<PAGE>
As filed with the Securities and Exchange Commission on January 20, 1998
Registration No. 333-63469
================================================================================
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------
AMENDMENT NO. 2 TO FORM S-3
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933
------------------
<TABLE>
<S> <C>
PMC Capital I PMA Capital Corporation
- -------------------------------------- ------------------------------------------
(Exact name of registrant as specified (Exact name of registrant as specified
in its charter) in its charter)
Delaware Pennsylvania
- --------------------------------- -------------------------------
(State or other jurisdiction of (State or other jurisdiction of
incorporation or organization) incorporation or organization)
Applied For 23-2217932
- -------------------------------------- ----------------------------------------
(I.R.S. Employer Identification No.) (I.R.S. Employer Identification No.)
The PMA Building Mellon Bank Center
380 Sentry Parkway 1735 Market Street
Blue Bell, Pennsylvania 19422-2328 Philadelphia, Pennsylvania 19103-7590
(215) 665-5046 (215) 665-5046
- -------------------------------------- ----------------------------------------
(address, including zip code, and (address, including zip code, and
telephone number, including area telephone number, including area
code, of registrant's principal code, of registrant's principal
executive offices) executive offices)
</TABLE>
--------------------
Francis W. McDonnell
Senior Vice President and Chief Financial Officer
PMA Capital Corporation
1735 Market Street
Philadelphia, Pennsylvania 19103-7590
(215) 665-5070
-------------------------------------------
(Name, address, including zip code, and
telephone number, including area code,
of agent for service)
--------------------
Copies to:
Robert L. Pratter, Esquire William D. Torchiana, Esquire
Duane, Morris & Heckscher LLP Sullivan & Cromwell
4200 One Liberty Place 125 Broad Street
Philadelphia, PA 19103-7396 New York, New York 10004
(215) 979-1000 (212) 558-4000
--------------------
Approximate date of commencement of proposed sale to the public: As soon
as practicable after this Registration Statement becomes effective.
<PAGE>
If the only securities being registered on this Form are to be offered
pursuant to dividend or interest reinvestment plans, please check the following
box. [_]
If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 of the Securities Act of 1933
other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [_]
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration number of the earlier effective
registration statement for the same offering. [_]
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act of 1933, check the following box and list the
Securities Act registration statement number of the earlier effective
registration statement for the same offering. [_]
If delivery of the prospectus is expected to be made pursuant to Rule 434
under the Securities Act of 1933, please check the following box. [_]
<PAGE>
____________________
THE REGISTRANTS HEREBY AMEND THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANTS SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A),
MAY DETERMINE.
===========================================
<PAGE>
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
+INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A +
+REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE +
+SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY +
+OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT +
+BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR +
+THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE +
+SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE +
+UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF +
+ANY SUCH STATE. +
++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
SUBJECT TO COMPLETION, DATED JANUARY 20, 1999
$100,000,000
PMC CAPITAL I
% CAPITAL SECURITIES, SERIES A
(LIQUIDATION AMOUNT $1,000 PER CAPITAL SECURITY)
FULLY AND UNCONDITIONALLY GUARANTEED, AS DESCRIBED HEREIN, BY
PMA CAPITAL CORPORATION
-----------
The % Capital Securities, Series A (the "Capital Securities") offered
hereby (the "Offering") represent undivided beneficial interests in the assets
of PMC Capital I, a statutory business trust formed under the laws of the State
of Delaware (the "Issuer" or the "Trust"). PMA Capital Corporation ("PMA
Capital"), a Pennsylvania corporation, will be the owner of all of the
beneficial interests represented by common securities (the "Common Securities")
of the Issuer. The Bank of New York is the Property Trustee of the Issuer. The
Issuer exists for the sole purpose of issuing the Capital Securities and the
Common Securities and investing the proceeds thereof in % Junior
Subordinated Debentures, Series A (the "Junior Subordinated Debentures") to be
issued by PMA Capital. The Junior Subordinated Debentures will mature on
, 2029 (the "Stated Maturity"). The Capital Securities will have a
preference under certain circumstances with respect to cash distributions and
amounts payable on liquidation, redemption or otherwise over the Common
Securities. See "Description of the Capital Securities--Subordination of Common
Securities." PMA Capital and the Issuer do not intend to list the Capital
Securities on any securities exchange. See "Risk Factors--Liquidity of Trading;
Trading Price of the Capital Securities May Not Fully Reflect Value of Unpaid
Interest."
(continued on next page)
SEE "RISK FACTORS" BEGINNING ON PAGE 16 HEREOF FOR CERTAIN INFORMATION
RELEVANT TO AN INVESTMENT IN THE CAPITAL SECURITIES.
-----------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION
PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY
REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
-----------
<TABLE>
<CAPTION>
INITIAL PUBLIC UNDERWRITING PROCEEDS TO THE
OFFERING PRICE(1) COMMISSIONS(2) ISSUER(3)(4)
----------------- -------------- ---------------
<S> <C> <C> <C>
Per Capital Security........... $1,000 (3)
Total.......................... $100,000,000 (3)
</TABLE>
- -----
(1) Plus accrued distributions, if any, from ,1999.
(2) The Issuer, PMA Capital and PMA Reinsurance Corporation have agreed to
indemnify the several Underwriters against certain liabilities, including
liabilities under the Securities Act of 1933, as amended. See
"Underwriting."
(3) In view of the fact that the proceeds of the sale of the Capital Securities
will be used to purchase the Junior Subordinated Debentures, PMA Capital
has agreed to pay to the Underwriters as compensation ("Underwriters'
Compensation") for their arranging the investment therein of such proceeds,
$ per Capital Security (or $ in the aggregate). See "Underwriting."
(4) Other expenses of issuance and distribution, which are payable by PMA
Capital, are estimated to be $500,000.
-----------
The Capital Securities offered hereby are offered severally by the
Underwriters, as specified herein, subject to receipt and acceptance by them
and subject to their right to reject any order in whole or in part. It is
expected that the Capital Securities will be ready for delivery in book-entry
form only through the facilities of The Depository Trust Company, on or about
, 1999, against payment therefor in immediately available funds.
-----------
GOLDMAN, SACHS & CO.
MERRILL LYNCH & CO.
FIRST UNION CAPITAL MARKETS
The date of this Prospectus is , 1999
<PAGE>
(Continued from Cover Page)
Holders of the Capital Securities will be entitled to receive preferential
cumulative cash distributions accruing from the date of original issuance and
payable semi-annually in arrears on and of each year, commencing , 1999, at
the annual rate of % of the liquidation amount of $1,000 per Capital
Security ("distributions"). PMA Capital has the right to defer payments of
interest on the Junior Subordinated Debentures, so long as no Debenture Event
of Default (as defined herein) has occurred and is continuing, at any time and
from time to time for a period not exceeding 10 consecutive semi-annual
periods with respect to each deferral period (each an "Extension Period"),
provided that no Extension Period may extend beyond the Stated Maturity of the
Junior Subordinated Debentures. Upon the termination of any such Extension
Period and the payment of all interest then accrued and unpaid (together with
interest thereon at the rate of % per annum, compounded semi-annually, to
the extent permitted by applicable law), PMA Capital may elect to begin a new
Extension Period subject to the requirements set forth herein. If interest
payments are so deferred, distributions on the Capital Securities will also be
deferred and PMA Capital will not be permitted to declare or pay any
distributions with respect to PMA Capital's capital stock or make any payment
on any debt securities of PMA Capital that rank pari passu with or junior to
the Junior Subordinated Debentures or make any guarantee payments with respect
to any guarantee by PMA Capital of the debt securities of any subsidiary of
PMA Capital that rank pari passu with or junior to the Junior Subordinated
Debentures subject to certain exceptions described herein. During an Extension
Period, interest on the Junior Subordinated Debentures will continue to accrue
(and the amount of distributions to which holders of the Capital Securities
are entitled will accumulate) at the rate of % per annum, compounded semi-
annually from the relevant payment date for such interest and holders of the
Capital Securities will be required to accrue interest income for United
States federal income tax purposes. See "Description of the Junior
Subordinated Debentures--Option to Extend Interest Payment Period" and "United
States Federal Income Taxation--Original Issue Discount."
PMA Capital has, through the Guarantee, the Trust Agreement, the Capital
Securities, the Indenture and the Expense Agreement (each as defined herein),
taken together, fully, irrevocably and unconditionally guaranteed all of the
Issuer's obligations under the Capital Securities. See "Relationship Among the
Capital Securities, the Junior Subordinated Debentures and the Guarantee--Full
and Unconditional Guarantee." The Guarantee of PMA Capital guarantees the
payment of distributions and payments on liquidation or redemption of the
Capital Securities, but in each case only to the extent of funds held by the
Issuer, as described herein (the "Guarantee"). See "Description of the
Guarantee." If PMA Capital does not make interest payments on the Junior
Subordinated Debentures held by the Issuer, the Issuer will have insufficient
funds to pay distributions on the Capital Securities. The Guarantee does not
cover payment of distributions when the Issuer does not have sufficient funds
to pay such distributions. In such event, a holder of Capital Securities may
institute a legal proceeding directly against PMA Capital pursuant to the
terms of the Indenture to enforce payment of amounts equal to such
distributions to such holder. See "Description of the Junior Subordinated
Debentures--Debenture Events of Default and Consequent Rights of Certain
Holders--Rights of Holders of Capital Securities to Direct Action." PMA
Capital's obligations under the Guarantee and the Junior Subordinated
Debentures are subordinate and junior in right of payment to all Senior Debt
(as defined herein) of PMA Capital.
The Capital Securities are subject to mandatory redemption, in whole or in
part, upon repayment of the Junior Subordinated Debentures at maturity or
their earlier redemption. See "Description of the Capital Securities--
Redemption." The Junior Subordinated Debentures are redeemable prior to their
Stated Maturity at the option of PMA Capital (i) on or after , 2009, in
whole at any time or in part from time to time or (ii) prior to , 2009,
in whole (but not in part), within 90 days following the occurrence of a
Special Event (as defined herein). For a description of redemption prices for
the Capital Securities pursuant to clause (i) or (ii) above, see "Description
of the Capital Securities--Redemption" and "Description of the Junior
Subordinated Debentures--Optional Redemption."
2
<PAGE>
The Junior Subordinated Debentures are unsecured and subordinated and junior
in right of payment to all Senior Debt of PMA Capital. After the completion of
this Offering and the repayment of debt with the proceeds thereof, PMA Capital
will have approximately $104.5 million principal amount of indebtedness for
borrowed money constituting Senior Debt. The terms of the Junior Subordinated
Debentures do not limit PMA Capital's ability to incur additional Senior Debt.
PMA Capital is an insurance holding company and substantially all of the
operating assets of PMA Capital are owned by its subsidiaries. PMA Capital
relies primarily on the receipt of sufficient funds from its subsidiaries in
the form of dividends, net payments under a tax-sharing agreement between PMA
Capital and its subsidiaries and loans to meet its obligations for payment of
principal and interest on its outstanding debt obligations and corporate
expenses. Accordingly, the Junior Subordinated Debentures will be effectively
subordinated to all existing and future liabilities of PMA Capital's
subsidiaries, which debt totalled approximately $2.4 billion at September 30,
1998, and holders of Junior Subordinated Debentures should look only to the
assets of PMA Capital for payments on the Junior Subordinated Debentures. The
payment of dividends by PMA Capital's insurance subsidiaries is limited under
the insurance laws of their states of domicile (primarily Pennsylvania). PMA
Capital's insurance subsidiaries have the ability to loan funds to PMA Capital
subject to certain regulatory restrictions. See "Description of the Junior
Subordinated Debentures--Subordination."
PMA Capital will have the right at any time to terminate the Issuer and
cause the Junior Subordinated Debentures to be distributed to the holders of
the Capital Securities in liquidation of the Issuer. In the event of the
termination of the Issuer, after satisfaction of liabilities to creditors of
the Issuer as required by applicable law, the holders of the Capital
Securities will be entitled to receive for each Capital Security a Liquidation
Amount of $1,000 per Capital Security, plus accumulated and unpaid
distributions thereon to the date of payment, or a distribution of such
Liquidation Amount in Junior Subordinated Debentures, subject to certain
limitations. See "Description of the Capital Securities--Liquidation
Distribution Upon Termination."
The Capital Securities will be represented by global certificates registered
in the name of The Depository Trust Company ("DTC") or its nominee. Beneficial
interests in the Capital Securities will be shown on, and transfers thereof
will be effected only through, records maintained by participants in DTC.
Except as described herein, the Capital Securities in certificated form will
not be issued in exchange for the global certificates. See "Description of the
Capital Securities--Book-Entry-Only Issuance--The Depository Trust Company."
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE CAPITAL
SECURITIES, INCLUDING OVER-ALLOTMENT, STABILIZING AND SHORT COVERING
TRANSACTIONS IN SUCH SECURITIES, AND THE IMPOSITION OF A PENALTY BID, DURING
AND AFTER THE OFFERING. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE
"UNDERWRITING."
3
<PAGE>
AVAILABLE INFORMATION
The Trust and PMA Capital have filed with the Securities and Exchange
Commission (the "Commission") a Registration Statement on Form S-3 (together
with all amendments and exhibits thereto, the "Registration Statement") under
the Securities Act of 1933, as amended (the "Securities Act"), with respect to
the Capital Securities, the Junior Subordinated Debentures and the Guarantee.
This Prospectus, which forms a part of the Registration Statement, does not
contain all the information set forth in the Registration Statement, certain
parts of which have been omitted in accordance with the Rules and Regulations
of the Commission. Statements made in this Prospectus as to the contents of
any contract, agreement or other document referred to are not necessarily
complete. With respect to each such contract, agreement or other document
filed as an exhibit to the Registration Statement, reference is made to the
exhibit for a more complete description of the matter involved, and each such
statement shall be deemed qualified in its entirety by such reference.
PMA Capital is subject to the informational requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act"), and, in accordance
therewith, files reports and other information with the Commission. In
addition, the Trust and PMA Capital intend to furnish to holders of the
Capital Securities annual reports containing consolidated financial statements
of PMA Capital certified by an independent public accounting firm. Such
reports and other information and the Registration Statement, including the
exhibits and schedules filed therewith, may be examined without charge at the
public reference facilities maintained by the Commission at Room 1024,
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, and at the
Commission's regional offices at Citicorp Center, 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661 and 7 World Trade Center, 13th Floor, New
York, New York 10048. Copies of all or any part of the Registration Statement
may be obtained from the Public Reference Section of the Commission at
Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates. The Commission maintains a Web Site (http://www.sec.gov) that contains
reports, proxy and information statements and other information regarding
registrants who file electronically with the Commission. The public may obtain
information on the operation of the Public Reference Room by calling the
Commission at 1-800-SEC-0330.
No separate financial statements of the Trust have been included herein. PMA
Capital and the Trust do not consider such financial statements material to
holders of the Capital Securities because the Trust is a newly formed special
purpose entity, has no operating history or independent operations and is not
engaged in, and does not propose to engage in, any activity other than its
holding as trust assets the Junior Subordinated Debentures of PMA Capital and
the Trust's issuance of the Capital Securities and the Common Securities. See
"The Issuer," "Description of the Capital Securities," "Description of the
Guarantee" and "Description of the Junior Subordinated Debentures." In
addition, PMA Capital does not expect that the Trust will file reports under
the Exchange Act with the Commission. The Trust is a statutory business trust
formed under the laws of the State of Delaware. PMA Capital, as of the date
hereof, beneficially owns all of the beneficial interests in the Trust. PMA
Capital's and the Trust's principal executive offices are located at 1735
Market Street, Philadelphia, Pennsylvania 19103-7590, telephone number (215)
665-5046.
4
<PAGE>
FORWARD-LOOKING STATEMENTS
Certain statements made throughout this Prospectus contain forward-looking
statements that involve risks and uncertainties. These forward-looking
statements are based on currently available financial, competitive and
economic data and PMA Capital's current operating plans based on management's
current views and assumptions regarding future events. Potential investors
should be aware that actual events may significantly differ from management's
current views and assumptions and that PMA Capital's actual results could
differ materially from those expected by PMA Capital's management. The factors
that could cause actual results to vary materially, some of which are
described in the forward-looking statements, include, but are not limited to,
changes in general economic conditions, including the performance of financial
markets and interest rates; regulatory or tax changes, including changes in
risk-based capital or other regulatory standards that affect the ability of
PMA Capital to conduct its business; competitive or regulatory changes that
affect the cost of or demand for PMA Capital's products; PMA Capital's ability
to meet its marketing objectives; the effect of changes in workers'
compensation statutes and the administration thereof; PMA Capital's ability to
predict and manage effectively claims related to insurance and reinsurance
policies; reliance on key management; adequacy of reserves for claims
liabilities; adequacy and collectibility of reinsurance purchased by PMA
Capital; frequency and severity of natural disasters and other catastrophes;
and other factors disclosed from time to time in reports filed by PMA Capital
with the Commission. Investors should not place undue reliance on any such
forward- looking statements.
5
<PAGE>
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to the
detailed information and consolidated financial statements appearing elsewhere
in this Prospectus. Certain insurance terms and other capitalized terms used
herein are defined in "Glossary of Certain Insurance and Other Defined Terms."
Unless the context otherwise requires, all references in this Prospectus to:
(i) "PMA Capital" or the "Company" refers to PMA Capital Corporation (formerly
Pennsylvania Manufacturers Corporation) and, depending on the context, its
subsidiaries on a consolidated basis; (ii) "PMA Re" refers to the Company's
property and casualty reinsurance operations, including PMA Reinsurance
Corporation, a Pennsylvania insurance subsidiary of the Company; (iii)
"Property and Casualty Group" refers to the Company's workers' compensation and
standard commercial lines of property and casualty insurance operations, which
are written through the "Pooled Companies" consisting of three Pennsylvania
insurance subsidiaries of the Company, including Pennsylvania Manufacturers
Association Insurance Company ("PMAIC"), which share underwriting results
through an intercompany pooling arrangement; (iv) "Caliber One" refers to the
Company's specialty insurance operation, including Caliber One Indemnity
Company, a Delaware insurance subsidiary of the Company; (v) "PMA Cayman"
refers to PMA Insurance, Cayman Ltd., a Cayman Islands run-off insurance
subsidiary of the Company which the Company sold effective July 1, 1998 and
(vi) "MASCCO" refers to Mid- Atlantic States Casualty Company, a Pennsylvania
run-off insurance subsidiary of the Company.
Unless otherwise specified, all financial information is presented in
accordance with United States generally accepted accounting principles
("GAAP"). Statutory data included herein have been derived from the annual and
quarterly statements of PMA Capital's insurance subsidiaries as filed with
insurance regulatory authorities and prepared in accordance with statutory
accounting principles ("SAP") prescribed or permitted by such regulatory
authorities.
Unless otherwise specified herein, the information contained herein assumes
no exercise of the Underwriters' over-allotment option.
