding commissions.
Premiums for such contracts tend to be higher relative to the losses when
compared to contracts that do not contain ceding commissions.
The ratio of amortization of deferred acquisition costs to net premiums earned
("Acquisition Expense Ratio") increased 0.5 points to 24.7% in 1996. This slight
increase is due to the fact that PMA Re has written more contracts with ceding
commissions. 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
1995, the Acquisition Expense Ratio decreased 2.1 points from the three-year
high of 26.3% recorded in 1994. Such decrease relates primarily to the fact
that, beginning in 1996, PMA Re's property retrocession program was changed to
include a ceding commission, which resulted in additional $10.6 million and $7.5
million of offsets to acquisition costs in 1996 and 1995, respectively.
In the three-year period ended December 31, 1996, PMA Re added to its operating
infrastructure in the following ways: (i) added staff in response to increased
volume, and to increase the level of specialized support services to customers;
(ii) in November 1994, moved its headquarters into a new facility and
significantly upgraded several of its data processing systems; and (iii) in
1995, added a facultative underwriting unit. In 1994, the resulting increases in
operating expenses outpaced the increase in premium volume, as all of the costs
associated with the move to the new facility were incurred, and a large
proportion of the new support services were added. As such, the ratio of
operating expenses to net premiums earned (the "Operating Expense Ratio") was
7.0%. In 1995 and 1996, the increases in premium volume, coupled with relatively
flat levels of operating expenses, caused the Operating Expense Ratio to remain
relatively stable.
Net Investment Income
Net investment income increased from $42.1 million in 1994 to $45.2 million in
1995, and from $45.2 million in 1995 to $48.7 million in 1996, increases of 7.4%
and 7.8%, respectively. Such increases were primarily attributable to the
overall increase in PMA Re's invested assets. At amortized cost, PMA Re's cash
and invested assets increased $34.9 million, or 4.4% and $92.4 million, or 13.1%
during 1996 and 1995, respectively. Additionally, the 1996 increase was also due
to a decrease in holdings of tax-exempt securities for which yields tend to be
lower than other investment vehicles.
Comparison of SAP and GAAP Results
The difference between the combined ratios presented on a GAAP basis versus the
SAP combined ratios is primarily attributable to the different accounting
treatment of acquisition costs. As PMA Re has grown in terms of premium volume
during 1996 and 1995, PMA Re has incurred additional acquisition costs, which
are deferred for GAAP. Since, for SAP purposes, PMA Re is not permitted to defer
its acquisition costs, there is an incremental expense recorded on a SAP basis
which is not required for GAAP.
Corporate Operations
The corporate segment is primarily comprised of corporate overhead and the
operations of the Company's properties. In 1995 and 1994, management reviewed
its property holdings, some of which the Company is presently attempting to sell
or lease. In doing such review, management determined that the fair market
values of the Company's former headquarters building and certain adjacent
properties were less than the carrying values plus the costs to carry and sell
the properties. As such, the Company recorded charges of $8.4 million and $4.9
million, in 1995 and 1994, respectively, to write down these properties to their
fair market values less costs to carry and sell the properties. No such charges
were recorded during 1996. In addition, certain overhead costs were reduced in
1996 as compared to 1995.
50
<PAGE>
Net Realized Investment Gains
Net realized investment gains amounted to $3.0 million, $31.9 million, and $47.5
million in 1996, 1995, and 1994, respectively. During the three-year period
ended December 31, 1996, 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) sales 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. 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
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 $0.9 million, versus 1995 when such transactions
resulted in a net gain of $12.1 million. During 1995, the declining interest
rate environment gave rise to favorable sales opportunities; these opportunities
were less prevalent in 1996 due to the higher interest rate environment. In
early 1994, the Company realized gains of approximately $47.5 million from sales
of taxable securities. The objective of such transactions was to increase the
proportion of tax-advantaged securities and to shorten the duration of the
investment portfolio. 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, $0.9 million, and $8.5 million in 1996, 1995, and 1994,
respectively.
Interest Expense and Income Taxes
Interest expense decreased from $18.7 million in 1995 to $17.1 million in 1996.
Such reduction relates to slightly lower average debt balances in 1996. In
addition, principal payments on the Company's higher coupon senior notes
(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. In March 1997, the Company refinanced all of its existing debt
facilities with a new revolving credit arrangement, which is expected to reduce
interest expense (See "Liquidity and Capital Resources" below). Interest expense
increased to $18.7 million in 1995 from $13.1 million in 1994. This increase
relates mainly to the fact that the Company added $25.0 million of revolving
bank debt in late December 1994, which brought the total bank debt at that time
to $100.0 million. In addition, the Company refinanced $100.0 million of
floating rate bank debt through the issuance of $107.0 million of fixed rate
senior notes. See "Liquidity and Capital Resources" below. The senior notes
carried a higher fixed rate of interest (approximately 100 basis points) than
the average variable rate the Company had been paying during 1994 on the
revolving credit facility.
The Company's effective tax rates were 29.3% (benefit), 30.9%, and 12.4% in
1996, 1995, and 1994, respectively. The Company recorded a net deferred tax
asset of $101.6 million and $67.3 million in 1996 and 1995, respectively. The
$34.3 million increase from 1995 to 1996 resulted primarily from the operating
loss reported in 1996. The net deferred tax asset of $101.6 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. Management believes that the benefit of its net deferred
tax asset will be fully realized, and, therefore, has not provided for a
valuation allowance. At December 31, 1996, the Company had $153.2 million of net
operating carryforwards (expiring in 2011) and $13.3 million of AMT credit
carryforwards (which do not expire). The increase in the effective tax rate in
1995 versus 1994 relates primarily to three factors. First, in 1995, management
determined that, for AMT purposes, the Company did not require as much tax-
exempt income as was projected; therefore, the Company reduced its exposure to
tax-advantaged securities throughout the year. For GAAP purposes, such portfolio
adjustments generally increase the effective tax rate, even though there were
economic advantages associated with the transactions. In terms of the targeted
amount of tax-exempt investments, management assesses the optimal level of tax-
exempt interest, with such assessment based
51
<PAGE>
upon: (i) the Company's tax position in terms of the margin between regular
federal taxes and AMT and (ii) the relative attractiveness of tax-advantaged
securities versus other investment vehicles. Second, the effective tax rate in
1995 was impacted by the fact that net realized investment gains were a larger
proportion of income than in 1994. Third, the Company's effective tax rate
increased in 1995 due to losses of a foreign reinsurance affiliate utilized in
the Property and Casualty Group's 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 and dividends to shareholders, to
pay 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 $16.6 million, $15.1 million and $12.9 million in
1996, 1995 and 1994, respectively. In addition, the Company made scheduled debt
repayments of $25.1 million, $125.1 million and $15.9 million in 1996, 1995 and
1994 respectively, and paid dividends to shareholders of $7.9 million in 1996
and 1995 and $5.9 million in 1994. PMC also made cash capital contributions to
its subsidiaries totaling $50.0 million, $61.0 million and $17.1 million in
1996, 1995 and 1994, respectively. In 1995, PMC also utilized cash to settle
intercompany balances with its domestic insurance subsidiaries.
Dividends from subsidiaries were $53.6 million, $103.2 million and $34.0 million
in 1996, 1995 and 1994, respectively. Net tax cash flows were $12.0 million,
$11.4 million and $11.9 million in 1996, 1995 and 1994, respectively.
In addition to dividends and tax payments from subsidiaries, the Company
utilized the following sources to generate liquidity for the above needs. During
1996, the Company financed scheduled repayments on its senior note facilities of
$25.0 million through drawdowns on its revolving credit facility. In 1995, the
Company converted its expiring revolving credit agreement into a more permanent
form of financing by issuing $107.0 million of 7.62% privately placed senior
notes. Additionally, 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, 1996, the
Company had $6.0 million available on such revolving credit agreement. In March
1997, management refinanced all of its existing credit agreements not otherwise
expiring in 1997 through a new revolving credit facility (the "New Credit
Facility"). See "Capital Resources" below for further discussion.
The Company's domestic insurance subsidiaries' ability to pay dividends to the
holding 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 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.
Under this standard, the Pooled Companies and PMA Re can pay an aggregate of
$51.9 million of dividends without the prior approval of the Commissioner during
1997. Under its plan of operation filed with the Pennsylvania Insurance
Department, MASCCO must maintain a ratio of unpaid losses and loss adjustment
expenses to surplus of no more than eight to one; as of December 31, 1996,
MASCCO was in compliance with such requirement. In addition, certain covenants
within the Company's debt agreements in effect at December 31, 1996 require the
Company's insurance subsidiaries to maintain combined statutory capital and
surplus of $375.0 million. The New Credit Facility requires the Company's
insurance subsidiaries to maintain combined statutory capital and surplus of
$450.0 million. At December 31, 1996, the Company's insurance subsidiaries had
combined statutory capital and surplus of $535.7 million. Additionally, the New
Credit Facility requires the domestic insurance subsidiaries of the Property
52
<PAGE>
and Casualty Group to maintain an adjusted surplus to authorized control level
ratio (as calculated under risk based capital rules) of not less than 200%, and
requires PMA Re to maintain such ratio at 300%. At December 31, 1996, the ratios
of the domestic insurance subsidiaries of the Property and Casualty Group ranged
from 230% to 210%, and PMA Re's ratio was 380%.
PMC's dividends to shareholders are restricted by its debt agreements. Based
upon the terms of the New Credit Facility, on a pro forma basis under the most
restrictive debt covenant, PMC would be able to pay dividends of approximately
$11.0 million in 1997. See "Capital Resources" for further discussion.
Management believes that the Company's sources of funds will provide sufficient
liquidity to meet short-term and long-term obligations.
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 on all investments, (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 sophisticated 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
obligations), industry segments or geographic regions.
The Company's Board of Directors is responsible for the Company's investments
and 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
Company's Executive and Finance Committees of the Board of Directors meet
periodically with the investment advisers to review the performance of the
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. The Company's capital not allocated to the Pooled Companies,
MASCCO and PMA Re 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
December 31, 1996, 1995 and 1994:
(dollar amounts in millions)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
Carrying Carrying Carrying
Investment Value Percent Value Percent Value Percent
- ---------- ----- ------- ----- ------- ----- -------
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities and
obligations of U.S. Government
agencies.......................... $1,602.8 70.8% $1,666.3 67.9% $1,050.8 45.4%
Obligations of states and political
subdivisions....................... 76.5 3.4% 435.9 17.8% 841.8 36.4%
Corporate debt securities............ 372.8 16.5% 128.8 5.2% 45.6 2.0%
Mortgage backed securities........... 74.0 3.3% -- -- 179.2 7.7%
Equity securities.................... 0.3 -- 10.9 0.4% 17.5 0.8%
Short-term investments............... 135.0 6.0% 214.1 8.7% 178.4 7.7%
-------- ------ --------- ------ -------- ------
Total (1)............................ $2,261.4 100.0% $2,456.0 100.0% $2,313.3 100.0%
======== ====== ========= ====== ======== ======
</TABLE>
53
<PAGE>
(1) As of December 31, 1996, the market value of the Company's total investments
was $2,261.4 million.
The following table indicates the composition of the Company's fixed maturities
portfolio at carrying value, excluding short-term investments by rating as of
December 31, 1996, 1995 and 1994:
(dollar amounts in millions)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
Carrying Carrying Carrying
Ratings (1) Value Percent Value Percent Value Percent
- ----------- ----- ------- ----- ------- ----- -------
<S> <C> <C> <C> <C> <C> <C>
U.S. Treasury securities and AAA..... $1,882.4 88.5% $2,025.5 90.8% $1,749.2 82.6%
AA................................... 95.8 4.5% 174.1 7.8% 329.3 15.6%
A.................................... 147.9 7.0% 31.4 1.4% 38.9 1.8%
-------- ----- -------- ----- -------- -----
Total................................ $2,126.1 100.0% $2,231.0 100.0% $2,117.4 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
(1) Ratings as assigned by Standard and 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.
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 December 31, 1996. 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)
<TABLE>
<CAPTION>
Carrying Value Percent
-------------- -------
<S> <C> <C>
1 year or less......................... $ 110.8 5.2%
Over 1 year through 5 years............ 525.5 24.7%
Over 5 years through 10 years.......... 661.2 31.1%
Over 10 years.......................... 754.6 35.5%
Mortgage backed securities............. 74.0 3.5%
-------- ------
Total.................................. $2,126.1 100.0%
======== ======
</TABLE>
The following table reflects the Company's investment results for each year in
the three-year period ended December 31, 1996:
(dollar amounts in millions)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Average invested assets (1)......... $2,366.8 $2,395.8 $2,350.9
Net investment income (2)........... $ 133.9 $ 139.4 $ 138.7
Net effective yield (3)............. 5.66% 5.82% 5.90%
Net realized investment gains....... $ 3.0 $ 31.9 $ 47.5
</TABLE>
(1) Average of beginning and ending amounts of cash and investments for the
period at carrying 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.
As of December 31, 1996, the duration of the Company's investments was
approximately 5.6 years and the duration of its liabilities was approximately
4.9 years.
54
<PAGE>
Capital Resources
The Company's total assets decreased to $3,117.5 million at December 31, 1996
from $3,258.6 million at December 31, 1995. Total investments decreased $194.6
million to $2,261.4 million at December 31, 1996. The decrease in investments is
primarily attributable to the Property and Casualty Group's paydown of loss
reserves from prior accident years. All other assets increased $53.5 million in
1996, mainly due to a $34.3 million increase in the deferred tax asset and an
increase of $37.5 million in other assets, offset by decreases in investment
income due and accrued of $5.2 million, uncollected premiums of $4.7 million,
and reinsurance receivables of $6.7 million.
Upon adoption of Statement of Financial Accounting Standards (SFAS) No. 115,
"Accounting for Certain Investments in Debt and Equity Securities," in 1994, the
Company designated securities with a fair value of $1,420.6 million as available
for sale. Accordingly, in 1994, the Company recorded a credit to equity of $45.3
million (net of tax effect of $24.4 million) representing the cumulative effect
of the adoption of SFAS No. 115 related to the net unrealized gain position of
fixed maturity securities available for sale at January 1, 1994. The Company
does not actively trade its securities, and, therefore, none of the portfolio
was classified as trading securities. In 1995, the Company re-evaluated the
classifications of its investments. As a result, effective June 30, 1995, the
Company reclassified its entire held to maturity portfolio to available for
sale. This reclassification resulted in a $1,238.1 million increase in available
for sale securities and a $2.4 million unrealized loss.
During 1996, interest rates increased substantially. The effect of this increase
in interest rates was to decrease the fair value of the Company's portfolio.
Overall, the portfolio experienced a net unrealized loss of $65.2 million in
1996, as the fair value of the portfolio as of December 31, 1996 was lower than
its amortized cost by $38.3 million; at December 31, 1995 the fair value of the
portfolio was higher than its amortized cost by $26.9 million. As a result, the
Company recorded a total charge of $42.4 million (net of tax effect of $22.8
million) to shareholders' equity in 1996. In 1995, the decrease in interest
rates caused the fair value of the Company's available for sale portfolio to
increase by $182.7 million, resulting in a credit to shareholders' equity of
$67.0 million (net of tax effect of $36.1 million). The difference between
amortized cost and fair value for available for sale securities decreased
shareholders' equity by $24.9 million (net of tax effect of $13.4 million) at
December 31, 1996 and increased shareholders' equity by $17.5 million (net of
tax effect of $9.4 million) at December 31, 1995.
The Company's deferred income tax asset increased to $101.6 million at December
31, 1996 from $67.3 million at December 31, 1995. The primary reasons for such
increase relate to net operating losses resulting from the Property and Casualty
Group's reserve strengthening and the tax effect of the unrealized loss on
investments available for sale. 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. The
increase in other assets is mainly attributable to $18.3 million in Federal
taxes receivable relating to net operating loss carrybacks. Such increase was
partially offset by reductions in uncollected premiums and reinsurance
receivables of $4.7 million and $6.7 million, respectively, mainly attributable
to lower volume for the Property and Casualty Group.
Unpaid losses and loss adjustment expenses increased $21.1 million to $2,091.1
million at December 31, 1996. This increase reflects the Property and Casualty
Group's reserve strengthening charge of $191.4 million, offset by favorable
reserve development at PMA Re and loss payments on prior accident years.
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
55
<PAGE>
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 loss adjustment expenses is subject to many
uncertainties, management believes that it has made adequate provision for its
claims liabilities. However, if actual losses exceed the amounts recorded in the
financial statement, the Company's financial condition and results of operations
could be adversely affected.
At December 31, 1996, the Company's loss reserves were stated net of $75.0
million of salvage and subrogation, of which $65.8 million related to the
Property and Casualty Group allocable to the following lines of business:
workers' compensation, $61.9 million; commercial automobile, $1.4 million;
commercial multi-peril, $1.0 million, and all other lines, $1.5 million; the
anticipated salvage and subrogation was $9.2 million for PMA Re. Incurred
salvage and subrogation reduced (increased) losses and LAE by ($0.6) million,
$9.5 million and $(3.9) million in 1996, 1995 and 1994, respectively. In 1995,
the Property and Casualty Group implemented new automated programs to track and
collect amounts due for salvage and subrogation. These programs increased
collection of amounts due for salvage and subrogation by $5.1 million in 1995 as
compared to 1994. 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 typical 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 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 $46.0 million excess of $2.0 million per
occurrence, and the Property and Casualty Group maintains catastrophe
reinsurance protection of $15.0 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.
The Company also maintains reinsurance and retrocessional protection for other
lines of business at December 31, 1996, as follows:
<TABLE>
<CAPTION>
Retention Limits
--------- ------
<S> <C> <C>
The Property and Casualty Group:
Per Occurrence:
Workers' compensation........................ $ 1.5 million $ 103.5 million
Other casualty lines......................... 0.5 million /(1)/ 49.5 million
Auto physical damage......................... 0.5 million 2.0 million
Per Risk:
Property..................................... 0.5 million /(2)/ 19.5 million
PMA Re:
Per Occurrence:
Casualty lines............................... 2.5 million /(3)/ 12.5 million
Workers' compensation........................ 2.0 million 53.0 million
Per Risk:
Property..................................... 0.5 million 1.5 million
Casualty..................................... 1.0 million /(3)/ 4.0 million
</TABLE>
(1) Effective January 1, 1997, the retention on this program was reduced to
$175,000.
56
<PAGE>
(2) This coverage also provides protection of $28.5 million per occurrence over
its combined net retention of $0.5 million.
(3) Effective January 1, 1997, PMA Re's casualty program was changed to $6.0
million excess of $1.5 million per risk and $12.5 million excess of $2.75
million 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 Pennsylvania.
At December 31, 1996, the Company had reinsurance recoverables due from the
following unaffiliated single reinsurers in excess of 3% of shareholders'
equity:
<TABLE>
<CAPTION>
Gross amount
due to the Company A.M. Best
Reinsurer (in thousands) Rating
- --------- -------------- ------
<S> <C> <C>
United States Fidelity and Guaranty Company.............. $ 84,802 A
American Re-Insurance Corporation........................ $ 34,009 A+
Kemper Reinsurance Corporation........................... $ 17,421 A
Odyssey Reinsurance...................................... $ 15,614 A-
</TABLE>
The Company maintained funds held to collateralize the above balances in the
amount of $86.3 million at December 31, 1996. 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 increased by $13.2 million in 1996,
reflecting ceded premiums paid on reinsurance and retrocessional agreements
written on a funds held basis. Taxes, licenses and fees and other expenses
accrued increased $9.6 million in 1996, which was primarily related to
additional costs associated with the VERIP.
Long-term debt remained essentially constant between 1996 and 1995. During 1996,
the Company funded scheduled repayments on its senior notes through drawdowns on
its revolving credit facility. The revolving credit facility carried a .25%
charge on the undrawn balance, and interest was payable on the utilized portion
at LIBOR plus .60%.
As noted previously, management refinanced its existing credit agreements during
March 1997. As of December 31, 1996, the following debt was outstanding, all of
which the Company refinanced under the New Credit Facility on March 14, 1997:
(dollar amounts in thousands)
<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................. 36,000/(1)/
---------
Total........................................................ $ 189,428
</TABLE>
(1) The Company repaid $8,000 of the revolving credit agreement subsequent to
December 31, 1996.
The early extinguishment of the senior note agreements will result in an
extraordinary loss of $4.7 million ($7.3 million pre-tax) which will be recorded
in the first quarter of 1997. The New Credit Facility bears interest at LIBOR
plus .70% on the utilized portion, and carries a .275% facility fee on the
unutilized
57
<PAGE>
portion. The margin over LIBOR is adjustable downward based upon future
reductions in the Company's debt to capitalization ratio. As of March 14, 1997,
the interest rate on the New Credit Facility was 5.70%. The final expiration of
the New Credit Facility will be December 31, 2002, with level 25% reductions in
availability each year beginning December 31, 1999. Management also entered into
an interest rate swap agreement which will manage the impact of the potential
volatility of the interest rate associated with the floating rates on the New
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
New Credit Facility to a fixed 7.24%.
The Company has entered into one other interest rate swap agreement in its
management of present interest rate exposures. This transaction effectively
changed the Company's interest rate exposure on one of its fixed rate senior
note agreements to a floating rate obligation as follows:
<TABLE>
<CAPTION>
Principal Balance
Debt Agreement at December 31, 1996 Fixed Rate Floating Rate
-------------- -------------------- ---------- -------------
<S> <C> <C> <C>
Senior note, due 1997.................. $ 7.1 million 9.53% 5.60%
</TABLE>
The variable rate resets every six 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 ($7.1 million). Management believes such credit
risk is minimal and any loss would not be significant.
