<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO __________
Commission File Number 000-22761
Pennsylvania Manufacturers Corporation
--------------------------------------
(Exact name of registrant as specified in its charter)
Pennsylvania 23-2217932
------------------------------- ----------
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
The PMA Building
380 Sentry Parkway
Blue Bell, Pennsylvania 19422-2328
---------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (215) 665-5046
--------------
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
-----------------------------------------------
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
YES [X] NO [ ]
There were 14,459,672 shares outstanding of the registrant's Common Stock, $5
par value per share, and 9,253,263 shares outstanding of the registrant's Class
A Common Stock, $5 par value per share, as of the close of business on March 31,
1998.
<PAGE>
INDEX
- --------------------------------------------------------------------------------
Page
Part I. Financial Information
Item 1. Financial statements
Consolidated statements of operations for the three months
ended March 31, 1998 (unaudited) and 1997 (unaudited) 1
Consolidated balance sheets as of March 31, 1998 (unaudited)
and December 31, 1997 2
Consolidated statements of comprehensive income for the three
months ended March 31, 1998 (unaudited) and 1997 (unaudited) 3
Consolidated statements of cash flows for three months ended
March 31, 1998 (unaudited) and 1997 (unaudited) 4
Notes to the consolidated financial statements (unaudited) 5
Item 2. Management's discussion and analysis of financial condition
and results of operations 8
Part II. Other Information
Item 6. Exhibits and reports on Form 8-K 21
<PAGE>
Part 1. Item 1
Pennsylvania Manufacturers Corporation
Consolidated Statements of Operations
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
(dollar amounts in thousands, except per share data) 1998 1997
-------- --------
<S> <C> <C>
Revenues:
Net premiums written $156,186 $151,279
Change in net unearned premiums (46,484) (41,932)
Change in accrued retrospective premiums (2,780) (1,397)
-------- --------
Net premiums earned 106,922 107,950
Net investment income 32,515 35,847
Net realized investment gains (losses) 7,514 (1,251)
Service revenues 2,435 2,548
-------- --------
Total revenues 149,386 145,094
-------- --------
Losses and expenses:
Losses and loss adjustment expenses 84,857 94,904
Acquisition expenses 22,703 18,339
Operating expenses 19,467 16,942
Dividends to policyholders 3,917 3,257
Interest expense 3,701 4,334
-------- --------
Total losses and expenses 134,645 137,776
-------- --------
Income before income taxes and
extraordinary item 14,741 7,318
-------- --------
Provision (benefit) for income taxes:
Current 210 (353)
Deferred 2,443 2,914
-------- --------
Total 2,653 2,561
-------- --------
Income before extraordinary item 12,088 4,757
Extraordinary loss from early
extinguishment of debt (net of income
tax benefit of $2,549) -- (4,734)
-------- --------
Net income $ 12,088 $ 23
======== ========
Earnings per basic and diluted share
Basic:
Earnings before extraordinary item $ 0.51 $ 0.20
Extraordinary item -- (0.20)
-------- --------
Net earnings $ 0.51 $ --
======== ========
Diluted:
Earnings before extraordinary item $ 0.49 $ 0.19
Extraordinary item -- (0.19)
-------- --------
Net earnings $ 0.49 $ --
======== ========
</TABLE>
See accompanying notes to the consolidated financial statements.
1
<PAGE>
Pennsylvania Manufacturers Corporation
Consolidated Balance Sheets
<TABLE>
<CAPTION>
(Unaudited)
March 31, December 31,
(dollar amounts in thousands, except share data) 1998 1997
---------- ------------
<S> <C> <C>
Assets
Investments:
Fixed maturities available for sale, at fair value
(amortized cost: 1998 - $1,961,904; 1997 - $1,900,594) $1,984,800 $1,929,518
Equity securities, at fair value (cost: 1998 - $5; 1997 - $5) 14 13
Short-term investments, at amortized cost which approximates fair value 189,267 265,207
---------- ----------
Total investments 2,174,081 2,194,738
Cash 2,267 32,148
Investment income due and accrued 26,845 23,818
Uncollected premiums (net of allowance for uncollectible accounts:
1998 - $18,493; 1997 - $18,406) 310,558 252,425
Reinsurance receivables (net of allowance for uncollectible reinsurance:
1998 - $2,096; 1997 - $2,096) 354,113 332,406
Property and equipment (net of accumulated depreciation:
1998 - $43,841; 1997 - $42,771) 38,135 38,621
Deferred income taxes, net 70,058 70,391
Deferred acquisition costs 56,562 45,288
Other assets 70,861 67,423
---------- ----------
Total assets $3,103,480 $3,057,258
========== ==========
Liabilities
Unpaid losses and loss adjustment expenses $1,989,115 $2,003,187
Unearned premiums 261,045 211,455
Long-term debt 203,000 203,000
Dividends to policyholders 9,317 10,200
Funds held under reinsurance treaties 73,452 69,545
Taxes, licenses and fees, and other expenses 45,842 49,410
Other liabilities 42,216 32,114
---------- ----------
Total liabilities 2,623,987 2,578,911
---------- ----------
Shareholders' Equity
Common stock, $5 par value (40,000,000 shares authorized;
14,895,146 shares issued and 14,459,672 outstanding - 1998;
15,286,263 shares issued and 14,850,789 outstanding - 1997) 74,476 76,431
Class A common stock, $5 par value (40,000,000 shares authorized;
9,547,799 shares issued and 9,253,263 outstanding - 1998;
9,156,682 shares issued and 9,117,735 outstanding - 1997) 47,738 45,783
Additional paid-in capital - Class A common stock 339 339
Retained earnings 353,053 343,368
Unrealized gain on investments available for sale
(net of deferred income taxes: ($8,017) and ($10,126)) 14,888 18,806
Notes receivable from officers (198) (198)
Treasury stock, at cost:
Common stock (shares: 435,474 - 1998 and 435,474 - 1997) (5,572) (5,572)
Class A common stock (shares: 294,536 - 1998 and 38,947 - 1997) (5,231) (610)
---------- ----------
Total shareholders' equity 479,493 478,347
---------- ----------
Total liabilities and shareholders' equity $3,103,480 $3,057,258
========== ==========
</TABLE>
See accompanying notes to the consolidated financial statements.
2
<PAGE>
Pennsylvania Manufacturers Corporation
Consolidated Statements of Comprehensive Income
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
(dollar amounts in thousands)
1998 1997
------- --------
<S> <C> <C>
Net income $12,088 $ 23
------- --------
Other comprehensive income, net of tax:
Unrealized losses on securities:
Holding gains (losses) arising during the period 966 (38,867)
Less: reclassification adjustment for (gains) losses included in net
income (4,884) 813
------- --------
Other comprehensive loss (3,918) (38,054)
------- --------
Comprehensive income (loss) $ 8,170 $(38,031)
======= ========
</TABLE>
See accompanying notes to the consolidated financial statements.