THE COMPANY
GENERAL
The Company is an insurance holding company, whose subsidiaries operate in
three distinct segments of the property and casualty insurance industry: (i)
reinsurance, through PMA Re, which commenced business in 1980; (ii) standard
commercial lines of insurance, with an emphasis on workers' compensation,
through the Property and Casualty Group, which has been in business since 1915
and (iii) specialty insurance products, focusing on excess and surplus lines,
through the Company's recently-formed operation, Caliber One. PMA Re writes a
broad range of property and casualty reinsurance products with an emphasis on
risk-exposed casualty excess of loss reinsurance and operates in the United
States domestic brokered market. The Property and Casualty Group offers a full
range of workers' compensation products and services, as well as other standard
commercial lines including commercial general liability, commercial automobile
and commercial multi-peril, primarily in nine contiguous jurisdictions in the
Mid-Atlantic and Southern regions of the United States, utilizing the PMA Group
trade name. In 1998, Caliber One commenced writing excess and surplus lines of
insurance, including commercial general liability, automobile and certain
property exposures on a non-admitted basis. For the nine months ended September
30, 1998, the Company's net premiums written of $369.1 million were derived
46.7% from PMA Re, 52.6% from the Property and Casualty Group and 0.7% from
Caliber One. Net income for the Company for the nine months ended September 30,
1998 and the year ended December 31, 1997 was $32.0 million and $15.0 million,
respectively. As of September 30, 1998, the Company had total assets of
$3,131.9 million and shareholders' equity of $517.6 million.
6
<PAGE>
According to data provided by the Reinsurance Association of America ("RAA"),
as of September 30, 1998, PMA Reinsurance Corporation was the 23rd largest
reinsurer in the United States in terms of statutory surplus and 18th largest
in terms of net premiums written. Management believes that PMA Re competes on
the basis of its ability to offer prompt and responsive service and products
designed to meet clients' needs and its excellent long-term relationships in
the broker and ceding company communities. PMA Re's net premiums written grew
at a compound annual rate of 13.2% between 1992 and 1997. As of September 30,
1998, statutory surplus of PMA Reinsurance Corporation was $283.0 million, and
for the nine months ended September 30, 1998, PMA Re's net premiums written
were $172.6 million. PMA Re reported pre-tax operating income of $34.9 million
and $34.7 million for the nine-month periods ended September 30, 1998 and 1997,
respectively, and $46.0 million, $44.8 million and $39.8 million for the years
ended December 31, 1997, 1996 and 1995, respectively.
The Property and Casualty Group markets its products and services primarily
to middle market accounts (premiums ranging from $40,000 to $300,000) and
smaller accounts (premiums less than $40,000). The Property and Casualty Group
distributes its products primarily through approximately 260 regional brokers
and agents throughout its marketing territories and also utilizes an internal
sales force in Pennsylvania and Delaware, which accounted for approximately 13%
of direct premiums written in 1997. In 1997, workers' compensation insurance
accounted for 60% of the Property and Casualty Group's direct premiums written,
and Pennsylvania workers' compensation insurance accounted for 50% of the
Property and Casualty Group's workers' compensation direct premiums written.
The Property and Casualty Group offers a variety of workers' compensation
products, such as third-party claims administration services, rent-a-captives
and high-deductible plans in addition to traditional fixed-cost and loss-
sensitive workers' compensation products. Management believes that the Property
and Casualty Group competes in workers' compensation on the basis of its
ability to provide prompt and responsive service.
In 1996, the Company restructured the Property and Casualty Group with the
goal of restoring its profitability after three years of operating losses. The
operating losses resulted primarily from unfavorable underwriting experience
and adverse reserve development related to accident years 1987 through 1991,
when the Property and Casualty Group wrote a much higher volume of business
than its current volume. The principal components of the restructuring were:
(i) strengthening loss reserves; (ii) initiating a commutation program to
settle a significant number of open claims from the 1987 to 1991 period; (iii)
designating PMA Cayman and MASCCO as separate run-off companies to alleviate
the SAP impact on the Pooled Companies of the loss reserve strengthening and to
manage the capital deployed in running off pre-1992 workers' compensation
claims; (iv) initiating an expense reduction program and (v) implementing
management changes, including the appointment of a new Chief Operating Officer
and the creation of a new position of, and appointment of, a Chief Underwriting
Officer. Effective July 1, 1998, the Company sold PMA Cayman. Largely as a
result of the restructuring, the Property and Casualty Group recorded pre-tax
operating income of $8.4 million for the nine months ended September 30, 1998,
compared to pre-tax operating losses of $5.0 million for the nine months ended
September 30, 1997 and $3.7 million, $215.7 million (including restructuring
and other special charges of $223.1 million) and $3.9 million for the years
ended December 31, 1997, 1996 and 1995, respectively. As of September 30, 1998,
the Property and Casualty Group's statutory surplus was $263.3 million, and for
the nine months ended September 30, 1998, the Property and Casualty Group's net
premiums written were $194.3 million. See "Business--The Property and Casualty
Group."
In December 1997, the Company acquired an insurance company, which was
renamed Caliber One Indemnity Company, to enter the excess and surplus lines
insurance business. Within the last year, the Company hired several experienced
specialty insurance executives to manage Caliber One,
7
<PAGE>
who have substantial relationships within the wholesale brokerage community,
which management believes will have a favorable impact on Caliber One's ability
to obtain market acceptance. Caliber One distributes its products primarily
through national wholesale brokers, and Caliber One Indemnity Company is
approved as a surplus lines carrier in 41 states, Puerto Rico and the District
of Columbia. As of September 30, 1998, Caliber One Indemnity Company's
statutory surplus was $25.4 million, and for the nine months ended September
30, 1998, Caliber One's net premiums written were $2.6 million.
The Company's insurance subsidiaries have the following ratings from A.M.
Best: PMA Reinsurance Corporation, A+ ("Superior"); the Pooled Companies, A-
("Excellent") and Caliber One Indemnity Company, A ("Excellent"). Management
believes that ratings from A.M. Best are material to its operations and that a
downgrade from the present rating classifications could have an adverse effect
on the Company's ability to market its products. A.M. Best's ratings are based
upon an assessment of an insurance company's perceived financial strength
regarding its ability to pay obligations to its policyholders and are not
directed toward the protection of investors.
The Company maintains its principal executive offices at 1735 Market Street,
Philadelphia, Pennsylvania 19103-7590, and its telephone number is (215) 665-
5046.
BUSINESS STRATEGY
Management believes that PMA Capital's three insurance businesses are
characterized by the need for specialized expertise and a requirement for
strong underwriting skills. Management also believes that each of PMA Capital's
businesses targets sophisticated customers who desire products designed for
specific client needs that require a high level of service. The following
discussion sets forth the main components of the Company's overall operating
strategies and the implementation thereof by the Company's operating units.
UNDERWRITING DISCIPLINE
Management believes that risk selection and pricing is critical to the
Company's success. Maintenance of underwriting discipline has become more
difficult and more critical to the achievement of an acceptable level of
profitability for the Company given the present competitive conditions in the
property and casualty insurance and reinsurance industries. The Company's three
operations have rejected and non-renewed certain accounts because market rates
and contract terms for such risks did not provide the opportunity to achieve a
rate of return that management considers acceptable.
The Company relies on experienced underwriting management in order to
maintain underwriting discipline. The underwriting management at PMA Re, the
Property and Casualty Group and Caliber One averages 21, 22 and 16 years of
experience, respectively, in the property and casualty insurance industry. In
addition, in 1997 the Property and Casualty Group strengthened its underwriting
management by creating the new position of and appointing a Chief Underwriting
Officer, who has over 22 years of experience in the industry. Also, the
Property and Casualty Group reorganized its reporting structure so that field
underwriting management now reports functionally to the Chief Underwriting
Officer rather than to branch managers who have primarily marketing
responsibilities.
Underwriting management is evaluated and compensated for all of the Company's
insurance operations with an emphasis on profit objectives.
MARKETING
The Company markets its products on the basis of price, service, product
design and financial security. The Company attempts to price its products in
such a way that the prices charged to its
8
<PAGE>
clients are commensurate with the overall marketplace. The current soft pricing
environment has made competition and marketing solely on the basis of price
increasingly difficult. Therefore, the Company has focused its marketing
efforts on providing excellent service and products designed for specific
client needs, as well as maintaining stable and solid relationships with the
Company's distribution system.
Beginning in 1996, PMA Re undertook a target marketing program designed to
increase its business with certain existing accounts and obtain new ceding
company clients from a pre-screened list developed by the Company. Management
believes that PMA Re has been able to write certain business that has been
displaced as a result of the recent consolidation of the United States
reinsurance industry. As a result of these factors and PMA Re's other
competitive attributes, including management's relationships with broker and
ceding company communities, PMA Re's net premiums written grew 8.5% in 1997
compared to 1996 and increased 22.1% for the nine months ended September 30,
1998 compared to the nine months ended September 30, 1997, notwithstanding the
non-renewal or cancellation of a total of $66.9 million of business since
January 1, 1997 primarily for underwriting reasons. The Property and Casualty
Group's marketing strategy is focused on: (i) reestablishing a portion of its
historical market share in its traditional marketing territories on a
profitable basis; (ii) implementing planned geographic expansion into selected
territories bordering its present marketing territories; (iii) increasing its
business with national brokerages and (iv) increasing its business with smaller
accounts (less than $40,000 in annual premium) in certain jurisdictions in
response to workers' compensation reforms which have made such business more
attractive. Caliber One's marketing strategy is based upon management's
relationships within the wholesale brokerage community and responsiveness to
marketplace needs through product design.
PRODUCTS AND SERVICES
Management believes that the Company's results depend on its ability to offer
products designed to meet client needs and services that distinguish the
Company from its competitors. The Company's service standards have been
designed to emphasize prompt turn-around time for underwriting submissions,
access to information and claims handling. PMA Re offers a full range of
reinsurance products, including traditional treaty reinsurance, facultative
reinsurance, finite risk and other specialized products. In addition, PMA Re
has been at the forefront of service initiatives within the brokered
reinsurance market, including fastrack claims, electronic data interchange and
electronic funds transfer. Fastrack claims is a process whereby certain claims
are pre-approved for payment as long as the request for payment falls within
certain parameters, thereby accelerating remittance to the client. The Property
and Casualty Group has developed products and services to serve the various
segments of its market. It offers its workers' compensation insureds the
enhanced ability to control medical costs, through its affiliation with First
Health Group, Inc., a third party preferred provider organization. The Property
and Casualty Group has also utilized aggressive claims settlement processes,
including commutations, as part of its strategy to assist clients in reducing
the overall cost of their workers' compensation benefits. The Property and
Casualty Group also offers alternative market products, such as large
deductible plans, rent-a-captive services and third party administration of
claims to self-insured clients. In addition, in 1998, the Property and Casualty
Group began marketing an integrated disability product, PMA One, which combines
occupational and non-occupational disability coverages. Caliber One develops
products for specialized segments of the market, including coverages for
clinical trials, environmental risks, special events, toy manufacturers and
retroactive liability.
9
<PAGE>
PMC CAPITAL I
PMC Capital I is a statutory business trust formed under Delaware law. The
Issuer exists for the exclusive purposes of (i) issuing the Capital Securities
and the Common Securities representing undivided beneficial interests in the
assets of the Issuer, (ii) investing the gross proceeds of the sale of the
Capital Securities and the Common Securities in the Junior Subordinated
Debentures and (iii) engaging in only those other activities necessary or
incidental thereto. All of the Common Securities, having an aggregate
liquidation amount equal to 3% of the total capital of the Issuer, will be
owned by PMA Capital. The Common Securities will rank pari passu, and payments
will be made thereon pro rata, with the Capital Securities, except that upon
the occurrence and continuance of an event of default under the Amended and
Restated Trust Agreement (the "Trust Agreement"), among PMA Capital as
Depositor, The Bank of New York as Property Trustee and The Bank of New York
(Delaware) as Delaware Trustee and the Administrative Trustees named therein,
resulting from an event of default by PMA Capital on the Junior Subordinated
Debentures, the rights of the holders of the Common Securities to payment in
respect of distributions and payments upon liquidation, redemption and
otherwise will be subordinated to the rights of the holders of the Capital
Securities. The Property Trustee and the Administrative Trustees are referred
to herein, collectively, as the "Trustees." Subject to the right of holders of
a majority in Liquidation Amount of the outstanding Capital Securities to
appoint a substitute Property Trustee upon the occurrence of certain events
described herein, PMA Capital, as the owner of all of the Common Securities,
has the exclusive right (subject to the provisions of the Trust Agreement) to
appoint, remove or replace the Property Trustee, the duties and obligations of
which will be governed by the Trust Agreement. PMA Capital will pay all fees
and expenses related to the Issuer and the offering of the Capital Securities.
THE OFFERING
Issuer...................... PMC Capital I
Securities Offered.......... $100,000,000 of % Capital Securities
Ownership...................
The ownership interests in the Trust will be
evidenced by (i) a class of Capital Securities
representing approximately 97% of the ownership
interests in the Trust and (ii) a class of Common
Securities (together with the Capital Securities,
the "Trust Securities") representing
approximately 3% of the ownership interests in
the Trust.
Maturity of the Junior
Subordinated Debentures....
, 2029 (the "Stated Maturity"). The Capital
Securities are mandatorily redeemable upon the
maturity or earlier redemption of the Junior
Subordinated Debentures.
Distribution Payment 1 and 1, commencing , 1999.
Dates......................
Extension of Interest
Payment Period.............
PMA Capital will have the right to extend the
interest payment period on the Junior
Subordinated Debentures, so long as no Event of
Default has occurred and is continuing, for a
period not exceeding ten consecutive semi-annual
periods (each, an
10
<PAGE>
"Extension Period"), and, as a consequence,
during an Extension Period, semi-annual
distributions on the Capital Securities would be
deferred (and the amount of distributions to
which holders of the Capital Securities are
entitled will accumulate additional distributions
thereon at the rate of % thereof, compounded
semi-annually from the relevant payment date for
such distributions). During an Extension Period,
neither PMA Capital nor any of its subsidiaries
shall (i) declare or pay any dividends or
distributions on, or redeem, purchase, acquire or
make a liquidation payment with respect to, any
of PMA Capital's outstanding capital stock or
(ii) make any payment of principal, interest or
premium, if any, on or repay, repurchase or
redeem any debt securities of PMA Capital that
rank pari passu with or junior to the Junior
Subordinated Debentures or make any guarantee
payments with respect to any guarantee by PMA
Capital of the debt securities of any
subsidiaries of PMA Capital that rank pari passu
with or junior to the Junior Subordinated
Debentures (other than (a) dividends or
distributions in Common Stock or Class A Common
Stock of PMA Capital, (b) payments under the
Guarantee and (c) purchases of Common Stock or
Class A Common Stock of PMA Capital related to
the issuance of Common Stock or Class A Common
Stock of PMA Capital under any of PMA Capital's
benefit plans for directors, officers or
employees). This deferral feature cannot be used
to extend the maturity of the Junior Subordinated
Debentures.
Guarantee...................
Taken together, PMA Capital's obligations under
the Junior Subordinated Debentures, the
Indenture, the Trust Agreement, the Expense
Agreement and the Guarantee provide, in the
aggregate, a full, irrevocable and unconditional
guarantee of payments of distributions and other
amounts due on the Capital Securities. No single
document standing alone or operating in
conjunction with fewer than all the other
documents constitutes such guarantee.
Mandatory Redemption........
The Capital Securities are subject to mandatory
redemption upon repayment of the Junior
Subordinated Debentures at maturity or their
earlier redemption. PMA Capital will have the
option at any time on or after, , 2009, to
redeem, in whole or in part, the Junior
Subordinated Debentures, at par, plus accrued and
unpaid interest, if any, through the redemption
date. PMA Capital will also have the right at any
time, upon the occurrence of a Special Event (as
defined herein), to redeem, in whole but not in
part, the Junior Subordinated Debentures.
Liquidation Amount.......... $1,000.00 per Capital Security (the "Liquidation
Amount").
11
<PAGE>
Subordination of Common
Securities.................
Income distributions, payments of redemption
prices and amounts distributed in connection with
the liquidation of the Trust will be made pari
passu among holders of the Capital Securities and
PMA Capital, as holder of the Common Securities,
except that, in the event of a default by PMA
Capital on the Junior Subordinated Debentures,
(i) full income distributions and payments of
redemption prices will be made on the Capital
Securities before further income distributions or
payments of redemption prices are made on the
Common Securities and (ii) the full liquidation
preference will be paid on the Capital Securities
in the event of a liquidation of the Trust before
any liquidating distribution is made on the
Common Securities.
Use of Proceeds.............
All of the proceeds from the sale of the Capital
Securities will be invested by the Trust in the
Junior Subordinated Debentures. PMA Capital will
use the proceeds from issuance of the Junior
Subordinated Debentures to repay debt that is
outstanding under the Revolving Credit Facility
as defined herein. See "Use of Proceeds."
The Company has elected not to provide pro forma financial statements to give
effect to the issuance of the Capital Securities because the issuance thereof
is not expected to result in a change in the Company's overall level of
capitalization (only the components thereof will change), and the issuance of
the Capital Securities is not expected to result in a change in the Company's
ratio of earnings to fixed charges of more than 10%. See "Capitalization" and
"Ratio of Earnings to Fixed Charges."
12
<PAGE>
SUMMARY CONSOLIDATED FINANCIAL AND OPERATING DATA
The summary consolidated financial and operating data set forth below as of
December 31, 1997, 1996 and 1995 and for each of the three years in the period
ended December 31, 1997 were derived from the audited consolidated financial
statements of the Company. The summary consolidated financial and operating
data as of September 30, 1998 and 1997 and for the nine-month periods ended
September 30, 1998 and 1997 were derived from the Company's unaudited
consolidated financial statements. The unaudited consolidated financial
statements have been prepared on the same basis as the Company's audited
consolidated financial statements, and, in the opinion of management, include
all adjustments, consisting of only normal recurring adjustments, necessary for
a fair presentation of the Company's financial position and results of
operations for these periods. The results of operations for the nine months
ended September 30, 1998 may not be indicative of results of operations for the
full year. All summary consolidated financial and operating data set forth
below should be read in conjunction with the consolidated financial statements
of the Company, together with the notes thereto, and Management's Discussion
and Analysis of Financial Condition and Results of Operations, both appearing
elsewhere in this Prospectus.