Shareholders' equity decreased to $425.8 million at December 31, 1996 from
$609.7 million at December 31, 1995. This decrease is primarily due to the net
loss of $135.3 million, unrealized losses on investments available for sale of
$42.4 million, and dividends declared of $7.9 million.
At December 31, 1996, the Company's capital structure consisted of $204.7
million of long-term debt and $425.8 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,
(loss) earnings before interest and taxes to interest expense, pre-tax operating
(loss) income before interest to interest expenses, and debt to capitalization
ratio. The following table indicates the Company's status with respect to these
statistics:
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Statutory dividends to interest expense (times).......... 3.1 3.8 2.6
(Loss) earnings before interest and taxes to interest
expense (times)........................................ (11.2) 2.9 6.0
Pre-tax operating (loss) income before interest to
interest expenses (times)............................... (11.4) 1.2 2.4
Debt to total capitalization (excluding SFAS No. 115
adjustment)............................................ 31.2% 25.6% 26.2%
</TABLE>
Presently, management believes that the existing capital structure is
appropriate for the Company. In addition, the impact of the New Credit Facility
is not expected to change such conclusion. However,
58
<PAGE>
management continually monitors the capital structure in light of developments
in the business, and the present assessment could change as management becomes
aware of new opportunities and challenges in the Company's business.
Regulation
NAIC has adopted risk-based capital ("RBC") 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%
PMA Re and each of the Pooled Companies had ratios in excess of 200% as of
December 31, 1996. As a result of the Property and Casualty Group's 1996 loss
reserve strengthening (See "Loss Reserves" above), the ratios for the individual
Pooled Companies range from 230% to 210%. PMA Re's ratio was 380% at December
31, 1996.
RBC requirements for property/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 discounts previously taken for workers' compensation reserves.
The discount phase-out has increased by 20% in each year since 1994, ultimately
phasing out 100% of such discount by 1998. As a result, this phase-out
negatively impacts the RBC ratios of companies which write workers' compensation
insurance and discount such reserves on a non-tabular basis relative to
companies which write other types of property/casualty insurance. Management
believes that it will be able to maintain the Pooled Companies' RBC in excess of
regulatory requirements through prudent underwriting and claims handling,
investing and capital management. However, no assurances can be given that
developments affecting the Property and Casualty Group will not occur, 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.
In addition, 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 1996, each of the Pooled
Companies reported unusual values in three ratios relating to reserve
development and two ratios relating to historical profitability, directly as a
result of the reserve strengthening and asset valuations that occurred in 1996.
MASCCO reported unusual values in three historical profitability ratios,
directly as a result of a large intercompany reinsurance transaction that
occurred at year end 1996.
59
<PAGE>
Three and Six Months Ended June 30, 1997 Compared to Three and Six Months
Ended June 30, 1996
The table below presents the major components of net income for the three and
six months ended June 30, 1997, and June 30, 1996, respectively:
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
--------- --------- -------- --------
<S> <C> <C> <C> <C>
Pre-tax operating (loss) income.................. $(4,018) $ 2,389 $ 4,551 $9,647
Net realized investment losses................... (680) (1,412) (1,931) (469)
------- ------- ------- ------
(Loss) income before income taxes and
extraordinary item
extraordinary item............................. (4,698) 977 2,620 9,178
(Benefit) provision for income taxes............. (5,218) (139) (2,657) 2,433
------- ------- ------- ------
Income before extraordinary item................. 520 1,116 5,277 6,745
Extraordinary item, net of related taxes......... -- -- (4,734) --
------- ------- ------- ------
Net income....................................... $ 520 $ 1,116 $ 543 $6,745
======= ======= ======= ======
Per Share Data:
Income before extraordinary item................. $ 0.02 $ 0.05 $ 0.21 $ 0.27
Extraordinary item............................... -- -- (0.19) --
------- ------- ------- ------
Net income....................................... $ 0.02 $ 0.05 $ 0.02 $ 0.27
======= ======= ======= ======
</TABLE>
The following table indicates the Company's pre-tax operating income (loss) by
principal business segment for the three and six months ended June 30, 1997, and
June 30, 1996, respectively:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
The Property and Casualty Group........................ $(8,703) $(2,545) $(8,412) $ 1,166
PMA Re................................................. 9,274 9,479 22,094 18,537
Corporate operations................................... (701) (187) (909) (1,226)
------- ------- ------- -------
Pre-tax operating (loss) income before interest expense (130) 6,747 12,773 18,477
Interest expense....................................... 3,888 4,358 8,222 8,830
------- ------- ------- -------
Pre-tax operating (loss) income........................ $(4,018) $ 2,389 $ 4,551 $ 9,647
</TABLE>
On a consolidated basis, the Company reported pre-tax operating income of $4.6
million for the six months ended June 30, 1997, compared to $9.6 million for the
six months ended June 30, 1996, a decrease of 52.8%. For the three months ended
June 30, 1997, the Company reported a pre-tax operating loss of $4.0 million in
comparison to pre-tax operating income of $2.4 million for the three months
ended June 30, 1996. The decreases in pre-tax operating income for the three and
six month periods ended June 30, 1997, in comparison to same periods in 1996 are
due primarily to higher than anticipated operating costs related to the Property
and Casualty Group's operations in 1997, partially offset by the increased
operating income generated by PMA Re for the six months ended June 30, 1997.
Interest expense decreased $470,000 and $608,000 for the three and six months
ended June 30, 1997, respectively, compared to same periods in 1996. These
decreases are due to the refinancing of the Company's debt with the New Credit
Facility. See "Liquidity and Capital Resources" below.
60
<PAGE>
Net income on a consolidated basis, before extraordinary items, was $5.3
million, or $0.21 per share, for the six months ended June 30, 1997, compared to
net income of $6.7 million, or $0.27 per share, for the six months ended June
30, 1996. On March 14, 1997, the Company refinanced substantially all of its
outstanding credit agreements not already maturing in 1997 with the New Credit
Facility. See "Liquidity and Capital Resources" below. In connection with this
refinancing, the Company recognized an extraordinary loss from the early
extinguishment of debt of $4.7 million, or $0.19 per share, net of tax.
The Property and Casualty Group Results of Operations
For the six months ended June 30, 1997, the Property and Casualty Group
accounted for 62.3% of the Company's operating revenues while for the three
months ended June 30, 1997, it accounted for 60.8% of the Company's operating
revenues. Summarized financial results of this segment are as follows:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net premiums written:
Workers' compensation....................... $38,055 $42,239 $ 99,610 $108,959
Commercial lines............................ 23,545 21,315 52,382 45,412
------- ------- -------- --------
Total....................................... $61,600 $63,554 $151,992 $154,371
Net premiums earned:
Workers' compensation....................... $46,898 $44,206 $ 95,616 $ 96,964
Commercial lines............................ 21,762 22,628 41,698 46,184
------- ------- -------- --------
Total....................................... 68,660 66,834 137,314 143,148
Net investment income......................... 19,774 20,204 41,902 42,402
Service revenues.............................. 2,490 2,264 5,038 4,012
------- ------- -------- --------
Operating revenues............................ 90,924 89,302 184,254 189,562
------- ------- -------- --------
Losses and LAE incurred....................... 65,879 62,216 130,970 129,385
Acquisition and operating expenses............ 30,388 26,901 55,079 53,159
Policyholders' dividends...................... 3,360 2,730 6,617 5,852
------- ------- -------- --------
Total losses and expenses..................... 99,627 91,847 192,666 188,396
------- ------- -------- --------
Pre-tax operating (loss) income............... $(8,703) $(2,545) $ (8,412) $ 1,166
======= ======= ======== ========
GAAP loss ratio............................... 95.9% 93.1% 95.4% 90.4%
GAAP combined ratio........................... 145.1% 137.4% 140.3% 131.6%
SAP loss ratio................................ 85.2% 80.1% 85.2% 82.7%
SAP combined ratio............................ 106.0% 121.1% 119.1% 119.8%
</TABLE>
Premium Revenues
Direct premiums written for the Property and Casualty Group decreased $2.0
million for the three months ended June 30, 1997, but increased $6.3 million for
the six months ended June 30, 1997, compared to the same periods ended June 30,
1996. Direct premiums written for Commercial Lines increased $3.7 million and
$15.1 million for the three and six months ended June 30, 1997, respectively,
compared to the same periods ended June 30, 1996. Direct premiums written for
workers' compensation decreased $5.6 million and $8.8 million for the three and
six months ended June 30, 1997, respectively, compared to the same periods ended
June 30, 1996. For the three and six months ended June 30, 1997, reinsurance
premiums assumed decreased $270,000 and $962,000, respectively, compared to the
same periods ended June 30,
61
<PAGE>
1996. Reinsurance premiums ceded decreased $270,000 and increased $7.7 million
for the three and six months ended June 30, 1997, respectively, compared to the
same periods ended June 30, 1996.
For the three and six months ended June 30, 1997, net premiums written decreased
$2.0 million and $2.4 million, respectively, compared to the same periods ended
June 30, 1996. Earned premiums increased by $1.8 million for the three months
ended June 30, 1997, and decreased by $5.8 million for the six months ended June
30, 1997, compared to the same periods ended June 30, 1996.
The decrease in direct premiums written for workers' compensation was due
primarily to rate changes in Pennsylvania, the Property and Casualty Group's
principal business jurisdiction, continued changes in product mix toward
alternative market products and competitive conditions. 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 rate decreases resulting from these changes
were partially offset by an increase in exposures underwritten by the Property
and Casualty Group.
The Property and Casualty Group has continued its marketing of alternative
market workers' compensation products for larger accounts, including large-
deductible policies and offshore rent-a-captive programs. Typically, the
Property and Casualty Group receives a lower up-front premium for these types of
alternate 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. A substantial portion of related revenues are recorded as
service revenues. Such service revenues increased $226,000 and $1.0 million for
the three and six months ended June 30, 1997, respectively, compared to the same
periods in 1996.
Direct workers' compensation premiums written were also impacted by changes in
the level of premium adjustments, primarily related to audit premiums and
retrospective policies. For the three and six months ended June 30, 1997, such
adjustments reduced premiums written by $700,000 ($4.0 million in audit premiums
billed and $4.7 million in retrospective returns) and $1.7 million ($8.3 million
in audit premiums billed and $10.0 million in retrospective returns),
respectively, while in the comparable 1996 periods, such adjustments increased
premiums written by $600,000 ($6.9 million in audit premiums billed and $6.3
million in retrospective returns) and $2.3 million ($13.3 million in audit
premiums billed and $11.0 million in retrospective returns), respectively. These
changes in premium adjustments billed in 1997 compared to the same periods in
1996 are primarily due to the increase in retrospectively rated premiums
returned to insureds, resulting from the favorable loss experience in more
recent accident years in workers' compensation. These adjustments do not impact
earned premiums, as the effects of these changes have been accrued while such
policies were in force.
For the three and six months ended June 30, 1997, the Property and Casualty
Group's direct writings of Commercial Lines increased $3.7 million and $15.1
million compared to the same periods in 1996. These increases were primarily
focused in the property lines of business, which accounted for $4.6 million and
$12.9 million of the increases, respectively, and is primarily due to the timing
of policy renewals.
Ceded premiums increased $7.7 million for the six months ended June 30, 1997,
compared to the six months ended June 30, 1996, but decreased by $270,000 in the
second quarter 1997 compared to 1996. In 1997, the Property and Casualty Group
entered into a new reinsurance treaty that covers substantially
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<PAGE>
all commercial lines casualty business at a $175,000 per risk attachment point,
compared to a $500,000 per risk attachment point in 1996. The effect of this new
treaty, and the increased direct premiums written in property lines, for which
the Property and Casualty Group generally purchases more reinsurance, caused
ceded premiums to increase in the six months ended June 30, 1997, compared to
the same period in 1996.
For the three months ended June 30, 1997 as compared to the three months ended
June 30, 1996, earned premiums increased $1.8 million due to the fluctuation in
net premiums written, offset by the timing of certain new and nenewal business.
For the six months ended June 30, 1997 as compared with the June 30, 1996
period, net premiums earned decreased $5.8 million, which was attributable to
the decrease in net premiums written as well as the timing of the production of
certain business.
Losses and Expenses
The following table reflects the components of the Property and Casualty Group's
combined ratios, as computed under GAAP:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Loss ratio..................................... 95.9% 93.1% 95.4% 90.4%
----- ----- ----- -----
Expense ratio:
Amortization of deferred acquisition costs 21.0% 19.1% 18.4% 18.0%
Operating expenses........................... 23.3% 21.1% 21.7% 19.1%
----- ----- ----- -----
Total expense ratio............................ 44.3% 40.2% 40.1% 37.1%
----- ----- ----- -----
Policyholders' dividends....................... 4.9% 4.1% 4.8% 4.1%
----- ----- ----- -----
Combined ratio - GAAP.......................... 145.1% 137.4% 140.3% 131.6%
===== ===== ===== =====
</TABLE>
(1) The combined ratio computed on a GAAP basis is equal to losses and loss
adjustment expenses, plus amortization of deferred acquisition costs, plus
operating expenses, plus policyholders' dividends, all divided by net
premiums earned.
The increase in the GAAP loss ratio for the three and six months ended June 30,
1997, compared to the same periods in 1996 is due primarily to the accretion of
loss reserve discount in the Property and Casualty Group's run-off operations.
In December 1996, the Property and Casualty Group designated two of its
insurance subsidiaries as run-off companies, for the purpose of reinsuring the
Pooled Companies for substantially all of the accident years 1991 and prior
workers' compensation indemnity reserves and certain medical reserves. The
domestic insurance subsidiary MASCCO, reinsures only established Pennsylvania
indemnity claims, while the offshore insurance subsidiary, PMA Cayman, reinsures
both medical and indemnity claims. The increase in accretion of discount is
primarily due to the reserve strengthening that the Property and Casualty Group
recorded in December 1996. Reserves recorded for prior accident years continue
to be within the ranges estimated by management, and the 1997 accident year loss
ratios recorded by management for its principal lines of business are generally
consistent with those ratios established for accident year 1996. The lower level
of increase in the second quarter of 1997 compared to the same period in 1996 is
due to environmental losses incurred in the second quarter of 1996, which
increased the loss ratio of such quarter.
The Property and Casualty Group paid $17.8 million in the fourth quarter of 1996
and $60.2 million for the six months ended June 30, 1997 to commute workers'
compensation indemnity claims. Savings associated with these claims were
consistent with management's expectations. The savings that have been generated
by the commutation program were included in management's projected 1996 loss
reserves.
63
<PAGE>
The GAAP expense ratio for the three and six months ended June 30, 1997, was
greater than that in the same periods in 1996 by 4.1 points and 3.0 points,
respectively, due to an increase in sales of alternative market products, which
have much lower, if any, premiums, and a $1.0 million charge associated with
certain expense reduction initiatives. To date, operating expenses have not
decreased commensurately with the decrease in net premiums earned. Management
continues to review expense reduction alternatives, including work flow
redesign, in an effort to decrease personnel costs.
The policyholder dividend ratios were 4.9% and 4.1% during the three months
ended June 30, 1997, and 1996, respectively, and 4.8% and 4.1% during the six
months ended June 30, 1997, and 1996, respectively. The ratios increased in 1997
compared to the same periods in 1996 due primarily to 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, as measured by
such plans, improved relative to the years prior to these periods, the Property
and Casualty Group has incurred higher policyholder dividends.
Net Investment Income
Net investment income was $19.8 million and $41.9 million for the three and six
months ended June 30, 1997, respectively, compared to $20.2 million and $42.4
million for the same periods in 1996. Net investment income remained relatively
stable primarily due to higher fixed income yields and lower investment
expenses, offset by lower average invested assets resulting from the pay-down of
loss reserves from prior accident years and decreasing premium volume. The
ongoing commutation strategy is expected to lower investment income in 1997
relative to 1996, as average invested asset balances are expected to be lower in
1997.
PMA Re Results of Operations
PMA Re accounted for 38.7% and 37.3% of the Company's operating revenues for the
three and six months ended June 30, 1997, respectively. Summarized financial
results of this segment are as follows:
<TABLE>
<CAPTION>
(dollar amounts in thousands)
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net premiums written......................... $36,789 $32,782 $ 96,279 $89,409
======= ======= ======== =======
Net premiums earned.......................... $45,791 $35,393 $ 85,087 $77,016
Net investment income........................ 12,134 11,488 25,288 22,642
------- ------- -------- -------
Operating revenues........................... 57,925 46,881 110,375 99,658
------- ------- -------- -------
Losses and LAE incurred...................... 32,386 23,226 62,231 56,070
Acquisition and operating expenses........... 16,265 14,175 26,050 25,050
------- ------- -------- -------
Total losses and expenses.................... 48,651 37,401 88,281 81,120
------- ------- -------- -------
Pre-tax operating income..................... $ 9,274 $ 9,480 $ 22,094 $18,538
======= ======= ======== =======
GAAP loss ratio.............................. 70.7% 65.6% 73.1% 72.8%
GAAP combined ratio.......................... 106.2% 105.7% 103.7% 105.3%
SAP loss ratio............................... 70.7% 65.6% 73.1% 72.8%
SAP combined ratio........................... 105.1% 106.6% 103.5% 105.0%
</TABLE>
Premium Revenues
Net premiums written increased $4.0 million and $6.9 million for the three and
six months ended June 30, 1997, respectively, compared to the same periods ended
June 30, 1996. The main reasons for this increase are new treaties resulting
from a marketing program initiated in late 1996 which has resulted in increased
participations on reinsurance treaties and new programs with existing clients.
These
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<PAGE>
increases were partially offset by the trend toward large ceding companies
increasing their retentions, which decreases PMA Re's subject premium, and
highly competitive conditions in the US reinsurance market.
The following table indicates PMA Re's gross and net premiums written by major
category of business:
<TABLE>
<CAPTION>
(dollar amounts in thousands)
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Gross Premiums Written:
Casualty lines........................ $32,861 $28,482 $ 83,289 $ 77,698
Property lines........................ 13,150 12,757 36,916 34,569
Other lines........................... 48 63 501 517
------- ------- -------- --------
Total................................... $46,059 $41,302 $120,706 $112,784
======= ======= ======== ========
Net Premiums Written:
Casualty lines........................ $25,536 $23,026 $ 68,286 $ 65,527
Property lines........................ 11,214 9,687 27,501 23,372
Other lines........................... 39 69 492 510
------- ------- -------- --------
Total................................... $36,789 $32,782 $ 96,279 $ 89,409
======= ======= ======== ========
</TABLE>
The majority of the growth in the net premiums written was in the property
lines, which increased 15.8% and 17.7% for the three and six months ended June
30, 1997, respectively, compared to the same periods in 1996. The net increase
in property lines primarily relates to additional auto programs added during
1996 and certain large agribusiness programs added during 1997. The net written
casualty premiums increased 10.9% and 4.2% for the three and six months ended
June 30, 1997, respectively, compared to the same periods in 1996 related mainly
to additional participations on existing treaties. Net premiums earned increased
29.4% and 10.5% for the three and six months ended June 30, 1997, respectively,
compared to the same periods in 1996.
Losses and Expenses
The following table reflects the components of PMA Re's combined ratios, as
computed under GAAP:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Loss ratio........................................ 70.7% 65.6% 73.1% 72.8%
----- ----- ----- -----
Expense ratio:
Amortization of deferred acquisition costs...... 27.9% 34.7% 23.8% 27.0%
Operating expenses.............................. 7.6% 5.4% 6.8% 5.5%
----- ----- ----- -----
Total expense ratio............................... 35.5% 40.1% 30.6% 32.5%
----- ----- ----- -----
Combined ratio - GAAP............................. 106.2% 105.7% 103.7% 105.3%
===== ===== ===== =====
</TABLE>
PMA Re's loss ratio increased 5.1 and 0.3 points for the three and six months
ended June 30, 1997, respectively, compared to the same periods in 1996. The
increase in the second quarter loss ratio in 1997 compared to the second quarter
of 1996 relates to the fact that PMA Re recorded additional favorable
development of unpaid losses and loss adjustment expenses in the second quarter
of 1996 which reduced the 1996 loss ratio. For the six months ended June 30,
1997, compared to the same period in 1996, the amount of favorable development
is comparable.
65
<PAGE>
The ratio of amortization of deferred acquisition costs to net premiums earned,
the Acquisition Expense Ratio, decreased 6.8 points and 3.2 points for the three
and six months ended June 30, 1997, respectively, compared to the same periods
in 1996. The decrease in the ratio of amortization of deferred acquisition costs
compared to 1996 is based on the change in the mix of business for PMA Re.
The ratio of operating expenses to net premiums earned increased 2.2 points and
1.3 points for the three and six months ended June 30, 1997, respectively,
compared to the same periods in 1996. The increases are attributable to
increases in operating expenses, such as salaries and facility expenses, in
connection with the addition of staff and expansion of its office facilities.
Net Investment Income
Net investment income increased $646,000 and $2.6 million for the three and six
months ended June 30, 1997, respectively, compared to the three and six months
ended June 30, 1996. The increases are attributable to two factors: (i)
increases in the average invested assets, and (ii) changes in portfolio
holdings. During the first half of 1997, PMA Re shifted some of its holdings
from government securities to high-quality corporate securities, which generally
yield higher levels of investment income.