3
<PAGE>
Pennsylvania Manufacturers Corporation
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
(dollar amounts in thousands)
1998 1997
---------- ----------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 12,088 $ 23
Adjustments to reconcile net income to net cash flows used by
operating activities:
Depreciation 1,373 1,367
(Accretion) amortization (431) 1,469
Provision for deferred income taxes 2,443 2,914
Extraordinary loss from early extinguishment of debt -- (4,734)
Net realized investment (gains) losses (7,514) 1,251
Change in uncollected premiums and unearned premiums, net (8,543) (289)
Change in dividends to policyholders (883) (424)
Change in reinsurance receivables (21,707) (19,994)
Change in unpaid losses and loss adjustment expenses (14,072) (5,340)
Change in investment income due and accrued (3,027) (6,256)
Other, net (4,312) (15,126)
--------- ---------
Net cash flows used by operating activities (44,585) (45,139)
--------- ---------
Cash flows from investing activities:
Fixed maturity investments available for sale:
Purchases (461,925) (534,318)
Maturities or calls 41,154 23,839
Sales 367,404 473,116
Net sales of short-term investments 75,940 93,617
Net purchases of furniture and equipment (887) (987)
--------- ---------
Net cash flows provided by investing activities 21,686 55,267
--------- ---------
Cash flows from financing activities:
Dividends paid to shareholders (2,008) (1,991)
Proceeds from long-term debt -- 195,998
Repayments of long-term debt -- (197,465)
Repayments of notes receivable from officers -- 137
Treasury stock transactions, net (4,974) 3
--------- ---------
Net cash flows used by financing activities (6,982) (3,318)
--------- ---------
Net (decrease) increase in cash (29,881) 6,810
Cash January 1 32,148 7,176
--------- ---------
Cash March 31 $ 2,267 $ 13,986
========= =========
Supplementary cash flow information:
Cash received for income taxes $ -- $ (2,900)
Cash paid for interest $ 3,316 $ 7,913
</TABLE>
4
<PAGE>
Pennsylvania Manufacturers Corporation
Notes to the Consolidated Financial Statements
(dollar amounts in thousands except share and per share data)
1. General
The accompanying consolidated financial statements include the accounts of
Pennsylvania Manufacturers Corporation (PMC) and its wholly and majority owned
subsidiaries (the Company). PMC is an insurance holding company that sells
property and casualty reinsurance and insurance through its insurance
subsidiaries. PMC's insurance subsidiaries are domiciled in Pennsylvania, except
for its newly established excess and surplus lines writer which is domiciled in
Delaware, and certain foreign subsidiaries.
Reinsurance -- PMC's reinsurance subsidiary, PMA Reinsurance Corporation (PMA
Re), emphasizes risk-exposed, excess of loss reinsurance and operates in the
brokered market. PMA Re's business is predominantly in casualty lines of
reinsurance.
Workers' Compensation and Primary Standard Insurance -- PMC's property and
casualty insurance subsidiaries (the Property and Casualty Group) write workers'
compensation and other standard lines of commercial insurance primarily in the
Mid-Atlantic and Southern regions of the U.S.
Specialty Property and Casualty -- In January of 1998, the Company's specialty
insurance unit, Caliber One, commenced writing business. It is management's
intention that Caliber One will write primarily casualty business through
wholesale surplus lines brokers on a nationwide basis. Caliber One's excess and
surplus lines insurance subsidiary, Caliber One Indemnity Company, is presently
authorized as a surplus lines carrier in 33 states, Washington, DC, and Puerto
Rico, with applications either pending or being prepared for the remaining
states.
The consolidated financial statements have been prepared in accordance with
generally accepted accounting principles (GAAP) for interim financial
information and with the instructions to Form 10-Q and Article 10 of Regulation
S-X. It is management's opinion that all adjustments, including normal recurring
accruals, considered necessary for a fair presentation have been included.
Certain reclassifications of prior year amounts have been made to conform with
the 1998 presentation. Additionally, net premiums written were adjusted to
include $2.8 million and $1.4 million for the three months ended March 31, 1998
and 1997, respectively, representing estimated retrospective policy adjustments
related to the current accident year and retrospective policy adjustments paid.
This adjustment was made for presentation purposes only and does not impact the
Company's reported revenues, financial position or results of operations as
these adjustments have no effect on net premiums earned.
Operating results for the three months ended March 31, 1998, are not necessarily
indicative of the results to be expected for the full year. For further
information, refer to the December 31, 1997, audited consolidated financial
statements and footnotes thereto included in PMC's Annual Report to Shareholders
and incorporated by reference in Form 10-K.
2. Per Share Data
In February 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No. 128"),
which supersedes Accounting Principles Board Opinion No. 15, "Earnings Per
Share," and Related Interpretations, and which the Company adopted during 1997.
In accordance with SFAS No. 128, all prior period data presented has been
restated to conform with the provisions of this statement. SFAS No. 128 replaces
the presentation of primary earnings per share with a presentation of basic
earnings per share and requires the presentation of both basic and diluted
earnings per share on the face of the income statement. SFAS No. 128 also
requires a reconciliation of the numerators and denominators used in the basic
earnings per share calculation to the numerators and denominators used in the
diluted earnings per share calculation. Such reconciliation is provided below:
5
<PAGE>
<TABLE>
<CAPTION>
March 31,
1998 1997
----------- -----------
<S> <C> <C>
Numerator:
Control number - income
before extraordinary item.............. $ 12,088 $ 4,757
Denominator:
Basic shares - weighted average
common and Class A common
shares outstanding 23,850,631 23,836,878
Dilutive stock options................... 731,704 738,489
----------- -----------
Total diluted shares..................... 24,582,335 24,575,367
=========== ===========
</TABLE>
Basic earnings per share: For the three months ended March 31, 1998 and 1997,
basic earnings per share was based upon the weighted average number of common
and Class A common shares outstanding for the period.
Diluted earnings per share: For the three months ended March 31, 1998 and 1997,
diluted earnings per share was based upon the weighted average number of common
and Class A common shares outstanding during the year and the assumed exercise
price of dilutive stock options, less the number of treasury shares assumed to
be purchased from the proceeds using the average market price of the Company's
Class A common stock.
3. Accounting Pronouncements
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Comprehensive Income" ("SFAS No. 130"), which establishes
standards for the reporting and disclosure of comprehensive income and its
components (revenues, expenses, gains and losses). SFAS No. 130 requires that
all items required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. Comprehensive income
includes a reclassification adjustment for net realized investment gains
included in net income of $4,884 (after income taxes of $2,630) for the three
months ended March 31, 1998 and net realized investment losses of $813 (after
income taxes of $438) for the three months ended March 31, 1997. The new
standard requires only additional disclosures in the consolidated financial
statements; it does not affect the Company's financial position or results of
operations.