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
--------------------- ----------------------------------
1998 1997 1997(1) 1996(1) 1995(1)
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
Net premiums
written(2)............. $ 369,134 $ 315,760 $ 381,282 $ 432,975 $ 485,876
========== ========== ========== ========== ==========
CONSOLIDATED REVENUES:
Net premiums earned..... $ 335,593 $ 285,371 $ 375,951 $ 420,575 $ 484,952
Net investment income... 94,363 102,812 136,698 133,936 139,355
Net realized investment
gains.................. 15,362 3,600 8,598 2,984 31,923
Service revenues........ 7,282 7,712 10,311 9,189 5,106
---------- ---------- ---------- ---------- ----------
Total consolidated
revenues.............. $ 452,600 $ 399,495 $ 531,558 $ 566,684 $ 661,336
========== ========== ========== ========== ==========
Income (loss) before
extraordinary item..... 31,997 12,621 19,753 (135,334) 24,130
Extraordinary loss from
early extinguishment of
debt, net of related
tax effect(3).......... -- (4,734) (4,734) -- --
---------- ---------- ---------- ---------- ----------
Net income (loss)...... $ 31,997 $ 7,887 $ 15,019 $ (135,334) $ 24,130
========== ========== ========== ========== ==========
<CAPTION>
AT SEPTEMBER 30, AT DECEMBER 31,
--------------------- ----------------------------------
1998 1997 1997 1996 1995
---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
CONSOLIDATED FINANCIAL
POSITION:
Total investments....... $1,967,253 $2,202,645 $2,194,738 $2,261,353 $2,455,949
Total assets............ 3,131,922 3,066,361 3,057,258 3,117,516 3,258,572
Reserves for unpaid
losses and LAE......... 1,951,497 1,989,160 2,003,187 2,091,072 2,069,986
Long-term debt.......... 203,000 203,000 203,000 204,699 203,848
Shareholders' equity.... 517,580 446,264 478,347 425,828 609,668
</TABLE>
13
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------ ---------------------------
1998 1997 1997(1) 1996(1) 1995(1)
-------- -------- ------- --------- -------
<S> <C> <C> <C> <C> <C>
PRE-TAX OPERATING INCOME
(LOSS)(4):
PMA Re........................ $ 34,882 $ 34,674 $45,957 $ 44,807 $39,793
-------- -------- ------- --------- -------
The Property and Casualty
Group(5):
Excluding Run-off Operations.. 8,343 (4,857) (3,607) (215,669) (3,885)
Run-off Operations............ 41 (108) (73) -- --
-------- -------- ------- --------- -------
Total Property and Casualty
Group....................... 8,384 (4,965) (3,680) (215,669) (3,885)
Caliber One................... (1,317) -- -- -- --
Corporate and Other........... (7,980) (7,148) (9,954) (6,464) (14,184)
-------- -------- ------- --------- -------
Total pre-tax operating
income (loss) before
interest expense............ 33,969 22,561 32,323 (177,326) 21,724
Interest expense.............. 11,231 12,025 15,768 17,052 18,734
Pre-tax operating income
(loss)....................... 22,738 10,536 16,555 (194,378) 2,990
Net realized investment
gains........................ 15,362 3,600 8,598 2,984 31,923
-------- -------- ------- --------- -------
Income (loss) before income
taxes and extraordinary
item........................ 38,100 14,136 25,153 (191,394) 34,913
Provision (benefit) for income
taxes........................ 6,103 1,515 5,400 (56,060) 10,783
-------- -------- ------- --------- -------
Income (loss) before
extraordinary item.......... 31,997 12,621 19,753 (135,334) 24,130
Extraordinary loss from early
extinguishment of debt, net
of related tax effect(3)..... -- (4,734) (4,734) -- --
-------- -------- ------- --------- -------
Net income (loss)............ $ 31,997 $ 7,887 $15,019 $(135,334) $24,130
======== ======== ======= ========= =======
Ratio of earnings to fixed
charges (6).................. 4.0x 2.0x 2.4x -- 2.7x
GAAP RATIOS FOR INSURANCE
SUBSIDIARIES (7):
PMA Re:
Loss ratio................... 68.2% 73.0% 69.6% 73.7% 74.6%
Expense ratio................ 35.6% 30.3% 34.2% 28.9% 29.3%
-------- -------- ------- --------- -------
Combined ratio (8)........... 103.8% 103.3% 103.8% 102.6% 103.9%
======== ======== ======= ========= =======
The Property and Casualty
Group, including Run-off
Operations (5):
Loss ratio.................... 83.5% 93.3% 91.1% 158.2% 92.5%
Expense ratio (9)............. 33.2% 42.5% 42.8% 47.1% 30.4%
Policyholders' dividend
ratio........................ 7.7% 6.3% 6.9% 6.1% 4.8%
-------- -------- ------- --------- -------
Combined ratio (8)........... 124.4% 142.1% 140.8% 211.4% 127.7%
======== ======== ======= ========= =======
The Property and Casualty
Group, excluding Run-off
Operations (5):
Loss ratio.................... 77.5% 84.6% 83.7% -- --
Expense ratio (9)............. 32.0% 33.4% 32.9% -- --
Policyholders' dividend
ratio........................ 7.7% 5.2% 5.6% -- --
-------- -------- ------- --------- -------
Combined ratio (8)........... 117.2% 123.2% 122.2% -- --
======== ======== ======= ========= =======
</TABLE>
- --------
(1) Operating results in 1997, 1996 and 1995 were impacted by approximately
$12,100, $223,100 and $8,400, respectively, of restructuring and other
special charges. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for further information.
(2) Net premiums written were reduced by $3,000 and $37,000 for the nine months
ended September 30, 1998 and 1997, respectively, and reduced by $37,000,
$10,500 and $4,000 for the years ended December 31, 1997, 1996 and 1995,
respectively, representing estimated retrospective policy adjustments
related to the current accident year and retrospective policy adjustments
paid. These adjustments to net premiums written were made for presentation
purposes only and had previously been reflected in the Company's reported
revenues, financial position and results of operations.
14
<PAGE>
(3) In 1997, the Company refinanced substantially all of its long-term debt,
resulting in a $4,734 extraordinary loss, net of tax effect. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(4) Pre-tax operating income (loss) excludes net realized investment gains.
Pre-tax operating income by business segment for all periods is unaudited
and has been presented in accordance with SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information," which the Company
adopted on January 1, 1998. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Company's interim
financial statements and notes thereto as of September 30, 1998 and 1997
included elsewhere in this Prospectus. The Company has excluded net
realized investment gains (losses) from the profit and loss measurement it
utilizes to assess the performance of its operating segments because (i)
net realized investment gains (losses) are unpredictable and not
necessarily indicative of future performance and (ii) in many instances,
decisions to buy and sell securities are made at the parent holding company
level, and such decisions result in net realized gains (losses) that do not
relate to the operations of the individual segments.
(5) Run-off operations ("Run-off Operations") of the Property and Casualty
Group are comprised of MASCCO, PMA Cayman and PMA Life Insurance Company
("PMA Life"), which were established in December 1996 to reinsure certain
obligations primarily associated with workers' compensation claims written
by the Pooled Companies for the accident years 1991 and prior. The Run-off
Operations are separate legal entities and substantially all of the assets
of the Run-off Operations are held in trust for the benefit of the Pooled
Companies. Effective July 1, 1998, the Company sold PMA Cayman, and all
data presented excludes PMA Cayman subsequent to such date. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
(6) For the purposes of determining this ratio, earnings (loss) consist of
income (loss) before income taxes and extraordinary loss, plus fixed
charges. Fixed charges consist of interest expense on debt, amortization of
debt issuance costs and the portion of operating leases that management
believes is representative of the interest factor. In 1996, earnings were
insufficient to cover fixed charges by $191,394. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
(7) The results of operations of Caliber One are not material to the
underwriting ratios of the Company; accordingly, the ratios for Caliber One
have not been presented.
(8) The combined ratio computed on a GAAP basis is equal to losses and LAE plus
amortization of deferred acquisition costs, operating expenses and
policyholders' dividends (where applicable), all divided by net premiums
earned.
(9) The GAAP operating expense ratios exclude $6,872 and $6,928 for the nine
months ended September 30, 1998 and 1997, respectively, and $9,316, $8,227
and $5,300 for the years ended December 31, 1997, 1996 and 1995,
respectively, of PMA Management Corp. direct expenses related to service
revenues, which are not included in premiums earned. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
15
<PAGE>
RISK FACTORS
Potential investors should carefully consider the following risk factors and
other information in this Prospectus prior to making an investment decision
regarding the Capital Securities. In addition, because holders of the Capital
Securities may receive Junior Subordinated Debentures in exchange therefor
upon liquidation of the Trust, prospective purchasers of the Capital
Securities are also making an investment decision with regard to the Junior
Subordinated Debentures and should carefully review all the information
regarding the Junior Subordinated Debentures and PMA Capital herein.
RISK FACTORS RELATING TO THE CAPITAL SECURITIES
SUBORDINATION OF THE GUARANTEE AND THE JUNIOR SUBORDINATED DEBENTURES
PMA Capital's obligations under the Guarantee and under the Junior
Subordinated Debentures are unsecured and rank subordinate and junior in right
of payment to all present and future Senior Debt of PMA Capital and pari passu
with obligations to or rights of PMA Capital's other general unsecured
creditors. Substantially all of PMA Capital's debt constitutes Senior Debt.
PMA Capital is an insurance holding company and substantially all of the
operating assets of PMA Capital are owned by its consolidated subsidiaries.
PMA Capital relies primarily on the receipt of sufficient funds from its
subsidiaries in the form of dividends, net payments under a tax-sharing
agreement between PMA Capital and its subsidiaries and loans to meet its
obligations for payment of principal and interest on its outstanding debt
obligations and corporate expenses. Accordingly, the Junior Subordinated
Debentures will be effectively subordinated to all existing and future
liabilities of PMA Capital's subsidiaries, and holders of the Junior
Subordinated Debentures should look only to the assets of PMA Capital for
payments on the Junior Subordinated Debentures. The payment of dividends by
PMA Capital's insurance subsidiaries is limited under the insurance laws of
their states of domicile (primarily Pennsylvania). At December 31, 1997, PMA
Reinsurance Corporation and the Pooled Companies could pay dividends of
approximately $48.7 million to PMA Capital without regulatory permission. For
the year ended December 31, 1998, $35.5 million in dividends have been
declared and paid. See "Supervision and Regulation." In addition, the ability
of PMA Capital's subsidiaries to pay dividends is effectively restricted by
certain minimum surplus and risk-based capital requirements contained in the
Company's revolving credit agreement. See "Risk Factors Associated with the
Company--Restrictions on Subsidiary Dividends." None of the Capital
Securities, the Junior Subordinated Debentures or the Guarantee limit PMA
Capital's ability to incur additional indebtedness, including Senior Debt.
After the completion of this Offering and the repayment of debt with the
proceeds thereof, PMA Capital will have outstanding approximately $104.5
million of principal amount of indebtedness constituting Senior Debt. PMA
Capital expects from time to time to incur additional indebtedness
constituting Senior Debt. See "Description of the Guarantee--Status of the
Guarantee" and "Description of the Junior Subordinated Debentures--
Subordination."
The ability of the Issuer to pay amounts due on the Capital Securities is
solely dependent upon PMA Capital making payments on the Junior Subordinated
Debentures as and when required.
LIMITED RIGHTS UNDER THE GUARANTEE
The Guarantee will be qualified as an indenture under the Trust Indenture
Act of 1939, as amended (the "Trust Indenture Act"). The Property Trustee
(herein sometimes called the "Trustee") will act as indenture trustee under
the Guarantee for the purposes of compliance with the Trust Indenture Act and
to hold the Guarantee for the benefit of the holders of the Capital
Securities. The Guarantee guarantees to the holders of the Capital Securities
the following payments, to the extent not paid by or on behalf of the Issuer:
(i) any accumulated and unpaid distributions that are required to be paid on
the Capital Securities, to the extent the Trust has funds available therefor
at such time, (ii) the redemption price with respect to the Capital Securities
called for redemption by the Trust, to the extent the Trust has funds
available therefor at such time and (iii) upon a voluntary or involuntary
dissolution, winding-up or termination of the Trust (other than in connection
with the distribution of
16
<PAGE>
Junior Subordinated Debentures to the holders of the Capital Securities), the
lesser of (a) the aggregate of the Liquidation Amount and all accumulated and
unpaid distributions on the Capital Securities to the date of the payment to
the extent the Trust has funds available therefor at such time and (b) the
amount of assets of the Trust remaining available for distribution to holders
of the Capital Securities in liquidation of the Trust. The holders of not less
than a majority in aggregate Liquidation Amount of the outstanding Capital
Securities have the right to direct the time, method and place of conducting
any proceeding for any remedy available to the Trustee or exercising any trust
or power conferred upon the Trustee under the Guarantee. Any holder of the
Capital Securities may institute a legal proceeding directly against PMA
Capital to enforce the holder's rights under the Guarantee without first
instituting a legal proceeding against the Issuer, the Guarantee Trustee or
any other person or entity. If PMA Capital were to default on its obligation
to pay amounts payable under the Junior Subordinated Debentures, the Issuer
would lack funds for the payment of distributions or amounts payable on
redemption of the Capital Securities or otherwise, and, in such event, holders
of the Capital Securities would not be able to rely upon the Guarantee for
payment of such amounts. Instead, in the event a Debenture Event of Default
shall have occurred and be continuing and such event is attributable to the
failure of PMA Capital for 30 days to pay interest on the Junior Subordinated
Debentures when due and payable or the failure of PMA Capital to pay principal
on the Junior Subordinated Debentures when due and payable, then a holder of
Capital Securities may, pursuant to the terms of the Indenture and in addition
to its rights under the Guarantee, institute a legal proceeding directly
against PMA Capital for enforcement of payment to such holder of the principal
of and interest on such Junior Subordinated Debentures having a principal
amount equal to the aggregate Liquidation Amount of the Capital Securities of
such holder (a "Direct Action"). In connection with such a Direct Action, PMA
Capital shall have a right of set-off under the Indenture to the extent of any
payment made by PMA Capital to such holder of Capital Securities in the Direct
Action. See "Description of Junior Subordinated Debentures--Set-Off." Except
as set forth herein, holders of the Capital Securities will not be able to
exercise directly any other remedy available to the holders of the Junior
Subordinated Debentures or assert directly any other rights in respect of the
Junior Subordinated Debentures. See "Description of the Junior Subordinated
Debentures--Debenture Events of Default and Consequent Rights of Certain
Holders--Rights of Holders of Capital Securities to Direct Action" and
"Description of the Guarantee." The Trust Agreement provides that each holder
of the Capital Securities by acceptance thereof agrees to the provisions of
the Guarantee and the Indenture.
LIMITED VOTING RIGHTS
Holders of the Capital Securities will generally have limited voting rights
relating only to the conduct of proceedings for remedies available to the
Debenture Trustee, waiver of certain defaults, rescission of any declaration
of acceleration and certain modifications of the Capital Securities. Holders
of the Capital Securities will not be entitled to vote to appoint, remove or
replace the Property Trustee, which voting rights are vested exclusively in
the holder of the Common Securities, except upon the occurrence of certain
events described herein. The Property Trustee, the Administrative Trustees and
PMA Capital may amend the Trust Agreement without the consent of the holders
of the Capital Securities to ensure that the Issuer will be classified for
United States federal income tax purposes as a grantor trust or as other than
an association taxable as a corporation to ensure that the Junior Subordinated
Debentures will be treated as indebtedness of PMA Capital or to ensure that
the Issuer will not be required to register as an "investment company" under
the Investment Company Act of 1940 (the "Investment Company Act") unless such
action adversely and materially affects the interests of such holders. See
"Description of the Capital Securities--Voting Rights."
OPTION TO DEFER INTEREST PAYMENTS; TAX CONSEQUENCES AND MARKET PRICE
So long as no Debenture Event of Default (as defined herein) has occurred
and is continuing, PMA Capital has the right under the Indenture to defer
payments of interest on the Junior Subordinated Debentures at any time, and
from time to time for a period not exceeding 10 consecutive semi-annual
17
<PAGE>
periods with respect to each deferral period (each, an "Extension Period"),
provided that no Extension Period may extend beyond the Stated Maturity of the
Junior Subordinated Debentures. As a consequence of such a deferral, semi-
annual distributions on the Capital Securities will be deferred by the Trust
during any such Extension Period (and the amount of the distributions to which
holders of the Capital Securities are entitled will accumulate additional
distributions thereon at a rate of % per annum, compounded semi-annually
from the relevant payment date for such distributions). During any such
Extension Period, PMA Capital shall not, and shall cause any subsidiary of PMA
Capital not to, (a) declare or pay dividends or distributions on, or redeem,
purchase, acquire or make a liquidation payment with respect to, any of PMA
Capital's capital stock or (b) make any payment of interest, principal or
premium, if any, on or repay, repurchase or redeem any debt securities of PMA
Capital that rank pari passu with or junior to the Junior Subordinated
Debentures (other than (a) dividends or distributions in Common Stock or Class
A Common Stock of PMA Capital, (b) payments under the Guarantee and (c)
purchases of Common Stock or Class A Common Stock of PMA Capital related to
the issuance of Common Stock or Class A Common Stock of PMA Capital under any
of PMA Capital's benefit plans for its directors, officers or employees).
Prior to the termination of any such Extension Period, PMA Capital may further
defer the payment of interest, provided that no Extension Period shall exceed
10 consecutive semi-annual periods or extend beyond the Stated Maturity of the
Junior Subordinated Debentures. Upon the termination of any Extension Period
and the payment of all interest then accrued and unpaid (together with
interest thereon at the rate of % per annum, compounded semi-annually, to
the extent permitted by applicable law), PMA Capital may commence a new
Extension Period, subject to the above requirements. There is no limitation on
the number of times that PMA Capital may elect to begin an Extension Period.
See "Description of the Capital Securities--Distributions" and "Description of
the Junior Subordinated Debentures--Option to Extend Interest Payment Period."
If interest payments are so deferred, each holder of the Capital Securities
may be required to recognize income (in the form of original issue discount)
in respect of its pro rata share of the Junior Subordinated Debentures held by
the Issuer for United States federal income tax purposes. As a result, a
holder of the Capital Securities may be required to include such income in
gross income for United States federal income tax purposes in advance of the
receipt of cash attributable to such income and will not receive the cash from
the Trust related to such income if such holder disposes of its Capital
Securities prior to the record date for distributions of such amounts. See
"United States Federal Income Taxation--Interest Income and Original Issue
Discount." PMA Capital has no present intention of exercising its right to
defer payments of interest by extending the interest payment period on the
Junior Subordinated Debentures. However, if PMA Capital determines to exercise
such right in the future, the market price of the Capital Securities is likely
to be affected. A holder that disposes of its Capital Securities during an
Extension Period, therefore, might not receive the same return on its
investment as a holder that continues to hold its Capital Securities. In
addition, as a result of the existence of PMA Capital's right to defer
interest payments, the market price of the Capital Securities (which represent
an undivided beneficial interest in the Junior Subordinated Debentures) may be
more volatile than other securities on which original issue discount accrues
that are not subject to such deferrals.