Corporate Operations
The corporate segment is primarily comprised of corporate overhead and the
operations of the Company's properties. For the three and six months ended June
30, 1997, corporate operations experienced operating losses of approximately
$700,000 and $900,000, respectively, compared to operating losses of
approximately $200,000 and $1.2 million for the three and six months ended June
30, 1996. The $300,000 decrease in the operating loss for the six months ended
June 30, 1997, compared to the same period in 1996 was primarily related to
increased income earned by the Company's properties during the first half of
1997 versus the comparable 1996 period, offset partially by higher than expected
second quarter 1997 costs related to certain corporate properties to be disposed
of during the third quarter of 1997. No material gain or loss is anticipated
with the disposal of such properties.
Net Realized Investment Losses
The Company recorded net realized investment losses of $680,000 and $1.9 million
for the three and six month periods ended June 30, 1997, compared to net
realized investment losses of $1.4 million and $500,000 for the comparable 1996
periods. During the first quarter of 1997, the Company sold the remaining
portion of its tax-exempt portfolio in response to changes in the Company's tax
position. During the second quarter, the Company continued to reposition its
portfolio to invest in taxable securities with higher yields to complement the
Company's current tax position. Due to the higher interest rate environment, the
majority of these sales generated realized losses. During the first half of
1996, the interest rate environment was more favorable and the Company was able
to sell tax-exempt securities at realized gains, which partially offset losses
on other transactions.
Interest Expense and Income Taxes
Interest expense decreased $470,000 and $608,000 for the three and six months
ended June 30, 1997, respectively, compared to same periods in 1996. These
decreases are primarily attributable to the $470,000 decrease in interest
expense for the three month period ended June 30, 1997, compared to the same
period ended June 30, 1996, due to the refinancing of the Company's debt under
the New Credit Facility. See "Liquidity and Capital Resources" below. It is
expected that interest expense will decline in subsequent quarters in 1997 due
to the New Credit Facility.
The Company's effective tax rate was 111.1% and (101.4)% for the three and six
months ended June 30, 1997, respectively, compared to (14.2)% and 26.5% for the
three and six months ended June 30, 1996,
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<PAGE>
respectively. In 1997, the tax rate was impacted by the favorable resolution of
certain tax issues in the amount of $3.6 million.
Liquidity and Capital Resources at June 30, 1997
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, as well as to 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 $4.3 million and $12.2 million for the three and
six month periods ended June 30, 1997, respectively, compared to $4.2 million
and $8.4 million for the three and six month periods ended June 30, 1996,
respectively. During the first three months 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 New Credit
Facility. See "Capital Resources" below. The Company paid dividends to
shareholders of $2.0 million and $4.0 million for the three and six months ended
June 30, 1997, and 1996, respectively.
Dividends from subsidiaries were $4.0 million and $8.0 million for the three and
six months ended June 30, 1997, compared to $4.0 million and $8.0 million for
the three and six months ended June 30, 1996, respectively. Net tax cash flows
from subsidiaries were $5.8 million and $8.4 million for the three and six
months ended June 30, 1997, respectively, compared to $3.4 million and $5.9
million for the three and six months ended June 30, 1996, respectively.
The Company's domestic insurance subsidiaries' abilities to pay dividends to the
holding 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 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. Under this standard, the Pooled
Companies and PMA Re can pay an aggregate of $51.9 million of dividends,
including the $8.0 million already paid through June 30, 1997, without the prior
approval of the Commissioner during 1997.
PMC's dividends to shareholders are restricted by its debt agreements. Based
upon the terms of the New Credit Facility, under the most restrictive debt
covenant, PMC would be able to pay dividends totaling approximately $11.0
million in 1997.
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 remained stable, decreasing to $3,085.6 million at
June 30, 1997, compared to $3,117.5 million at December 31, 1996. Total
investments decreased $193.5 million to $2,067.8 million at June 30, 1997. This
decrease is primarily attributable to the Property and Casualty Group's pay-down
of loss reserves from prior accident years and an increase in the portfolio's
unrealized loss due to higher interest rates. All other assets increased $161.6
million, mainly due to increases in cash of $80.6 million, uncollected premiums
of $47.2 million, reinsurance receivables of $26.5 million, and other assets of
$11.8 million.
Consolidated shareholders' equity at June 30, 1997, totaled $415.1 million or
$17.40 per share compared to $425.8 million or $17.86 at December 31, 1996. As a
result of changes in market interest rates, the
67
<PAGE>
unrealized depreciation of investments, net of tax, was $32.2 million at June
30, 1997, compared to an unrealized depreciation of investments of $24.9 million
at December 31, 1996, resulting in a decrease in shareholders' equity of $7.3
million or $0.31 per share.
On March 14, 1997 the Company refinanced its existing credit agreements through
the establishment of the New Credit Facility. The Company drew down $196.0
million from the New Credit Facility to pay off the following outstanding
balances:
(dollar amounts in thousands)
<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 1998.... 36,000
--------
Total........................................ $189,428
========
</TABLE>
The New Credit Facility bears interest at LIBOR plus .70% on the utilized
portion, and carries a .275% facility fee on the unutilized portion. The margin
over LIBOR and the facility fee are adjustable downward based upon future
reductions in the Company's debt to capitalization ratio. The final expiration
of the New Credit Facility will be December 31, 2002, with level 25% reductions
in availability each year beginning December 31, 1999. At June 30, 1997, the
Company had $203.0 million outstanding under the New 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 New 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 New Credit Facility to a fixed rate of 7.24%.
The Company's interest rate swap 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 ($150,000,000). Management believes such credit
risk is minimal and any loss would not be significant.
New Accounting Pronouncements
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 currently participate in a transfer arrangement of
certain accounts receivable. Such arrangement has been restructured as a result
of the adoption of SFAS No. 125. The restructuring of such arrangement did not
have a material impact on the Company's financial condition or results of
operations.
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. SFAS No. 128, which is
effective for financial statements for both interim and annual periods ending
after December 15, 1997, requires presentation of earnings per share by all
entities that have issued common stock or potential common stock if those
securities trade in a public market either on a stock exchange or in the over-
the-counter market, including securities quoted only locally or regionally. SFAS
No. 128 establishes a new calculation for earnings per share showing both basic
and diluted earnings per share. Basic earnings per share will be calculated
using only weighted average shares outstanding with no dilutive impact from
common stock equivalents while diluted earnings per share will be calculated
similar to the current fully diluted earnings per share calculation. All prior
period earnings
68
<PAGE>
per share amounts will be restated to be consistent with the new requirements.
If earnings per share had been calculated in accordance with SFAS No. 128, the
basic earnings per share and diluted earnings per share for the three and six
months ended June 30, 1997 would have been as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Income before extraordinary item.......... $0.02 $0.05 $ 0.22 $0.28
Extraordinary item........................ -- -- (0.20) --
----- ----- ------ -----
Net income................................ $0.02 $0.05 $ 0.02 $0.28
===== ===== ====== =====
</TABLE>
Item 3. 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 13 other locations. The Company
believes that such owned properties are suitable and adequate for its current
business operations.
The Company also owns its former headquarters at 925 Chestnut Street,
Philadelphia, Pennsylvania and certain other adjacent properties. The Company
has entered into an agreement to sell the 925 Chestnut Street building; such
sale is expected to close in the third quarter of 1997, with no significant gain
or loss anticipated. In 1995 and 1994, the Company recorded $8.4 million and
$4.9 million, respectively, of expense charges to reflect the difference in the
carrying values versus the fair market values plus the costs to carry and sell
these properties. No such charges were incurred in 1996.
Subsidiaries of the Company also own various real estate properties that are not
used by the Company in its insurance operations but are leased to third parties.
These properties are one to eight story buildings that are generally located
within several blocks of the Company's former headquarters.
Item 4. Security Ownership of Certain Beneficial Owners and Management
Principal Beneficial Owners of Common Stock
The following table sets forth, as of July 31, 1997, (i) the number of shares
and percentage of the Company's Common Stock and Class A Common Stock
beneficially owned by each person who is known by the Company to own
beneficially more than 5% of its outstanding Common Stock or Class A Common
Stock, and (ii) the percentage of the total number of votes that such persons
will be entitled to cast on matters submitted to the shareholders of the
Company:
69
<PAGE>
<TABLE>
<CAPTION>
Class A
Common Stock Percent Common Stock Percent
Beneficially of Beneficially of Percent of
Name and Address Owned Class Owned/(1)/ Class/(1)/ Total Votes/(2)/
- ---------------- ----- ----- ---------- ---------- ----------------
<S> <C> <C> <C> <C> <C>
PMA Foundation................. 4,561,225 30.4% 5,473,450 40.8% 29.2%
The PMA Building
380 Sentry Parkway
Blue Bell, PA 19422-2328
Royce & Associates, Inc........ -0- 1,189,611 13.5% 0.7%
1414 Avenue of the Americas
New York, New York 10019
James F. Malone III............ 1,045,800 7.0% 1,344,000 13.6% 6.8%
Northridge Office Plaza
17 VIP Drive, Suite 310
Wexford, PA 15090
Edward H. Owlett............... 788,160/(3)/ 5.2% 950,200/(3)/ 9.9% 5.1%
One Charles Street
Wellsboro, PA 16901
John W. Miller, Jr............. 549,750 3.7% 658,000 7.0% 3.5%
1655 Crooked Oak Drive
Lancaster, PA 17601-4299
Frederick W. Anton III......... 166,979 1.1% 569,384/(4)/ 6.1% 1.1%
The PMA Building
380 Sentry Parkway
Blue Bell, PA 19422-2328
John W. Smithson............... 195,000 1.3% 563,995/(5)/ 6.0% 1.3%
The PMA Building
380 Sentry Building
Blue Bell, PA 19422-2328
</TABLE>
/(1)/ These columns reflect the shares of Class A Common Stock issuable upon
conversion of the shares of Common Stock, each of which is convertible
into one share of Class A Common Stock.
/(2)/ This column sets forth the percentage of votes entitled to be cast by such
persons on matters submitted to shareholders for a vote on the basis of
ten votes per share of Common Stock and one vote per share of Class A
Common Stock. The calculation does not reflect any conversions of current
holdings of Common Stock into Class A Common Stock.
/(3)/ Includes 385,200 shares of Common Stock and 9,500 shares of Class A Common
Stock held in certain Owlett family trusts and 20,660 shares of Common
Stock and 7,840 shares of Class A Common Stock held by Mr. Owlett's wife.
Also includes 152,250 shares of Common Stock and 30,450 shares of Class A
Common Stock held in a trust for which Mr. Owlett serves as trustee; Mr.
Owlett disclaims beneficial ownership of the shares held in this trust.
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<PAGE>
/(4)/ Includes 305,422 shares of Class A Common Stock as to which Mr. Anton
holds currently exercisable options to acquire under the Company's equity
incentive plans.
/(5)/ Includes 312,300 shares of Class A Common Stock as to which Mr. Smithson
holds currently exercisable options to acquire under the Company's equity
incentive plans.
Beneficial Ownership by Directors and Executive Officers
The following table sets forth, as of July 31, 1997, (i) the number of shares
and percentage of the Company's Common Stock and Class A Common Stock
beneficially owned by (a) each director and each nominee for director, (b) each
executive officer named in the Summary Compensation Table and (c) all executive
officers and directors of the Company as a group, and (ii) the respective
percentage of the total number of votes that such persons and group will be
entitled to cast on matters submitted to the shareholders of the Company:
<TABLE>
<CAPTION>
Common Class A
Stock Percent Common Stock Percent
Name of Individual Beneficially of Beneficially of Percent of
or Identity of Group Owned/(1)/ Class/(2)/ Owned/(1)//(3)/ Class/(2)//(3)/ Total Votes/(2)//(4)/
- -------------------- ------------ ---------- --------------- --------------- ---------------------
<S> <C> <C> <C> <C> <C>
Frederick W. Anton III...... 166,979 1.1% 569,384/(5)/ 6.1% 1.1%
Paul I. Detwiler, Jr........ 72,750/(6)/ 83,175/(6)/
James J. Fleming, Jr........ 73,568 205,893/(7)/ 2.3%
Joseph H. Foster............ 12,025 17,025
Anne S. Genter.............. 500 1,000
Stephen F. Litz............. 4,757/(8)/ 259,135/(8)/ 2.9%
James F. Malone III......... 1,045,800 7.0% 1,344,000 13.6% 6.8%
A. John May................. 257,200/(9)/ 1.7% 326,600/(9)/ 3.6% 1.7%
Louis N. McCarter III....... 8,965/(10)/ 33,575/(10)/
John W. Miller, Jr.......... 549,750 3.7% 658,000 7.0% 3.5%
Edward H. Owlett............ 788,160/(11)/ 5.2% 950,200/(11)/ 9.9% 5.1%
Louis I. Pollock............ 308,125/(12)/ 2.1% 367,350/(12)/ 4.0% 2.0%
Roderic H. Ross............. 3,500 6,050
L.J. Rowell, Jr............. 1 1
John W. Smithson............ 195,000 1.3% 563,995/(13)/ 6.0% 1.3%
Stephen G. Tirney........... 106,375 248,225/(14)/ 2.7%
All executive officers and
directors as a group
(19 persons).............. 3,594,580 23.9% 5,789,283/(15)/ 42.7% 23.3%
</TABLE>
/(1)/ Certain directors are shareholders, directors and/or officers of
organizations that are members of PMA Foundation (the "Foundation"),
formerly known as Pennsylvania Manufacturers' Association. As of July 31,
1997, the Foundation owned 4,561,225 shares of Common Stock and 912,225
shares of Class A Common Stock, which entitle the Foundation to cast
approximately 29.2% of the total number of votes that will be entitled to
be cast on matters submitted to the shareholders of the Company. Certain
directors and officers of the Company are also trustees and officers of
the Foundation. Also, certain directors and officers of the Company are
trustees of the Pennsylvania Manufacturers Corporation Pension Plan (the
"Pension Plan") and directors and/or officers of Pennsylvania
Manufacturers' Association, Northeast Branch ("NE Branch"). As of July 31,
1997, the Pension Plan owned 249,000 shares of Common Stock, and NE Branch
owned 70,500 shares of Common Stock and 14,100 shares of Class A Common
Stock.
/(2)/ Less than 1% unless otherwise indicated.
71
<PAGE>
/(3)/ These columns reflect the shares of Class A Common Stock issuable upon
conversion of the shares of Common Stock, each of which is currently
convertible into one share of Class A Common Stock.
/(4)/ This column sets forth the percentage of votes entitled to be cast by such
persons on matters submitted to shareholders for a vote on the basis of
ten votes per share of Common Stock and one vote per share of Class A
Common Stock. The calculation does not reflect any conversions of shares
of Common Stock into Class A Common Stock. The calculation of these
percentages also does not include shares of Class A Common Stock issuable
upon currently exercisable stock options held by such persons under the
Company's equity incentive plans.
/(5)/ Includes 305,422 shares of Class A Common Stock as to which Mr. Anton
holds currently exercisable options to acquire under the Company's equity
incentive plans.
/(6)/ Includes 1,000 shares of Class A Common Stock owned jointly by Mr.
Detwiler and his wife and 9,375 shares of Common Stock and 2,500 shares of
Class A Common Stock owned by one of Mr. Detwiler's children who resides
in his household.
/(7)/ Includes 132,325 shares of Class A Common Stock as to which Mr. Fleming
holds currently exercisable options to acquire under the Company's equity
incentive plans.
/(8)/ Includes 2,125 shares of Common Stock and 25,000 shares of Class A Common
Stock held by Mr. Litz's wife and 129,325 shares of Class A Common Stock
as to which Mr. Litz holds currently exercisable options to acquire under
the Company's equity incentive plans.
/(9)/ Includes 11,250 shares of Common Stock and 2,650 shares of Class A Common
Stock owned jointly by Mr. May and his wife; 1,550 shares of Class A
Common Stock owned by Mr. May's wife as custodian for their minor
grandchildren; and 17,250 shares of Class A Common Stock held by a
partnership of which Mr. May is a general partner.
/(10)/These shares are owned jointly by Mr. McCarter and his wife.
/(11)/Includes 385,200 shares of Common Stock and 9,500 shares of Class A Common
Stock held in certain Owlett family trusts and 20,660 shares of Common
Stock and 7,840 shares of Class A Common Stock held by Mr. Owlett's wife.
Also includes 152,250 shares of Common Stock and 30,450 shares of Class A
Common Stock held in a trust for which Mr. Owlett serves as trustee; Mr.
Owlett disclaims beneficial ownership of the shares held in this trust.
/(12)/Includes 164,375 shares of Common Stock and 31,625 shares of Class A
Common Stock held by Mr. Pollock's wife and 100 shares of Class A Common
Stock owned jointly by Mr. Pollock and his wife.
/(13)/Includes 312,300 shares of Class A Common Stock as to which Mr. Smithson
holds currently exercisable options to acquire under the Company's equity
incentive plans.
/(14)/Includes 122,125 shares of Class A Common Stock as to which Mr. Tirney
holds currently exercisable options to acquire under the Company's equity
incentive plans.
/(15)/Includes 1,109,112 shares of Class A Common Stock as to which such persons
hold currently exercisable options to acquire under the Company's equity
incentive plans.
Item 5. Directors and Executive Officers
The executive officers and directors of the Company are as follows:
72
<PAGE>
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Frederick W. Anton III.............. 63 Chairman of the Board
John W. Smithson.................... 51 President and Chief Executive Officer
Francis W. McDonnell................ 41 Senior Vice President, Chief Financial Officer
and Treasurer
Vincent T. Donnelly................. 44 President and Chief Operating Officer -
The Property and Casualty Group
Stephen G. Tirney................... 43 President and Chief Operating Officer - PMA Re
Ronald S. Austin.................... 40 President and Chief Operating Officer - Excess and
Surplus Lines Division
Paul I. Detwiler, Jr................ 63 Director
Joseph H. Foster.................... 68 Director
Anne S. Genter...................... 62 Director
James F. Malone III................. 53 Director
A. John May......................... 68 Director
Louis N. McCarter III............... 68 Director
John W. Miller, Jr., M.D............ 62 Director
Edward H. Owlett.................... 70 Director
Louis I. Pollock.................... 67 Director
Roderic H. Ross..................... 67 Director
L. J. Rowell, Jr.................... 65 Director
</TABLE>
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 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.
73
<PAGE>
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 the Company's Excess and Surplus Lines Division. 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.
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 1998.
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 1998.
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 1998. 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
1998.
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.
74
<PAGE>
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
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.
Item 6. Executive Compensation
Compensation of Directors and Executive Officers
Executive Compensation
The following table sets forth certain information with respect to compensation
paid or accrued by the Company during the fiscal year ended December 31, 1996 to
the chief executive officer of the Company and the four most highly compensated
executive officers of the Company and its principal subsidiaries whose
compensation exceeded $100,000 in the fiscal year ended December 31, 1996:
Summary Compensation Table
<TABLE>
<CAPTION>
Long-Term
Compensation
-------------
Annual Compensation Awards
------
Securities
Other Annual Underlying All Other
Name and Principal Position Year Salary($) Bonus($) Compensation($) Options(#) Compensation($)
- --------------------------- ---- --------- --------- --------------- ------------- ---------------
<S> <C> <C> <C> <C> <C> <C>
Frederick W. Anton III (1) 1996 $700,311 -- -- 75,000 $71,198/(1)/
Chairman of the Board and
Chief
Executive Officer
John W. Smithson (2) 1996 $675,440 $330,000 -- 75,000 $55,765/(2)/
President and Chief Operating
Officer
Stephen G. Tirney 1996 $315,544 -- -- 25,000 $32,466/(3)/
President and Chief Operating
Officer of PMA Reinsurance
Corporation
Stephen F. Litz (4) 1996 $275,542 -- -- 25,000 $26,083/(4)/
Senior Vice President of the
Property and Casualty Group
James J. Fleming, Jr. (5) 1996 $276,989 -- -- 25,000 $ 8,952/(5)/
Senior Vice President of the
Property and Casualty Group
</TABLE>
75
<PAGE>
(1) On May 7, 1997, Mr. Anton was elected Chairman of the Board of the Company.
This amount includes Company contributions to the Company's non-qualified
defined contribution plan of $35,000 and $36,198 of life insurance premiums
paid by the Company.
(2) On May 7, 1997, Mr. Smithson was elected President and Chief Executive
Officer of the Company. This amount includes Company contributions to the
Company's non-qualified defined contribution plan of $33,500 and $22,265 of
life insurance premiums paid by the Company.
(3) This amount includes Company contributions to the Company's non-qualified
defined contribution plan of $18,000, Company contributions to the 401(k)
plan of $7,500 and $6,966 of life insurance premiums paid by the Company.
(4) In July, 1997, Mr. Litz ceased serving as an executive officer of the
Company. The amount under All Other Compensation includes Company
contributions to the Company's non-qualified defined contribution plan of
$9,000, Company contributions to the 401(k) plan of $6,754 and $10,329 of
life insurance premiums paid by the Company.
(5) In July, 1997, Mr. Fleming ceased serving as an executive officer of the
Company. The amount under All Other Compensation consists of $8,952 of life
insurance premiums paid by the Company.