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" (SFAS No. 131), which establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and interim financial reports issued to shareholders. SFAS
No. 131 also establishes standards for related disclosures about products and
services, geographic areas and major customers. In connection with the adoption
of SFAS No. 131, the Company has identified four reportable segments: (i) PMA
Re, which provides reinsurance products and services; (ii) the Property and
Casualty Group, which writes workers' compensation and other standard lines of
commercial insurance and includes run-off operations; (iii) Caliber One, which
writes specialty insurance focusing on excess and surplus lines; and (iv)
Corporate and Other, which is primarily comprised of corporate overhead and the
operations of the Company's properties. Pursuant to the adoption of SFAS No.
131, the Company has restated the corresponding information from 1997 for
comparability, primarily related to certain corporate expenses which were
previously allocated to the operating segments. SFAS No. 131 requires only
additional disclosures in the consolidated financial statements; it does not
affect the Company's financial position or results of operations.
In January 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 97-3,
"Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments" (SOP 97-3). SOP 97-3, which is effective for fiscal years
beginning after December 15, 1998, provides guidance for determining when an
insurance company should recognize a liability for guaranty fund and
6
<PAGE>
other insurance related assessments and how to measure that liability. While the
Company is presently evaluating the impact of SOP 97-3, the adoption of SOP 97-3
is likely to result in an increase in the Company's liabilities for such
assessments, and such increase may be material. The impact of adopting SOP 97-3
will be reflected as a cumulative effect of an accounting change in the first
quarter of 1999.
7
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis and other statements made throughout
this report contain forward-looking statements that involve risks and
uncertainties. The Company's actual results could differ materially from those
expected by the Company. The factors that could cause actual results to vary
materially, some of which are described with the forward-looking statements,
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.
Results of Operations
The table below presents the major components of net income for the three months
ended March 31, 1998 and 1997:
(dollar amounts in thousands, except per share data)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
Pre-tax operating income (1) $ 7,227 $ 8,569
Net realized investment gains (losses) 7,514 (1,251)
------- -------
Income before income taxes and
extraordinary item 14,741 7,318
Provision for income taxes 2,653 2,561
------- -------
Income before extraordinary item 12,088 4,757
Extraordinary item, net of related taxes -- (4,734)
------- -------
Net income $12,088 $ 23
======= =======
Per Basic Share:
Income before extraordinary loss $ 0.51 $ 0.20
Extraordinary loss -- (0.20)
------- -------
Net income $ 0.51 $ --
======= =======
Per Diluted Share:
Income before extraordinary loss $ 0.49 $ 0.19
Extraordinary loss -- (0.19)
------- -------
Net income $ 0.49 $ --
======= =======
</TABLE>
(1) Pre-tax operating income is defined as income from continuing operations
before income taxes, but excluding net realized investment gains (losses).
The following table indicates the Company's pre-tax operating income by
principal business segment for the three months ended March 31, 1998 and 1997:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
- ----------------------------------------------------------------------------------------------------
<S> <C> <C>
PMA Re $11,372 $13,358
The Property and Casualty Group 2,736 1,422
Caliber One (389) --
Corporate and Other (2,791) (1,877)
------- -------
Pre-tax operating income before interest expense 10,928 12,903
Interest expense 3,701 4,334
------- -------
Pre-tax operating income $ 7,227 $ 8,569
======= =======
</TABLE>
8
<PAGE>
The following table indicates the Company's total assets by principal business
segment at March 31, 1998 and December 31, 1997:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
March 31 , December 31,
1998 1997/(1)/
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
PMA Re $1,169,538 $1,128,635
The Property and Casualty Group 1,880,335 1,869,333
Caliber One 62,088 64,302
Corporate and Other (8,481) (5,012)
---------- ----------
Total assets $3,103,480 $3,057,258
========== ==========
</TABLE>
(1) Total assets by business segment have been reclassified for 1997 to reflect
the changes related to the implementation of SFAS No. 131 (see Note 3 to the
Consolidated Financial Statements for further discussion).
On a consolidated basis, the Company reported pre-tax operating income of $7.2
million for the three months ended March 31, 1998, compared to $8.6 million for
the three months ended March 31, 1997. The decrease in pre-tax operating income
for the three months ended March 31, 1998, in comparison to the same period in
1997 was primarily due to decreased operating income at PMA Re and Corporate and
Other, partially offset by increased operating income generated by the Property
and Casualty Group in the first quarter of 1998. In addition, Caliber One had a
pre-tax operating loss of $389,000 related to the commencement of its
operations. The decrease in operating income at PMA Re was mainly related to
higher acquisition costs. Also, PMA Re's operating results in the first quarter
of 1998, as compared to the first quarter of 1997, were impacted by the timing
of certain expenses, which impacted the first quarter of 1998, but not the first
quarter of 1997. These expenses were associated with the restructuring of its
outbound reinsurance program and the implementation of certain compensation
plans, both of which occurred in the second half of 1997. The higher operating
loss at Corporate and Other was primarily due to increased corporate expenses,
mainly compensation related, during the first quarter of 1998 compared to 1997.
The increase in operating income for the Property and Casualty Group was due to
lower losses and expenses recorded in the first quarter of 1998 compared to 1997
as a result of the restructuring efforts made during 1997.
Interest expense decreased $633,000 for the three months ended March 31, 1998,
compared to the same period in 1997 due to the March 1997 refinancing of the
Company's debt with a new $235.0 million revolving credit facility.
Net income on a consolidated basis, before extraordinary item, was $12.1
million, or $0.51 per basic share and $0.49 per diluted share, for the three
months ended March 31, 1998, compared to $4.8 million, or $0.20 per basic share
and $0.19 per diluted share, for the three months ended March 31, 1997. On
March 14, 1997, the Company refinanced substantially all of its outstanding
credit agreements not already maturing in 1997. In connection with this
refinancing, the Company recognized an extraordinary loss from the early
extinguishment of debt of $4.7 million, or $0.20 per basic share and $0.19 per
diluted share, net of tax.
9
<PAGE>
PMA Re Results of Operations
Summarized financial results of PMA Re for the three months ended March 31,
1998 and 1997, are as follows:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
- -----------------------------------------------------------------------
<S> <C> <C>
Net premiums written $70,819 $59,490
======= =======
Net premiums earned $46,098 $39,296
Net investment income 13,500 13,154
------- -------
Operating revenues 59,598 52,450
------- -------
Losses and LAE incurred 32,814 29,845
Acquisition and operating expenses 15,412 9,247
------- -------
Total losses and expenses 48,226 39,092
------- -------
Pre-tax operating income $11,372 $13,358
======= =======
GAAP loss ratio 71.2% 75.9%
GAAP combined ratio 104.6% 99.4%
SAP loss ratio 71.0% 75.9%
SAP combined ratio 102.9% 103.8%
</TABLE>
Premium Revenues
The following table indicates PMA Re's gross and net premiums written by major
category of business:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
- -----------------------------------------------------------------------
<S> <C> <C>
Gross premiums written:
Casualty lines $60,804 $50,428
Property lines 25,911 23,766
Other lines 394 453
------- -------
Total $87,109 $74,647
======= =======
Net premiums written:
Casualty lines $48,421 $42,750
Property lines 22,004 16,287
Other lines 394 453
------- -------
Total $70,819 $59,490
======= =======
</TABLE>
Gross premiums written increased $12.5 million, or 16.7%, in the first quarter
of 1998 compared to the first quarter of 1997. Net premiums written increased
$11.3 million, or 19.0%, for the three months ended March 31, 1998, compared to
the same period ended March 31, 1997. The main reasons for these increases were
increased
10
<PAGE>
participations on reinsurance treaties and new programs with existing clients,
as well as contracts with new clients. These increases were partially offset
by the trend toward large ceding companies increasing their retentions, which
decreases PMA Re's subject premium, and highly competitive conditions in the
U.S. reinsurance market, which caused PMA Re to non-renew certain accounts due
to inadequate rates and/or other underwriting concerns.