SPECIAL EVENT REDEMPTION OR EXCHANGE
Upon the occurrence and continuance of a Special Event (as defined herein),
prior to 1, 2009, PMA Capital shall have the right to redeem the Junior
Subordinated Debentures, in whole but not in part, within 90 days following
the occurrence of such Special Event and therefore cause a mandatory
redemption of the Capital Securities. Any such redemption shall be at a price
equal to the Make-Whole Amount (as defined in "Description of the Capital
Securities--Redemption") together with accrued interest to but excluding the
date fixed for redemption. If a Special Event were to occur, there can be no
assurance that PMA Capital would have sufficient funds to effectuate an
optional redemption of the Junior Subordinated Debentures and pay the
redemption price. PMA Capital's ability to exercise
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its option to redeem the Junior Subordinated Debentures may be limited by the
terms of its then-existing borrowing and other agreements. "Special Event"
means either an Investment Company Event or a Tax Event. An "Investment
Company Event" means the receipt by the Issuer of an opinion of counsel
experienced in such matters to the effect that, as a result of the occurrence
of a change in law or regulation or change in interpretation or application of
law or regulation by any legislative body, court, governmental agency or
regulatory authority (a "Change in 1940 Act Law"), the Issuer is or will be
considered an investment company that is required to be registered under the
Investment Company Act, which Change in 1940 Act Law becomes effective on or
after the date of original issuance of the Capital Securities. A "Tax Event"
means the receipt by the Issuer of an opinion of counsel experienced in such
matters to the effect that, as a result of (a) any amendment to, or change
(including any announced prospective change) in, the laws (or any regulations
thereunder) of the United States or any political subdivision or taxing
authority thereof or therein affecting taxation or (b) any official
administrative pronouncement or judicial decision interpreting or applying
such laws and regulations, which amendment or change is effective or such
pronouncement or decision is announced on or after the date of issuance of the
Capital Securities under the Trust Agreement, there is more than an
insubstantial risk that (i) the Issuer is, or will be within 90 days of the
date of such opinion, subject to United States federal income tax with respect
to income received or accrued on the Junior Subordinated Debentures, (ii)
interest payable by PMA Capital on the Junior Subordinated Debentures is not,
or within 90 days of the date of such opinion, will not be, deductible by PMA
Capital, in whole or in part, for United States federal income tax purposes or
(iii) the Issuer is, or will be within 90 days of the date of such opinion,
subject to more than a de minimis amount of other taxes, duties or other
governmental charges. See "Description of the Capital Securities--Redemption--
Special Event Redemption or Distribution of Junior Subordinated Debentures."
At any time, PMA Capital has the right to terminate the Issuer and, after
satisfaction of the liabilities of creditors of the Issuer as provided by
applicable law, cause the Junior Subordinated Debentures to be distributed to
the holders of the Capital Securities in liquidation of the Trust. See
"Description of the Capital Securities--Liquidation Distribution upon
Termination."
TAX CONSEQUENCES
The receipt of cash by the holders of the Capital Securities upon a
termination of the Trust would be a taxable event to such holders. Under
current United States federal income tax law, a distribution of the Junior
Subordinated Debentures upon the termination of the Trust generally would not
be a taxable event to holders of the Capital Securities. See "United States
Federal Income Taxation--Receipt of Junior Subordinated Debentures or Cash
Upon Liquidation of the Trust."
EFFECT ON MARKET PRICES
There can be no assurance as to the market prices for the Capital Securities
or the Junior Subordinated Debentures that may be distributed in exchange for
the Capital Securities if a termination or liquidation of the Trust were to
occur. Accordingly, the Capital Securities that an investor may purchase,
whether pursuant to the offer made hereby or in the secondary market, or the
Junior Subordinated Debentures that a holder of the Capital Securities may
receive on termination and liquidation of the Trust, may trade at a discount
to the price that the investor paid to purchase the Capital Securities offered
hereby.
CORRESPONDING INVESTMENT DECISION IN JUNIOR SUBORDINATED DEBENTURES
Because holders of the Capital Securities may receive Junior Subordinated
Debentures in connection with a liquidation of the Trust, prospective
purchasers of the Capital Securities are also making an investment decision
with regard to the Junior Subordinated Debentures and should carefully review
all the information regarding the Junior Subordinated Debentures contained
herein. See
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"Description of the Capital Securities--Liquidation Distribution upon
Termination" and "Description of the Junior Subordinated Debentures."
POSSIBLE TAX LAW CHANGES
Prospective investors should be aware that legislation has been proposed by
the Clinton Administration in the past that, if enacted, would have denied an
interest deduction to issuers of instruments such as the Junior Subordinated
Debentures. No such legislation is currently pending. There can be no
assurance, however, that similar legislation will not ultimately be enacted
into law, or that other developments will not occur on or after the date
hereof that would adversely affect that tax treatment of the Junior
Subordinated Debentures or the Issuer. Such changes also could give rise to a
Tax Event, which would permit PMA Capital to cause a redemption of the Capital
Securities, as described more fully under "Description of Capital Securities--
Redemption--Special Event Redemption or Distribution of Junior Subordinated
Debentures."
LIQUIDITY OF TRADING; TRADING PRICE OF THE CAPITAL SECURITIES MAY NOT FULLY
REFLECT VALUE OF UNPAID INTEREST
PMA Capital and the Issuer do not intend to have the Capital Securities
listed on any securities exchange. If the Underwriters do not make a market
for the Capital Securities, the liquidity of the Capital Securities could be
adversely affected.
The Capital Securities may trade at a price that does not fully reflect the
value of accrued but unpaid interest with respect to the underlying Junior
Subordinated Debentures. A holder who disposes of his Capital Securities
between record dates for payments of distributions thereon (and consequently
does not receive a distribution from the Issuer for the period prior to such
disposition) will nevertheless be required to include accrued but unpaid
interest on the Junior Subordinated Debentures through the date of disposition
in income as ordinary income, and to add such amount to his adjusted tax basis
in the Capital Securities disposed of. To the extent that the selling price
(which may not fully reflect the value of accrued but unpaid interest) is less
than the holder's adjusted tax basis (which will include accrued but unpaid
interest), the holder may recognize a capital loss. Subject to certain limited
exceptions, capital losses cannot be applied to offset ordinary income for
United States federal income tax purposes. See "United States Federal Income
Taxation--Interest Income and Original Issue Discount" and "--Sales of Capital
Securities."
RISK FACTORS ASSOCIATED WITH THE COMPANY
HOLDING COMPANY STRUCTURE
PMA Capital is an insurance holding company and the right of PMA Capital to
participate in any distribution of assets of any subsidiary upon such
subsidiary's liquidation or reorganization or otherwise (and thus the ability
of holders of the Junior Subordinated Debentures and the Capital Securities to
benefit indirectly from such distribution) is subject to the prior claims of
creditors of that subsidiary, except to the extent that PMA Capital may itself
be recognized as a creditor of that subsidiary. Accordingly, the Junior
Subordinated Debentures will be effectively subordinated to all existing and
future liabilities of the subsidiaries of PMA Capital, and the holders of the
Junior Subordinated Debentures should look only to the assets of PMA Capital
for payments on the Junior Subordinated Debentures. At September 30, 1998, the
subsidiaries of PMA Capital had total liabilities, excluding liabilities owed
to PMA Capital and intercompany transactions, of approximately $2.4 billion.
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RESTRICTIONS ON SUBSIDIARY DIVIDENDS AND OTHER PAYMENTS
PMA Capital is an insurance holding company whose assets consist principally
of all of the outstanding common stock of its insurance subsidiaries. PMA
Capital's ongoing ability to pay dividends to its shareholders and meet its
other obligations, including operating expenses and any principal and interest
on debt (including the Junior Subordinated Debentures), is primarily dependent
on the receipt of sufficient funds from its insurance subsidiaries in the form
of dividends, net payments under a tax-sharing agreement between PMA Capital
and its subsidiaries and loans. The payment of dividends by PMA Capital's
subsidiaries to PMA Capital is regulated under the insurance laws of
Pennsylvania and Delaware (such laws are substantially similar). In addition,
to the extent tax-sharing payments and loans exceed certain threshold amounts,
notice to and non-disapproval by the Pennsylvania Insurance Commissioner would
be required. Under Pennsylvania law, PMA Capital's Pennsylvania-domiciled
subsidiaries (PMA Reinsurance Corporation and the Pooled Companies) may pay
dividends only from unassigned surplus and future earnings arising from their
businesses and must receive prior approval of the Pennsylvania Insurance
Commissioner to pay a dividend if such dividend would exceed the greater of
(i) 10% of the insurer's policyholders' surplus, as shown on its last annual
statement on file with the Pennsylvania Insurance Commissioner or (ii) the
insurer's statutory net income for the previous calendar year. Pennsylvania
law gives the Pennsylvania Insurance Commissioner broad discretion to
disapprove requests for dividends in excess of these limits. Based upon this
limitation and the 1997 statutory results of PMA Reinsurance Corporation and
the Pooled Companies, PMA Reinsurance Corporation and the Pooled Companies
have the legal capacity to pay approximately $48.7 million in dividends in the
aggregate to PMA Capital in 1998 without obtaining the approval of the
Pennsylvania Insurance Commissioner. For the year ended December 31, 1998,
$35.5 million in dividends were declared and paid. Pennsylvania law also
provides that following the payment of any dividend, the insurer's
policyholders' surplus must be reasonable in relation to its outstanding
liabilities and adequate for its financial needs, and permits the Pennsylvania
Insurance Commissioner to bring an action to rescind a dividend which violates
these standards.
Caliber One Indemnity Company is a Delaware-domiciled insurance subsidiary
of PMA Reinsurance Corporation. As a subsidiary of PMA Reinsurance
Corporation, Caliber One Indemnity Company's dividends are not directly
available to PMA Capital. As noted above, the Delaware insurance law
provisions restricting dividends by insurers are substantially similar to such
provisions under Pennsylvania insurance laws. During 1998, Caliber One
Indemnity Company may pay up to $2.5 million of dividends to PMA Reinsurance
Corporation without prior approval of the Delaware Insurance Commissioner.
During 1998, no dividends have been declared or paid by Caliber One Indemnity
Company.
In the event that the ability of either the Pooled Companies or PMA
Reinsurance Corporation to pay dividends or make other payments to PMA Capital
in the future is reduced or eliminated, PMA Capital's ability to pay principal
and interest on, and/or redeem, the Junior Subordinated Debentures could be
materially and adversely affected, depending upon the extent of such
reduction. See "Supervision and Regulation."
In March 1997, the Company refinanced substantially all of its existing debt
facility with a $235.0 million revolving credit facility (the "Revolving
Credit Facility"). In addition to the Revolving Credit Facility, the Company
maintains a committed facility of $50.0 million for letters of credit (the
"Letter of Credit Facility"). The Revolving Credit Facility and the Letter of
Credit Facility are sometimes referred to herein as the "Credit Facilities."
In addition to the foregoing regulatory restrictions, the Credit Facilities
also impose restrictions on the ability of the Company's subsidiaries to pay
dividends. Under these restrictions, the statutory surplus of PMA Capital's
insurance subsidiaries (as measured each calendar quarter) must not be less
than $450 million and such subsidiaries must annually maintain certain minimum
ratios of adjusted surplus to risk-based capital (300% for PMA Reinsurance
Corporation and 230% for the Pooled Companies in 1998, increasing to 240%
thereafter). As of
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September 30, 1998, the Company's insurance subsidiaries reported combined
statutory surplus of $565.5 million, and as of December 31, 1997, PMA
Reinsurance Corporation's risk-based capital ratio was 355% and the Pooled
Companies' risk-based capital ratios ranged from 293% to 324%.
CERTAIN RISKS AFFECTING THE PROPERTY AND CASUALTY INSURANCE INDUSTRY
The Company's operating results may be impacted by several factors that
broadly impact the property and casualty insurance industry. Such factors
include weather-related and other catastrophic losses, general economic
conditions, including interest rate changes, employment rates and trends in
inflation of claims costs, legislative and regulatory initiatives, frequency
of litigation and trends in the size of awards, as well as competitive
conditions.
In writing property and casualty insurance, the Company's insurance
subsidiaries are subject to the possibility of losses from catastrophic
events. In order to reduce risk and increase its underwriting capacity, the
Company actively manages its exposure to such events through the underwriting
process and through the purchase of reinsurance coverages; as a result, the
Company's historical underwriting results have not been significantly impacted
by catastrophes. However, catastrophic events could exceed the Company's
reinsurance and/or retrocessional protection, and materially and adversely
impact the Company's financial position. See "Business--The Company's
Reinsurance Ceded."
Overall economic trends, as well as legislative, regulatory and judicial
trends may impact the operations of the Company's insurance subsidiaries. In
addition, because the Company's earnings are substantially dependent on
investment income and capital gains, changes in interest rates or other
factors affecting the Company's investment portfolio and the credit quality
and performance thereof may reduce the Company's investment results and have a
material adverse effect on its results of operations. An economic downturn may
reduce the overall demand for the Company's insurance products. Also,
management believes that, in times of less favorable economic conditions,
workers' compensation claims (particularly indemnity claims) have a tendency
to be more severe. Legislative, regulatory and judicial issues that could
adversely affect the Company include (i) an environment of more frequent and
severe claims, (ii) increases in the overall cost of doing business, through
increased capital requirements, higher taxes and assessments, residual market
charges or higher overall costs of regulatory compliance, (iii) restrictions
on premium rates and policy terms and (iv) reduced demand for the Company's
products. The impact of these factors can dramatically impact the Company's
insurance capacity, pricing and claims experience and, ultimately, have a
material adverse effect on the Company's business, results of operations and
financial condition. See "--Certain Concentrations" below, "Business--
Regulatory Matters," "Business--The Property and Casualty Group--Workers'
Compensation Insurance" and "Supervision and Regulation."
ADEQUACY OF LOSS RESERVES
In many cases, significant periods of time, ranging up to several years or
more, may elapse between the occurrence of an insured loss, the reporting of
the loss to the insurer and the insurer's payment of that loss. Liabilities
for reinsurers generally become known more slowly than for primary insurers
and are generally subject to more unforeseen development.
In addition, the reserving for workers' compensation insurance is more
difficult than for many other lines of insurance. The Company has recorded
favorable (adverse) development of $86.0 million, ($156.1) million and ($51.5)
million in 1997, 1996 and 1995, respectively, of which $44.1 million, ($110.0)
million and ($54.7) million in 1997, 1996 and 1995, respectively, were
associated with workers' compensation. See "Business--Loss Reserves" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Estimating reserves for workers' compensation claims can be more difficult
than for many other lines of property and casualty insurance for several
reasons, including (i) the long payment "tail"
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associated with the business, (ii) the impact of social, political and
regulatory trends on benefit levels for both medical and indemnity payments,
(iii) the impact of economic trends and (iv) the impact of changes in the mix
of business. At various times, one or a combination of such factors can make
the interpretation of actuarial data associated with workers' compensation
loss development more difficult, and it can take additional time to recognize
changes in loss development patterns. Under such circumstances, reserve
adjustments will be made as loss patterns develop and new information becomes
available, and such adjustments may be material.
As is common practice in the property and casualty insurance industry, the
Company discounts its workers' compensation unpaid losses; the average
discount rate presently utilized is approximately 5.0%. As such, future
operating results of the Company will be impacted by accretion of loss reserve
discount. For the nine-month periods ended September 30, 1998 and 1997,
respectively, accretion of discount increased losses incurred by $17.2 million
and $35.0 million, and for the years ended December 31, 1997, 1996 and 1995,
respectively, accretion of discount increased losses incurred by $51.4
million, $57.5 million and $13.3 million (net of $35.0 million related to the
change in discount rate from approximately 4.0% to 5.0%). At September 30,
1998, the Company had loss reserve discount of $209.4 million, comprised as
follows: the Pooled Companies, $114.7 million; MASCCO, $52.5 million, other
Property and Casualty Group entities, $6.9 million and PMA Re, $35.3 million.
See "Business--Loss Reserves."
Estimation of obligations for asbestos and environmental exposures continues
to be more difficult than for other loss reserves because of several factors,
including (i) evolving methodologies for the estimation of liabilities; (ii)
lack of reliable historical claim data; (iii) uncertainties with respect to
insurance and reinsurance coverage related to these obligations; (iv) changing
judicial interpretations and (v) changing government standards. The Company
recorded incurred losses for asbestos and environmental exposures of $1.0
million, $60.4 million and $25.3 million in 1997, 1996 and 1995, respectively,
and at December 31, 1997, the Company maintained loss reserves of $48.6
million ($76.7 million gross of reinsurance) for asbestos-related losses (of
which $41.9 million was IBNR) and loss reserves of $31.7 million ($45.1
million gross of reinsurance) for environmental-related losses (of which $20.5
million was IBNR). Management believes that the Company's reserves for
asbestos and environmental claims are appropriately established based upon
known facts, existing case law and generally accepted actuarial methodologies.
However, due to changing interpretations by courts involving coverage issues,
the potential for changes in federal and state standards for clean-up
liability and other factors, the ultimate exposure to the Property and
Casualty Group for these claims may vary significantly from the reserves
currently recorded, resulting in a potential future adjustment in the claims
reserves recorded. See "Business--Loss Reserves" and "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Estimating the Company's ultimate claims liability is necessarily a complex
and judgmental process as the amounts are based upon management's informed
estimates and judgments using data currently available. As additional
experience and data become available regarding claims payment and reporting
patterns, legislative developments and economic conditions, the estimates are
revised accordingly. If the Company's ultimate net losses prove to be
substantially greater than the reserves recorded, the related adjustments
could have a material adverse impact on the Company's financial condition and
results of operations.
COMPETITIVE CONDITIONS
The domestic property and casualty insurance and reinsurance industries are
very competitive and consist of many companies, with no one company dominating
the market. Competitive conditions may vary from state to state and market to
market for a variety of reasons, including the regulatory climate, the number
of market participants and similar factors. In addition to other insurance
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companies, the Company's insurance subsidiaries compete with certain
alternative market arrangements, such as captive insurers, risk-sharing pools
and associations, risk-retention groups and self-insurance programs. Many of
the Company's competitors are larger and have greater financial resources than
the Company and offer a broader range of products than the Company.
Historically, the financial performance of the property and casualty insurance
industry has tended to fluctuate in cyclical patterns of very competitive
(soft) markets followed by less competitive (hard) markets. Although an
individual insurance company's financial performance depends in part upon its
own specific business characteristics, the profitability of most property and
casualty insurance companies tends to follow this cyclical market pattern. At
present, the property and casualty insurance industry is experiencing a
prolonged soft market, and the extension of the current market conditions
could have an adverse effect on the Company's business, results of operations
and financial condition. There can be no assurance that market conditions will
improve or, if they do improve that they will have a favorable impact on the
Company. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
One of the bases of competition in the insurance industry, particularly in
the reinsurance segment, is size of capitalization. While management believes
that PMA Re's present level of capitalization is appropriate and has not
materially adversely affected its participation in business opportunities or
resulted in any significant erosion of its client base, PMA Re could be
affected by (i) changes in market perception of appropriate levels of
capitalization or (ii) the need to increase capitalization in response to
market opportunities. While the purpose of the Offering is to increase the
Company's flexibility to respond to such situations, there can be no assurance
that PMA Capital will have the ability to increase PMA Re's capitalization to
satisfy state insurance regulators or to maintain the current A.M. Best
ratings of PMA Capital's insurance subsidiaries. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations," "Business--
Competition" and "Use of Proceeds."
The Property and Casualty Group must attract and retain productive agents to
sell its insurance products and services. Strong competition exists among
insurance companies for agents with demonstrated abilities. Competition among
insurance companies for such agents is based upon, among other things, the
services provided to, and relationships developed with, these agents in
addition to compensation and product structure. If the Property and Casualty
Group is not able to continue to attract and retain productive agents, there
could be a material adverse effect on the Company.