The following table sets forth certain information with respect to options to
purchase shares of Class A Common Stock granted to the persons named in the
Summary Compensation Table during the fiscal year ended December 31, 1996.
Option Grants in Last Fiscal Year
<TABLE>
<CAPTION>
Number of % of Total
Securities Options Potential Realizable Value
Underlying Granted to Exercise at Assumed Annual Rates of
Options Employees in Price Expiration Stock Price Appreciation
Name Granted(#)/(1)/ Fiscal Year ($/Share) Date for Option Term
- ---- --------------- ----------- --------- ---- ---------------
5% 10%
-- ---
<S> <S> <C> <C> <C> <C> <C>
Frederick W. Anton III............. 75,000/(2)/ 23.1% $17.00 7/23/06 $801,841 $2,032,022
John W. Smithson................... 75,000/(3)/ 23.1% 17.00 7/23/06 801,841 2,032,022
Stephen G. Tirney.................. 25,000/(4)/ 7.7% 17.00 7/23/06 267,280 677,341
Stephen F. Litz.................... 25,000/(5)/ 7.7% 17.00 7/23/06 267,280 677,341
James J. Fleming, Jr............... 25,000/(5)/ 7.7% 17.00 7/23/06 267,280 677,341
</TABLE>
(1) All of the options in the above table represent options to purchase the
Company's Class A Common Stock under the 1996 Equity Incentive Plan.
(2) These options become exercisable as follows: 61,000 shares on July 23, 1996;
2,350 shares on January 2, 1998; 5,850 shares on January 2, 1999 and 5,800
shares on January 2, 2000.
(3) These options become exercisable as follows: 51,800 shares on July 23, 1996;
and installments of 5,800 shares each on January 2, 1997, 1998, 1999 and
2000, respectively.
(4) These options become exercisable as follows: 1,800 shares on July 23, 1996;
and installments of 5,800 shares each on January 2, 1997, 1998, 1999 and
2000, respectively.
(5) These options become exercisable as follows: 3,350 shares on July 23, 1996;
3,350 shares on January 2, 1997; 3,350 shares on January 2, 1998; 9,150
shares on January 2, 1999; and 5,800 shares on January 2, 2000.
76
<PAGE>
The following table sets forth information with respect to options to purchase
shares of Class A Common Stock exercised by the persons named in the Summary
Compensation Table during the fiscal year ended December 31, 1996 and options
held by such persons at December 31, 1996.
Aggregated Option Exercises in the Last Fiscal Year and Fiscal Year-End Option
Values
<TABLE>
<CAPTION>
Number of Securities Underlying Value of Unexercised
Shares Unexercised Options at In-the-Money Options
Acquired Fiscal Year-End at Fiscal Year-End/(2)/
on Value
Name Exercise(#) Realized/(1)/ Exercisable(#) Unexercisable(#) Exercisable Unexercisable
- ---- ----------- ------------- --------------- ---------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
Frederick W. Anton III..... 38,900 $284,400 325,260 46,500 $1,056,945 $268,125
John W. Smithson........... 33,400 285,540 306,500 23,200 1,126,275 --
Stephen G. Tirney.......... 1,850 14,569 109,200 37,450 557,800 5,313
Stephen F. Litz............ 3,000 23,250 119,100 35,400 613,588 4,688
James J. Fleming, Jr....... -- -- 122,100 35,400 638,338 4,688
</TABLE>
(1) Represents the difference between the aggregate exercise price and the
aggregate market value as of the date of exercise.
(2) Represents the difference between the aggregate exercise price and the
aggregate market value as of December 31, 1996.
Pension Plans
Under The PMC Pension Plan and The PMC Supplemental Executive Retirement Plan,
participants are entitled to benefits pursuant to the formula set forth under
such plans, without regard to the limits under Section 415 and Section
401(a)(17) of the Internal Revenue Code of 1986 (the "Code"). The benefit is
based upon the accrued pension benefit for the participant at December 31, 1992
plus annual accruals beginning January 1, 1993 equal to the sum of (i) 1.5% of
the participant's compensation for the applicable benefit year, consisting of
wages and commissions but excluding bonus, severance payments or other
supplementary payments, plus (ii) .3% of the participant's covered compensation,
consisting of the average of the participant's taxable wage base in effect for
each calendar year during the 35-year period ending the last day of the calendar
year in which the participant attains Social Security retirement age. A maximum
of 25 years of service is considered in calculating the annual benefit payable
upon normal retirement at normal retirement age. Based upon this formula, the
estimated annual benefits payable upon normal retirement at age 65 for each
person named in the Summary Compensation Table are as follows: (i) Mr. Anton,
$141,509; (ii) Mr. Smithson, $95,511; (iii) Mr. Tirney, $44,789; (iv) Mr. Litz,
$62,030; and (v) Mr. Fleming, $59,937. These amounts for Mr. Anton and Mr.
Smithson do not include other retirement payments that would be provided
pursuant to their respective employment agreements.
Employment Agreements
Frederick W. Anton III has an employment agreement with the Company for a term
that commenced April 1, 1995 and ends March 31, 2000, and is automatically
extended for an additional period of one year for each year Mr. Anton is elected
as Chairman of the Board of the Company commencing with the 1996 organizational
meeting of the Board of Directors of the Company. The employment agreement
provides for a salary of not less than $700,000, which may be increased but not
decreased by the Company at any time or from time to time. Mr. Anton is also
entitled to receive such bonus compensation as he may be awarded from time to
time. Mr. Anton has agreed during the term of the employment agreement not to
engage or have a material financial interest in any business that competes with
the business of the Company as then conducted. In the event of Mr. Anton's death
during the term of the agreement, Mr.
77
<PAGE>
Anton's survivors are entitled to an annual payment of 60% of Mr. Anton's annual
salary on the date of his death for a period of 10 years. If Mr. Anton retires
at any time after April 1, 1996, Mr. Anton would be entitled to receive monthly
payments equal to 5% of his annual salary on the date of his retirement and
continuing throughout his lifetime. If, during his retirement and prior to his
death, the total payments made during retirement are less than 60% of his annual
salary at retirement multiplied by 15, the difference is to be paid to his
survivors within one year of the date of his death. Under the agreement, the
Company is required to maintain a split-dollar life insurance policy in the face
amount of $1,000,000 on the life of Mr. Anton.
John W. Smithson has an employment agreement with the Company for a term that
commenced April 1, 1995 and ends March 31, 1998, and is automatically extended
for an additional period of one year for each year Mr. Smithson is elected
President of the Company commencing with the 1996 organizational meeting of the
Board of Directors of the Company. The employment agreement provides for a
salary of not less than $670,000 per year, which may be increased but not
decreased at the discretion of the Company at any time or from time to time. Mr.
Smithson is also entitled to receive such bonus compensation as he may be
awarded from time to time. Mr. Smithson has agreed during the term of the
employment agreement not to engage in or have a material financial interest in
any business that competes with the Company as then conducted. In the event of
Mr. Smithson's death during the term of the agreement, Mr. Smithson's survivors
are entitled to 180 consecutive monthly payments of an amount equal to 25% of
Mr. Smithson's monthly salary as of the date of his death, reduced by the amount
of any similar payments for disability paid to Mr. Smithson during his lifetime
in the event Mr. Smithson becomes disabled during the employment term. Under the
agreement, the Company is required to maintain a split-dollar life insurance
policy in the face amount of $1,000,000 on the life of Mr. Smithson.
Director Compensation
In addition to expenses of attendance, which are paid to all directors,
directors of the Company who are not also employees of the Company are paid an
annual retainer of $7,000 for their services and a fee of $300 for each Board of
Directors meeting attended. A non-employee director who serves on the Executive
and Finance Committees receives a $2,000 annual retainer and a fee of $600 for
each Executive and Finance Committees meeting attended. A non-employee director
who serves on the Audit Committee receives a $1,000 annual retainer and a fee of
$300 for each Audit Committee meeting attended.
Compensation Committee Interlocks and Insider Participation
The following directors constitute the members of the Compensation Committee of
the Board of Directors: James F. Malone III, A. John May and Edward H. Owlett.
Also, Mr. Anton and Mr. Smithson, whose respective compensation is described
above, are ex officio member of the Compensation Committee under the Company's
Bylaws. Mr. Malone, Mr. May and Mr. Owlett are or have been members of law firms
that furnished legal representation to the Company and its subsidiaries during
1996, 1995 and 1994. In the opinion of the Company's management, the amounts
paid to such firms represented reasonable charges for the services rendered and
were as fair as the charges would have been had such services been furnished by
law firms unaffiliated with any of the directors. Duane, Morris & Heckscher
LLP, of which Mr. May is a member, was paid an aggregate of $3,671,875 and
$3,165,092 in 1996 and 1995, respectively. Also, Mr. Anton and Mr. Smithson have
been participants during 1996, 1995 and 1994 in the Company's executive loan
program as described under Item 7 "Certain Relationships and Related
Transactions" below.
Item 7. Certain Relationships and Related Transactions.
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 and
whose purposes include the promotion of the common business interests of its
members and the economic prosperity of the Commonwealth of Pennsylvania. As
78
<PAGE>
of April 1, 1997, the Foundation owned 4,561,225 shares of Common Stock (29.4%
of the class) and 912,225 shares of Class A Common Stock (11.0% of the class),
which constitutes 28.4% of the total number of votes available to be cast in
matters brought before the Company's shareholders. See "Item 4. Security
Ownership of and Beneficial Owners and Management." All of the members of the
Company's Board of Directors currently serve as the members of the Foundation's
Board of Trustees. Also, Frederick W. Anton III, Chairman and former Chief
Executive Officer 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
affiliates receive reimbursement. Total reimbursements amounted to $82,000,
$269,000, and none for years ended December 31, 1996, 1995, and 1994,
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 $20,000 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 $247,428, $294,109, and $315,272 for
the years ended December 31, 1996, 1995, and 1994, respectively.
James F. Malone III, A. John May, Edward H. Owlett and Joseph H. Foster, who are
directors of the Company, are or have been members of law firms that furnished
legal representation to the Company and its subsidiaries during 1996, 1995 and
1994. In the opinion of the Company's management, the amounts paid to such firms
represented reasonable charges for the services rendered and were as fair as the
charges would have been had such services been furnished by law firms
unaffiliated with any of the directors. Duane, Morris & Heckscher LLP, of which
Mr. May is a member, was paid an aggregate of $3,671,875 and $3,165,092 in 1996
and 1995, respectively.
The Company has provided demand loans to certain officers of the Company and its
subsidiaries, for the purpose of providing such officers with funds to purchase
Common Stock or Class A Common Stock. The loans are collateralized by the Common
Stock or the Class A Common Stock purchased by the officer and bear interest at
a rate of 6% per annum. The following table sets forth certain information with
respect to indebtedness of executive officers of the Company under such program:
<TABLE>
<CAPTION>
Largest Amount Balance at
Executive Officer Year Outstanding During Period End of Period
- ----------------- ---- ------------------------- --------------
<S> <C> <C> <C>
Frederick W. Anton III............... 1996 $146,600 $ --
1995 $146,600 $146,600
1994 $246,600 $146,600
John W. Smithson..................... 1996 $158,400 $ --
1995 $158,400 $158,400
1994 $258,400 $158,400
Stephen G. Tirney.................... 1996 $220,000 $220,000
1995 $220,000 $220,000
1994 $220,000 $220,000
Stephen F. Litz...................... 1996 $270,000 $ --
1995 $270,000 $270,000
1994 $270,000 $270,000
James F. Fleming, Jr................. 1996 $127,833 $127,833
1995 $127,833 $127,833
1994 $127,833 $127,833
Francis W. McDonnell................. 1996 $437,813 $437,813
</TABLE>
79
<PAGE>
The Company has arranged an executive loan program (the "Financial Support
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 75% loan to
value ratio. The Company has agreed to purchase any loan made under the
Financial Support Program (including accrued interest and related expenses) from
the financial institution in the event that the borrower defaults on such loan.
The following table sets forth certain information with respect to indebtedness
of executive officers of the Company under the Financial Support Program:
<TABLE>
<CAPTION>
Largest Amount Balance at
Executive Officer Year Outstanding During Period End of Period
- ----------------- ---- ------------------------- -------------
<S> <C> <C> <C>
John W. Smithson................... 1996 $1,081,935 $1,081,935
1995 $1,081,935 $1,081,935
1994 $1,081,935 $1,081,935
Stephen G. Tirney.................. 1996 $ 187,100 $ 187,100
1995 $ 187,100 $ 187,100
1994 $ 187,100 $ 187,100
Stephen F. Litz.................... 1996 $ 504,000 $ 504,000
1995 $ 210,000 $ 210,000
1994 $ 210,000 $ 210,000
James J. Fleming, Jr............... 1996 $ 192,275 $ 192,275
1995 $ 192,275 $ 192,275
1994 $ 192,275 $ 192,275
</TABLE>
Subsidiaries of the Company, in the ordinary course of their business, have had
and intend to continue to have insurance transactions with directors and
officers of the Company and the various businesses with which directors and
officers of the Company are associated. Such insurance is written in accordance
with rates and terms authorized for use in the applicable jurisdictions.
Item 8. Legal Proceedings
The Insurance Subsidiaries are defendants in routine litigation involving their
insurance business and from time to time are involved in various governmental
and administrative proceedings arising in the ordinary course of business. 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. See "Item 1. Business - Loss Reserves" and
"Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations."
Item 9. Market Price of and Dividends on the Registrant's Common Equity and
Related Stockholder Matters
As of July 31, 1997, there were 191 shareholders of record of Common Stock and
380 shareholders of record of Class A Common Stock. The Company is registering
the Class A Common Stock under this registration statement.
Neither class of common equity is traded on an established exchange.
Transactions in the Common Stock are conducted privately among persons qualified
to own the Common Stock. See "Item 11. Description of Registrant's Securities to
Be Registered." No price information is available for such transactions. Class A
Common Stock trades under the symbol, "PMFRA", on the OTC Bulletin Board through
approximately ten broker/dealers who voluntarily make a market in Class A Common
Stock. The following table sets forth high and low bid information for Class A
Common Stock, as well as dividend information for both
80
<PAGE>
Common Stock and Class A Common Stock. The Company intends to apply for
qualification for listing of the Class A Common Stock on the Nasdaq National
Market System under the proposed symbol "PMRA." The foregoing bid information is
based upon over-the-counter market quotations, which reflects inter-dealer
prices, without retail mark-up, mark-down, or commission, and may not represent
actual transactions. Additionally, the limited and sporadic quotations may not
constitute an established public trading market and may not be indicative of the
fair market value of Class A Common Stock.
<TABLE>
<CAPTION>
Class A Common Class A Common Dividends Per Dividends
Stock High Stock Low Share - Class A Per Share -
Quarter Ended Bid Price Bid Price Common Stock Common Stock
- ------------- --------- --------- ------------- -------------
<S> <C> <C> <C> <C>
March 31, 1997........... $16.000 $14.000 $.09 $.08
June 30, 1997............ $16.625 $16.125 $.09 $.08
Third Quarter Through
August 7, 1997......... $15.250 $15.000 $.09* $.08*
December 31, 1996........ $17.500 $15.625 $.09 $.08
September 30, 1996....... $17.500 $17.000 $.09 $.08
June 30, 1996............ $18.500 $16.500 $.09 $.08
March 31, 1996........... $20.500 $18.250 $.09 $.08
---- ----
Total 1996 $.36 $.32
==== ====
December 31, 1995........ $18.250 $17.750 $.09 $.08
September 30, 1995....... $18.250 $15.250 $.09 $.08
June 30, 1995............ $15.250 $14.500 $.09 $.08
March 31, 1995........... $15.500 $14.500 $.09 $.08
---- ----
Total 1995 $.36 $.32
==== ====
December 31, 1994........ $15.500 $15.500 $.09 $.08
September 30, 1994....... $14.750 $14.500 $.09 $.08
June 30, 1994............ $14.000 $13.250 $.09 $.08
March 31, 1994........... $13.250 $12.750 $.09 $.08
---- ----
Total 1994 $.36 $.32
==== ====
</TABLE>
* Dividend declared payable on October 1, 1997.
The Company's ability to pay dividends is limited by certain restrictions in its
debt agreements. In addition, dividends from certain of the Company's
subsidiaries are limited by the insurance laws and regulations of Pennsylvania.
See "Item 1. - Business - Restrictions on Insurance Subsidiaries Dividends" and
"Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations" and Note 15 to the Consolidated Financial Statements included in
Item 13 for further discussion of dividend restrictions.
Item 10. Recent Sales of Unregistered Securities
During the years ended December 31, 1996, 1995 and 1994, the Company sold shares
of Class A Common Stock pursuant to the exercise of employee stock options
pursuant to the terms of the Company's stock option plans. In 1996, an aggregate
of 97,150 shares were sold to five officers of the Company pursuant to such
options at exercise prices ranging from $6.60 to $10.00 per share for an
aggregate price of $806,000. In 1995, an aggregate of 205,199 shares were sold
to six officers and employees of the Company pursuant to such options at
exercise prices ranging from $6.60 to $11.50 per share for an aggregate price of
$1,776,288. In 1994, an aggregate of 26,925 shares were sold to two officers and
employees of the Company pursuant to such options at exercise prices ranging
from $8.00 to $10.00 per share for an aggregate price of $230,400. The Company
believes that these sales were made pursuant
81
<PAGE>
to the exemption afforded by Section 4(2) of the Securities Act inasmuch as the
sales were made to a limited number of sophisticated investors in transactions
not involving a public offering.
Item 11. Description of Registrant's Securities to Be Registered
The following summary description is subject to the detailed provisions of the
Company's Amended and Restated Articles of Incorporation and the Company's
Bylaws, as amended, and does not purport to be complete and is qualified in its
entirety by reference thereto.
The authorized capital stock of the Company consists of 40,000,000 shares of
Common Stock, par value $5 per share, ("Common Stock") and 40,000,000 shares of
Class A Common Stock, par value $5 per share, ("Class A Common Stock"). As of
July 31, 1997, the Company had issued and outstanding 15,028,139 shares of
Common Stock and 8,842,611 shares of Class A Common Stock issued and
outstanding. This registration statement relates to the Company's Class A Common
Stock. The description of the Common Stock included herein is for information
purposes only.
Voting
Except as otherwise required under Pennsylvania law, or as otherwise provided in
the Company's Articles of Incorporation or Bylaws, with respect to all matters
upon which shareholders of the Company are entitled to vote or to which
shareholders are entitled to give consent, the holders of the outstanding shares
of Common Stock and the holders of the outstanding shares of Class A Common
Stock vote together without regard to class, and every holder of the outstanding
shares of Common Stock is entitled to cast thereon ten votes in person or by
proxy for each share of Common Stock standing in the holder's name, and every
holder of outstanding shares of Class A Common Stock is entitled to cast thereon
one vote in person or by proxy for each share of Class A Common Stock standing
in the holder's name.
Cumulative voting rights exist with respect to the election of directors, which
means that each shareholder has the right, in person or by proxy, to multiply
the number of votes to which he is entitled by the number of directors of the
class to be elected, and to cast the whole number of such votes for one
candidate or to distribute them among two or more candidates.
With respect to any proposed amendment to the Company's Articles of
Incorporation which would increase or decrease the number of authorized shares
of either Common Stock or Class A Common Stock, increase or decrease the par
value of the shares of Common Stock or Class A Common Stock, or alter or change
the powers, preferences, relative voting power or special rights of the shares
of Common Stock or Class A Common Stock so as to affect such class of shares
adversely, the approval of a majority of the votes entitled to be cast by the
holders of the class affected by the proposed amendment, voting separately as a
class, shall be obtained in addition to the approval of a majority of the votes
entitled to be cast by the holders of Common Stock and Class A Common Stock
voting together without regard to class as provided in the Articles of
Incorporation.
Dividends and Distributions
With respect to dividend rights, Class A Common Stock is entitled to cash
dividends at a rate that is 10% higher on a per share basis than the cash
dividends declared and paid on shares of Common Stock.
Each share of Common Stock and each share of Class A Common Stock have equal
rights in respect to dividends (other than cash) and distributions, declared and
paid, in the form of stock or other property of the Company, except that in the
case of dividends or other distributions payable in stock of the Company,
including distributions pursuant to stock split-ups or divisions, only shares of
Common Stock will be distributed with respect to Common Stock and only shares of
Class A Common Stock will be distributed with respect to Class A Common Stock.
82
<PAGE>
Convertibility
Each share of Common Stock may at any time be converted at the election of the
holder thereof into one fully paid and nonassessable share of Class A Common
Stock. Any holder of shares of Common Stock may elect to convert any or all of
such shares at one time or at various times in such holder's discretion.