Gross premiums written increased $10.4 million, or 20.6%, and $2.1 million, or
9.0%, for casualty lines and property lines, respectively. Net premiums written
for casualty lines and property lines increased $5.7 million, or 13.3%, and $5.7
million, or 35.1%, respectively, compared to the first quarter of 1997. PMA Re
made changes to its retrocessional program in the second half of 1997 and in
1998 which reduced the amount of premiums ceded to retrocessionaires in the
first quarter of 1998 and also impacted the Acquisition Expense Ratio in 1998
(see below for further discussion). Net premiums earned for PMA Re increased
$6.8 million, or 17.3%, for the three months ended March 31, 1998, compared to
the same period in 1997, consistent with the increases in gross and net premiums
written mentioned above. Net premiums earned generally follow growth patterns
similar to net premiums written factoring in an earnings lag.
Losses and Expenses
The following table reflects the components of PMA Re's combined ratios, as
computed on a GAAP basis:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
- ----------------------------------------------------------------------
<S> <C> <C>
Loss ratio 71.2% 75.9%
----- ----
Expense ratio:
Acquisition expenses 26.0% 19.0%
Operating expenses 7.4% 4.5%
----- ----
Total expense ratio 33.4% 23.5%
----- ----
Combined ratio - GAAP (1) 104.6% 99.4%
===== ====
</TABLE>
(1) The combined ratio computed on a GAAP basis is equal to losses and loss
adjustment expenses (LAE), plus acquisition expenses, plus operating expenses,
plus policyholders' dividends (where applicable), all divided by net premiums
earned.
PMA Re's loss ratio decreased 4.7 points for the three months ended March 31,
1998, compared to the same period in 1997. This decrease primarily relates to
changes in the mix of business toward proportionately more contracts with ceding
commissions plus additional favorable development of unpaid losses and LAE
recorded in the first quarter of 1998 compared to 1997. For contracts written on
a pro rata basis and other contracts containing ceding commissions, premiums
tend to be higher relative to the losses when compared to contracts that do not
contain ceding commissions. Over the past year, PMA Re has written more
contracts containing ceding commissions, which has contributed to the decrease
in the loss ratio. For such contracts, PMA Re pays the ceding company a
commission, but in return, PMA Re receives a higher proportion of the subject
premium. PMA Re recorded net favorable development on prior years' unpaid losses
and LAE of $4.0 million in the first quarter of 1998 compared to none in the
first quarter of 1997.
The ratio of acquisition expenses to net premiums earned (the "Acquisition
Expense Ratio") increased 7.0 points for the three months ended March 31, 1998,
compared to the same period in 1997. Acquisition costs for gross premiums
written began increasing during 1997 and into 1998 due to the competitive market
conditions and the change in the mix of business toward more contracts with
ceding commissions as discussed above. The impact of these increases was more
significant for the first quarter of 1998 as compared to the 1997 period due to
the deferral and amortization of the acquisition costs over the contract
periods. Additionally, the Acquisition Expense Ratio was negatively impacted by
changes PMA Re made to its retrocessional program in the second half of 1997 and
in 1998, which reduced the commissions received from retrocessionaires in the
first quarter of 1998.
11
<PAGE>
The ratio of operating expenses to net premiums earned increased 2.9 points for
the three months ended March 31, 1998, compared to the same period in 1997. The
increase is attributable to increases in operating expenses in connection with
the addition of staff associated with higher activity levels. PMA Re has
increased staffing by approximately 15% from the first quarter of 1997 to the
first quarter of 1998. Additionally, PMA Re implemented a new management
incentive compensation plan in the second quarter of 1997 that has increased
expenses for 1998 compared to the first quarter of 1997.
PMA Re incurred costs amounting to approximately $125,000 related to the Year
2000 Project ("Year 2000 Project"). Management expects that PMA Re will incur
approximately $600,000 in 1998 related to the Year 2000 Project and that such
project will be completed in 1998 (see "Liquidity and Capital Resources" for
further discussion).
Net Investment Income
Net investment income increased $346,000 for the three months ended March 31,
1998, compared to the three months ended March 31, 1997. The increase primarily
relates to an increase in average invested assets. The invested asset balance
increased $44.9 million to $913.9 million at March 31, 1998 compared to $869.0
million at March 31, 1997.
The Property and Casualty Group Results of Operations
Run-off operations ("Run-off Operations") of the Property and Casualty Group are
comprised of Mid-Atlantic States Casualty Company, PMA Insurance, Cayman Limited
and PMA Life Insurance Company and have been established internally to reinsure
certain obligations primarily associated with workers' compensation claims
written by Pennsylvania Manufacturers' Association Insurance Company,
Manufacturers Alliance Insurance Company and Pennsylvania Manufacturers
Indemnity Company (the "Pooled Companies") for the years 1991 and prior for
statutory accounting purposes. Excluding the Run-Off Operations, the Property
and Casualty Group is comprised of the Pooled Companies, PMA Management Corp.,
and Pennsylvania Manufacturers International Insurance, Limited. The Run-off
Operations have been segregated into separate legal entities and substantially
all of the assets of the Run-off Operations are held in trust for the benefit of
the Pooled Companies.