The surplus lines of insurance offered by Caliber One are generally placed
by wholesale brokers and managing general agents who specialize in particular
lines of coverage or classes of insureds. These insureds tend to be
sophisticated and price-conscious insurance purchasers. As a result, surplus
lines insurers may experience increased premium rate competition in soft
markets, which could result in a material adverse effect on the Company.
COLLECTIBILITY OF REINSURANCE
The Company follows the customary insurance practice of reinsuring a portion
of the risks underwritten by its insurance subsidiaries with other insurance
companies. This reinsurance is maintained to protect the Company against the
severity of losses on individual claims and unusually serious occurrences in
which a number of claims produces an aggregate extraordinary loss. Reinsurance
does not discharge the Company's insurance subsidiaries from their obligations
to their policyholders; however, it does make the assuming reinsurers liable
to the Company's insurance subsidiaries for the reinsured portion of the risk.
At September 30, 1998, the Company had $217.3 million in reinsurance
receivables which are not directly secured by letters of credit, trust
arrangements, funds held or other collateral. Although management believes
that the Company's reinsurance protection is placed with financially sound
companies, there can be no assurance that such reinsurers will pay reinsurance
claims on a timely basis, if at all. Further, although the Company has
reinsurance it believes to be adequate, there can be no assurance that the
Company will continue
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to be able to obtain reinsurance on acceptable terms and that the Company's
reinsurance protection will be adequate in the event of a catastrophe. See
"Certain Risks Affecting the Property and Casualty Insurance Industry" above
and "Business--The Company's Reinsurance Ceded."
CERTAIN CONCENTRATIONS
In 1997, the Property and Casualty Group derived 49% of its direct premiums
written from Pennsylvania, 61% of which was workers' compensation. Also in
1997, the Property and Casualty Group derived 60% of its direct premiums
written from workers' compensation in all of the states in which it conducts
business. This concentration in workers' compensation has increased to
approximately 67% as of September 30, 1998, primarily due to a planned
reduction in Commercial Lines of business. This concentration exposes the
Company to changes affecting the Pennsylvania economy, as well as changes
impacting benefit and/or rate levels for workers' compensation in Pennsylvania
and the other states in which it conducts business.
Since 1993, two major benefit reform laws have been passed in Pennsylvania,
which have had a favorable impact on workers' compensation loss costs. In
1993, Act 44 introduced medical cost containment measures and improved the
Property and Casualty Group's ability to utilize managed care techniques.
Specifically, Act 44 introduced medical cost containment measures to the
Pennsylvania workers' compensation benefit system and increased the length of
time in which an insurer may require an employee to accept medical treatment
from the employer's list of designated health care providers from 14 days to
30 days. In addition, the law reduced the minimum wage replacement benefit to
injured workers, introduced a credit for unemployment compensation benefits,
restored the right of subrogation against tort recoveries in work-related
automobile accidents and created new anti-fraud measures. In 1996, Act 57
introduced measures that primarily reduce indemnity loss costs. Among its
provisions, Act 57: (i) imposes application of American Medical Association
Impairment Guidelines for the assessment of permanent and total claims after
the first two years of total disability compensation payments and limits
indemnity benefits to an additional 500 weeks for workers who are not at least
50% disabled (as measured by those guidelines); (ii) contains certain Social
Security and pension benefits offsets; (iii) further increases the time frame
for directed medical treatment; (iv) addresses certain inequities in the
average weekly wage calculation; (v) increases the ability of employers to
demonstrate that injured workers have earning capacity and (vi) facilitates
the use of full and final settlements of employers' workers' compensation
obligations on particular claims. As a result of these Acts, as well as
reforms in several other states in which the Property and Casualty Group
operates, the frequency and severity of workers' compensation claims have been
decreasing, which has contributed to the decreased accident year workers'
compensation loss ratios of the Property and Casualty Group since 1993. In
conjunction with these benefit reforms, manual rate levels in Pennsylvania
decreased approximately 10% in 1994, 25% in 1997 and 19% in the first nine
months of 1998 when compared to the respective preceding year. Management
believes the projected savings derived from the reforms will offset these
manual rate decreases. However, the ultimate cost of workers' compensation
claims can be difficult to predict and there can be no assurance that rates
will remain adequate. While management believes that the Company has benefited
from workers' compensation reform in Pennsylvania and elsewhere, as well as a
generally good economic climate in the states in which it conducts business,
there can be no assurance that: (i) there will not be initiatives, legislative
or otherwise, to reverse the effects of workers' compensation reforms; (ii)
workers' compensation rates will remain adequate or (iii) economic conditions
will remain favorable. See "Business--The Property and Casualty Group" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
PMA Re distributes its products through reinsurance intermediaries, known as
brokers. In 1997, three brokers each accounted for more than 10% of PMA Re's
gross premiums in force: Aon Reinsurance (35.7%); Guy Carpenter & Company
(23.3%); and E.W. Blanch (13.6%). PMA Re's top five brokers accounted for
90.8% of its gross premiums in force in 1997. In 1998, four brokers each
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accounted for more than 10% of PMA Re's gross premiums in force: Aon
Reinsurance (34.3%); Guy Carpenter & Company (32.7%); E.W. Blanch (14.2%) and
Towers Perrin Re (10.3%). For 1998, Guy Carpenter & Company's gross premiums
in-force include the gross premiums in-force of Sedgwick Payne Company due to
the acquisition of Sedgwick Group plc by Marsh & McLennan Companies, the
parent of Guy Carpenter & Company, in 1998. PMA Re's top four brokers
accounted for 91.5% of its gross premiums in-force in 1998. While management
believes that these relationships with these brokers are generally excellent,
if relations with any of its major brokers were to deteriorate, resulting in
reduced premium flow, it could have a material adverse effect on PMA Re and
the Company. See "Business--PMA Re--Marketing and Distribution."
IMPORTANCE OF RATINGS
As insurers and reinsurers tend to compete on the basis of financial
stability, among other things, management believes that the ratings of the
Company's insurance subsidiaries by the major independent rating agencies,
particularly A.M. Best, are material to its operations. Presently, A.M. Best
has rated PMA Reinsurance Corporation, A+ ("Superior"), the Pooled Companies,
A- ("Excellent") and Caliber One Indemnity Company, A ("Excellent"). In
addition, Moody's has rated PMA Reinsurance Corporation A3 ("Good") and the
Pooled Companies Baa2 ("Adequate"). The Company is also presently seeking
ratings of its insurance subsidiaries from Standard & Poor's. The ratings of
the insurance subsidiaries from these rating agencies are generally based upon
an analysis of the insurance company's perceived financial strength regarding
its ability to pay obligations to its policyholders and are not directed
toward the protection of investors. Such ratings would be subject to changes
and would not constitute recommendations to buy, sell or hold securities.
There can be no assurance that PMA Reinsurance Corporation, the Pooled
Companies or Caliber One Indemnity Company will obtain or maintain any
ratings, and any downgrade could have a material adverse effect on their
respective businesses. In addition, there can be no assurance that any rating
received from Standard & Poor's would not have a detrimental effect on the
Company's competitive position. See "Business--Competition."
REGULATION
The Company is subject to regulation under applicable insurance statutes,
including the insurance holding company statutes of Pennsylvania. In addition,
the Company's insurance subsidiaries are subject to regulation in each of the
states in which they transact business. Insurance regulation is intended to
protect policyholders rather than to protect investors in insurance companies
or their holding companies. The extent of regulation by the states varies, but
in general, most jurisdictions have laws and regulations governing standards
of solvency, adequacy of reserves, reinsurance, capital adequacy and standards
of business conduct. In addition, statutes and regulations usually require the
licensing of insurers and their agents, the approval of policy forms for
admitted insurers and, for certain lines of insurance, including all of the
lines written by the Property and Casualty Group, approval of rates. In
supervising and regulating insurance companies, including reinsurers, state
insurance departments enjoy broad authority and discretion in applying
applicable insurance laws and regulations for the protection of policyholders
and the public. Inasmuch as they are subject to regulatory approval, the rates
that the Property and Casualty Group can charge for workers' compensation and
standard commercial lines of property and casualty insurance might not keep
pace with the underlying claim costs. In addition, any changes in these laws
and regulations or the failure of the Company to comply with such laws and
regulations could materially adversely affect the Company's operations. See
"Supervision and Regulation."
Workers' compensation insurers doing business in certain states are required
to provide insurance for risks which are not otherwise written on a voluntary
basis by the private market ("residual market business"). This system exists
in all of the Property and Casualty Group's current marketing territories,
except Pennsylvania and Maryland, in which separate governmental entities
write all of the workers' compensation residual market business. Because
residual market business consists of difficult to
26
<PAGE>
insure risks and entities and classes with poor claims experience, the
underwriting results of residual market business tend to be worse than those
of voluntary business. In 1997, the Property and Casualty Group wrote $5.2
million of residual market business, which constituted approximately 3% of its
voluntary market volume. While management believes that the Property and
Casualty Group has a lesser exposure to residual market business than many
other companies writing workers' compensation business, based upon the volume
of residual market business written, the Company is exposed to the possibility
that its underwriting results will be adversely affected by increases in the
size of the residual market and worsening claims experience in the residual
market. See "Business--the Property and Casualty Group--Workers' Compensation
Residual Market Business."
In recent years, various proposals have been introduced in Congress, which
call for the federal government to assume some role in the regulation of
insurance. To date, none of these proposals has been enacted, and the Company
cannot predict what form such future proposals might take or what effect, if
any, such proposals might have on PMA Capital or its subsidiaries if enacted
into law.
YEAR 2000 ISSUE
As a consequence of the programming convention which utilized a two-digit
field rather than a four-digit field, most computers require relatively costly
reprogramming to enable them to perform correctly date operations involving
year 2000 ("Year 2000") or later (the "Year 2000 Issue"). Many anticipate that
the Year 2000 Issue will have substantial repercussions on the business world,
since computer operations involving date calculations are pervasive.
With the assistance of outside consulting groups, the Company began
evaluating and reprogramming its own computer systems to address the Year 2000
Issue in late 1995. As of December 31, 1998, the Company has substantially
completed all necessary programming work and will continue testing throughout
1999. Accordingly, management believes that Year 2000 Issues related to the
Company's hardware and internal software programs are not likely to result in
any material adverse disruptions in the Company's computer systems or its
internal business operations. The cost of this work through December 31, 1998
has been approximately $5.4 million, including approximately $1.6 million
incurred during 1998.
In addition to assessing Year 2000 Issues relating to computer systems, the
Company is also in the process of reviewing its use of office equipment and
facilities which contain microprocessors or other embedded technology ("non-IT
Systems") over which it has control to ensure that they are, to the extent
reasonably necessary to conduct the Company's day-to-day operations, Year 2000
compliant. Because the Company is not materially dependent upon non-IT
Systems, the Company does not believe it has any material non-IT Systems Year
2000 exposure.
The Company is currently in the process of evaluating its relationships with
third parties with which the Company has a direct and material relationship to
determine whether they are Year 2000 compliant, such as banks, brokers,
reinsurers, third party service providers, software and other service vendors,
insureds and agents and other intermediaries. The responses by such third
parties to inquiries made by the Company as have been received to date
indicate that these third parties either are or expect to be compliant by the
Year 2000.
Even assuming that all material third parties provide a timely
representation affirming such Year 2000 compliance, however, it is not
possible to state with certainty that such representations will turn out to
have been accurate, or that the operations of such third parties will not be
materially impacted in turn by other parties with whom they themselves have a
material relationship, and who fail to timely become Year 2000 compliant.
Consequently, it is not possible to predict whether or to what extent the Year
2000 Issues may have an adverse material impact on the Company as a result of
their impact on the operations of third parties with whom the Company has a
material relationship. The failure of one or more third parties with whom the
Company has a material relationship to be Year 2000
27
<PAGE>
compliant could cause significant disruptions in the Company's ability to pay
claims, receive and deposit funds and make investments, which could have a
material adverse effect on the Company's financial condition and results of
operations. The Company's contingency plans in the event of failure of such
third parties to be Year 2000 compliant include replacing the third party,
performing directly the services performed by the third party and maintaining
liquidity under the Company's Revolving Credit Facility, which may have a
material impact on the Company.
Many experts now believe that Year 2000 Issues may have a material adverse
effect on the national and global economy generally. In addition, it seems
likely that if businesses are materially damaged as a result of Year 2000
Issues, at least some such businesses may attempt to recoup their losses by
claiming coverage under various types of insurance policies. Management of the
Property and Casualty Group and Caliber One believe that under a fair reading
of the various policies issued by them, no coverage for Year 2000 Issues
should exist. In an effort to assess whether or not a material liability
relating to Year 2000 Issues exists under policies reinsured by PMA Re, the
company has developed underwriting guidelines to try to ascertain how ceding
companies are underwriting their Year 2000 exposures, including any non-IT
exposures. Some ceding companies have indicated that, in their opinion,
exposure may exist on some types of policies in certain circumstances for
defense costs, indemnification or both. PMA Re is attempting, whenever
possible, to avoid or otherwise limit the exposure to Year 2000 Issues through
its underwriting process. However, it is not possible to make reasonable
estimates of the size or types of claims that may be asserted against PMA Re
and, accordingly, there can be no assurance that PMA Re will not have a
material exposure. In the event that claims for Year 2000 Issues are asserted
against the Property and Casualty Group, Caliber One or PMA Re, it is not
possible to predict whether or to what extent any such coverage could
ultimately be found to exist by courts in various jurisdictions, or, if found,
the effect thereof on any of such companies or the Company. In addition, to
the extent that the Property and Casualty Group, Caliber One or PMA Re contest
the assertion of Year 2000 coverage claims, it is likely that the costs of
litigation could be material, even if they are able to prevail in their
coverage positions as to which no assurance can be given.
DEPENDENCE UPON KEY PERSONNEL
The Company depends upon its executive management, including the executive
management of its insurance subsidiaries, to execute its business strategy.
The loss of any of these individuals or a reduction in the time devoted by
such persons to the Company's business could have a material adverse effect on
the Company's business. The Company's future success will depend, in part,
upon its ability to attract and retain highly qualified personnel. The Company
faces competition for such personnel from other companies, many of which have
significantly greater resources than the Company. There can be no assurance
that the Company will be able to attract and retain the necessary personnel on
acceptable terms. See "Business" and "Management."
28
<PAGE>
THE COMPANY
The Company is an insurance holding company, whose subsidiaries operate in
three distinct segments of the property and casualty insurance industry: (i)
reinsurance, through PMA Re, which commenced business in 1980; (ii) standard
commercial lines of insurance, with an emphasis on workers' compensation
through the Property and Casualty Group, which has been in business since 1915
and (iii) specialty insurance products, focusing on excess and surplus lines,
through the Company's recently-formed operation, Caliber One. PMA Re writes a
broad range of property and casualty reinsurance products with an emphasis on
risk-exposed casualty excess of loss reinsurance and operates in the United
States domestic brokered market. The Property and Casualty Group offers a full
range of workers' compensation products and services, as well as other
standard commercial lines products including commercial general liability,
commercial automobile and commercial multi-peril, primarily in nine contiguous
jurisdictions in the Mid-Atlantic and Southern regions of the United States,
utilizing the PMA Group trade name. In 1998, Caliber One commenced writing
excess and surplus lines of property and casualty insurance, including
commercial general liability, automobile and certain property exposures on a
non-admitted basis. For the nine months ended September 30, 1998, the
Company's net premiums written of $369.1 million were derived 46.7% from PMA
Re, 52.6% from the Property and Casualty Group and 0.7% from Caliber One. Net
income for the Company for the nine months ended September 30, 1998 and the
year ended December 31, 1997 was $32.0 million and $15.0 million,
respectively. As of September 30, 1998, the Company had total assets of
$3,131.9 million and shareholders' equity of $517.6 million.
According to data provided by the RAA, as of September 30, 1998, PMA
Reinsurance Corporation was the 23rd largest reinsurer in the United States in
terms of statutory surplus and 18th largest in terms of net premiums written.
Management believes that PMA Re competes on the basis of its ability to offer
prompt and responsive service and products designed to meet client needs and
its excellent long-term relationships in the broker and ceding company
communities. PMA Re's net premiums written grew at a compound annual rate of
13.2% between 1992 and 1997. As of September 30, 1998, statutory surplus of
PMA Reinsurance Corporation was $283.0 million, and for the nine months ended
September 30, 1998, PMA Re's net premiums written were $172.6 million. PMA Re
reported pre-tax operating income of $34.9 million and $34.7 million for the
nine-month periods ended September 30, 1998 and 1997, respectively, and $46.0
million, $44.8 million and $39.8 million for the years ended December 31,
1997, 1996 and 1995, respectively.
The Property and Casualty Group markets its products and services primarily
to middle market accounts (premiums ranging from $40,000 to $300,000) and
smaller accounts (premiums less than $40,000). The Property and Casualty Group
distributes its products primarily through approximately 260 regional brokers
and agents throughout its marketing territories and also utilizes an internal
sales force in Pennsylvania and Delaware, which accounted for approximately
13% of direct premiums written in 1997. In 1997, workers' compensation
insurance accounted for 60% of the Property and Casualty Group's direct
premiums written, and Pennsylvania workers' compensation insurance accounted
for 50% of the Property and Casualty Group's workers' compensation direct
premiums written. This concentration in workers' compensation has increased to
approximately 67% as of September 30, 1998, primarily due to a planned
reduction in Commercial Lines of business. The Property and Casualty Group
offers a variety of workers' compensation products, such as third-party claims
administration services, rent-a-captives and high-deductible plans in addition
to traditional fixed-cost and loss-sensitive workers' compensation products.
Management believes that the Property and Casualty Group competes in workers'
compensation on the basis of its ability to provide prompt and responsive
service.
In 1996, the Company restructured the Property and Casualty Group with the
goal of restoring its profitability after three years of operating losses. The
losses resulted primarily from unfavorable underwriting experience and adverse
reserve development related to accident years 1987 through
29
<PAGE>
1991, when the Property and Casualty Group wrote a much higher volume of
business than its current volume. The principal components of the
restructuring were: (i) strengthening loss reserves; (ii) initiating a
commutation program to settle a significant number of open claims from the
1987 to 1991 period; (iii) designating PMA Cayman and MASCCO as separate run-
off companies to alleviate the SAP impact on the Pooled Companies of the loss
reserve strengthening and to manage the capital deployed in running off pre-
1992 workers' compensation claims; (iv) initiating an expense reduction
program and (v) implementing management changes, including the appointment of
a new Chief Operating Officer and the creation of the position of, and
appointment of, a Chief Underwriting Officer. Effective July 1, 1998, the
Company sold PMA Cayman. Largely as a result of the restructuring, the
Property and Casualty Group recorded pre-tax operating income of $8.4 million
for the nine months ended September 30, 1998, compared to pre-tax operating
losses of $5.0 million for the nine months ended September 30, 1997 and $3.7
million, $215.7 million (including restructuring and other special charges of
$223.1 million) and $3.9 million for the years ended December 31, 1997, 1996
and 1995, respectively. As of September 30, 1998, the Property and Casualty
Group's statutory surplus was $263.3 million, and for the nine months ended
September 30, 1998, the Property and Casualty Group's net premiums written
were $194.3 million. See "Business--The Property and Casualty Group."