Such right can be exercised by the surrender of the certificate representing
each share of Common Stock to be converted to the agent for the registration for
transfer of shares of Common Stock at its office, or to the Company at its
principal executive offices, accompanied by a written notice of the election by
the holder thereof to convert and (if so required by the transfer agent or by
the Company) by instruments of transfer, in form satisfactory to the transfer
agent and to the Company, duly executed by such holder or his duly authorized
attorney. The issuance of a certificate or certificates for shares of Class A
Common Stock upon conversion of shares of Common Stock will be made without
charge for any stamp or other similar tax in respect of such issuance. However,
if any such certificate or certificates is or are to be issued in a name other
than that of the holder of the share or shares of Common Stock converted, the
person or persons requesting the issuance thereof must pay to the transfer agent
or to the Company the amount of any tax which may be payable in respect of any
such transfer, or must establish to the satisfaction of the transfer agent or of
the Company that such tax has been paid. As promptly as practicable after the
surrender for conversion of a certificate or certificates representing shares of
Common Stock and the payment of any tax as hereinbefore provided, the Company
will deliver or cause to be delivered at the office of the transfer agent to, or
upon the written order of, the holder of such certificate or certificates, a
certificate or certificates representing the number of shares of Class A Common
Stock issuable upon such conversion, issued in such name or names as such holder
may direct. Such conversion will be irrevocable and will be deemed to have been
made immediately prior to the close of business on the date of the surrender of
the certificate or certificates representing shares of Common Stock (if on such
date the transfer books of the Company shall be closed, then immediately prior
to the close of business on the first date thereafter that said books shall be
open), and all rights of such holder arising from ownership of such shares of
Common Stock will cease at such time, and the person or persons in whose name or
names the certificate or certificates representing shares of Class A Common
Stock are to be issued will be treated for all purposes as having become the
record holder or holders of such shares of Class A Common Stock at such time and
will have and may exercise all the rights and powers appertaining thereto.
No adjustments in respect of past cash dividends will be made upon the
conversion of any share of Common Stock; provided, however, that if any shares
of Common Stock are converted subsequent to the record date for the payment of a
cash or stock dividend or other distribution on shares of Common Stock but prior
to such payment, the registered holder of such shares at the close of business
on such record date will be entitled to receive the cash or stock dividend or
the distribution payable to holders of Common Stock.
The Company is required at all times to reserve and keep available, solely for
the purpose of issue upon conversion of outstanding shares of Common Stock, such
number of shares of Class A Common Stock as may be issuable upon the conversion
of all such outstanding shares of Common Stock, provided, the Company may
deliver shares of Class A Common Stock which are held in the treasury of the
Company for shares of Common Stock to be converted. If any shares of Class A
Common Stock require registration with or approval of any governmental authority
under any federal or state law before such shares of Class A Common Stock may be
issued upon conversion, the Company will cause such shares to be duly registered
or approved, as the case may be. All shares of Class A Common Stock which may be
issued upon conversion of shares of Common Stock will, upon issue, be fully paid
and nonassessable.
Shares of Class A Common Stock are not convertible into shares of Common Stock.
83
<PAGE>
Preemptive Rights of Common Stock
Except with respect to shares, rights, options, and other securities of the
Company that are issued or granted in connection with any stock purchase plan,
stock option plan or other similar benefit plan that has been approved by the
holders of a majority of the Company's outstanding Common Stock, the holders of
Common Stock of the Company are entitled, as such, as a matter of right, to
subscribe for and to purchase any part of any new or additional issue of Common
Stock, any rights or options to purchase Common Stock, whether now or hereafter
authorized, but only in those instances in which such shares of Common Stock,
rights or options to purchase Common Stock are issued for a consideration
consisting solely of money. In the event of the issuance of such shares or other
securities solely for money, such preemptive right is only an opportunity to
acquire such shares or other securities under such terms and conditions as the
Board of Directors shall fix. The preemptive rights granted under the Articles
of Incorporation do not apply in any respect to Class A Common Stock, and
holders of Class A Common Stock, as such, have no preemptive rights.
Other Rights
Except as otherwise required by Pennsylvania law or as provided in the Articles
of Incorporation of the Company, each share of Common Stock and each share of
Class A Common stock has identical powers, preferences and rights, including
rights in liquidation.
There are no redemption or sinking fund provisions applicable to Common Stock or
Class A Common Stock. Holders of Common Stock and Class A Common Stock are not
subject to further calls or assessments by the Company. All outstanding shares
of Common Stock and Class A Common Stock are fully paid and non-assessable.
Certain Articles of Incorporation and Bylaw Provisions; Pennsylvania Anti-
Takeover Provisions
The Company's Bylaws provide for the division of the Company's Board of
Directors into three classes. Only one class is elected each year, and the
regular term of each class is three years. See "Item 5 - Executive Officers and
Directors." The classification of the Board of Directors and cumulative voting
rights of holders of the Company's Common Stock and Class A Common Stock could
have the effect of making it more difficult for third party to acquire, or of
discouraging a third party from acquiring control of the Company. The Company's
Bylaws also require any shareholder who desires to nominate a candidate for
election as a director to provide certain information concerning such person
that is equivalent to that contained in the Company's proxy materials for those
candidates nominated by the Company's Board of Directors not later than 60 days
prior to the date of election.
Pennsylvania has also adopted certain laws that may be deemed to be "anti-
takeover" in effect. One provision permits directors, in considering the best
interests of the Company, to consider the effects of any action upon its
employees, suppliers, customers, shareholders and creditors and the communities
in which the Company maintains facilities. The effect of this provision is to
put the considerations of these constituencies on parity with one another, with
the result that no one group, including shareholders, is required to be the
dominant or controlling concern of directors in determining what is in the best
interests of the Company. This provision applies to all Pennsylvania
corporations. Other provisions under Pennsylvania law that may be deemed to be
anti-takeover in effect include the authorization for the adoption of poison
pill plans and the prohibition of shareholders' calling a special meeting of
shareholders, taking action by less than unanimous written consent or proposing
an amendment to the articles of incorporation of the Company.
The Company's Amended and Restated Articles of Incorporation provides that
certain other anti-takeover provisions under the Pennsylvania Business
Corporation Law of 1988, as amended, shall not be applicable to the Company.
84
<PAGE>
Restrictions on Ownership of Common Stock
Under the Company's Bylaws, no person, firm, association, corporation or other
entity is qualified to own any shares of Common Stock except: (i) PMA
Foundation; (ii) a member of PMA Foundation; (iii) a former member of PMA
Foundation who resigned in good standing, but only in respect to Common Stock
owned by such former member on the date of resignation; (iv) the Company or
PMAIC; (v) an officer, proprietor or partner of a member of PMA Foundation, or a
retired officer, proprietor or partner of a member or former member, but only in
respect to Common Stock owned on the date of retirement; (vi) a director or
officer of the Company, PMAIC or PMA Foundation; (vii) a retired director or
officer of the Company, PMAIC or PMA Foundation, but only in respect to the
Common Stock owned on the date of retirement; (viii) a surviving spouse of a
deceased person who, at the time of his or her death, was qualified to own
Common Stock; (ix) a person, firm, association, corporation or other entity who
was a shareholder of record of PMAIC on April 1, 1982; (x) any child or
grandchild of a shareholder of PMAIC of record on April 1, 1982; (xi) a trustee
under a written trust solely for the benefit of a person qualified under the
Company's Bylaws to own Common Stock or a spouse, child or grandchild of such
qualified person; and (xii) such other classes of person as are from time to
time approved by the Board of Directors of the Company. Pursuant to the Bylaws,
the Board of Directors has authorized the following classes of persons to own
shares of Common Stock: (i) employees of the Company or any of its affiliates
who are not officers of these entities, but whose duties require the exercise of
executive and administrative responsibilities; and (ii) a spouse of a person who
owned Common Stock of record on December 8, 1990. The Company's Bylaws also
provide that no person, firm, association, corporation or other entity, except
PMA Foundation, may at any time hold more than 7% of the outstanding shares of
Common Stock of the Company.
If any shareholder ceases to be qualified to own Common Stock under the
Company's Bylaw provisions, 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
person, firm, association, corporation or other entity who is not qualified to
own Common Stock under the Company's Bylaws becomes the holder of Common Stock,
then in any such case, unless a transfer of such Common Stock is made to a
qualified person within six months, such holder will be required to offer to
sell such Common Stock to PMA Foundation at a price agreed upon by the holder
and PMA Foundation, or by a committee of arbitrators if the holder and PMA
Foundation are unable to agree upon a price.
The foregoing restrictions relating to the Common Stock do not apply to shares
of Class A Common Stock.
Shares Eligible for Future Sale
As of July 31, 1997, the Company has outstanding 15,028,139 shares of Common
Stock and 8,842,611 shares of Class A Common Stock. Transferability of shares of
the Company's Common Stock is limited by the restrictions on ownership under the
Company's Bylaws. See "Restrictions on Ownership of Common Stock" above.
Of the outstanding shares of Class A Common Stock, 7,947,258 shares will be
freely transferable by persons other than "affiliates" of the Company without
restriction or further registration under the Securities Act. Of the 7,947,258
shares of Class A Common Stock that are freely transferable, 1,690,355 shares
are held by affiliates and may not be sold unless registered under the
Securities Act or an exemption from registration is available, including the
exemption afforded by Rule 144.
The remaining 895,353 shares of Class A Common Stock are "restricted securities"
("Restricted Securities") within the meaning of Rule 144 under the Securities
Act and may not be sold unless registered under the Securities Act or an
exemption from registration is available, including the exemption afforded by
Rule 144.
85
<PAGE>
Rule 144, as currently in effect, provides that an affiliate of the Company or a
person (or persons whose shares are aggregated) who has beneficially owned
Restricted Shares for at least one year but less than two years is entitled to
sell, commencing 90 days after the effective date of this Registration
Statement, within any three-month period a number of shares that does not exceed
the greater of one percent of the then outstanding shares of Class A Common
Stock (88,426 shares immediately after the effective date of this Registration
Statement) or the average weekly trading volume in the Class A Common Stock
during the four calendar weeks preceding such sale. Sales under Rule 144 also
are subject to certain manner-of-sale provisions, notice requirements and the
availability of current public information about the Company. However, a person
who is not an "affiliate" of the Company at any time during the three months
preceding a sale, and who has beneficially owned Restricted Shares for at least
two years, is entitled to sell such shares under Rule 144(k) without regard to
the limitations described above.
Therefore, of the 895,353 shares of Restricted Securities, (i) 178,547 shares
held by affiliates and 292,330 shares held by non-affiliates may not be sold
under Rule 144 until they have been held for at least one year, (ii) 17,961
shares held by affiliates and 25,592 shares held for more than one year but less
than two years by non-affiliates may be sold under Rule 144, assuming all
conditions of Rule 144 have been satisfied and (iii) 380,923 shares held for
more than two years by non-affiliates may be sold without restriction under Rule
144(k).
Each share of Common Stock is convertible into one share of Class A Common
Stock. If the outstanding shares of Common Stock were to be converted into
shares of Class A Common Stock, (i) 6,457,381 shares of Class A Common Stock
held by non-affiliates of the Company that would be received upon such
conversion could be sold without further restriction, (ii) 173,778 shares held
by non-affiliates and 144,375 shares held by affiliates may not be sold under
Rule 144 until they have been held for at least one year, and (iii) 8,252,605
shares of Class A Common Stock held by affiliates that would be received upon
such conversion could not be sold unless registered under the Securities Act or
an exemption from registration is available, including the exemption afforded by
Rule 144.
In addition, the Company intends to file a registration statement under the
Securities Act to register 3,491,387 shares of Class A Common Stock reserved for
issuance pursuant to the exercise of outstanding stock options and shares
reserved for future grants under the Company's stock option plans. Shares issued
upon exercise of outstanding stock options after the effective date of such
registration statement generally will be eligible for sale in the public market.
There are no shares of Common Stock underlying options or warrants.
Since there has been no public market for the Company's shares of the Class A
Common Stock, the Company is unable to predict the effect that sales made
pursuant to Rule 144 or otherwise may have on the prevailing market price at
such times for shares of the Class A Common Stock. Nevertheless, sales of a
substantial amount of the Class A Common Stock in the public market, or the
perception that such sales could occur, could adversely affect market prices.
Transfer Agent
The Transfer Agent for the capital stock of the Company is ChaseMellon
Shareholder Services, L.L.C. Its address for such purposes is P.O. Box 590,
Ridgefield Park, New Jersey 07660, and its telephone number is 800-851-9677.
Item 12. Indemnification of Directors and Officers
As permitted by the provisions for indemnification of directors and officers in
the Pennsylvania Business Corporation Law, which applies to the Company, the
Company's Bylaws provide for indemnification of directors and officers for
reasonable expenses, judgments, fines and amounts paid in settlement of actions
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.
86
<PAGE>
The Bylaws of the Company also avail directors of the Pennsylvania law limiting
directors' liability for money damages except in those cases where they have
breached their fiduciary duty and such breach constitutes self-dealing, willful
misconduct or recklessness. Such provisions are subject to applicable federal
and state regulatory restrictions. Such provisions do not apply, however, to the
responsibility or liability of a director pursuant to any criminal statute or
the liability of a director for the payment of taxes pursuant to local, federal
or state law.
The Company provides liability insurance for each director and officer of the
Company and its subsidiaries for certain losses arising from claims or charges
against them while serving in their capacities as directors or officers up to an
aggregate of $10,000,000 including defense costs, expenses and charges.
87
<PAGE>
Item 13. Financial Statements and Supplementary Data
Index to Consolidated Financial Statements
<TABLE>
<CAPTION>
Page
----
<S> <C>
Consolidated Statements of Operations for the years ended
December 31, 1996, 1995 and 1994...................................................... F-1
Consolidated Balance Sheets as of
December 31, 1996 and 1995............................................................ F-2
Consolidated Statements of Cash Flows for the years ended
December 31, 1996, 1995 and 1994...................................................... F-3
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 1996, 1995 and 1994.................................. F-4
Notes to Consolidated Financial Statements............................................ F-5
Report of Independent Accountants..................................................... F-29
Condensed Consolidated Statements of Operations for the
Three and Six Months Ended June 30, 1997 and June 30, 1996 (unaudited)................ F-30
Condensed Consolidated Balance Sheets as of June 30, 1997
(unaudited) and December 31, 1996..................................................... F-31
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 1997 and June 30, 1996 (unaudited).............................. F-32
Notes to the Interim Condensed Consolidated Financial
Statements (unaudited)................................................................ F-33
</TABLE>
88
<PAGE>
Pennsylvania Manufacturers Corporation
Consolidated Statements of Operations
<TABLE>
<CAPTION>
for the years ended December 31,
(in thousands, except per share data) 1996 1995 1994
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Net premiums written $ 443,475 $ 489,876 $ 466,502
Change in net unearned premiums (12,400) (924) 1,032
Change in accrued retrospective premiums (10,500) (4,000) (1,000)
-----------------------------------------------
Net premiums earned 420,575 484,952 466,534
Net investment income 133,936 139,355 138,719
Net realized investment gains 2,984 31,923 47,521
Service revenues 9,189 5,106 3,380
-----------------------------------------------
Total revenues 566,684 661,336 656,154
-----------------------------------------------
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) 536,623 422,578 402,869
Amortization of deferred acquisition costs 90,292 87,207 83,527
Operating expenses 97,856 81,161 74,648
Dividends to policyholders 16,255 16,743 16,679
Interest expense 17,052 18,734 13,051
-----------------------------------------------
Total losses and expenses 758,078 626,423 590,774
-----------------------------------------------
(Loss) income before income taxes (191,394) 34,913 65,380
-----------------------------------------------
(Benefit) provision for income taxes:
Current (44,572) (4,570) 8,000
Deferred (11,488) 15,353 130
-----------------------------------------------
Total (56,060) 10,783 8,130
-----------------------------------------------
Net (loss) income $(135,334) $ 24,130 $ 57,250
===============================================
(Loss) Earnings per Common and Equivalent Share
Primary:
(Loss) earnings per primary share $ (5.68) $ 0.98 $ 2.32
===============================================
Fully diluted:
(Loss) earnings per fully-diluted share $ (5.68) $ 0.97 $ 2.32
===============================================
</TABLE>
See accompanying notes to the consolidated financial statements.
F-1
<PAGE>
Pennsylvania Manufacturers Corporation
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31, December 31,
(in thousands, except share data) 1996 1995
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Investments:
Fixed maturities available for sale, at fair value
(amortized cost: 1996--$2,164,391; 1995--$2,206,806) $ 2,126,120 $ 2,230,992
Equity securities, at fair value (cost: 1996-$259: 1995-$8,132) 262 10,886
Short-term investments, at amortized cost which approximates fair value 134,971 214,071
-----------------------------------
Total investments 2,261,353 2,455,949
Cash 7,176 9,170
Investment income due and accrued 30,268 35,456
Uncollected premiums (net of allowance for uncollectible accounts:
1996--$18,877; 1995--$16,330) 285,982 290,705
Reinsurance receivables (net of allowance for
uncollectible reinsurance: 1996--$3,901; 1995--$6,208) 257,983 264,647
Property and equipment ( net of accumulated depreciation:
1996--$41,219; $1995--$28,614) 50,861 56,649
Deferred income taxes, net 101,642 67,331
Deferred acquisition costs 44,006 37,901
Other assets 78,245 40,764
-----------------------------------
Total assets $ 3,117,516 $ 3,258,572
===================================
Liabilities
Unpaid losses and loss adjustment expenses $ 2,091,072 $ 2,069,986
Unearned premiums 205,982 192,722
Long-term debt 204,699 203,848
Dividends to policyholders 12,524 13,156
Funds held under reinsurance treaties 86,804 73,605
Taxes, licenses and fees, and other expenses 39,226 29,607
Other liabilities 51,381 65,980
-----------------------------------
Total liabilities 2,691,688 2,648,904
-----------------------------------
Commitments and contingencies (Note 13)
Shareholders' Equity
Common stock, $5 par value (40,000,000 shares authorized; 16,095,416 shares
issued and 15,670,052 outstanding -- 1996;
17,044,580 shares issued and 16,652,016 outstanding -- 1995) 80,477 85,223
Class A common stock, $5 par value (40,000,000 shares authorized;
8,247,804 shares issued and 8,173,023 outstanding -- 1996;
7,298,640 shares issued and 7,225,232 outstanding -- 1995) 41,239 36,493
Retained earnings 336,921 480,181
Unrealized (loss) gain on investments (net of deferred income taxes:
1996--$13,394; 1995--($9,429)) (24,874) 17,511
Notes receivable from officers (1,162) (3,896)
Treasury stock, at cost:
Common stock (1996--425,364 shares; 1995--392,564 shares) (5,408) (4,769)
Class A common stock (1996--74,781 shares; 1995--73,408 shares) (1,365) (1,075)
-----------------------------------
Total shareholders' equity 425,828 609,668
-----------------------------------
Total liabilities and shareholders' equity $ 3,117,516 $ 3,258,572
===================================
</TABLE>
See accompanying notes to the consolidated financial statements.
F-2
<PAGE>
Pennsylvania Manufacturers Corporation
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
for the years ended December 31,
(in thousands) 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net (loss) income $ (135,334) $ 24,130 $ 57,250
Adjustments to reconcile net (loss) income to net cash flows (used)
provided by operating activities:
Depreciation 12,511 7,652 8,551
Amortization (accretion) 7,243 35 (405)
(Benefit) provision for deferred income taxes (11,488) 15,353 130
Net realized investment gains (2,984) (31,923) (47,521)
Change in uncollected premiums and unearned premiums, net 17,983 22,381 35,623
Change in dividends to policyholders (632) 910 (7,754)
Change in unpaid losses and loss adjustment expenses 21,086 (33,728) (46,951)
Change in investment income due and accrued 5,188 4,961 (267)
Change in deferred acquisition costs (6,105) (5,665) (1,844)
Other, net (23,413) 11,807 5,482
------------------------------------------
Net cash flows (used) provided by operating activities (115,945) 15,913 2,294
------------------------------------------
Cash flows from investing activities:
Fixed maturity investments held to maturity:
Purchases - - (354,379)
Maturities or calls - 3,809 16,658
Fixed maturity investments available for sale:
Purchases (1,227,173) (2,147,600) (756,704)
Maturities or calls 52,280 75,861 34,900
Sales 1,210,114 2,085,864 1,161,133
Equity securities:
Purchases (5,196) (18,104) (46,828)
Sales 16,984 28,793 88,909
Net sales (purchases) of short-term investments 78,935 (35,445) (120,675)
Net purchases of property and equipment (6,723) (6,017) (12,905)
------------------------------------------
Net cash flows provided (used) by investing activities 119,221 (12,839) 10,109
------------------------------------------
Cash flows from financing activities:
Proceeds from issuances of long-term debt 26,000 125,000 25,000
Repayments of long-term debt (25,149) (125,127) (15,861)
Dividends paid to shareholders (7,926) (7,885) (5,881)
Treasury stock transactions, net (929) 480 (3,893)
Repayments of notes receivable from officers 2,734 478 235
------------------------------------------
Net cash flows used by financing activities (5,270) (7,054) (400)
------------------------------------------
Net (decrease) increase in cash (1,994) (3,980) 12,003
Cash January 1 9,170 13,150 1,147
------------------------------------------
Cash December 31 $ 7,176 $ 9,170 $ 13,150
==========================================
Supplementary cash flow information:
Amounts paid (received) for income taxes $ 5,525 $ (951) $ 4,532
Amounts paid for interest $ 16,622 $ 15,062 $ 12,899
Fair value of securities transferred from held to maturity
classification fo available for sale classification $ - $ 1,238,077 $ -
</TABLE>
See accompanying notes to the consolidated financial statements.