Net premiums written for the Property and Casualty Group were adjusted to
include $2.8 million and $1.4 million for the three months ended March 31,
1998 and 1997, respectively, representing estimated retrospective policy
adjustments related to the current accident year and retrospective policy
adjustments paid. This adjustment was made for presentation purposes only and
does not impact the Property and Casualty Group's reported revenues, financial
position or results of operations as these adjustments have no effect on net
premiums earned. Summarized financial results of the Property and Casualty Group
for the three months ended March 31, 1998 and 1997, are as follows:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
- -----------------------------------------------------------------------
<S> <C> <C>
Net premiums written:
Workers' compensation $67,501 $62,952
Commercial Lines 17,654 28,837
------- -------
Total $85,155 $91,789
======= =======
Net premiums earned:
Workers' compensation $44,313 $49,718
Commercial Lines 16,485 18,936
------- -------
Total $60,798 $68,654
------- -------
Net investment income:
Excluding Run-off Operations 12,710 14,615
Run-off Operations 5,839 7,513
------- -------
Total 18,549 22,128
Service revenues 2,435 2,548
------- -------
Operating revenues 81,782 93,330
------- -------
</TABLE>
12
<PAGE>
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
- -----------------------------------------------------------------------
<S> <C> <C>
Losses and LAE incurred:
Excluding Run-off Operations 47,206 56,983
Run-off Operations 4,896 8,108
------- -------
Total 52,102 65,091
------- -------
Acquisition and operating expenses:
Excluding Run-off Operations 22,219 22,767
Run-off Operations 808 793
------- -------
Total 23,027 23,560
------- -------
Policyholders' dividends 3,917 3,257
------- -------
Total losses and expenses 79,046 91,908
------- -------
Pre-tax operating income $ 2,736 $ 1,422
======= =======
GAAP loss ratio 85.7% 94.8%
GAAP combined ratio 126.2% 130.5%
SAP loss ratio (1) 77.4% 85.3%
SAP combined ratio (1) 109.7% 115.9%
</TABLE>
(1) The SAP loss and combined ratios above relate to the Pooled Companies only
and do not include the results of the statutory entities within the Run-Off
Operations.
Property and Casualty Group Excluding Run-off Operations
--------------------------------------------------------
Premium Revenues
Direct premiums written for the Property and Casualty Group decreased $8.2
million for the three months ended March 31, 1998, compared to the same period
in 1997. Direct premiums written for commercial lines of business other than
workers' compensation, such as commercial auto, general liability, umbrella,
multi-peril and commercial property lines (collectively, "Commercial Lines")
decreased $11.5 million for the three months ended March 31, 1998, compared to
the same period in 1997. Direct premiums written for workers' compensation
increased $3.3 million for the three months ended March 31, 1998, compared to
the same period in 1997. For the three months ended March 31, 1998, reinsurance
premiums assumed decreased $643,000 compared to the same period in 1997.
Reinsurance premiums ceded decreased $2.2 million for the three months ended
March 31, 1998, compared to the same period in 1997.
For the three months ended March 31, 1998, net premiums written decreased $6.6
million compared to the same period in 1997. Earned premiums decreased by $7.9
million for the three months ended March 31, 1998, compared to the same period
in 1997. Net premiums earned generally follow growth patterns similar to net
premiums written factoring in an earnings lag, absent any significant
adjustments to accrued retrospective premiums. Such adjustments did not
fluctuate materially between periods.
The increase in direct premiums written for workers' compensation was primarily
due to an increase in exposures underwritten. Workers' compensation reform laws
adopted in Pennsylvania (Act 57) resulted in a reduction in manual workers'
compensation rates in excess of 25%, effective February 1997 for new and renewal
business. Management does not expect manual rate changes to be as significant
for the 1998 policy year as compared to the 1997 policy year.
The Property and Casualty Group has continued its marketing of alternative
market workers' compensation products for larger accounts, including large-
deductible policies and providing excess coverage to self-insured groups.
Typically, the Property and Casualty Group receives a lower up-front premium for
these types of alternative market
13
<PAGE>
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 decreased $113,000 for the three months ended
March 31, 1998, compared to the same period in 1997. The rate changes in
Pennsylvania, combined with continued intense price competition in the workers'
compensation line of business have reduced the market for alternative market
products.
Direct workers' compensation premiums written were also impacted by changes in
the level of premium adjustments, primarily related to audit premiums. For the
three months ended March 31, 1998, such adjustments increased premiums written
by $4.6 million, compared to a $4.3 million increase in the comparable 1997
period.
The Property and Casualty Group's direct writings of Commercial Lines decreased
$11.5 million for the three months ended March 31, 1998, compared to the same
period in 1997. The decrease was primarily due to a planned reduction in net
Commercial Lines business as well as continued competitive conditions in
Commercial Lines pricing in 1998. Rather than lower prices to what it believes
are unacceptable levels, the Property and Casualty Group has chosen not to renew
some of its Commercial Lines business. Additionally, the Property and Casualty
Group has reduced its writings of new accounts in the first quarter of 1998
compared to the same period in 1997.
For the three months ended March 31, 1998, ceded premiums decreased $2.2 million
compared to the same period in 1997. The decrease in ceded premiums is
primarily due to the decrease in Commercial Lines direct written premiums.
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
March 31,
1998 1997
- -----------------------------------------------------------------------
<S> <C> <C>
Loss ratio 77.6% 84.0%
----- -----
Expense ratio:
Acquisition expenses 17.7% 16.0%
Operating expenses (1) 15.1% 14.2%
----- -----
Total expense ratio 32.8% 30.2%
----- -----
Policyholders' dividends 6.4% 4.8%
----- -----
Combined ratio - GAAP (2) 116.8% 119.0%
===== =====
</TABLE>
(1) The GAAP Operating Expense Ratio excludes $2.3 million in 1998 and 1997,
respectively, of PMA Management Corp. direct expenses related to service
revenues, which are not included in premiums earned.
(2) The GAAP combined ratios for the Property and Casualty Group including the
Run-off Operations were 126.2% and 130.5% in the first quarter of 1998 and
1997, respectively. See "Run-off Operations."
For the three months ended March 31, 1998, the GAAP loss ratio improved by 6.4
points compared to the same period in 1997. This improvement was primarily due
to a lower amount of discount accretion on workers' compensation loss reserves,
improved loss and LAE ratios in Commercial Lines, and an improvement in medical
costs and in loss adjustment expenses in the workers' compensation line.
The improvement in loss and LAE ratios in Commercial Lines has favorably
impacted the overall loss ratio by 2.3 points for the three months ended March
31, 1998, compared to the same period in 1997. This improvement in the
14
<PAGE>
Commercial Lines loss and LAE ratio was primarily due to a reduction in
exposures underwritten by the Property and Casualty Group in 1998, as well as
reduced large losses in the first quarter of 1998 compared to the same period in
1997. The Property and Casualty Group believes that the loss of this business,
which has been primarily as a result of price competition, has improved the
overall loss ratio on its remaining Commercial Lines business.
Measures to control medical costs and loss adjustment expenses in workers'
compensation have improved the overall loss and LAE ratio by 1.0 point in the
three months ended March 31, 1998, compared to the same period in 1997. Medical
costs have improved primarily due to the Property and Casualty Group's
affiliation with a national preferred provider organization, which became
effective January 1998, and has lowered its cost to provide medical benefits
to injured workers. Loss adjustment expenses have decreased primarily due to
continued use of certain claims resolution practices. By using techniques such
as managed care and commutations, the Property and Casualty Group has reduced
the amount of outstanding claims and the amount of time that a claim remains
open. This in turn has lowered costs associated with managing open claims.
During the past five years, direct premiums written for workers' compensation
have declined significantly and the Property and Casualty Group has underwritten
less exposures in more recent years. As a result, loss reserve levels have
declined and the level of discount has declined as well. This has decreased the
amount of discount accretion related to the established loss reserves. As a
result, this lower amount of discount accretion improved the overall loss and
LAE ratio by 3.1 points in the first three months of 1998, compared to the same
period in 1997. The Property and Casualty Group has initiated another
commutation program which is currently underway and expected to continue through
the second quarter of 1998. This program is expected to continue to focus on
claims from accident years 1991 and prior.