In December 1997, the Company acquired an insurance company, which was
renamed Caliber One Indemnity Company, to enter the excess and surplus lines
insurance business. Within the last year, the Company hired several
experienced specialty insurance executives to manage Caliber One, who have
substantial relationships within the wholesale brokerage community, which
management believes will have a favorable impact on Caliber One's ability to
obtain market acceptance. Caliber One distributes its products primarily
through national wholesale brokers, and Caliber One Indemnity Company is
approved as a surplus lines carrier in 41 states, Puerto Rico and the District
of Columbia. As of September 30, 1998, Caliber One Indemnity Company's
statutory surplus was $25.4 million, and for the nine months ended September
30, 1998, Caliber One's net premiums written were $2.6 million.
The Company's insurance subsidiaries have the following ratings from A.M.
Best: PMA Reinsurance Corporation, A+ ("Superior"); the Pooled Companies, A-
("Excellent") and Caliber One Indemnity Company, A ("Excellent"). Management
believes that ratings from A.M. Best are material to its operations and that a
downgrade from the present rating classifications could have an adverse effect
on the Company's ability to market its products. A.M. Best's ratings are based
upon an assessment of an insurance company's perceived financial strength
regarding its ability to pay obligations to its policyholders and are not
directed toward the protection of investors.
The Company maintains its principal executive offices at 1735 Market Street,
Philadelphia, Pennsylvania 19103-7590 and its telephone number is (215) 665-
5046.
THE ISSUER
The Issuer is a statutory business trust formed under Delaware law pursuant
to (i) a trust agreement executed by PMA Capital as Depositor, The Bank of New
York, as the Property Trustee of the Issuer, and The Bank of New York
(Delaware), as Trustee, and (ii) a certificate of trust filed with the
Delaware Secretary of State. The trust agreement will be amended and restated
in its entirety (as so amended and restated, the "Trust Agreement")
substantially in the form filed as an exhibit to the Registration Statement of
which this Prospectus forms a part. The Trust Agreement will be qualified as
an indenture under the Trust Indenture Act. The Issuer exists for the
exclusive purposes of (i) issuing the Capital Securities and the Common
Securities representing undivided beneficial interests in the assets of the
Issuer, (ii) investing the gross proceeds from the sale of the Capital
Securities and the Common Securities in the Junior Subordinated Debentures
issued by PMA Capital and (iii) engaging in only those other activities
necessary or incidental thereto. Accordingly, the Junior Subordinated
Debentures, the rights of the Property Trustee under the Guarantee and the
right to
30
<PAGE>
reimbursement of expenses under the Expense Agreement will be the sole assets
of the Issuer, and payments under the Junior Subordinated Debentures and the
Expense Agreement will be the sole revenue of the Issuer.
All of the Common Securities of the Issuer will be owned by PMA Capital. The
Common Securities will rank pari passu, and payments will be made thereon pro
rata, with the Capital Securities, except that upon the occurrence and
continuance of an Event of Default under the Trust Agreement (as defined
therein) resulting from a Debenture Event of Default, the rights of PMA
Capital as holder of the Common Securities to payment in respect of
distributions and payments upon liquidation, redemption or otherwise will be
subordinated to the rights of the holders of the Capital Securities. See
"Description of the Capital Securities--Subordination of Common Securities."
PMA Capital will acquire the Common Securities in an aggregate liquidation
amount equal to approximately 3% of the total capital of the Issuer.
The Issuer has a term of approximately 55 years, but may terminate earlier
as provided in the Trust Agreement. The Issuer's business and affairs are
conducted by its trustees, each appointed by PMA Capital as holder of the
Common Securities. The trustees for the Issuer will be The Bank of New York,
as the Property Trustee, The Bank of New York (Delaware), as Delaware Trustee,
and three individual Administrative Trustees who are employees or officers of
or affiliated with PMA Capital. The Bank of New York, as Property Trustee,
will act as sole indenture trustee under the Trust Agreement for purposes of
compliance with the Trust Indenture Act. The Bank of New York will also act as
Trustee under the Guarantee and the Indenture (each as defined herein). See
"Description of the Guarantee" and "Description of the Junior Subordinated
Debentures." The holder of the Common Securities of the Issuer, or the holders
of a majority in Liquidation Amount of the Capital Securities if a Debenture
Event of Default has occurred and is continuing, will be entitled to appoint,
remove or replace the Property Trustee. In no event will the holders of the
Capital Securities have the right to vote to appoint, remove or replace the
Administrative Trustees; such voting rights are vested exclusively in the
holder of the Common Securities. The duties and obligations of the Property
Trustee are governed by the Trust Agreement. PMA Capital will pay all fees and
expenses related to the Issuer and the offering of the Capital Securities and
will pay, directly or indirectly, all ongoing costs, expenses and liabilities
of the Issuer.
The principal executive office of the Issuer is located at 1735 Market
Street, Philadelphia Pennsylvania 19103-7590, and its telephone number is
(215) 665-5046.
RATIO OF EARNINGS TO FIXED CHARGES
The following table sets forth the Company's ratio of earnings to fixed
charges for the nine months ended September 30, 1998 and 1997 and the years
ended December 31, 1997, 1996, 1995, 1994 and 1993.
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------- ---------------------------
1998 1997 1997 1996(2) 1995 1994 1993
------ ------ ---- ------- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C>
Ratio of Earnings to Fixed
Charges(1)......................... 4.0x 2.0x 2.4x -- 2.7x 5.5x 7.7x
</TABLE>
- --------
(1) For the purposes of determining this ratio, earnings (loss) consist of
income (loss) before income taxes and extraordinary loss, plus fixed
charges. Fixed charges consist of interest expense on debt, amortization
of debt issuance costs and the portion of operating leases that management
believes is representative of the interest factor.
(2) In 1996, earnings were insufficient to cover fixed charges by $191.4
million. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations."
31
<PAGE>
CAPITALIZATION
The following table sets forth the unaudited consolidated capitalization of
the Company at September 30, 1998 on an actual basis and as adjusted to
reflect the issuance of the Junior Subordinated Debentures in connection with
the Offering as if the Offering had occurred on September 30, 1998, after
deducting the estimated underwriting discount and expenses of the Offering.
This table should be read in conjunction with the Company's consolidated
financial statements, including the notes thereto, appearing elsewhere in this
Prospectus.
(UNAUDITED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
AT SEPTEMBER 30,
1998
------------------
AS
ACTUAL ADJUSTED
-------- --------
<S> <C> <C>
LONG-TERM DEBT:
Revolving Credit Facility(1).............................. $203,000 $104,500
-------- --------
Company-obligated mandatorily redeemable Capital
Securities of subsidiary trust holding solely Junior
Subordinated Debentures of the Company(2)................ -- 100,000
SHAREHOLDERS' EQUITY:
Common stock, $5.00 par value, 40,000,000 shares
authorized, 14,615,587 shares issued and 14,179,580
shares outstanding....................................... 73,078 73,078
Class A common stock, $5.00 par value, 40,000,000 shares
authorized, 9,827,358 shares issued and 9,146,028 shares
outstanding.............................................. 49,136 49,136
Additional paid-in capital--Class A common stock.......... 339 339
Retained earnings......................................... 367,999 367,999
Accumulated other comprehensive income.................... 46,009 46,009
Notes receivable from officers............................ (198) (198)
Treasury stock, at cost (436,007 shares--common stock and
681,330 shares--Class A common stock).................... (18,783) (18,783)
-------- --------
Total shareholders' equity.............................. 517,580 517,580
-------- --------
Total capitalization.................................. $720,580 $722,080
======== ========
</TABLE>
- --------
(1) At September 30, 1998, $32,000 was available for borrowing under the
Company's Revolving Credit Facility. As adjusted, at September 30, 1998,
available borrowings under the Company's Revolving Credit Facility were
$130,500.
(2) Represents the issuance of the Capital Securities by the Trust (net of
related issuance costs). One hundred percent of the assets of the Trust
will consist of approximately $103,093 of Junior Subordinated Debentures
of PMA Capital. The financial statements of the Trust will be reflected in
the consolidated financial statements of the Company with the Capital
Securities reflected as Company-obligated mandatorily redeemable Capital
Securities of subsidiary trust holding solely Junior Subordinated
Debentures of the Company. See "Accounting Treatment."
32
<PAGE>
USE OF PROCEEDS
PMA Capital currently estimates the net proceeds to be received from the
Offering will be $98.5 million, after giving effect to estimated underwriting
discounts and estimated offering expenses. All of the net proceeds from the
sale of the Capital Securities will be invested in the Junior Subordinated
Debentures. PMA Capital intends to use the proceeds from the sale of such
Junior Subordinated Debentures to repay indebtedness under the Revolving
Credit Facility, which will increase the availability under the Revolving
Credit Facility from $32.0 million to $130.5 million. The final maturity of
the Revolving Credit Facility is December 31, 2002, with reductions in
availability of $47.5 million on December 31, 1999 and level reductions in
availability of $62.5 million each December 31 thereafter, commencing in 2000.
The Revolving Credit Facility bears interest at a variable interest rate of
LIBOR plus .70% on the drawn amount (with such spread adjustable downward
based upon reductions in the Company's ratio of debt to total capitalization),
or 6.3% at September 30, 1998, and carries a .275% facility fee on the undrawn
portion (also adjustable downward based upon reductions in the Company's ratio
of debt to total capitalization). It is the Company's intention to utilize
availability under the Revolving Credit Facility, from time to time in the
future, to capitalize subsidiaries and make other strategic investments as
business opportunities arise, subject to the maintenance of appropriate
financial leverage ratios. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources."
ACCOUNTING TREATMENT
For financial reporting purposes, the Issuer will be treated as a subsidiary
of the Company, and, accordingly, the accounts of the Issuer will be included
in the consolidated financial statements of the Company. The Capital
Securities will be presented as a separate line item in the consolidated
balance sheets of the Company, entitled "Company-obligated mandatorily
redeemable Capital Securities of subsidiary trust holding solely Junior
Subordinated Debentures of the Company" and the audited notes to the
consolidated financial statements will contain disclosure that (a) the Common
Securities of the Trust are wholly owned by PMA Capital, (b) the sole asset of
the Trust is the % Junior Subordinated Debentures of PMA Capital in the
approximate principal amount of $103.093 million, having a stated maturity of
, 2029, and (c) PMA Capital fully and unconditionally guarantees the
Trust's obligations under the Capital Securities. For financial reporting
purposes, the Company will record distributions payable on the Capital
Securities as an expense in its consolidated statements of operations.
33
<PAGE>
SELECTED CONSOLIDATED FINANCIAL AND OPERATING DATA
The selected consolidated financial and operating data set forth below as of
December 31, 1997, 1996, 1995, 1994, and 1993 and for each of the five years
in the period ended December 31, 1997 were derived from the audited
consolidated financial statements of the Company. The selected consolidated
financial and operating data as of September 30, 1998 and 1997 and for the
nine-month periods ended September 30, 1998 and 1997 were derived from the
Company's unaudited consolidated financial statements. The unaudited
consolidated financial statements have been prepared on the same basis as the
Company's audited consolidated financial statements, and, in the opinion of
management, include all adjustments, consisting of only normal recurring
adjustments, necessary for a fair presentation of the Company's financial
position and results of operations for these periods. The results of
operations for the nine months ended September 30, 1998 may not be indicative
of results of operations for the full year. All selected consolidated
financial and operating data set forth below should be read in conjunction
with the consolidated financial statements of the Company, together with the
notes thereto, and Management's Discussion and Analysis of Financial Condition
and Results of Operations, both appearing elsewhere in this Prospectus.
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
--------------------- --------------------------------------------------------
1998 1997 1997(1) 1996(1) 1995(1) 1994(1) 1993
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Net premiums
written(2)............. $ 369,134 $ 315,760 $ 381,282 $ 432,975 $ 485,876 $ 465,502 $ 533,487
========== ========== ========== ========== ========== ========== ==========
CONSOLIDATED REVENUES:
Net premiums earned..... $ 335,593 $ 285,371 $ 375,951 $ 420,575 $ 484,952 $ 466,534 $ 547,407
Net investment income... 94,363 102,812 136,698 133,936 139,355 138,719 153,842
Net realized investment
gains ................. 15,362 3,600 8,598 2,984 31,923 47,521 69,798
Service revenues........ 7,282 7,712 10,311 9,189 5,106 3,380 1,321
---------- ---------- ---------- ---------- ---------- ---------- ----------
Total consolidated
revenues.............. $ 452,600 $ 399,495 $ 531,558 $ 566,684 $ 661,336 $ 656,154 $ 772,368
========== ========== ========== ========== ========== ========== ==========
Income (loss) before
cumulative effect of
accounting changes and
extraordinary item..... 31,997 12,621 19,753 (135,334) 24,130 57,250 68,297
Cumulative effect of
accounting changes, net
of related tax
effects(3)............. -- -- -- -- -- -- 14,119
Extraordinary loss from
early extinguishment of
debt, net of related
tax effect(4).......... -- (4,734) (4,734) -- -- -- --
---------- ---------- ---------- ---------- ---------- ---------- ----------
Net income (loss)...... $ 31,997 $ 7,887 $ 15,019 $ (135,334) $ 24,130 $ 57,250 $ 82,416
========== ========== ========== ========== ========== ========== ==========
PER SHARE DATA:
Weighted average shares:
Basic(5)............... 23,704,376 23,845,194 23,855,031 23,800,791 23,816,088 23,897,263 24,231,071
Diluted(5),(6)......... 24,649,404 24,506,738 24,567,378 23,800,791 24,781,949 24,650,741 24,470,024
Income (loss) before
cumulative effect of
accounting changes and
extraordinary item per
share:
Basic(5)............... $ 1.35 $ .53 $ .83 $ (5.68) $ 1.01 $ 2.40 2.82
Diluted(5),(6)......... 1.30 .51 .80 (5.68) .97 2.32 2.79
Net income (loss) per
share:
Basic(5)............... 1.35 .33 .63 (5.68) 1.01 2.40 3.40
Diluted(5),(6)......... 1.30 .32 .61 (5.68) .97 2.32 3.37
Dividends paid per
common share........... .24 .24 .32 .32 .32 .32 .28
Dividends paid per Class
A common share......... .27 .27 .36 .36 .36 .36 32
Shareholders' equity per
share.................. 22.19 19.96 19.96 17.86 25.53 22.10 22.23
<CAPTION>
AT SEPTEMBER 30, AT DECEMBER 31,
--------------------- --------------------------------------------------------
1998 1997 1997 1996 1995 1994 1993
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED FINANCIAL
POSITION:
Total investments....... $1,967,253 $2,202,645 $2,194,738 $2,261,353 $2,455,949 $2,313,261 $2,374,208
Total assets............ 3,131,922 3,066,361 3,057,258 3,117,516 3,258,572 3,181,979 3,197,909
Reserves for unpaid
losses and LAE......... 1,951,497 1,989,160 2,003,187 2,091,072 2,069,986 2,103,714 2,150,665
Long-term debt.......... 203,000 203,000 203,000 204,699 203,848 203,975 194,836
Shareholders'
equity(7).............. 517,580 446,264 478,347 425,828 609,668 524,862 534,383
</TABLE>
34
<PAGE>
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
---------------- ---------------------------------------------
1998 1997 1997(1) 1996(1) 1995(1) 1994(1) 1993
------- ------- ------- --------- ------- ------- -------
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
PRE-TAX OPERATING INCOME
(LOSS)(8):
PMA Re.................. $34,882 $34,674 $45,957 $ 44,807 $39,793 $33,703 $33,511
------- ------- ------- --------- ------- ------- -------
The Property and
Casualty Group(9):
Excluding Run-off Opera-
tions.................. 8,343 (4,857) (3,607) (215,669) (3,885) 3,893 (1,153)
Run-off Operations...... 41 (108) (73) -- -- -- --
------- ------- ------- --------- ------- ------- -------
Total Property and Casu-
alty Group............. 8,384 (4,965) (3,680) (215,669) (3,885) 3,893 (1,153)
Caliber One............. (1,317) -- -- -- -- -- --
Corporate and Other..... (7,980) (7,148) (9,954) (6,464) (14,184) (6,686) (885)
------- ------- ------- --------- ------- ------- -------
Total pre-tax operating
income (loss) before
interest expense...... 33,969 22,561 32,323 (177,326) 21,724 30,910 31,473
Interest expense........ 11,231 12,025 15,768 17,052 18,734 13,051 11,650
------- ------- ------- --------- ------- ------- -------
Pre-tax operating income
(loss)................. 22,738 10,536 16,555 (194,378) 2,990 17,859 19,823
Net realized investment
gains.................. 15,362 3,600 8,598 2,984 31,923 47,521 69,798
------- ------- ------- --------- ------- ------- -------
Income (loss) before
income taxes and
extraordinary item..... 38,100 14,136 25,153 (191,394) 34,913 65,380 89,621
Provision (benefit) for
income taxes........... 6,103 1,515 5,400 (56,060) 10,783 8,130 21,324
------- ------- ------- --------- ------- ------- -------
Income (loss) before
cumulative effect of
accounting changes and
extraordinary item..... 31,997 12,621 19,753 (135,334) 24,130 57,250 68,297
Cumulative effect of ac-
counting changes, net
of related tax effects
(3).................... -- -- -- -- -- -- 14,119
Extraordinary loss from
early extinguishment of
debt, net of related
tax effect (4)......... -- (4,734) (4,734) -- -- -- --
------- ------- ------- --------- ------- ------- -------
Net income (loss)....... $31,997 $ 7,887 $15,019 $(135,334) $24,130 $57,250 $82,416
======= ======= ======= ========= ======= ======= =======
Ratio of earnings to
fixed charges(10)...... 4.0x 2.0x 2.4x -- 2.7x 5.5x 7.7x
GAAP RATIOS FOR
INSURANCE
SUBSIDIARIES(11):
PMA Re:
Loss ratio............. 68.2% 73.0% 69.6% 73.7% 74.6% 74.7% 80.6%
Expense ratio.......... 35.6% 30.3% 34.2% 28.9% 29.3% 33.3% 29.4%
------- ------- ------- --------- ------- ------- -------
Combined ratio(12)..... 103.8% 103.3% 103.8% 102.6% 103.9% 108.0% 110.0%
======= ======= ======= ========= ======= ======= =======
The Property and
Casualty Group,
including Run-off
Operations(9):
Loss ratio.............. 83.5% 93.3% 91.1% 158.2% 92.5% 90.1% 96.3%
Expense ratio(13)....... 33.2% 42.5% 42.8% 47.1% 30.4% 31.4% 25.0%
Policyholders' dividend
ratio.................. 7.7% 6.3% 6.9% 6.1% 4.8% 4.6% 3.5%
------- ------- ------- --------- ------- ------- -------
Combined ratio(12)..... 124.4% 142.1% 140.8% 211.4% 127.7% 126.1% 124.8%
======= ======= ======= ========= ======= ======= =======
The Property and
Casualty Group,
excluding Run-off
Operations(9):
Loss ratio.............. 77.5% 84.6% 83.7% -- -- -- --
Expense ratio(13)....... 32.0% 33.4% 32.9% -- -- -- --
Policyholders' dividend
ratio.................. 7.7% 5.2% 5.6% -- -- -- --
------- ------- ------- --------- ------- ------- -------
Combined ratio(12)..... 117.2% 123.2% 122.2% -- -- -- --
======= ======= ======= ========= ======= ======= =======
</TABLE>
- --------
(1) Operating results in 1997, 1996 and 1995 were impacted by approximately
$12,100, $223,100 and $8,400, respectively, of restructuring and other
special charges. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations" for further information. In
addition, 1994 operating results included a charge of approximately
$4,908 to write down the value of the Company's former headquarters
building.