F-3
<PAGE>
Pennsylvania Manufacturers Corporation
Consolidated Statements of Shareholders' Equity
(in thousands, except share and per sahre data)
<TABLE>
<CAPTION>
Unrealized Notes
gain receivable
Common Stock Class A Common Stock Retained (loss) on from
----------------------------------------------------
Shares Amounts Shares Amounts earnings investments officers
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance-January 1, 1994 18,400,506 92,003 5,942,714 29,713 414,132 6,276 (4,609)
Net income 57,250
Common stock dividends
declared ($.32 per share) (5,686)
Class A common stock
dividends declared ($.36 per
share) (2,160)
Conversion of common stock
into Class A common stock (793,656) (3,969) 793,656 3,969
Cumulative effect of
accounting change-adoption
of SFAS No. 115 (net of tax
effect of ($24,415)) 45,343
Unrealized loss on
investments available for sale
(net of tax effect of $54,430) (101,084)
Repayments of notes 235
Purchase of treasury shares,
net
Effect of other treasury stock
transactions (58)
Stock options issued 474
- ------------------------------------------------------------------------------------------------------------------------------
Balance-December 31, 1994 17,606,850 88,034 6,736,370 33,682 463,952 (49,465) (4,374)
Net income 24,130
Common stock dividends
declared ($.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 (562,270) (2,811) 562,270 2,811
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
Effect of other treasury stock
transactions
- ------------------------------------------------------------------------------------------------------------------------------
Balance-December 31, 1995 17,044,580 $ 85,223 7,298,640 $ 36,493 $ 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 stock
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) (42,385)
Repayment of notes 2,734
Purchase of treasury shares,
net
==============================================================================================================================
Balance-December 31, 1996 16,095,416 $ 80,477 8,247,804 $ 41,239 $ 336,921 $ (24,874) $ (1,162)
==============================================================================================================================
<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, 1994 125,799 (1,337) 177,103 (1,795) 534,383
Net income 57,250
Common stock dividends
declared ($.32 per share) (5,686)
Class A common stock
dividends declared ($.36 per
share) (2,160)
Conversion of common stock
into Class A common stock -
Cumulative effect of
accounting change-adoption
of SFAS No. 115 (net of tax
effect of ($24,415)) 45,343
Unrealized loss on
investments available for sale
(net of tax effect of $54,430) (101,084)
Repayments of notes 235
Purchase of treasury shares,
net 262,715 (3,369) 52,320 (785) (4,154)
Effect of other treasury stock
transactions (28,925) 319 261
Stock options issued 474
- ---------------------------------------------------------------------------------------------------------
Balance-December 31, 1994 388,514 (4,706) 200,498 (2,261) 524,862
Net income 24,130
Common stock dividends
declared ($.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 stock
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
=========================================================================================================
</TABLE>
See accompanying notes to the consolidated financial statements.
F-4
<PAGE>
Notes to Consolidated Financial Statements
(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 insurance and reinsurance through its insurance
subsidiaries; with the exception of certain foreign affiliates, PMC's insurance
subsidiaries are domiciled in Pennsylvania. Its property and casualty insurance
subsidiaries (the Property and Casualty Group) write workers' compensation and
other lines of commercial insurance primarily in the Mid-Atlantic and Southern
regions. 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.
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.
These consolidated financial statements vary in certain respects from statutory
accounting practices prescribed or permitted by the Pennsylvania Insurance
Department (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.
SAP net (loss) income and capital and surplus for PMC's domestic insurance
subsidiaries as reported to the Pennsylvania Insurance Department are
as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
SAP Net (Loss) Income
The Property and Casualty Group................... $(191,640) $ 30,925 $ 51,110
PMA Re............................................ 26,338 36,854 33,662
--------- -------- --------
Total............................................... $(165,302) $ 67,779 $ 84,772
========= ======== ========
December 31,
1996 1995 1994
---- ---- ----
SAP Capital and Surplus
The Property and Casualty Group................... $ 279,764 $402,968 $405,020
PMA Re............................................ 260,853 254,088 237,387
--------- -------- --------
Total............................................... $ 540,617 $657,056 $642,407
========= ======== ========
</TABLE>
A reconciliation of PMC's domestic insurance subsidiaries' SAP net (loss) income
and capital and surplus to the Company's GAAP net (loss) income and
shareholders' equity is as follows:
F-5
<PAGE>
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Net (Loss) Income
SAP net (loss) income:
Domestic insurance subsidiaries..................... $(165,302) $ 67,779 $ 84,772
Other entities and eliminations..................... 18,706 (34,147) (27,682)
--------- -------- --------
SAP net (loss) income -- the Company.................. (146,596) 33,632 57,090
GAAP adjustments:
Change in deferred acquisition costs................ 6,105 5,665 1,844
Benefit (provision) for deferred income
taxes............................................. 11,488 (15,353) (130)
Allowance for doubtful accounts..................... (5,317) 4,105 (1,080)
Retirement accruals................................. (76) (3,613) --
Other............................................... (938) (306) (474)
--------- -------- --------
GAAP net (loss) income................................ $(135,334) $ 24,130 $ 57,250
========= ======== ========
</TABLE>
<TABLE>
<CAPTION>
December 31,
1996 1995 1994
---------- ---------- ----------
<S> <C> <C> <C>
Shareholders' equity
SAP capital and surplus:
Domestic insurance subsidiaries...................... $ 540,617 $ 657,056 $ 642,407
Other entities and eliminations...................... (206,642) (175,213) (188,000)
--------- --------- ---------
SAP capital and surplus -- the Company................. 333,975 481,843 454,407
GAAP adjustments:
Deferred acquisition costs........................... 44,006 37,901 32,236
Deferred income taxes................................ 101,642 67,331 118,747
Allowance for doubtful accounts...................... (26,214) (20,897) (25,002)
Retirement accruals.................................. (14,571) (14,495) (10,954)
Reversal of non-admitted assets...................... 25,599 32,841 29,324
Unrealized (loss) gain on fixed maturity investments
available for sale.................................. (38,271) 24,186 (75,688)
Other................................................ (338) 958 1,792
--------- --------- ---------
GAAP shareholders' equity.............................. $ 425,828 $ 609,668 $ 524,862
========= ========= =========
</TABLE>
B. Investments -- Effective January 1, 1994, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Upon adoption of SFAS No. 115, the
Company designated investments in fixed maturities with a total amortized cost
and fair value of $1,350,884 and $1,420,642, respectively, as available-for-
sale. Under SFAS No. 115, 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 reevaluated the classifications of its 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.
Equity securities for all periods are stated at fair value with changes in fair
value, net of income tax effects, reflected in shareholders' equity.
F-6
<PAGE>
Realized gains and losses, determined by the first-in, first-out method, 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 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 is 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.
At December 31, 1996, the Company's loss reserves were stated net of $75,000 of
salvage and subrogation, of which $65,800 related to the Property and Casualty
Group allocable to the following lines of business: workers' compensation,
$61,900; commercial automobile, $1,400; commercial multi-peril, $1,000, and all
other lines, $1,500; the anticipated salvage and subrogation was $9,200 for PMA
Re. 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 typical 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.
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. In addition, the Company defers
certain internal costs that vary with and are directly related to the production
of business. The internal costs subject to the deferral include: salaries of
underwriting, sales, and marketing personnel; advertising costs; and an
allocation of management information systems costs related to underwriting,
marketing, and policy issuance. 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. Policyholder Dividends -- 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.
F-7
<PAGE>
G. Income Taxes --The Company accounts for income taxes under SFAS No. 109
"Accounting for Income Taxes" (SFAS 109). SFAS 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.
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 $4,800.
I. Per Share Information -- In 1996, earnings per share was based upon the
weighted average number of common shares outstanding during the year. The
assumed exercise price of stock options using the average market price was not
taken into consideration as these stock options would have an anti-dilutive
effect on net loss per share. The number of weighted average common shares
outstanding for the year ended December 31, 1996 for both primary and fully
diluted earnings per share was 23,800,791.
In 1995, earnings per share was based upon the weighted average number of 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 as if using the average market price and the closing price of the
Company's common stock and Class A common stock for primary and fully-diluted
earnings per share, respectively. The number of weighted average common shares
and common share equivalents outstanding for primary and fully-diluted earnings
per share were 24,709,031 and 24,934,579, respectively, for the year ended
December 31, 1995.
In 1994, the weighted average number of common shares and common share
equivalents outstanding during each year were equivalent for primary and fully-
diluted earnings per share. The weighted average number of common shares and
common share equivalents outstanding was 24,650,741 for the year ended
December 31, 1994.
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 stock at the date of the grants over the amount an employee must pay
to acquire the 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 $1,808 to operating expenses during the year ended December 31, 1996,
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 and prior period financial statements were reclassified
accordingly.
F-8
<PAGE>
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 currently
participate in a transfer arrangement of certain accounts receivable. Such
arrangement will be restructured or terminated as a result of SFAS No. 125. The
restructuring or termination of such arrangement is not expected to have a
material impact on the Company's financial condition or results of operations.
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. SFAS No. 128, which is
effective for financial statements for both interim and annual periods ending
after December 15, 1997, requires presentation of earnings per share by all
entities that have issued common stock or potential common stock if those
securities trade in a public market either on a stock exchange or in the over-
the-counter market, including securities quoted only locally or regionally. As
SFAS No. 128 is a disclosure standard, adoption is not expected to have a
material impact on the Company's financial condition or results of operations.
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 three years in the period ended December 31, 1996:
<TABLE>
<CAPTION>
1996 1995 1994
--------- --------- ---------
Estimated retrospective policy
adjustments related to current
<S> <C> <C> <C>
accident year.......................... ($18,767) ($12,941) ($17,334)
Revision of estimate of retrospective
policy adjustments related to
prior accident years................... (9,888) (4,845) (6,552)
Retrospective policy adjustments paid.... 23,155 13,786 22,886
Uncollectible write-off.................. (5,000) -- --
-------- -------- --------
Total.................................... ($10,500) ($ 4,000) ($ 1,000)
======== ======== ========
</TABLE>
F-9
<PAGE>
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,
high-quality obligations of states and political subdivisions and corporations,
and mortgage-backed securities. The Company does not have any investments in its
portfolio that are considered below investment grade, as defined by independent
security rating agencies. Equity securities consist entirely of common stocks of
financial institutions, public utilities, and industrial and service entities.
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, 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
========== ======= ======= ==========
December 31, 1995
Fixed maturities available for sale:
U.S. Treasury securities and obligations of
U.S. Government agencies....................... $1,651,858 $17,395 $ 2,978 $1,666,275
Obligations of states and political
subdivisions................................... 429,118 9,073 2,322 435,869
Corporate debt securities....................... 125,830 3,059 41 128,848
---------- ------- ------- ----------
Total fixed maturities available for sale......... 2,206,806 29,527 5,341 2,230,992
Equity securities................................. 8,132 2,967 213 10,886
Short-term investments............................ 214,071 -- -- 214,071
---------- ------- ------- ----------
Total investments................................. $2,429,009 $32,494 $ 5,554 $2,455,949
========== ======= ======= ==========
</TABLE>
The amortized cost and estimated fair value of fixed maturities at December 31,
1996, 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.
F-10
<PAGE>
<TABLE>
<CAPTION>
Amortized Fair
Cost Value
---- -----
<S> <C> <C>
1997.......................................... $ 110,974 $ 110,798
1998-2001..................................... 534,450 525,507
2002-2006..................................... 679,444 661,184
2007 and thereafter........................... 766,195 754,628
Mortgage backed securities.................... 73,328 74,003
---------- ----------
$2,164,391 $2,126,120
========== ==========
</TABLE>
Net investment income consists of the following:
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Fixed maturities......................... $131,530 $129,883 $135,299
Equity securities........................ 148 503 1,253
Short-term investments................... 7,711 11,764 3,397
Other.................................... 3,251 4,303 830
-------- -------- --------
Total investment income................ 142,640 146,453 140,779
Investment expenses...................... 8,704 7,098 2,060
-------- -------- --------
Net investment income.................. $133,936 $139,355 $138,719
======== ======== ========
</TABLE>
Net realized investment gains consist of the following:
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
---- ---- -----
<S> <C> <C> <C>
Realized gains:
Fixed maturities......................... $12,762 $37,900 $40,767
Equity securities........................ 4,351 3,117 12,822
Other.................................... 4 -- 101
------- ------- -------
17,117 41,017 53,690
------- ------- -------
Realized losses:
Fixed maturities......................... 12,861 5,956 1,844
Equity securities........................ 436 2,200 4,325
Other.................................... 836 938 --
------- ------- -------
14,133 9,094 6,169
------- ------- -------
Total net realized investment gains........ $ 2,984 $31,923 $47,521
======= ======= =======
</TABLE>
On December 31, 1996, the Company had securities with a total amortized cost and
fair value of $17,102 and $16,886, respectively, on deposit with various
governmental authorities, as required by law. In addition, at December 31, 1996,
securities with a total amortized cost and fair value of $10,527 and $10,404,
respectively, were pledged as collateral for letters of credit issued on behalf
of the Company.
Change in unrealized (depreciation) appreciation of investments consists of the
following:
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
----------- --------- ----------
<S> <C> <C> <C>
Cumulative effect of accounting change........................... $ -- $ -- $ 69,758
Fixed maturities available for sale........................ (62,457) 99,874 (145,444)
Equity securities.......................................... (2,751) 3,165 (10,070)
-------- -------- ---------
Change in unrealized (depreciation) appreciation of investments.. $(65,208) $103,039 $ (85,756)
======== ======== =========
</TABLE>
F-11
<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,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Balance at January 1......................................... $2,069,986 $2,103,714 $2,150,665
Less: reinsurance recoverable on unpaid losses and LAE....... 261,492 247,856 218,695
---------- ---------- ----------
Net balance at January 1..................................... 1,808,494 1,855,858 1,931,970
---------- ---------- ----------
Losses and LAE incurred, net:
Current year............................................... 323,069 357,787 352,025
Prior years................................................ 156,074 51,491 366
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).................................................. 57,480 13,300 50,478
---------- ---------- ----------
Total losses and LAE incurred, net........................... 536,623 422,578 402,869
---------- ---------- ----------
Losses and LAE paid, net:
Current year............................................... (72,194) (71,126) (71,965)
Prior years................................................ (438,427) (398,816) (407,016)
---------- ---------- ----------
Total losses and LAE paid, net............................... (510,621) (469,942) (478,981)
---------- ---------- ----------
Net balance at December 31................................... 1,834,496 1,808,494 1,855,858
Reinsurance recoverable on unpaid losses and LAE............. 256,576 261,492 247,856
---------- ---------- ----------
Balance at December 31....................................... $2,091,072 $2,069,986 $2,103,714
========== ========== ==========
</TABLE>
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>
<S> <C>
Workers' compensation............... $110,000
Asbestos and environmental.......... 60,400
Other lines of business............. 21,000
--------
$191,400
========
</TABLE>
The Company's results of operations included an increase in estimated incurred
losses and LAE related to prior years of $156,074, $51,491, and $366 in 1996,
1995, and 1994, respectively. 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
year is as follows: prior to 1987: $16,000; 1987-1991: $101,000; and 1992 and
subsequent years: $(15,000). In 1995 and 1994, 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; 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,
F-12
<PAGE>
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 and 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 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 $110,000.
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. Also, during 1996, management undertook efforts to reduce
its exposure to claimants from the pre-1992 accident years through a more formal
commutation program (See below for further discussion).
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 is 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 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 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
F-13
<PAGE>
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 other loss reserves
because of several factors, including: (1) evolving methodologies for the
estimation of the liabilities; (2) lack of reliable historical claim data; (3)
uncertainties with respect to insurance and reinsurance coverage related to
these obligations; (4) changing judicial interpretations; and (5) changing
government standards.
The Company's asbestos related losses were as follows:
Years Ended December 31,
------------------------
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves................................. $ 27,611 $13,969 $12,913
Incurred losses and LAE............................ 62,854 22,482 6,424
Calendar year payments for losses and LAE.......... (10,410) (8,840) (5,368)
-------- ------- -------
Ending reserves.................................... $ 80,055 $27,611 $13,969
======== ======= =======
Net of reinsurance:
Beginning reserves................................. $ 23,443 $ 8,168 $ 7,700
Incurred losses and LAE............................ 39,427 21,826 5,834
Calendar year payments for losses and LAE......... (9,570) (6,551) (5,366)
-------- ------- -------
Ending reserves.................................... $ 53,300 $23,443 $ 8,168
======== ======= =======
</TABLE>
The Company's environmental-related losses were as follows:
Years Ended December 31,
------------------------
(dollar amounts in thousands)
<TABLE>
<CAPTION>
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves................................. $20,134 $20,952 $26,129
Incurred losses and LAE............................ 22,143 3,516 (2,150)
Calendar year payments for losses and LAE.......... (6,651) (4,334) (3,027)
------- ------- -------
Ending reserves.................................... $35,626 $20,134 $20,952
======= ======= =======
Net of reinsurance:
Beginning reserves................................. $20,134 $20,952 $26,129
Incurred losses and LAE............................ 21,109 3,516 (2,150)
Calendar year payments for losses and LAE......... (6,651) (4,334) (3,027)
------- ------- -------
Ending reserves.................................... $34,592 $20,134 $20,952
======= ======= =======
</TABLE>
F-14
<PAGE>
Of the total net asbestos and environmental reserves, $19,296 were for
established claims reserves at December 31, 1996 ($17,100 at December 31, 1995)
and $68,596 were for incurred but not reported losses ($26,500 at December 31,
1995). 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 Property and Casualty
Group include approximately $1,012,000 and $1,024,000 at December 31, 1996 and
1995, respectively, discounted to present value. The approximate discount rate
used was 5% at December 31, 1996 and 1995. 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 ($0.92 per
primary share and $0.91 per fully-diluted share).
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,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Balance at January 1........................... $ 37,901 $ 32,236 $ 30,392
Deferral of acquisition costs.................. 96,397 92,872 85,371
Amortization of deferred acquisition costs..... (90,292) (87,207) (83,527)
-------- -------- --------
Balance at December 31......................... $ 44,006 $ 37,901 $ 32,236
======== ======== ========
</TABLE>
5. Reinsurance
In the ordinary course of business, PMC's insurance and reinsurance subsidiaries
assume and cede reinsurance with other insurance companies and are members of
various pools and associations. The insurance and reinsurance 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
F-15
<PAGE>
catastrophic event. The insurance and reinsurance 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.
The components of net premiums earned and losses and LAE incurred are as
follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
---- ---- ----
Earned Premiums:
<S> <C> <C> <C>
Direct.......................... $299,386 $370,590 $379,216
Assumed......................... 209,688 149,838 147,876
Ceded........................... (88,499) (35,476) (60,558)
-------- -------- --------
Net............................... $420,575 $484,952 $466,534
======== ======== ========
Losses and LAE Incurred:
Direct.......................... $420,157 $317,552 $336,183
Assumed......................... 163,799 127,910 109,246
Ceded........................... (47,333) (22,884) (42,560)
-------- -------- --------
Net............................... $536,623 $422,578 $402,869
======== ======== ========
</TABLE>
The Company performs extensive credit reviews on its reinsurers, focusing on,
among other things, financial capacity, stability, trends and apparent
commitment to the reinsurance business. Prospective and existing reinsurers
failing to meet the Company's standards are not accepted into 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
Pennsylvania, the state of domicile of the Company's domestic insurance
subsidiaries. At December 31, 1996, 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......... $84,802 A
American Re-Insurance Corporation................... 34,009 A+
Kemper Reinsurance Corporation...................... 17,421 A
Odyssey Reinsurance................................. 15,614 A-
</TABLE>
The Company maintained funds held to collateralize the above balances in the
amount of $86,301 at December 31, 1996. 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.
F-16
<PAGE>
6. Long-Term Debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
<S> <C> <C>
Senior notes 9.35%, due 1996......................... $ -- $ 8,572
Senior notes 9.53%, due 1997 (A)..................... 7,143 14,286
Senior notes 9.60%, due 2001 (B)..................... 46,428 55,714
Senior notes 7.62%, due 2001, Series A (C)........... 71,000 71,000
Senior notes 7.62%, due 2000, Series B............... 36,000 36,000
Revolving credit agreement, expiring in 1998......... 44,000 18,000
Mortgage notes....................................... 128 276
-------- --------
Long-term debt....................................... $204,699 $203,848
======== ========
</TABLE>
(A) Maturing in annual installment of $7,143 in 1997.
(B) Maturing in annual installments of $9,286 through 2001.
(C) Maturing in annual installments of $23,667 commencing in 1999 through 2001.
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....... 36,000/(1)/
---------
Total.............................................. $ 189,428
=========
</TABLE>
/(1)/ The company repaid $8,000 of the revolving credit agreement subsequent to
December 31, 1996.
The early extinguishment of the senior note agreements will result in an
extraordinary loss of $4,732 ($7,279 pre-tax). The New Credit Facility bears
interest at LIBOR plus .70% on the utilized portion and carries as .275%
facility fee on the unutilized portion. The spread over LIBOR and the facility
fee is adjustable downward based upon the Company's debt to capitalization
ratios in the future. As of March 14, 1997, the interest rate on the New Credit
Facility was 5.70%. The Company entered into an interest rate swap agreement on
March 14, 1997, covering $150,000 notional principal of the New Credit Facility.
The interest rate swap effectively converts the floating rate to a fixed rate of
7.24% on such portion of the New Credit Facility.