The GAAP expense ratio increased by 2.6 points for the three months ended March
31, 1998, compared to the same period in 1997. The increase in the Acquisition
Expense Ratio of 1.7 points was primarily due to increased commission expenses
associated with the Property and Casualty Group's larger agents and lower ceding
commissions received from Commercial Lines business. The operating expense ratio
increased by 0.9 points, primarily due to lower earned premiums in the first
three months of 1998 compared to the same period in 1997. Operating expenses
decreased by $411,000 in the first quarter of 1998 compared to the same period
in 1997.
In the first quarter of 1998 and 1997, the Property and Casualty Group
incurred approximately $418,000 and none, respectively, related to severance
costs and approximately $171,000 and $293,000, respectively, related to the Year
2000 Project. Management anticipates that the Property and Casualty Group will
incur approximately $700,000 in 1998 related to the Year 2000 Project and that
such Project will be completed in 1998 (see "Liquidity and Capital Resources"
for further discussion).
The policyholder dividend ratio was 6.4% for the three months ended March 31,
1998, compared to 4.8 points for the same period in 1997. The increase in the
dividend ratio is primarily due to improved loss experience in more recent
accident years in the workers' compensation line of business.
Net Investment Income
Net investment income was $12.7 million for the three months ended March 31,
1998, compared to $14.6 million for the same period in 1997. Net investment
income decreased as a result of lower fixed income yields and lower average
invested assets resulting from the pay-down of loss reserves from prior accident
years and decreasing premium volume. The average portfolio yields decreased by
approximately 30 basis points for the three months ended March 31, 1998,
compared to the same period in 1997.
Run-off Operations
------------------
Mid-Atlantic States Casualty Company ("MASCCO") is a Pennsylvania insurance
company and a wholly owned subsidiary of the Company. Prior to December 31,
1996, MASCCO was a party to a pooling agreement with the Pooled Companies.
Effective December 31, 1996, and with the approval of the Pennsylvania Insurance
Commissioner (the "Commissioner"), MASCCO withdrew from the Pooled Companies and
ceased writing any new business. The Pooled Companies also ceded to MASCCO the
indemnity portion of Pennsylvania workers' compensation claims for accident
years 1991 and prior. At March 31, 1998, MASCCO had $103.7 million in total
assets and $88.3 million in
15
<PAGE>
total reserves. Substantially all of MASCCO's assets are held in trust for the
benefit of the Pooled Companies. MASCCO is also included in the Property and
Casualty Group's GAAP results.
PMA Insurance, Cayman Ltd. ("PMA Cayman"), was incorporated in Grand Cayman, and
had no material operations until 1996. In 1996, the Pooled Companies ceded to
PMA Cayman substantially all of its remaining liability for workers'
compensation claims for accident years 1991 and prior. In 1997, the Pooled
Companies also ceded to PMA Cayman a portion of its workers compensation
reserves from accident years 1992 to 1996. At March 31, 1998, PMA Cayman had
$245.9 million in total assets and $237.9 million in total reserves.
Substantially all of PMA Cayman's assets are held in trust for the benefit of
the Pooled Companies.
PMA Life Insurance Company ("PMA Life") is a Pennsylvania life insurance company
that derives all of its insurance revenues from intercompany transactions with
the Pooled Companies. In 1997, the Property and Casualty Group reinsured
substantially all of PMA Life's insurance liabilities with a third party
reinsurer, and no longer places insurance business with PMA Life. At March 31,
1998, PMA Life had assets of $23.0 million and $17.9 million in total reserves.
The following table reflects the components of the Property and Casualty Group -
Run-off Operations' operating results for the three months ended March 31, 1998
and 1997:
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998 1997
- ----------------------------------------------------------------------
<S> <C> <C>
Investment Income $5,839 $7,513
Net premiums earned (1) -- 814
------ ------
Total Operating Revenues 5,839 8,327
------ ------
Losses and LAE 4,896 8,108
Operating Expenses 808 793
------ ------
Total Expenses 5,704 8,901
------ ------
Operating income (loss) $ 135 $ (574)
====== ======
</TABLE>
(1) Amount represents net premiums earned during the first quarter of 1997 for
PMA Life prior to the reinsurance transaction mentioned above which put PMA
Life into run-off.
Investment income for the Run-off Operations decreased by $1.7 million in the
three months ended March 31, 1998, compared to the same period in 1997 primarily
due to lower average invested balances, as the Run-off Operations paid claims
aggregating $160.7 million in 1997 and $32.2 million in the first quarter of
1998. The commutation program initiated by the Property and Casualty Group in
late 1996 and completed in July 1997 accelerated payments to claimants, and
substantially all of such payments were funded by the Run-off Operations.
Losses and LAE of the Run-off Operations are comprised of discount accretion on
established loss reserves within the Run-off Operations. The decrease in loss
reserve discount accretion was primarily due to the payments made for the
underlying claims in 1997.
16
<PAGE>
Caliber One
Summarized financial results of Caliber One for the three months ended March 31,
1998, are as follows:
(dollar amounts in thousands)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
1998
- ---------------------------------------------------------
<S> <C>
Net premiums written $ 212
=====
Net premiums earned $ 26
Net investment income 343
-----
Operating revenues 369
-----
Losses and LAE incurred 20
Acquisition and operating expenses 738
-----
Total losses and expenses 758
-----
Pre-tax operating income $(389)
=====
</TABLE>
Due to the start-up nature of the business, the financial ratios for Caliber One
do not provide meaningful representation of the operating results, and
therefore, have been excluded from the table above. Gross premiums written and
net premiums written for Caliber One in the first quarter of 1998 were $291,000
and $212,000, respectively. The loss ratio for the first quarter of 1998 was
76.9%. As expected, operating expenses in 1998 were high relative to the
premium volume which distorts the expense ratio. Management expects operating
expenses to be more commensurate with premium volume over time as premium volume
continues to grow. Net investment income was $343,000 for the first quarter of
1998.
Corporate and Other
Corporate and Other is primarily comprised of corporate overhead and the
operations of the Company's properties. For the three months ended March 31,
1998, Corporate and Other experienced a pre-tax operating loss before interest
expense of $2.8 million, compared to $1.9 million for the three months ended
March 31, 1997. The higher operating loss in 1998 compared to the same period
in 1997 relates to increased corporate operating costs, primarily related to
compensation as the Company implemented a new management incentive compensation
plan in the second quarter of 1997 that increased expenses for 1998 relative to
the first quarter of 1997.
Net Realized Investment Gains
The Company recorded net realized investment gains of $7.5 million for the three
months ended March 31, 1998, compared to net realized investment losses of $1.3
million for the comparable 1997 period. Gains and losses on the sale of
investments are recognized as a component of net income, but the timing and
recognition of such gains and losses are unpredictable and are not indicative of
future results.