(2) Net premiums written were reduced by $3,000 and $37,000 for the nine
months ended September 30, 1998 and 1997, respectively, and reduced by
$37,000, $10,500, $4,000, $1,000, and $3,500 for the years ended December
31, 1997, 1996, 1995, 1994 and 1993, respectively, representing estimated
retrospective policy adjustments related to the current accident year and
retrospective policy adjustments paid. These adjustments to net premiums
written were made for presentation purposes only and had previously been
reflected in the Company's reported revenues, financial position and
results of operations.
35
<PAGE>
(3) In 1993, the Company recognized an after-tax net benefit of $14,119
resulting from the adoption of SFAS No. 109, "Accounting for Income
Taxes," ($21,500 benefit), and SFAS No. 106, "Employers' Accounting for
Post-retirement Benefits Other Than Pensions," ($7,381 after-tax charge).
(4) In 1997, the Company refinanced substantially all of its long-term debt
resulting in a $4,734 extraordinary loss, net of tax effect. See
"Management's Discussion and Analysis of Financial Condition and Results
of Operations."
(5) In 1997, the Company adopted SFAS No. 128, "Earnings Per Share," which
requires the presentation of basic and diluted earnings per share. See
Notes 1-I and 16 to the audited consolidated financial statements
appearing elsewhere in this Prospectus. All prior periods' presentation
of earnings per share data has been restated to conform to SFAS No. 128.
(6) For the year ended December 31, 1996, common stock equivalents were not
taken into consideration in the computation of weighted-average diluted
shares as these common stock equivalents would have an anti-dilutive
effect on the net loss per share.
(7) In 1994, shareholders' equity increased $45,343 related to the adoption
of SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities."
(8) Pre-tax operating income (loss) excludes net realized investment gains.
Pre-tax operating income by business segment for all periods is unaudited
and has been presented in accordance with SFAS No.131, "Disclosures about
Segments of an Enterprise and Related Information", which the Company
adopted on January 1, 1998. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and the Company's interim
financial statements and notes thereto as of September 30, 1998 and 1997
included elsewhere in this Prospectus. The Company has excluded net
realized investment gains (losses) from the profit and loss measurement
it utilizes to assess the performance of its operating segments because
(i) net realized investment gains (losses) are unpredictable and not
necessarily indicative of future performance and (ii) in many instances,
decisions to buy and sell securities are made at the parent holding
company level, and such decisions result in net realized gains (losses)
that do not relate to the operations of the individual segments.
(9) Run-off Operations of the Property and Casualty Group are comprised of
MASCCO, PMA Cayman and PMA Life, which were established in December 1996
to reinsure certain obligations primarily associated with workers'
compensation claims written by the Pooled Companies for the accident
years 1991 and prior. The Run-off Operations are separate legal entities
and substantially all of the assets of the Run-off Operations are held in
trust for the benefit of the Pooled Companies. Effective July 1, 1998,
the Company sold PMA Cayman, and all data presented excludes PMA Cayman
subsequent to such date. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
(10) For the purposes of determining this ratio, earnings (loss) consist of
income (loss) before income taxes and extraordinary loss, plus fixed
charges. Fixed charges consist of interest expense on debt, amortization
of debt issuance costs and the portion of operating leases that
management believes is representative of the interest factor. In 1996,
earnings were insufficient to cover fixed charges by $191,394. See
"Management's Discussion and Analysis of Financial Condition and Results
of Operations."
(11) The results of operations of Caliber One are not material to the
underwriting ratios of the Company; accordingly, the ratios for Caliber
One have not been presented.
(12) The combined ratio computed on a GAAP basis is equal to losses and LAE,
plus amortization of deferred acquisition costs, operating expenses and
policyholders' dividends (where applicable), all divided by net premiums
earned.
(13) The GAAP operating expense ratios exclude $6,872 and $6,928 for the nine
months ended September 30, 1998 and 1997, respectively, and $9,316,
$8,227 and $5,300, for the years ended December 31, 1997, 1996 and 1995,
respectively, of PMA Management Corp. direct expenses related to service
revenues, which are not included in premiums earned. See "Management's
Discussion and Analysis of Financial Condition and Results of
Operations."
36
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
The following discussion of the Company's financial condition, results of
operations and its liquidity and capital resources should be read in
connection with the Selected Consolidated Financial and Operating Data of the
Company and the consolidated financial statements of the Company and notes
thereto, and the unaudited consolidated financial statements of the Company
and notes thereto included elsewhere in this Prospectus.
RESULTS OF OPERATIONS
The table below presents the major components of net income for the Company
for the three and nine months ended September 30, 1998 and 1997:
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- ---------------
1998 1997 1998 1997
------- ------- ------- -------
<S> <C> <C> <C> <C>
Pre-tax operating income(1).................. $ 8,485 $ 5,985 $22,738 $10,536
Net realized investment gains................ 4,099 5,531 15,362 3,600
------- ------- ------- -------
Income before income taxes and extraordinary
loss........................................ 12,584 11,516 38,100 14,136
Provision for income taxes................... 2,032 4,172 6,103 1,515
------- ------- ------- -------
Income before extraordinary loss............. 10,552 7,344 31,997 12,621
Extraordinary loss, net of related taxes..... -- -- -- (4,734)
------- ------- ------- -------
Net income................................... $10,552 $ 7,344 $31,997 $ 7,887
======= ======= ======= =======
PER BASIC SHARE:
Income before extraordinary loss............. $ .45 $ .31 $ 1.35 $ .53
Extraordinary loss........................... -- -- -- (.20)
------- ------- ------- -------
Net income................................... $ .45 $ .31 $ 1.35 $ .33
======= ======= ======= =======
PER DILUTED SHARE:
Income before extraordinary loss............. $ .43 $ .30 $ 1.30 $ .51
Extraordinary loss........................... -- -- -- (.19)
------- ------- ------- -------
Net income................................... $ .43 $ .30 $ 1.30 $ .32
======= ======= ======= =======
</TABLE>
- --------
(1) Pre-tax operating income is defined as income from continuing operations
before income taxes, but excluding net realized investment gains. The
Company has excluded net realized investment gains (losses) from the
profit and loss measurement it utilizes to assess the performance of its
operating segments because (i) net realized investment gains (losses) are
unpredictable and not necessarily indicative of future performance and
(ii) in many instances, decisions to buy and sell securities are made at
the parent holding company level, and such decisions result in net
realized gains (losses) that do not relate to the operations of the
individual segments.
37
<PAGE>
The following table indicates the Company's pre-tax operating income (loss)
by principal business segment for the three and nine months ended September
30, 1998 and 1997:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER ENDED SEPTEMBER
30, 30,
---------------- ----------------
1998 1997(1) 1998 1997(1)
------- ------- ------- -------
<S> <C> <C> <C> <C>
PMA Re.................................... $11,930 $11,487 $34,882 $34,674
The Property and Casualty Group:
Excluding Run-off Operations............. 3,389 (76) 8,343 (4,857)
Run-off Operations....................... (387) 999 41 (108)
------- ------- ------- -------
Total.................................... 3,002 923 8,384 (4,965)
Caliber One............................... (247) -- (1,317) --
Corporate and Other....................... (2,432) (2,622) (7,980) (7,148)
------- ------- ------- -------
Pre-tax operating income before interest
expense.................................. 12,253 9,788 33,969 22,561
Interest expense.......................... 3,768 3,803 11,231 12,025
------- ------- ------- -------
Pre-tax operating income.................. $ 8,485 $ 5,985 $22,738 $10,536
======= ======= ======= =======
</TABLE>
- --------
(1) Pre-tax operating income (loss) by principal business segment has 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).
The following table indicates the Company's total assets by principal
business segment at September 30, 1998:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<S> <C>
PMA Re.............................................................. $1,223,315
The Property and Casualty Group:
Excluding Run-off Operations....................................... 1,722,177
Run-off Operations................................................. 116,242
----------
Total.............................................................. 1,838,419
Caliber One......................................................... 63,725
Corporate and Other................................................. 6,463
----------
Total assets....................................................... $3,131,922
==========
</TABLE>
On a consolidated basis, the Company reported pre-tax operating income of
$8.5 million and $22.7 million for the three and nine months ended September
30, 1998, respectively, compared to pre-tax operating income of $6.0 million
and $10.5 million for the three and nine months ended September 30, 1997,
respectively. The increases in pre-tax operating income for the three and nine
months ended September 30, 1998 compared to the same periods in 1997, were
primarily due to increased operating income at the Property and Casualty Group
and PMA Re, partially offset by the Caliber One pre-tax operating losses
related to the commencement of its operations. The improvements in pre-tax
operating results for the Property and Casualty Group were primarily related
to improved loss experience in workers' compensation business, reduced
exposures in other commercial lines business and lower operating expenses
resulting from the Property and Casualty Group's ongoing cost reduction
initiatives. PMA Re's increased pre-tax operating results for the three and
nine months ended September 30, 1998 compared to the comparable periods in
1997 were as a result of increased premium volume, lower loss ratios and
higher investment income, partially offset by increased acquisition costs.
38
<PAGE>
Interest expense for the three months ended September 30,1998 was comparable
to the third quarter of 1997 and decreased $794,000 for the nine months ended
September 30, 1998 compared to the same period in 1997 due to the March 1997
refinancing of the Company's debt facility.
Net realized investment gains were $4.1 million and $15.4 million for the
three and nine months ended September 30, 1998, respectively, compared to $5.5
million and $3.6 million for the comparable 1997 periods. 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.
Net income on a consolidated basis, before extraordinary loss, was $10.6
million, or $.45 per basic share and $.43 per diluted share, and $32.0
million, or $1.35 per basic share and $1.30 per diluted share, for the three
and nine months ended September 30, 1998, respectively, compared to $7.3
million, or $.31 per basic share and $.30 per diluted share, and $12.6
million, or $.53 per basic share and $.51 per diluted share, for the three and
nine months ended September 30, 1997, respectively. 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 $.20 per basic share and $.19 per diluted share, net of tax.
PMA RE RESULTS OF OPERATIONS
Summarized financial results of PMA Re for the three and nine months ended
September 30, 1998 and 1997, were as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED SEPTEMBER NINE MONTHS ENDED
30, SEPTEMBER 30,
---------------- ------------------
1998 1997 1998 1997
------- ------- -------- --------
<S> <C> <C> <C> <C>
Net premiums written...................... $54,687 $45,019 $172,595 $141,298
======= ======= ======== ========
Net premiums earned....................... $56,386 $39,208 $157,353 $124,295
Net investment income..................... 13,732 13,460 40,903 38,748
------- ------- -------- --------
Operating revenues........................ 70,118 52,668 198,256 163,043
------- ------- -------- --------
Losses and LAE incurred................... 37,633 28,512 107,311 90,743
Acquisition and operating expenses........ 20,555 12,669 56,063 37,626
------- ------- -------- --------
Total losses and expenses................. 58,188 41,181 163,374 128,369
------- ------- -------- --------
Pre-tax operating income.................. $11,930 $11,487 $ 34,882 $ 34,674
======= ======= ======== ========
GAAP loss ratio........................... 66.7% 72.7% 68.2% 73.0%
GAAP combined ratio....................... 103.2% 105.0% 103.8% 103.3%
SAP loss ratio............................ 66.6% 72.5% 67.8% 72.9%
SAP combined ratio........................ 104.7% 102.6% 104.5% 103.2%
</TABLE>
39
<PAGE>
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 SEPTEMBER NINE MONTHS ENDED
30, SEPTEMBER 30,
--------------- -----------------
1998 1997 1998 1997
------- ------- -------- --------
<S> <C> <C> <C> <C>
Gross premiums written:
Casualty lines............................... $49,857 $34,331 $152,465 $117,620
Property lines............................... 17,066 21,789 58,379 58,705
Other lines.................................. 308 206 809 707
------- ------- -------- --------
Total........................................ $67,231 $56,326 $211,653 $177,032
======= ======= ======== ========
Net premiums written:
Casualty lines............................... $40,922 $25,576 $124,457 $ 93,862
Property lines............................... 13,516 19,259 47,365 46,760
Other lines.................................. 249 184 773 676
------- ------- -------- --------
Total........................................ $54,687 $45,019 $172,595 $141,298
======= ======= ======== ========
</TABLE>
Gross premiums written increased $10.9 million, or 19.4%, and $34.6 million,
or 19.6%, for the three and nine months ended September 30, 1998,
respectively, compared to the same periods ended September 30, 1997. For the
three months ended September 30, 1998, gross premiums written increased 45.2%
for casualty lines and decreased 21.7% for property lines compared to the same
period in 1997. For the nine months ended September 30, 1998, gross premiums
written increased 29.6% for casualty lines and decreased 0.6% for property
lines compared to the same period in 1997. Premium growth has resulted
primarily from expanding relationships with existing clients reflecting PMA
Re's focus on increased participations on existing reinsurance treaties and
participations on new programs for current clients. PMA Re added 33 new
programs for existing clients during the first nine months of 1998. PMA Re
also added contracts with 14 new ceding companies, which meet the criteria
established internally defining small to medium size companies. These
increases were partially offset by the highly competitive conditions in the
U.S. reinsurance market, which resulted in 46 accounts being non-renewed
during the first nine months of 1998, largely due to inadequate rates and/or
other underwriting concerns.
Net premiums written increased $9.7 million, or 21.5%, and $31.3 million, or
22.1%, for the three and nine months ended September 30, 1998, respectively,
compared to the same periods ended September 30, 1997. PMA Re made changes to
its retrocessional program in the second half of 1997 and in 1998, which
reduced the percentage of premiums ceded to retrocessionaires in 1998. Net
premiums earned for PMA Re also increased $17.2 million, or 43.8%, and $33.1
million, or 26.6%, for the three and nine months ended September 30, 1998,
respectively, compared to the same periods in 1997. Net premiums earned
generally follow growth patterns similar to net premiums written, after giving
effect to a lag in premium earnings.
40
<PAGE>
Losses and Expenses
The following table reflects the components of PMA Re's combined ratios, as
computed under GAAP:
<TABLE>
<CAPTION>
THREE
MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER SEPTEMBER
30, 30,
------------ ------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Loss ratio......................................... 66.7% 72.7% 68.2% 73.0%
----- ----- ----- -----
Expense ratio:
Acquisition expenses.............................. 30.6% 24.5% 29.2% 24.0%
Operating expenses................................ 5.9% 7.8% 6.4% 6.3%
----- ----- ----- -----
Total expense ratio............................... 36.5% 32.3% 35.6% 30.3%
----- ----- ----- -----
Combined ratio--GAAP(1)............................ 103.2% 105.0% 103.8% 103.3%
===== ===== ===== =====
</TABLE>
- --------
(1) The combined ratio computed on a GAAP basis is equal to losses and loss
adjustment expenses, plus acquisition expenses, plus operating expenses,
plus policyholders' dividends (where applicable), all divided by net
premiums earned.
For both the three and nine month periods ended September 30, 1998, PMA Re
posted lower loss ratios, reflecting higher levels of favorable loss reserve
development and the effects of more treaties written with ceding commissions,
which increase the proportion of the premium assumed by PMA Re. Favorable loss
reserve development on prior years' unpaid losses was $4.0 million and $12.0
million for the three and nine months ended September 30, 1998, respectively,
compared to $0 and $7.0 million for the comparable prior year periods. The
three and nine-month periods in 1998 were also impacted by higher acquisition
costs, which reflected the aforementioned increase in the number of treaties
written with ceding commissions, as well as competitive conditions.
The ratio of operating expenses to net premiums earned (the "Operating
Expense Ratio") decreased 1.9 points for the three months ended September 30,
1998, compared to the same period in 1997 and, for the nine months ended
September 30, 1998, remained comparable to the same period in 1997. The
decrease in the Operating Expense Ratio for the three months ended September
30, 1998 compared to the comparable period in 1997 primarily reflects a 43.8%
increase in net premiums earned versus a 7.4% increase in operating expenses.
Net Investment Income
PMA Re's operating income was also impacted by higher levels of investment
income, which reflected higher average invested assets. For the quarter ended
September 30, 1998, PMA Re's net investment income increased $272,000 versus
the third quarter of 1997, and for the nine months ended September 30, 1998,
net investment income increased $2.2 million versus the comparable 1997
period.
THE PROPERTY AND CASUALTY GROUP RESULTS OF OPERATIONS
The Property and Casualty Group is comprised of Pennsylvania Manufacturers'
Association Insurance Company, Manufacturers Alliance Insurance Company and
Pennsylvania Manufacturers Indemnity Company (the "Pooled Companies"), PMA
Management Corp., Pennsylvania Manufacturers International Insurance, Limited
and the Run-off Operations. Run-off operations ("Run-off Operations") of the
Property and Casualty Group are comprised of Mid-Atlantic States Casualty
Company ("MASCCO"), PMA Life Insurance Company ("PMA Life") and PMA Insurance,
Cayman Ltd. ("PMA Cayman") (which was sold effective July 1, 1998--see Run-off
Operations below for further discussion) and have been established internally
to reinsure certain obligations primarily associated with workers'
compensation claims written by the Pooled Companies for the years 1991 and
prior for statutory accounting purposes. The Run-off Operations have been
segregated into separate legal entities and
41
<PAGE>
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's Run-off
Operations were reduced by $37.0 million for both the three and nine months
ended September 30, 1997, representing estimated retrospective policy
adjustments related to the current accident year and retrospective policy
adjustments paid. These adjustments to net premiums written were made for
presentation purposes only and had previously been reflected in the Company's
reported revenues, financial position and results of operations. Summarized
financial results of the Property and Casualty Group for the three and nine
months ended September 30, 1998 and 1997, are as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED SEPTEMBER NINE MONTHS ENDED
30, SEPTEMBER 30,
----------------- ------------------
1998 1997 1998 1997
------- -------- -------- --------
<S> <C> <C> <C> <C>
Net premiums written:
Workers' compensation.................. $49,107 $ 8,989 $147,502 $108,613
Commercial lines....................... 15,397 13,467 46,829 65,849
------- -------- -------- --------
Total............................... $64,504 $ 22,456 $194,311 $174,462
======= ======== ======== ========
Net premiums earned:
Workers' compensation.................. $40,931 $ 4,366 $127,942 $ 99,982
Commercial lines....................... 16,458 19,396 50,036 61,094
------- -------- -------- --------
Total............................... 57,389 23,762 177,978 161,076
------- -------- -------- --------
Net investment income:
Excluding Run-off Operations........... 13,180 13,143 38,547 40,073
Run-off Operations..................... 1,477 7,161 12,780 22,133
------- -------- -------- --------
Total............................... 14,657 20,304 51,327 62,206
------- -------- -------- --------
Service revenues........................ 2,192 2,674 7,282 7,712
------- -------- -------- --------
Operating revenues...................... 74,238 46,740 236,587 230,994
------- -------- -------- --------
Losses and LAE incurred:
Excluding Run-off Operations........... 44,326 50,957 138,010 166,830
Run-off Operations..................... 1,241 (31,610) 10,642 (16,513)
------- -------- -------- --------
Total............................... 45,567 19,347 148,652 150,317
------- -------- -------- --------
Acquisition and operating expenses:
Excluding Run-off Operations........... 19,539 22,132 63,817 72,891
Run-off Operations..................... 623 772 2,097 2,568
------- -------- -------- --------
Total............................... 20,162 22,904 65,914 75,459
------- -------- -------- --------
Policyholders' dividends................ 5,507 3,566 13,637 10,183
------- -------- -------- --------
Total losses and expenses............... 71,236 45,817 228,203 235,959
------- -------- -------- --------
Pre-tax operating income (loss)......... $ 3,002 $ 923 $ 8,384 $ (4,965)
======= ======== ======== ========
GAAP loss ratio......................... 79.4% 81.4% 83.5% 93.3%
GAAP combined ratio(1).................. 120.4% 182.6% 124.4% 142.1%
SAP loss ratio(2)....................... 78.1% 84.2% 78.0% 84.9%
SAP combined ratio(2)................... 113.6% 120.7% 113.5% 119.3%
</TABLE>
- --------
(1) The GAAP combined ratio excludes $2.2 million and $6.9 million for the
three and nine months ended September 30, 1998, respectively, and $2.4
million and $6.9 million for the three and nine months ended September 30,
1997, respectively, of PMA Management Corp. direct expenses related to
service revenues, which are not included in net premiums earned.