The final expiration of the New Credit Facility is December 31, 2002, with level
25% reductions in availability beginning December 31, 1999. The following
reflects the scheduled maturities of the Company's debt agreements over the next
five years as they existed at December 31, 1996 and as adjusted for the New
Credit Facility:
<TABLE>
<CAPTION>
As of December 31, 1996 As Adjusted
----------------------- -----------
<S> <C> <C>
1997............................... $16,557 $ 7,271
1998............................... 53,286 --
1999............................... 32,952 8,500
2000............................... 68,952 62,500
2001............................... 32,952 62,500
</TABLE>
F-17
<PAGE>
In November 1996, the Company entered into a letter of credit agreement with a
group of banks that extends through November 1997. The agreement allows the
issuing bank to issue letters of credit having an aggregate outstanding face
amount up to $75,000. The agreement requires the Company to pay a commitment fee
during the existence of the agreement equal to .1875% per annum on the average
daily available amount. At December 31, 1996, the aggregate outstanding face
amount of letters of credit issued was $47,461. This agreement primarily secures
reinsurance liabilities of the insurance subsidiaries of the Company. Effective
March 14, 1997, this facility was reduced to an aggregate outstanding face
amount not to exceed $50,000.
During 1995, the Company issued $71,000 of 7.62% Series A Senior notes and
$36,000 of 7.62% Series B Senior notes. The notes pay interest semi-annually and
mature in July 2001 and 2000, respectively. The proceeds were utilized to retire
indebtedness under the revolving credit agreement due in 1995. This debt was
retired in the first quarter of 1997 (See above).
In August 1995, the Company entered into a $50,000 revolving credit facility
with a group of banks that originally extended through August 1998. The rate of
interest payable under the agreement was, at the Company's option, a function of
the prime rate or LIBOR. The agreement required the Company to pay a facility
fee equal to the Company's applicable fee percentage (such percentage was
dependent on the Company's leverage ratio as defined per the revolving credit
facility agreement) per annum of the average daily sum of the aggregate
commitments, regardless of usage. At December 31,1996, the Company had $44,000
outstanding under this agreement and $6,000 available to be drawn. The average
interest rate on the amounts outstanding and the applicable fee percentage under
this agreement were 6.08% and .25%, respectively, at December 31, 1996 and 6.19%
and .25%, respectively, at December 31, 1995. This facility was replaced with
the New Credit Facility in the first quarter of 1997 (See above).
The debt covenants supporting the senior notes, revolving credit agreement,
letter of credit agreement, and the New Credit Facility 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).
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 one of its fixed rate senior note
arrangements to a floating rate obligation as follows:
<TABLE>
<CAPTION>
Principal Balance at
Debt Agreement December 31, 1996 Fixed Rate Floating Rate
-------------------- ----------- --------------
<S> <C> <C> <C>
Senior Notes, due 1997........................ $7,143 9.53% 5.60%
</TABLE>
The variable rate resets every six 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 counter party fails to meet the terms of the
agreement, the Company's exposure is limited to the interest rate differential
on the notional principal amount ($7,143). 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 4,163,726 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
generally have a maximum term of ten years, vest over three years, and are
typically granted with an exercise price equal to the fair market value of the
stock. Information regarding these option plans for 1996, 1995, and 1994 are as
follows:
F-18
<PAGE>
<TABLE>
<CAPTION>
1996 1995 1994
-----------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Shares Price Shares Price Shares Price
---------- -------- ---------- -------- ---------- --------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
beginning of year...... 3,087,260 $ 11.80 2,926,000 $ 10.41 2,230,000 $ 9.82
Options granted.......... 325,000 17.00 775,000 15.59 740,000 12.11
Options exercised........ (99,150) (8.33) (205,199) (8.66) (26,925) (8.56)
Options canceled......... (70,950) (11.55) (408,541) (10.65) (17,075) (9.52)
--------- ------- --------- ------- --------- ------
Options outstanding,
end of year............ 3,242,160 $ 12.43 3,087,260 $ 11.80 2,926,000 $10.41
========= ======= ========= ======= ========= ======
Option price range at
end of year............. $8.00 to $17.00 $6.60 to $16.00 $6.60 to $12.75
Option price range for
exercised shares........ $6.60 to $10.00 $6.60 to $11.50 $8.00 to $10.00
Options available for
grant at end of year.... 921,566 425,616 42,075
</TABLE>
Stock options outstanding at December 31, 1996 and related weighted average
price and life information is as follows:
<TABLE>
<CAPTION>
Weighted
Options Options Average
Outstanding at Exercisable at Remaining Life
Exercise Prices December 31, 1996 December 31, 1996 (in years)
- --------------- ----------------- ----------------- ----------
<S> <C> <C> <C>
$8.00.................... 427,060 394,560 4.49
10.00.................... 535,600 535,600 5.46
11.50.................... 865,000 865,000 6.64
12.75.................... 326,500 243,875 7.17
15.00.................... 316,135 295,510 8.45
16.00.................... 446,865 173,490 8.43
17.00.................... 325,000 134,050 9.56
--------- ---------
3,242,160 2,642,085
========= =========
</TABLE>
The fair value of options at date of grant was estimated using a binomial model
with the following weighted average assumptions:
<TABLE>
<CAPTION>
1996 1995(1) 1995(2) 1994
----- ------- ------- -----
<S> <C> <C> <C> <C>
Expected life (years).............. 10 10 10 10
Interest rate...................... 6.8% 6.1% 6.2% 6.8%
Volatility......................... 18% 18% 18% 18%
Dividend yield..................... 2.3% 2.3% 2.3% 2.3%
</TABLE>
(1) Options granted on June 5, 1995
(2) 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
F-19
<PAGE>
grant date for awards granted during the year, pretax income would have been
reduced by $2,079 ($1,352 after tax, or $0.06 per share), $4,308 ($2,800 after
tax, or $0.11 per share), and $3,225 ($2,096 after tax, or $0.09 per share) in
1996, 1995, and 1994, respectively.
8. Income Taxes
A reconciliation between the total (benefit) provision for income taxes and the
amounts computed at the Statutory Federal income tax rate of 35% for the years
1996, 1995 and 1994 is as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Computed at the Statutory tax rate............ $(66,988) $ 12,220 $ 22,883
(Decrease) increase in taxes resulting from:
Excludable dividends........................ (36) (107) (273)
Tax-exempt interest......................... (4,547) (12,917) (14,697)
Losses of foreign reinsurance affiliate..... 16,060 8,469 --
Other....................................... (549) 3,118 217
-------- -------- --------
(Benefit) provision for income taxes.......... $(56,060) $ 10,783 $ 8,130
======== ======== ========
</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,
1996 1995
---- ----
<S> <C> <C>
Allowance for uncollectible accounts.......... $ 9,037 $ 7,176
Unearned premiums............................. 13,386 12,518
Discounting of unpaid losses.................. 51,086 56,119
Unrealized depreciation of investments........ 13,394 --
Depreciation.................................. 5,646 --
Postretirement benefit obligation............. 5,111 4,723
Tax carryforwards............................. 67,014 13,996
Other......................................... 9,458 9,684
-------- --------
Gross deferred tax asset...................... 174,132 104,216
-------- --------
Deferred acquisition costs.................... (15,352) (13,265)
Pension asset................................. (1,348) (1,178)
Depreciation.................................. -- (392)
Unrealized appreciation of investments........ -- (9,429)
Earned but unbilled premiums.................. -- (2,090)
Losses of foreign reinsurance affiliate....... (55,790) (9,295)
Other......................................... -- (1,236)
-------- --------
Gross deferred tax liability.................. (72,490) (36,885)
-------- --------
Net deferred tax asset........................ $101,642 $ 67,331
======== ========
</TABLE>
At December 31, 1996, the Company had $153,214 of net operating loss
carryforwards (expiring in 2011) and $13,328 of alternative minimum tax credit
carryforwards (which do not expire).
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 then 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.
F-20
<PAGE>
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>
<CAPTION>
<S> <C>
Pension costs................................................................. $4,300
Postemployment costs.......................................................... 2,360
Postretirement costs.......................................................... 975
------
$7,635
======
</TABLE>
A. Pension and Retirement Plans -- The Company sponsors a non-contributory
defined benefit pension plan (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 components of net pension cost are as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Service cost-benefits earned during the period.. $ 1,665 $ 1,132 $ 1,344
Interest cost on projected benefit obligation... 2,948 2,770 2,464
Actual return on plan assets.................... (2,830) (8,712) 715
Net amortization and deferral................... (842) 5,803 (3,564)
VERIP........................................... 4,300 -- --
------- ------- -------
Net pension cost................................ $ 5,241 $ 993 $ 959
======= ======= =======
</TABLE>
The funded status of the Pension Plan is as follows:
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
<S> <C> <C>
Actuarial present value of:
Vested benefit obligation.................................... $41,932 $31,401
Non-vested benefit obligation................................ 3,487 4,288
------- -------
Accumulated benefit obligation................................. $45,419 $35,689
======= =======
Projected benefit obligation................................... $49,331 $40,293
Fair value of Pension Plan assets.............................. 46,739 43,433
------- -------
Pension Plan assets (less than) in excess of projected benefit
obligation..................................................... (2,592) 3,140
Unrecognized net loss.......................................... 588 2,723
Unrecognized transition asset.................................. (1,081) (1,198)
Unrecognized prior service benefit............................. (1,199) (1,298)
------- -------
Pension (liability) asset...................................... $(4,284) $ 3,367
======= =======
</TABLE>
F-21
<PAGE>
Pension Plan assets consist of equity securities, fixed maturity securities,
fixed income contracts, and the Company's common stock.
Actuarial assumptions utilized by the Pension Plan are as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Discount rate..................................... 7.5% 7.0% 8.5%
Rate of compensation increase..................... 5.0% 5.0% 5.5%
Expected long-term rate of return on plan assets.. 8.0% 8.0% 7.5%
</TABLE>
The Company also maintains a voluntary defined contribution savings plans
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 $2,153, $1,726 and $1,692 in 1996, 1995 and
1994, 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,
1996 1995
---- ----
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees and dependents.......................... $ 6,931 $ 4,423
Fully eligible active employees.................. 952 1,022
Active employees not fully eligible.............. 1,871 2,004
------- -------
Total............................................ 9,754 7,449
Unrecognized prior service cost.................. 1,436 2,149
Unrecognized net gain............................ 4,031 3,649
------- -------
Accrued postretirement benefit liability......... $15,221 $13,247
======= =======
</TABLE>
The components of postretirement benefit cost include the following:
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Service cost.......................... $ 248 $ 330 $ 434
Interest cost......................... 561 658 886
Amortization.......................... (251) (209) 43
VERIP................................. 975 -- --
------ ----- ------
Postretirement benefit cost........... $1,533 $ 779 $1,363
====== ===== ======
</TABLE>
F-22
<PAGE>
Assumptions used in the computation of the funded status and postretirement
benefit cost are as follows:
<TABLE>
<CAPTION>
For the years ended December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Discount rate......................... 7.0% 7.0% 8.5%
Health care inflation rate:
Next year........................... 8.0% 8.5% 9.5%
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 8% for 1996 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 $360 and the
annual service and interest cost by $24.
C. Postemployment Benefits -- Effective January 1, 1994, the Company adopted
SFAS No. 112, "Employers' Accounting for Postemployment Benefits." SFAS No. 112
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. The effect of the
implementation of the standard on prior years was immaterial.
In connection with the VERIP described above, the Company recorded $2,360 of
postemployment costs in 1996.
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.
<TABLE>
<CAPTION>
December 31, 1996 December 31, 1995
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Fixed maturities available for sale...... $2,126,120 $2,126,120 $2,230,992 $2,230,992
Equity securities........................ 262 262 10,886 10,886
Financial liabilities:
Long-term debt........................... 204,699 218,101 203,848 216,408
Interest rate swap agreements............ -- 52 -- 174
</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:
F-23
<PAGE>
<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 insurance and
reinsurance 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
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
The Property and Casualty Group-total.......... 63.0% 68.8% 75.7%
The Property and Casualty Group-workers'
compensation................................. 45.6 42.8 57.2
PMA Re-total................................... 37.0 31.2 24.3
PMA Re-casualty reinsurance lines.............. 27.5 21.9 19.0
</TABLE>
The Property and Casualty Group's operations are concentrated in six contiguous
states in the Mid- Atlantic and Southern regions. 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 process, unfavorable developments in these factors
could have an adverse impact on the Company's financial condition and results of
operations.
PMA Re distributes its products through major reinsurance brokers. PMA Re's top
five such brokers accounted for 74.2% of PMA Re's gross premiums in force at
December 31, 1996.
While the Company focuses primarily on casualty lines of insurance and
reinsurance, certain property lines subject the Company to exposure to
catastrophic losses from natural disasters. However, management believes that
the Company appropriately manages concentrations of insured values in disaster-
prone areas and maintains sufficient reinsurance protection to minimize the risk
of a significant loss from a catastrophic event. The catastrophes that occurred
in the three year period ended December 31, 1996 did not have a significant
impact on the Company's results of operations.
F-24
<PAGE>
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, 1996, the Company
carried $2,091,072 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.
Management believes that its unpaid losses and loss adjustment expenses are
fairly stated at December 31, 1996, 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, 1996, the related adjustments could have a
material adverse impact on the Company's financial condition and results of
operations (See also Note 3).
Former Headquarters Building and Related Properties -- The Company owns its
former headquarters building and certain adjacent properties in Philadelphia. As
of December 31, 1996, the carrying value of these properties was $13,043.
Although the Company has leased a portion of such properties and has had
discussions with potential purchasers and additional lessees, no assurance can
be given that the Company will be able to sell or lease the facilities in the
near term on acceptable terms and conditions. In 1995 and 1994, the Company
recorded charges of $8,370 and $4,900, respectively, in operating expenses, to
reflect writedowns to fair market value of the properties less estimated costs
to sell. There were no such charges in 1996. While management believes that the
carrying values of the facilities are fairly stated at December 31, 1996, future
determinations of the fair market values of the properties will be dependent
upon market conditions in subsequent periods.
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 (29.4%
of the class) and 912,225 shares of Class A Common Stock (11.0% of the class),
which constitutes 28.4% of the total number of votes available to be cast in
matters brought before the Company's shareholders. Members of the Company's
Board of Directors currently serve as the members of the Foundation's Board of
Trustees. Also, Frederick W. Anton III, Chairman and Chief Executive Officer 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 affiliates receive
reimbursement; total reimbursements amounted to $82, $269, and none for years
ended December 31, 1996, 1995, and 1994, respectively. The Foundation also
leases its Harrisburg, Pennsylvania headquarters facility from a subsidiary of
the Company under a monthly operating lease presently requiring rent
F-25
<PAGE>
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
$247, $294, and $315, for the years ended December 31, 1996, 1995, and 1994,
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 75% 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, 1996 under this program was $3,106.
The Company incurred legal and consulting fees aggregating approximately $7,917,
$6,279 and $4,798 in 1996, 1995 and 1994, respectively, from firms in which
directors of the Company are partners.
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 $1,162 and $3,896 as of December 31, 1996 and
December 31, 1995, respectively. The interest rate on the notes is 6.0%.
13. Commitments and Contingencies
For the years ended December 31, 1996, 1995 and 1994, total rent expense was
$6,114, $4,536 and $4,543 respectively. At December 31, 1996, 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>
1997.................................. $ 4,198
1998.................................. 3,172
1999.................................. 2,017
2000.................................. 935
2001.................................. 921
Thereafter............................ 3,086
-------
Total................................. $14,329
=======
</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 charges these assessments to income in the period in
which it is notified of an insolvency. The Company is not aware of any material
potential assessments at December 31, 1996.
The Company has provided guarantees of approximately $10,150 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 engage in the practice of selling uncollected
premiums to a financial institution. The proceeds received from such sales were
$10,628, $19,509 and $3,023 in 1996, 1995 and
F-26
<PAGE>
1994, respectively. These receivables are excluded from uncollected premiums in
the accompanying balance sheets. However, the Company has recorded an allowance
for doubtful accounts related to the estimated uncollectible accounts since the
Company has retained risk under the recourse provisions. At December 31, 1996,
the Company was contingently obligated to repurchase $10,628 of uncollected
premiums under recourse provisions.
15. Shareholders' Equity
The Company maintains 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, 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, 1996, the maximum amount
available to be paid as dividends from the Company's insurance subsidiaries,
without the prior consent of the Pennsylvania Insurance Department, was $51,874.
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, on a pro forma basis under the most restrictive debt covenant, the
Company could pay dividends of approximately $11,000 in 1997.
F-27
<PAGE>
16. Business Segments
Operating revenues, (loss) income before income taxes, and identifiable assets
of the Company's business segments were as follows:
<TABLE>
<CAPTION>
For the year ending December 31,
1996 1995 1994
---- ---- ----
<S> <C> <C> <C>
Operating revenues (1)
The Property and Casualty Group
Net premiums earned................................... $ 268,601 $ 345,607 $ 361,124
Net investment income................................. 82,455 92,275 96,683
Service revenues...................................... 9,189 5,106 3,380
--------- --------- ---------
360,245 442,988 461,187
--------- --------- ---------
PMA Re
Net premiums earned................................... 151,974 139,345 105,410
Net investment income................................. 48,676 45,166 42,068
--------- --------- ---------
200,650 184,511 147,478
--------- --------- ---------
Corporate, Other and Consolidating Eliminations
Net investment income................................. 2,805 1,914 (32)
--------- --------- ---------
2,805 1,914 (32)
--------- --------- ---------
Total operating revenues.................................. $ 563,700 $ 629,413 $ 608,633
========= ========= =========
(Loss) income before income taxes
The Property and Casualty Group......................... $(219,619) $ (4,305) $ 3,893
PMA Re.................................................. 42,783 39,443 33,703
Corporate, Other and Consolidating Eliminations......... (490) (13,414) (6,686)
--------- --------- ---------
Pre-tax operating (loss) income before interest expense. (177,326) 21,724 30,910
Net realized investment gains........................... 2,984 31,923 47,521
Interest expense........................................ (17,052) (18,734) (13,051)
--------- --------- ---------
Total (loss) income before income taxes................... $(191,394) $ 34,913 $ 65,380
========= ========= =========
</TABLE>
(1) Operating revenues exclude net realized investment gains.
<TABLE>
<CAPTION>
December 31,
1996 1995
---- ----
<S> <C> <C>
Identifiable assets
The Property and Casualty Group........................ $ 2,423,463 $ 2,284,173
PMA Re................................................. 1,031,149 984,211
Corporate, Other and Consolidating Eliminations........ (337,096) (9,812)
----------- -----------
Total identifiable assets................................ $ 3,117,516 $ 3,258,572
=========== ===========
</TABLE>
F-28
<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, 1996 and 1995, and
the related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1996. 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, 1996
and 1995, and the consolidated results of their operations and their cash flows
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting principles.