Interest Expense and Income Taxes
Interest expense decreased $633,000 for the three months ended March 31, 1998,
compared to the same period in 1997 due to refinancing of the Company's debt in
March of 1997. The Company's effective tax rate was 18.0% for the three months
ended March 31, 1998, compared to 35.0% for the three months ended March 31,
1997. The Company recorded a net deferred tax asset of $70.1 million and $70.4
million in the first quarter of 1998 and 1997, respectively.
17
<PAGE>
Liquidity and Capital Resources
Liquidity
Liquidity is a measure of an entity's ability to secure enough cash to meet its
contractual obligations and operating needs. At the holding company level, the
Company requires cash to pay debt obligations and dividends to shareholders, pay
taxes to the federal government, 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 $3.3 million for the three months ended March 31,
1998, compared to $7.9 million for the three months ended March 31, 1997. The
decrease pertains to the fact that the March 1997 refinancing of PMC's debt
obligations accelerated certain interest payments to the first quarter of 1997.
The Company paid $2.0 million of dividends to shareholders in both the first
quarter of 1998 and 1997, respectively.
Dividends received from subsidiaries were $4.0 million for both three month
periods ended March 31, 1998 and 1997, respectively. Net tax cash flows from
subsidiaries were $6.0 million and $2.6 million for the three months ended March
31, 1998 and 1997, 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, but in no event to exceed
unassigned funds. Under this standard, the Company's domestic insurance
subsidiaries can pay an aggregate of $51.2 million of dividends, without the
prior approval of the Commissioner, during 1998. Caliber One Indemnity Company
is directly owned by PMA Re, and as such, its dividends may not be paid directly
to PMC.
PMC's dividends to shareholders are restricted by its debt agreements. Based
upon the terms of the Company's credit facility, under the most restrictive debt
covenant, PMC would be able to pay dividends of approximately $14.5 million in
1998.
Management believes that the Company's sources of funds will provide sufficient
liquidity to meet its short-term and long-term obligations.
Capital Resources
The Company's total assets increased $46.2 million to $3,103.5 million at March
31, 1998, compared to $3,057.3 million at December 31, 1997. Total investments
decreased $20.7 million to $2,174.1 million at March 31, 1998. This decrease
was primarily attributable to the Property and Casualty Group's pay-down of loss
reserves from prior accident years. All other assets increased $66.9 million,
mainly due to increases in uncollected premiums of $58.1 million, reinsurance
receivables of $21.7 million and deferred acquisition costs of $11.3 million, in
comparison to December 31, 1997. The increases in uncollected premiums and
deferred acquisition costs compared to December 31, 1997 were primarily related
to the cyclical nature of the premium volume in the first quarter. The
uncollected premiums and deferred acquisition costs are more comparable to the
balances at March 31, 1997. The increase in reinsurance receivables compared to
December 31, 1997 primarily relates to the Property and Casualty Group's new
reinsurance treaty for Commercial Lines entered into during 1997 which has
increased the amount of ceded losses, which increases the reinsurance
receivables balance. These increases were partially offset by a decrease in
cash of $29.9 million related to settlement timing of investment transactions at
December 31, 1997.
Consolidated shareholders' equity at March 31, 1998, totaled $479.5 million or
$20.22 per share compared to $478.3 million or $19.96 per share at December 31,
1997. As a result of changes in market interest rates, the unrealized
appreciation of investments, net of tax, was $14.9 million at March 31, 1998,
compared to $18.8 million at December 31, 1997, resulting in an decrease in
shareholders' equity of $3.9 million or $0.17 per share.
18
<PAGE>
At March 31, 1998, the Company had $203.0 million outstanding under its existing
credit facility, with $32.0 million available for additional borrowings.
Management also entered into an interest rte swap agreement which is intended to
manage the impact of the potential volatility of the interest rate associated
with the floating rates on the credit facility. The interest rate swap covers a
notional principal amount of $150.0 million and effectively converts the
floating rate on such portion of the credit facility to 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 ($150.0 million). Management believes such
credit risk is minimal and any loss would not be significant.
Year 2000 Issue
With the assistance of outside consulting groups, the Company began evaluating
and reprogramming its own computer systems to address the Year 2000 problem in
late 1995. Management anticipates that by year-end 1998, it will have
substantially completed all necessary programming work so that Year 2000 issues
are not likely to result in any material adverse disruptions in the Company's
computer systems or its internal business operations. The cost of this work
through March 31, 1998 has been approximately $4.1 million. The Company
estimates that the total remaining cost will be approximately $1.0 million,
which will be expensed through the remainder of 1998.
Many experts now believe that Year 2000 problems may have a material adverse
impact on the national and global economy generally. In addition, it seems
likely that if businesses are materially damaged as a result of Year 2000
problems, at least some such businesses may attempt to recoup their losses by
claiming coverage under various types of insurance policies. Although management
has concoluded that under a fair reading of the various policies of insurance
issued by it no coverage for Year 2000 problems should be considered to exist,
it is not possibly to predict whether or to what extend any such coverage could
ultimately be found to exist by courts in various jurisdicitions. Accordingly,
important factors which could cause actual results to differ materially from
those expressed in the forward looking statements include, but are not limited
to, the inability of the Company to accurately estimate the impact of the Year
2000 problem on the insurance issued by or other business operations of the
Company.
19
<PAGE>
New Accounting Pronouncements
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Comprehensive Income" ("SFAS No. 130"), which establishes
standards for the reporting and disclosure of comprehensive income and its
components (revenues, expenses, gains and losses). SFAS No. 130 requires that
all items required to be recognized under accounting standards as components of
comprehensive income be reported in a financial statement that is displayed with
the same prominence as other financial statements. Comprehensive income
includes a reclassification adjustment for net realized investment gains
included in net income of $4.9 million (after income taxes of $2.6 million) for
the three months ended March 31, 1998 and net realized investment losses of
$813,000 (after income taxes of $438,000) for the three months ended March 31,
1997. The new standard requires only additional disclosures in the consolidated
financial statements; it does not affect the Company's financial position or
results of operations.
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" (SFAS No. 131), which establishes standards for the way that public
business enterprises report information about operating segments in annual
financial statements and interim financial reports issued to shareholders. SFAS
No. 131 also establishes standards for related disclosures about products and
services, geographic areas and major customers. In connection with the adoption
of SFAS No. 131, the Company has identified four reportable segments: (i) PMA
Re, which provides reinsurance products and services; (ii) the Property and
Casualty Group, which writes workers' compensation and other standard lines of
commercial insurance and includes run-off operations; (iii) Caliber One, which
writes specialty insurance focusing on excess and surplus lines; and (iv)
Corporate and Other, which is primarily comprised of corporate overhead and the
operations of the Company's properties. Pursuant to the adoption of SFAS No.
131, the Company has restated the corresponding information from 1997 for
comparability, primarily related to certain corporate expenses which were
previously allocated to the operating segments. SFAS No. 131 requires only
additional disclosures in the consolidated financial statements; it does not
affect the Company's financial position or results of operations.
In January 1998, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants issued Statement of Position 97-3,
"Accounting by Insurance and Other Enterprises for Insurance-Related
Assessments" (SOP 97-3). SOP 97-3, which is effective for fiscal years
beginning after December 31, 1998, and provides guidance for determining when an
insurance company should recognize a liability for guaranty-fund and other
insurance related assessments and how to measure that liability. While the
Company is presently evaluating the impact of SOP 97-3, the adoption of SOP 97-3
is likely to result in an increase in the Company's liabilities for such
assessments, and such increase may be material. The impact of adopting SOP 97-3
will be reflected as a cumulative effect of an accounting change in the first
quarter of 1999.
20
<PAGE>
Part II. Other Information
Item 6. Exhibits and Reports on form 8-K
(a) Exhibits
Exhibit 3.1*: Amended and Restated Articles of Incorporation of the Company
Exhibit 3.2*: Amended and Restated Bylaws of the Company
Exhibit 11.1: Statement of Computation of Earnings Per Share
Exhibit 27: Financial Data Schedule
* Incorporated by reference to initial filing of Registrant's Registration
Statement on Form 10, filed June 26, 1997.
(b) Reports on Form 8-K filed during the quarter ended March 31, 1998:
A Current Report on Form 8-K, dated February 5, 1998, was filed regarding
Pennsylvania Manufacturers Corporations' commencement of trading of its Class A
Common Stock, $5.00 par value per share, on Nasdaq National Market under the
ticker symbol, "PMFRA."
A Current Report on Form 8-K, dated February 6, 1998, was filed announcing that
the Registrant's Board of Directors has authorized a share repurchase plan of
the Company's Common and Class A Common Stock over the next two years of up to
$25.0 million, subject to a maximum of 1.5 million shares of Common and Class A
Common Stock. On a pro forma basis, the 1.5 million shares would represent
approximately 6.25% of the Company's outstanding shares. Any repurchase may be
made from time to time in the open market or directly from shareholders at
prevailing market prices.
21
<PAGE>
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Company
has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
PENNSYLVANIA MANUFACTURERS
CORPORATION
Date: 5/15/98 By: /s/ Francis W. McDonnell
------- -------------------------
Francis W. McDonnell, Senior Vice
President, Chief Financial Officer and
Treasurer
22
<PAGE>
Exhibit Index
(a) Exhibits
Exhibit 3.1*: Amended and Restated Articles of Incorporation of the Company
Exhibit 3.2*: Amended and Restated Bylaws of the Company
Exhibit 11.1: Statement of Computation of Earnings Per Share
Exhibit 27: Financial Data Schedule
* Incorporated by reference to initial filing of Registrant's Registration
Statement on Form 10, filed June 26, 1997.
23
<PAGE>
EXHIBIT 11
Pennsylvania Manufacturers Corporation
Exhibit 11
Computation of Earnings Per Share
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended
March 31,
(in thousands, except per share data) 1997 1996
-------------------------
<S> <C> <C>
Basic:
Weighted average shares outstanding 23,850,631 23,836,878
Net income before extraordinary item $ 12,088 $ 4,757
Extraordinary loss - (4,734)
-------------------------
Net income $ 12,088 $ 23
=========================
Net income per common and equivalent share
before extraordinary item $ 0.51 $ 0.19
Extraordinary item - (0.19)
-------------------------
Net income per common and equivalent share $ 0.51 $ -
=========================
Diluted:
Weighted average shares outstanding 23,850,631 23,836,878
Net effect of dilutive stock options - based
on the treasury stock method using average
market price 731,704 738,489
-------------------------
Total diluted common shares 24,582,335 24,575,367
=========================
Net income before extraordinary item $ 12,088 $ 4,757
Extraordinary loss - (4,734)
-------------------------
Net income $ 12,088 $ 23
=========================
Net income per common and equivalent share
before extraordinary item $ 0.49 $ 0.19
Extraordinary item - (0.19)
-------------------------
Net income per common and equivalent share $ 0.49 $ -
=========================
</TABLE>
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 7
<S> <C> <C> <C>
<PERIOD-TYPE> 3-MOS 12-MOS 3-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1997 DEC-31-1997
<PERIOD-END> MAR-31-1998 DEC-31-1997 MAR-31-1997
<DEBT-HELD-FOR-SALE> 1,984,800 1,929,518 2,101,914
<DEBT-CARRYING-VALUE> 0 0 0
<DEBT-MARKET-VALUE> 0 0 0
<EQUITIES> 14 13 262
<MORTGAGE> 0 0 0
<REAL-ESTATE> 0 0 0
<TOTAL-INVEST> 2,174,081 2,194,738 2,143,426
<CASH> 2,267 32,148 13,986
<RECOVER-REINSURE> 354,113 332,406 277,977
<DEFERRED-ACQUISITION> 56,562 45,288 53,980
<TOTAL-ASSETS> 3,103,480 3,057,258 3,114,205
<POLICY-LOSSES> 1,989,115 2,003,187 2,085,732
<UNEARNED-PREMIUMS> 261,045 211,455 258,434
<POLICY-OTHER> 0 0 0
<POLICY-HOLDER-FUNDS> 9,317 10,200 12,100
<NOTES-PAYABLE> 203,000 203,000 203,232
0 0 0
0 0 0
<COMMON> 122,214 122,214 121,716
<OTHER-SE> 357,279 356,133 263,250
<TOTAL-LIABILITY-AND-EQUITY> 3,103,480 3,057,258 3,114,205
106,922 375,951 107,950
<INVESTMENT-INCOME> 32,515 136,698 35,847
<INVESTMENT-GAINS> 7,514 8,598 (1,251)
<OTHER-INCOME> 2,435 10,311 2,548
<BENEFITS> 84,857 307,281 94,904
<UNDERWRITING-AMORTIZATION> 22,703 93,501 18,339
<UNDERWRITING-OTHER> 23,384 89,855 20,199
<INCOME-PRETAX> 14,741 25,153 7,318
<INCOME-TAX> 2,653 5,400 2,561
<INCOME-CONTINUING> 0 0 0
<DISCONTINUED> 0 0 0
<EXTRAORDINARY> 0 (4,734) (4,734)
<CHANGES> 0 0 0
<NET-INCOME> 12,088 15,019 23
<EPS-PRIMARY> 0.51 0.63 0.00
<EPS-DILUTED> 0.49 0.61 0.00
<RESERVE-OPEN> 0 0 0
<PROVISION-CURRENT> 0 0 0
<PROVISION-PRIOR> 0 0 0
<PAYMENTS-CURRENT> 0 0 0
<PAYMENTS-PRIOR> 0 0 0
<RESERVE-CLOSE> 0 0 0
<CUMULATIVE-DEFICIENCY> 0 0 0
</TABLE>