/s/ Coopers & Lybrand L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
February 14, 1997, except for Notes 6 and 15,
as to which the date is March 14, 1997
F-29
<PAGE>
Pennsylvania Manufacturers Corporation
Condensed Consolidated Statements of Operations (Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
(in thousands, except per share data) 1997 1996 1997 1996
------------- ------------ ------------ -------------
<S> <C> <C> <C> <C>
Revenues
Net premiums written $ 98,389 $ 96,336 $ 248,271 $ 243,780
Change in net unearned premiums 20,762 12,190 (15,870) (12,617)
Change in accrued retrospective premiums (4,700) (6,300) (10,000) (11,000)
------------- ------------ ------------ -------------
Net premiums earned 114,451 102,226 222,401 220,163
Net investment income 32,612 32,511 68,459 65,931
Net realized investment losses (680) (1,412) (1,931) (469)
Service revenues 2,490 2,264 5,038 4,012
------------- ------------ ------------ -------------
Total revenues 148,873 135,589 293,967 289,637
------------- ------------ ------------ -------------
Losses and Expenses
Losses and loss adjustment expenses 98,230 85,512 193,134 185,455
Amortization of deferred acquisition costs 28,130 24,817 46,469 46,548
Operating expenses 19,963 17,195 36,905 33,774
Dividends to policyholders 3,360 2,730 6,617 5,852
Interest expense 3,888 4,358 8,222 8,830
------------- ------------ ------------ -------------
Total losses and expenses 153,571 134,612 291,347 280,459
------------- ------------ ------------ -------------
(Loss) income before income taxes and (4,698) 977 2,620 9,178
extraordinary item
(Benefit) provision for income taxes:
Current -- 1,479 (353) 3,005
Deferred (5,218) (1,618) (2,304) (572)
------------- ------------ ------------ -------------
Total (benefit) provision (5,218) (139) (2,657) 2,433
------------- ------------ ------------ -------------
Income before extraordinary item 520 1,116 5,277 6,745
Extraordinary loss from early
extinguishment of debt ( net of income
tax benefit of $2,549) - - (4,734) -
------------- ------------ ------------ -------------
Net income $ 520 $ 1,116 $ 543 $ 6,745
============= ============ ============ =============
Per Share Data:
Weighted Average Common Shares and
Common Share Equivalents 24,416 24,768 24,467 24,921
============= ============ ============ =============
Income before extraordinary item $ 0.02 $ 0.05 $ 0.22 $ 0.27
Extraordinary item - - (0.19) -
------------- ------------ ------------ -------------
Net income $ 0.02 $ 0.05 $ $ 0.02 $ 0.27
============= ============ ============ =============
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-30
<PAGE>
Pennsylvania Manufacturers Corporation
Condensed Consolidated Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
June 30, December 31,
1997 1996
- ------------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Investments:
Fixed maturities available for sale, at fair value
(amortized cost: 1997 -- $2,064,156; 1996 -- $2,164,391) $ 2,014,684 $ 2,126,120
Equity Securities, at fair value
(cost: 1997 and 1996 -- $259) 264 262
Short-term investments, at amortized cost
which approximates fair value 52,880 134,971
------------------------------------
Total investments 2,067,828 2,261,353
87,738 7,176
25,935 30,268
Cash
Investment income due and accrued
Uncollected premiums (net of allowance for
uncollectible accounts: 1997 -- $19,017; 1996 -- $18,877) 333,167 285,982
Reinsurance receivable (net of allowance for uncollectible
reinsurance: 1997 -- $2,567; 1996 -- $3,901) 284,465 257,983
Other assets 286,507 274,754
------------------------------------
Total assets $ 3,085,640 $ 3,117,516
====================================
Liabilities $ 2,052,791 $ 2,091,072
Unpaid losses and loss adjustment expenses 236,169 205,982
Unearned premiums 203,049 204,699
Long-term debt 178,511 189,935
Other liabilities ------------------------------------
Total liabilities 2,670,520 2,691,688
------------------------------------
Shareholders' Equity
Common stock, $5 par value (40,000 shares authorized; 15,663
issued and 15,228 outstanding -- 1997; 16,095 shares issued
and 15,670 outstanding -- 1996) 78,317 80,477
Class A common stock, $5 par value (40,000 shares authorized;
8,680 shares issued and 8,634 outstanding -- 1997; 8,248 shares
issued and 8,173 outstanding -- 1996) 43,399 41,239
Retained earnings 332,938 336,921
Unrealized loss on investments available for sale
net of deferred income taxes: $17,314 and $13,394) (32,154) (24,874)
Notes receivable from officers (1,093) (1,162)
Treasury stock, at cost;
Common stock (435 shares -- 1997; 425 shares -- 1996) (5,572) (5,408)
Class A common stock (46 shares -- 1997; 75 shares -- 1996) (715) (1,365)
------------------------------------
Total shareholders' equity 415,120 425,828
------------------------------------
Total liabilities and shareholders' equity $ 3,085,640 $ 3,117,516
====================================
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-31
<PAGE>
Pennsylvania Manufacturers Corporation
Condensed Consolidated Statements of Cash Flows (Unaudited)
<TABLE>
<CAPTION>
For the six months ended
June 30, June 30,
(in thousands) 1997 1996
------------------------------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 543 $ 6,745
Adjustments to reconcile net income to net cash flows used by operating activities:
Depreciation 3,945 3,831
Amortization 3,160 3,494
Benefit for deferred income taxes (2,304) (572)
Extraordinary loss from early extinguishment of debt (4,734) --
Net realized investment losses 1,931 469
Change in uncollected premiums and unearned premiums, net (16,998) 8,738
Change in dividends to policyholders 883 537
Change in reinsurance receivables (26,482) (10,215)
Change in unpaid losses and loss adjustment expenses (38,281) (51,844)
Change in investment income due and accrued 4,333 (2,961)
Change in deferred acquisition costs (3,823) (4,488)
Other, net (11,966) (4,283)
------------------------------------
Net cash flows used by operating activities (89,793) (50,549)
------------------------------------
Cash flows from investing activities:
Fixed maturity investments available for sale:
Purchases (771,135) (948,507)
Maturities or calls 75,400 35,903
Sales 790,994 858,172
Equity securities:
Purchases - (4,349)
Sales - 4,539
Net sales of short-term investments 81,974 116,939
Net (purchases) sales of furniture and equipment (2,239) 225
------------------------------------
Net cash flows provided by investing activities 174,994 62,922
------------------------------------
Cash flows from financing activities:
Proceeds from issuances of long-term debt 210,000 -
Repayments of long-term debt (211,650) (7,216)
Dividends paid to shareholders (3,982) (3,964)
Treasury stock transactions, net 486 (2,058)
Repayments of notes receivable from officers 507 2,152
------------------------------------
Net cash flows used by financing activities (4,639) (11,086)
------------------------------------
Net increase in cash 80,562 1,287
Cash January 1 7,176 9,170
------------------------------------
Cash June 30 $ 87,738 $ 10,457
====================================
</TABLE>
See accompanying notes to the condensed consolidated financial statements.
F-32
<PAGE>
Notes to the Interim Condensed Consolidated Financial Statements
(dollar amounts in thousands, except per share data)
1. General
Pennsylvania Manufacturers Corporation (PMC) is an insurance holding company
that sells property and casualty insurance and reinsurance through its insurance
subsidiaries. With the exception of certain foreign affiliates, PMC's insurance
subsidiaries are domiciled in Pennsylvania. Its property and casualty insurance
subsidiaries (the Property and Casualty Group) write workers' compensation and
other lines of commercial insurance primarily in the Mid-Atlantic and Southern
regions of the United States. 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.
The accompanying consolidated financial statements include the accounts of PMC
and its wholly and majority owned subsidiaries (the Company), and 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. Financial statements prepared in accordance with GAAP
require the use of management estimates. 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 1997 presentation.
Operating results for the three and six months ended June 30, 1997, are not
necessarily indicative of the results to be expected for the full year. For
further information, refer to the December 31, 1996, audited consolidated
financial statements and footnotes thereto included in PMC's Registration
Statement on Form 10.
2. Per Share Data
Earnings per share data are based on weighted average common shares and common
share equivalents outstanding during the period. Common stock options are
considered common stock equivalents and are included in average share
calculations if dilutive. See footnote 3 regarding the impact of SFAS No. 128.
3. Accounting Pronouncements
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 currently participate in a transfer arrangement of
certain accounts receivable. Such arrangement has been restructured as a result
of the adoption of SFAS No. 125. The restructuring of such arrangement did not
have a material impact on the Company's financial condition or results of
operations.
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. SFAS No. 128, which is
effective for financial statements for both interim and annual periods ending
after December 15, 1997, requires presentation of earnings per share by all
entities that have issued common stock or potential common stock if those
securities trade in a public market either on a stock exchange or in the over-
the-counter market, including securities quoted only locally or regionally.
SFAS No. 128 establishes a new calculation for earnings per share showing both
basic and diluted earnings per share.
F-33
<PAGE>
Basic earnings per share will be calculated using only weighted average shares
outstanding with no dilutive impact from common stock equivalents while diluted
earnings per share will be calculated similar to the current fully diluted
earnings per share calculation. All prior period earnings per share amounts will
be restated to be consistent with the new requirements. If earnings per share
had been calculated in accordance with SFAS No. 128, the basic earnings per
share and diluted earnings per share for the three and six months ended June 30,
1997, would have been as follows:
<TABLE>
<CAPTION>
Three Months Ended Six Months Ended
June 30, June 30,
1997 1996 1997 1996
---- ---- ---- ----
<S> <C> <C> <C> <C>
Income before extraordinary item.......... $0.02 $0.05 $0.22 $0.28
Extraordinary item........................ -- -- (0.20) --
----- ----- ------ -----
Net income................................ $0.02 $0.05 $0.02 $0.28
</TABLE>
4. Long-Term Debt
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 1998 36,000/(1)/
---------
Total.................................... $ 189,428
=========
</TABLE>
(1) The Company repaid $8,000 of the revolving credit agreement subsequent to
December 31, 1996.
The early extinguishment of the senior note agreements resulted in an
extraordinary loss of $4,734, ($7,283 pre-tax) recorded in the first quarter of
1997. The New Credit Facility bears interest at LIBOR plus .70% on the utilized
portion and carries a .275% facility fee on the unutilized portion. The spread
over LIBOR and the facility fee adjustable downward based upon the Company's
debt to capitalization ratios in the future. As of June 30, 1997, the interest
rate on the New Credit Facility was 6.24%. The Company entered into an interest
rate swap agreement on March 14, 1997, covering $150,000 notional principal of
the New Credit Facility. The interest rate swap effectively converts the
floating rate to a fixed rate of 7.24% on such portion of the New Credit
Facility. At June 30, 1997, the Company had $203,000 outstanding under the
Company's New Credit Facility, with $32,000 available for additional borrowings.
F-34
<PAGE>
Item 14. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
Item 15. Financial Statements and Exhibits
a) Financial Statements. See Item 13 of this Form 10 Registration Statement.
The following Financial Statement Schedules are being filed with this
registration statement:
<TABLE>
<CAPTION>
Schedule No. Description Page
------------ ----------- ----
<S> <C> <C>
I Summary of Investments - Other Than S-1
Investments in Related Parties at
December 31, 1996
II Condensed Financial Information of S-2 - S-4
Registrant as of December 31, 1996
and 1995 and for the years ended
December 31, 1996, 1995 and 1994
III Supplementary Insurance Information S-5
for the years ended December 31, 1996,
1995 and 1994
IV Reinsurance for the years ended S-6
December 31, 1996, 1995 and 1994
V Valuation and Qualifying Accounts S-7
for the years ended December 31, 1996,
1995 and 1994
VI Supplementary Information Concerning S-8
Property & Casualty Insurance Operations
for the years ended December 31, 1996,
1995 and 1994
</TABLE>
Schedules other than those listed above are omitted for the reason that they are
not applicable.
89
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule I
Summary of Investments-Other Than Investments in Related Parties
December 31, 1996
<TABLE>
<CAPTION>
Amount at
which shown in
Type of investment Cost Value the balance sheet
- ----------------------------------------------------------------------------------------------------------------
(Dollar amounts in thousands)
Fixed maturities:
<S> <C> <C> <C>
Bonds:
U.S. Treasury Securities and obligations of U.S.
Government agencies $ 1,640,881 $ 1,602,744 $ 1,602,744
Obligations of states and political subdivisions 77,562 76,527 76,527
Corporate debt securities 372,620 372,846 372,846
Mortgage-backed securities 73,328 74,003 74,003
-------------- ------------- -----------------
Total fixed maturities 2,164,391 2,126,120 2,126,120
-------------- ------------- -----------------
Equity securities:
Common Stocks:
Industrial, miscellaneous and all other 259 262 262
-------------- ------------- -----------------
Total equity securities 259 262 262
-------------- ------------- -----------------
Short-term investments 134,971 134,971 134,971
-------------- ------------- -----------------
Total investments $ 2,299,621 $ 2,261,353 $ 2,261,353
============== ============= =================
</TABLE>
S-1
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule II
Condensed Balance Sheets
(Parent Company Only)
<TABLE>
<CAPTION>
as of December 31, (in thousands, except share data) 1996 1995
- ----------------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Cash $ -- $ 799
----------------------------------
Investments - other than related parties:
Fixed maturities:
Available for sale, at fair value
(amortized cost: 1996 - $ - ; 1995 - $34) -- 45
Equity securities, at fair value
(cost: 1996 - $ - ; 1995 - $45) -- 70
----------------------------------
Total investments -- 115
----------------------------------
Investment in subsidiaries 584,608 832,226
Deferred tax asset, net 36,602 --
Receivables from subsidiaries 727 9,985
Other assets 21,096 3,157
----------------------------------
Total assets $ 643,033 $ 846,282
==================================
Liabilities
Long term debt $ 204,571 $ 203,571
Payables to subsidiaries 1,605 --
Deferred tax liability, net -- 8,146
Dividends payable to shareholders 1,983 1,981
Other liabilities 9,046 22,916
----------------------------------
Total liabilities 217,205 236,614
----------------------------------
Shareholders' Equity
Common stock, $5 par value (40,000,000 shares authorized; 16,095,416 shares
issued and 15,670,052 outstanding - 1996
17,044,580 shares issued and 16,652,016 outstanding - 1995) 80,477 85,223
Class A common stock, $5 par value (40,000,000 shares authorized;
8,247,804 shares issued and 8,173,023 outstanding - 1996
7,298,640 shares issued and 7,225,232 outstanding - 1995) 41,239 36,493
Retained earnings 336,921 480,181
Unrealized (loss) gain on investments of parent company and subsidiaries
(net of deferred income taxes: 1996 - $13,394; 1995 - ($9,429)) (24,874) 17,511
Notes receivable from officers (1,162) (3,896)
Treasury stock, at cost:
Common stock (1996 - 425,364 shares; 1995 - 392,564 shares) (5,408) (4,769)
Class A common stock (1996 - 74,781 shares; 1995 - 73,408 shares) (1,365) (1,075)
----------------------------------
Total shareholders' equity 425,828 609,668
----------------------------------
Total liabilities and shareholders' equity $ 643,033 $ 846,282
==================================
</TABLE>
These financial statements should be read in conjunction with the
Consolidated Financial Statements and the notes thereto.
S-2
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule II
Condensed Statements of Operations
(Parent Company Only)
<TABLE>
<CAPTION>
for the years ended December 31, (in thousands) 1996 1995 1994
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Net investment income $ 354 $ 217 $ 107
Net realized investment gains 35 4 --
Management fees charged to subsidiaries 5,974 350 219
Other related party income 263 1,642 1,623
Miscellaneous income -- -- 245
-----------------------------------------
Total revenues 6,626 2,213 2,194
-----------------------------------------
Expenses:
General expenses 7,082 6,982 3,602
Interest expense 17,039 18,712 13,020
-----------------------------------------
Total expenses 24,121 25,694 16,622
-----------------------------------------
Loss before income taxes and equity in (loss) earnings of subsidiaries (17,495) (23,481) (14,428)
Benefit for income taxes (60,345) (13,210) (3,540)
-----------------------------------------
Income (loss) before equity in (loss) earnings of subsidiaries 42,850 (10,271) (10,888)
Equity in (loss) earnings of subsidiaries (178,184) 34,401 68,138
-----------------------------------------
Net (loss) income $ (135,334) $ 24,130 $ 57,250
=========================================
</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
Condensed Statements of Cash Flows
(Parent Company Only)
<TABLE>
<CAPTION>
for the years ended December 31, (in thousands) 1996 1995 1994
- --------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows From Operating Activities:
Net (loss) income $ (135,334) $ 24,130 $ 57,250
Adjustments to reconcile net (loss) income to net cash flows
provided by operating activities:
Equity in losses (earnings) of subsidiaries 178,184 (34,401) (68,138)
Net realized investment gains (35) (4) --
(Benefit) provision for deferred income taxes (19,822) 7,000 4,688
Dividends received from subsidiaries 53,634 103,213 34,000
Change in income taxes receivable and payable (24,926) 310 (9,677)
Change in other assets and liabilities (8,357) (20,694) 11,933
--------------------------------------------
Net cash flows provided by operating activities 43,344 79,554 30,056
--------------------------------------------
Cash Flows From Investing Activities:
Capital contributions to subsidiaries (50,000) (61,000) (17,100)
Sales of fixed maturity investments 45 2,122 860
Sales (purchases) of equity investments, net 70 (16) (15)
--------------------------------------------
Net cash flows used by investing activities (49,885) (58,894) (16,255)
--------------------------------------------
Cash Flows From Financing Activities:
Change in receivables and payables to subsidiaries 10,863 (12,939) (13,547)
Proceeds from issuance of long-term debt 26,000 125,000 25,000
Repayments of long-term debt (25,000) (125,000) (15,715)
Dividends paid to shareholders (7,926) (7,885) (5,881)
Treasury stock transactions, net (929) 480 (3,893)
Repayments of notes receivable from officers 2,734 478 235
--------------------------------------------
Net cash flows provided (used) by financing activities 5,742 (19,866) (13,801)
--------------------------------------------
Net (decrease) increase in cash (799) 794 --
Cash January 1 799 5 5
============================================
Cash December 31 $ -- $ 799 $ 5
============================================
Supplemental disclosures of cash flow information:
Cash paid (received) for income taxes $ 5,525 $ (951) $ 4,532
Cash paid for interest $ 16,622 $ 15,062 $ 12,899
</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 III
Supplementary Insurance Information
<TABLE>
<CAPTION>
Future policy benefits, Benefits, claims losses
Deferred policy losses, claims, and loss Unearned Premium Net investment and settlement
(in thousands) acquisition costs expenses premiums revenue income(1) expenses
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Year ended December 31, 1996:
The Property and Casualty Group 23,488 1,501,897 127,986 268,601 82,455 424,686
PMA Re 20,518 589,175 77,996 151,974 48,676 111,937
Corporate - - - - 2,805 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total 44,006 2,091,072 205,982 420,575 133,936 536,623
- ----------------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 1995:
The Property and Casualty Group 20,747 1,518,163 124,988 345,607 92,275 318,631
PMA Re 17,154 551,823 67,734 139,345 45,166 103,947
Corporate - - - - 1,914 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total 37,901 2,069,986 192,722 484,952 139,355 422,578
- ----------------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 1994:
The Property and Casualty Group 20,910 1,583,922 138,112 361,124 96,683 324,119
PMA Re 11,326 519,792 51,339 105,410 42,068 78,750
Corporate - - - - (32) -
- ----------------------------------------------------------------------------------------------------------------------------------
Total 32,236 2,103,714 189,451 466,534 138,719 402,869
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
Amortization of Other
deferred policy operating Net Premiums
(in thousands) acquisition costs expenses(2) written
- --------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Year ended December 31, 1996:
The Property and Casualty Group 52,706 86,003 279,422
PMA Re 37,586 8,344 164,053
Corporate - 3,509 -
- ---------------------------------------------------------------------------------------------
Total 90,292 97,856 443,475
- ---------------------------------------------------------------------------------------------
Year ended December 31, 1995:
The Property and Casualty Group 53,420 57,486 337,116
PMA Re 33,787 7,334 152,760
Corporate - 16,341 -
- ---------------------------------------------------------------------------------------------
Total 87,207 81,161 489,876
- ---------------------------------------------------------------------------------------------
Year ended December 31, 1994:
The Property and Casualty Group 55,843 59,561 353,151
PMA Re 27,684 7,341 113,351
Corporate - 7,746 -
- ---------------------------------------------------------------------------------------------
Total 83,527 74,648 466,502
- ---------------------------------------------------------------------------------------------
</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-5
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule VI
Supplemental Information Concerning Property and Casualty Insurers
<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 Unearned Premiums Earned Premiums
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Consolidated property-casualty
subsidiaries:
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
Year Ended December 31, 1994 32,236 2,103,714 572,047 189,451 466,534
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------------------------------------------
Claims and claim adjustment
expenses incurred related to Amortization of
Net Investment ---------------------------- deferred policy Paid claims and Net Premiums
Affiliation with Registrant Income Current Year Prior Years acquisition costs adjustment expenses Written
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Consolidated property-casualty
subsidiaries:
Year Ended December 31, 1996 $131,131 $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
Year Ended December 31, 1994 138,751 352,025 366 83,527 478,981 466,502
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
S-8
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule V
Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
- ---------------------------------------------------------------------------------------------------------------------------------
Balance at beginning of Charge to costs and Deductions - write-offs of Balance
Description period expenses uncollectible accounts at end of period
- ---------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended December 31, 1996:
Allowance for uncollectible accounts:
Uncollected premiums $16,330 19,532 16,985 $18,877
- ---------------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 1995:
Allowance for uncollectible accounts:
Uncollected premiums $22,402 - 6,072 $16,330
- ---------------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 1994:
Allowance for uncollectible accounts:
Uncollected premiums $21,839 6,053 5,490 $22,402
- ---------------------------------------------------------------------------------------------------------------------------------
</TABLE>
S-7
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule IV
Reinsurance
<TABLE>
<CAPTION>
Ceded to Percentage of
Direct other Assumed from amount assumed
(dollar amounts in thousands) Amount companies other companies Net amount to net
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
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%
============== ============== ================ ================= =============
Year Ended December 31, 1994:
Premiums:
Property and liability insurance $ 379,216 $ 60,558 $ 147,876 $ 466,534 32%
============== ============== ================ ================= =============
</TABLE>
S-6
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
Pennsylvania Manufacturers Corporation:
Our report on the consolidated financial statements of Pennsylvania
Manufacturers Corporation is included on page F-29 of this Form 10 Registration
Statement. In connection with our audits of such financial statements, we have
also audited the related financial statement schedules listed in the index on
page 89 of this Form 10.
In our opinion, the financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as a whole,
present fairly, in all material respects, the information required to be
included therein.
/s/ Coopers & Lybrand L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
February 14, 1997, except for
Notes 6 and 15, as to which the date
is March 14, 1997
S-9
<PAGE>
Signatures
Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the Company has duly caused this registration statement to be signed on
its behalf by the undersigned, thereunto duly authorized.
PENNSYLVANIA MANUFACTURERS
CORPORATION
Date: 01/06/98 By: /s/ Francis W. McDonnell
Francis W. McDonnell, Senior Vice
President, Chief Financial Officer
and Treasurer
<PAGE>
(b) Exhibits filed with the Form 10 Registration Statement are as follows:
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
----------- ----------------------
<S> <C>
* 3.1 Amended and Restated Articles of Incorporation of
the Company.
* 3.2 Amended and Restated Bylaws of the Company.
Management Contracts
*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.
Other Material Contracts
*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.
</TABLE>
90
<PAGE>
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
----------- ----------------------
<S> <C>
**11.1 Computation of Per Share Earnings.
*21.1 Subsidiaries of the Company.
**27.1 Financial Data Schedule.
</TABLE>
* Incorporated by reference to initial filing of Registrant's Registration
Statement on Form 10, filed June 26, 1997.
** Incorporated by reference to Amendment No. 1 to the Registrant's
Registration Statement on Form 10/A filed August 22, 1997.
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