(2) The SAP loss and combined ratios above relate to the Pooled Companies
only.
42
<PAGE>
PROPERTY AND CASUALTY GROUP EXCLUDING RUN-OFF OPERATIONS
Premium Revenues
For the three and nine months ended September 30, 1998, net premiums written
increased $5.1 million and decreased $16.3 million compared to the same
periods in 1997. Earned premiums decreased by $3.4 million and $19.3 million,
respectively, for the three and nine months ended September 30, 1998, compared
to the same periods in 1997. Net premiums earned generally follow growth
patterns similar to net premiums written with the earnings lag factored into
the process, absent any significant adjustments to unearned premiums. Such
adjustments did not fluctuate materially between periods.
Net premiums written are comprised of direct premiums written, reinsurance
premiums assumed and reinsurance premiums ceded. Direct premiums written for
the Property and Casualty Group increased $2.7 million and decreased $20.1
million for the three and nine months ended September 30, 1998, respectively,
compared to the same periods 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 $3.0 million and $21.8 million
for the three and nine months ended September 30, 1998, respectively, compared
to the same periods in 1997. Direct premiums written for workers' compensation
increased $5.7 million and $1.7 million for the three and nine months ended
September 30, 1998, respectively, compared to the same periods in 1997.
Reinsurance premiums assumed decreased $323,000 and $395,000 for the three and
nine months ended September 30, 1998, respectively, compared to the same
periods in 1997. Reinsurance premiums ceded decreased $2.7 million and $4.2
million for the three and nine months ended September 30, 1998, respectively,
compared to the same periods in 1997. The percentage of net workers'
compensation premiums written to total net premiums written increased to 75.9%
for the nine months ended September 30, 1998, from 69.1% for the nine months
ended September 30, 1997, primarily due to a planned reduction in Commercial
LInes of business, as more fully described below.
Direct premiums written for workers' compensation increased due to an
increase in new business written, partially offset by continued intense price
competition in the workers' compensation market as well as the impact of rate
changes associated with workers' compensation benefit reforms in Pennsylvania.
The Property and Casualty Group has written $12.8 million and $42.0 million of
new workers' compensation business for the three and nine months ended
September 30, 1998, respectively; this increase has been partially offset by
reduced price levels on business renewed from prior years (the Property and
Casualty Group has retained 82% of its prior year workers' compensation
business). Workers' compensation reform laws adopted in Pennsylvania ("Act
57") resulted in a reduction in manual workers' compensation rates in excess
of 25%, effective February 1997 for new and renewal business. Management does
not expect manual rate decreases to be as significant for the 1998 policy year
as compared to the 1997 policy year, although manual rate levels in all of its
principal marketing states continue to decrease.
Direct workers' compensation premiums written were also impacted by changes
in the level of premium adjustments, primarily related to audit premiums. For
the three and nine months ended September 30, 1998, such adjustments increased
premiums written by $1.6 million and $9.7 million, compared to increases of
$3.5 million and $11.8 million in the same periods in 1997.
The decreases in Commercial Lines direct premium writings for the three and
nine months ended September 30, 1998 compared to the same periods in 1997 were
primarily due to a planned reduction in net Commercial Lines business of $7.8
million and $20.3 million for the three and nine months ended September 30,
1998, respectively, 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. The decrease has been partially offset
by an increase in new business and the timing of renewals.
43
<PAGE>
The Property and Casualty Group has continued its marketing of alternative
market workers' compensation products for larger accounts, including large-
deductible policies and providing excess coverage to self-insured groups.
Typically, the Property and Casualty Group receives a lower up-front premium
for these types of alternative market product plans because the insured
retains a greater portion of the underwriting risk than under rate-sensitive
or loss-sensitive products. A substantial portion of related revenues are
recorded as service revenues. Such service revenues decreased $482,000 and
$430,000 for the three and nine months ended September 30, 1998, compared to
the same periods in 1997.
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 NINE MONTHS
ENDED ENDED
SEPTEMBER SEPTEMBER
30, 30,
------------ ------------
1998 1997 1998 1997
----- ----- ----- -----
<S> <C> <C> <C> <C>
Loss ratio.......................................... 77.2% 83.9% 77.5% 84.6%
----- ----- ----- -----
Expense ratio:
Amortization of deferred acquisition costs......... 13.5% 17.2% 17.3% 18.6%
Operating expenses(1).............................. 16.8% 15.2% 14.7% 14.8%
----- ----- ----- -----
Total expense ratio................................ 30.3% 32.4% 32.0% 33.4%
----- ----- ----- -----
Policyholders' dividends............................ 9.6% 5.9% 7.7% 5.2%
----- ----- ----- -----
Combined ratio--GAAP(2)............................. 117.1% 122.2% 117.2% 123.2%
===== ===== ===== =====
</TABLE>
- --------
(1) The GAAP Operating Expense Ratio excludes $2.2 million and $6.9 million
for the three and nine months ended September 30, 1998, respectively, and
$2.4 million and $6.9 million for the three and nine months ended
September 30, 1997, respectively, of PMA Management Corp. direct expenses
related to service revenues, which are not included in net premiums
earned.
(2) The GAAP combined ratios for the Property and Casualty Group including the
Run-off Operations were 120.4% and 124.4% for the three and nine months
ended September 30, 1998, respectively, compared to 182.6% and 142.1% for
the three and nine months ended September 30, 1997, respectively. See
"Run-off Operations."
For the three months and nine months ended September 30, 1998, respectively,
the loss ratio improved by 6.7 and 7.1 points compared to the same periods in
1997. This improvement was primarily due to a lower amount of discount
accretion on workers' compensation loss reserves, improved loss and loss
adjustment expense ("LAE") ratios in Commercial Lines, and an improvement in
medical costs and in loss adjustment expenses in the workers' compensation
line.
In July 1997, the Property and Casualty Group completed a formal program
under which it commuted a large number of workers' compensation claims from
accident years 1991 and prior. The commutation program resulted in current
payments, which were less than the carried reserves. As substantially all of
these reserves were carried on a discounted basis, the ultimate level of
discount on the Property and Casualty Group's carried reserves decreased as
well. As the level of discount has decreased, the loss ratio has benefited
from lower amounts of discount accretion.
During the past five years, direct premium 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 on such reserves 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 4.4 and 3.2 points for
the three and nine months ended September 30, 1998, respectively,
44
<PAGE>
compared to the same periods in 1997. The Property and Casualty Group has
initiated another commutation program, which is currently underway and
expected to continue through 1998. This program is expected to focus on claims
from accident years 1992 to 1996.
The improvement in loss and LAE ratios in Commercial Lines has favorably
impacted the overall loss ratio by 1.3 and 1.9 points, respectively, for the
three and nine months ended September 30, 1998, compared to the same periods
in 1997. This improvement in the Commercial Lines loss and LAE ratio was
primarily due to a reduction in exposures underwritten by the Property and
Casualty Group in 1998, compared to the same period in 1997. The Property and
Casualty Group believes that reduced exposures, which have been primarily as a
result of price competition and more stringent underwriting, have improved the
overall loss ratio on its remaining Commercial Lines business.
Measures to control medical costs and loss adjustment expenses in workers'
compensation have improved the overall loss and LAE ratio by 1.0 and 1.7
points in the three and nine months ended September 30, 1998, respectively,
compared to the same periods 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. This affiliation
has enabled the Property and Casualty Group to lower its cost of providing
medical benefits to injured workers. Loss adjustment expenses have decreased
primarily due to continued use of certain claims resolution practices. By
using claims management techniques such as managed care and commutations, the
Property and Casualty Group has reduced the amount and number of outstanding
claims and the amount of time that a claim remains open. This in turn has
lowered costs associated with managing open claims.
The increase in the percentage of net workers' compensation premiums written
and earned to total net premiums written and earned had a favorable impact on
the 1998 loss and LAE ratio, as workers' compensation business has had better
loss experience than other Commercial Lines in the Property and Casualty
Group's marketing territory. This increase in the percentage of net workers'
compensation premiums written caused a 0.3 point decrease in the loss and LAE
ratio for the nine months ended September 30, 1998, compared to the same
period in 1997.
The expense ratio decreased by 2.1 points and 1.4 points for the three and
nine months ended September 30, 1998, respectively, compared to the same
periods in 1997. The decrease in the Acquisition Expense Ratio of 3.7 points
and 1.3 points for the three and nine months ended September 30, 1998,
respectively, was primarily due to lower taxes and assessments compared to the
same periods in 1997. The Operating Expense Ratio increased by 1.6 points for
the three months ended September 30, 1998, as compared with the same period in
1997, primarily due to lower earned premiums.
For the nine months ended September 30, 1998, the Property and Casualty
Group recorded approximately $500,000 of severance and other restructuring
costs compared with $2.7 million for the nine months ended September 30, 1997.
In addition, for the nine months ended September 30, 1998, $1.1 million of
costs related to the Year 2000 Project were incurred compared with $681,000
for the comparable period in 1997. The remaining Year 2000 costs are not
expected to be material and management anticipates that such project will be
completed in 1998. See "Liquidity and Capital Resources" for further
discussion.
The policyholder's dividend ratio increased 3.7 points and 2.5 points for
the three and nine months ended September 30, 1998, respectively, compared to
the same periods in 1997. The increase in the dividend ratio is primarily due
to increased writings of participating business within the Pooled Companies
and favorable loss experience in the workers' compensation line of business.
Net Investment Income
Net investment income was $13.2 million and $38.5 million, respectively, for
the three and nine months ended September 30, 1998, compared to $13.1 million
and $40.1 million for the same periods
45
<PAGE>
in 1997. Year-to-date net investment income decreased $1.6 million primarily
as a result of lower fixed income yields, partially offset by slightly higher
average invested assets.
RUN-OFF OPERATIONS
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 pooling agreement and ceased writing any new
business. The Pooled Companies also ceded to MASCCO the indemnity portion of
Pennsylvania workers' compensation claims for accident years 1991 and prior.
At September 30, 1998, MASCCO had $93.7 million in total assets and $74.4
million in 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 Cayman was incorporated in Grand Cayman as a wholly owned subsidiary of
the Company, 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.
Effective July 1, 1998, the Company sold PMA Cayman to a third party for a
purchase price of $1.8 million and recorded an after-tax loss of $1.6 million.
In addition, the Company transferred to the buyer $231.5 million in cash and
invested assets and recorded reinsurance receivables of $241.8 million as of
September 30, 1998 related to the existing reinsurance agreements with PMA
Cayman. If the actual claim payments in the aggregate exceed the estimated
payments upon which the loss reserves have been established, the Company has
agreed to indemnify the buyer, up to a maximum of $15.0 million. If the actual
claim payments in the aggregate are less than the estimated payments upon
which the loss reserves have been established, the Company will participate in
such favorable loss reserve development.
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 September 30, 1998, PMA Life had assets
of $22.6 million and $17.4 million in total reserves.
The following table reflects the components of the Property and Casualty
Group -- Run-off Operations' operating results for the three and nine months
ended September 30, 1998 and 1997:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------- ----------------
1998 1997 1998 1997
------ -------- ------- --------
<S> <C> <C> <C> <C>
Net investment income...................... $1,477 $ 7,161 $12,780 $ 22,133
Net premiums earned(1)..................... -- (37,000) -- (36,186)
------ -------- ------- --------
Total operating revenues................... 1,477 (29,839) 12,780 (14,053)
------ -------- ------- --------
Losses and LAE incurred.................... 1,241 (31,610) 10,642 (16,513)
Operating expenses......................... 623 772 2,097 2,568
------ -------- ------- --------
Total expenses............................. 1,864 (30,838) 12,739 (13,945)
------ -------- ------- --------
Pre-tax operating (loss) income............ $ (387) $ 999 $ 41 $ (108)
====== ======== ======= ========
</TABLE>
46
<PAGE>
- --------
(1) Amount represents a $37.0 million reduction of accrued retrospective
premiums, primarily due to commutation of claims for accident years 1991
and prior in 1997, the re-estimation of claims liabilities for more recent
accident years, and net premiums earned during the first nine months of
1997 for PMA Life prior to the reinsurance transaction mentioned above,
after which PMA Life was placed into run-off. The $37.0 million reduction
in earned premiums was offset by a corresponding loss and LAE reserve
release.
Investment income for the Run-off Operations decreased by $5.7 million and
$9.4 million, respectively, in the three and nine months ended September 30,
1998, compared to the same periods in 1997 due to the sale of PMA Cayman and
lower levels of invested assets.
Losses and LAE of the Run-off Operations are comprised primarily of discount
accretion on established loss reserves within the Run-off Operations. The
decrease in losses and LAE was primarily due to the sale of PMA Cayman as
discussed above, plus the reduction in discount accretion associated with
payments made for the underlying claims since 1997.
CALIBER ONE RESULTS OF OPERATIONS
Summarized financial results of Caliber One for the three and nine months
ended September 30, 1998 are as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1998
------------- -------------
<S> <C> <C>
Net premiums written................................ $1,660 $ 2,577
====== =======
Net premiums earned................................. $ 440 $ 631
Net investment income............................... 361 1,075
------ -------
Operating revenues.................................. 801 1,706
------ -------
Losses and LAE incurred............................. 352 505
Acquisition and operating expenses.................. 696 2,518
------ -------
Total losses and expenses........................... 1,048 3,023
------ -------
Pre-tax operating loss.............................. $ (247) $(1,317)
====== =======
</TABLE>
Due to the start-up nature of the business, the financial ratios for Caliber
One do not provide a 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 for the three months ended September 30,
1998 were $2.5 million and $1.7 million, respectively, compared to $1.3
million and $705,000 for the three months ended June 30, 1998, respectively,
representing a 90.7% increase in gross premiums written and a 135.5% increase
in net premiums written compared to the second quarter of 1998. The loss ratio
for the third quarter of 1998 was 80%. As expected, operating expenses, which
include start-up costs, in the first nine months of 1998 were high relative to
the premium volume, which distorts the expense ratio. Management expects
operating expenses to become more commensurate with premium volume over time
as premium volume continues to grow.
CORPORATE AND OTHER RESULTS OF OPERATIONS
Corporate and Other is primarily comprised of corporate overhead and the
operations of the Company's properties. For the three and nine months ended
September 30, 1998, Corporate and Other recorded pre-tax operating losses
before interest expense of $2.4 million and $8.0 million, respectively,
compared to $2.6 million and $7.1 million for the three and nine months ended
September 30, 1997, respectively. The operating loss in the third quarter of
1998 was comparable to the third
47
<PAGE>
quarter of 1997, while the year-to-date loss in 1998 was $832,000 higher than
the comparable 1997 period due to higher corporate operating costs.
NET REALIZED INVESTMENT GAINS
The Company recorded net realized investment gains of $4.1 million and $15.4
million for the three and nine months ended September 30, 1998, respectively,
compared to $5.5 million and $3.6 million for the comparable 1997 periods.
Gains and losses on the sale of investments are recognized as a component of
net income, but the timing and recognition of such gains and losses are
unpredictable and are not indicative of future results. In addition, the $1.6
million after tax loss related to the sale of PMA Cayman was included in net
realized investment gains for the three and nine months ended September 30,
1998.
INTEREST EXPENSE AND INCOME TAXES
Interest expense for the third quarter of 1998 was comparable to the same
period in 1997, with a decrease of approximately $794,000 for the nine months
ended September 30, 1998 compared to the 1997 period due to the refinancing of
the Company's debt in March of 1997. The Company's effective tax rate was
16.1% and 16.0%, respectively, for the three and nine months ended September
30, 1998, compared to 36.2% and 10.7% for the three and nine months ended
September 30, 1997. The Company recorded a net deferred tax asset of $49.9
million as of September 30, 1998 compared to $70.4 million as of December 31,
1997.
LIQUIDITY AND CAPITAL RESOURCES
LIQUIDITY
Liquidity is a measure of an entity's ability to secure enough cash to meet
its contractual obligations and operating needs. At the holding company level,
the Company requires cash to pay debt obligations and dividends to
shareholders, pay taxes to the federal government, 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 $3.7 million and $11.2 million for the three
and nine months ended September 30, 1998, respectively, compared to $3.5
million and $15.6 million for the three and nine months ended September 30,
1997. The decrease in interest paid for the first nine months of 1998 related
to the fact that the March 1997 refinancing of PMA Capital's debt obligations
accelerated certain interest payments to the first quarter of 1997. The
Company paid $2.0 million and $6.1 million of dividends to shareholders in the
three and nine months periods ended September 30, 1998, respectively, compared
to $2.0 million and $6.0 million for the comparable periods in 1997.
Dividends received from subsidiaries were $8.0 million and $18.0 million for
the three and nine months ended September 30, 1998, respectively, compared to
$4.0 million and $12.0 million for the comparable 1997 periods. Net tax cash
flows from subsidiaries were $7.5 million and $22.3 million for the three and
nine months ended September 30, 1998, respectively, compared to $5.5 million
and $13.9 million for the comparable 1997 periods.
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, 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 PMA Capital.
48
<PAGE>
PMA Capital'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, PMA Capital 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 $74.7 million to $3,131.9 million at
September 30, 1998 compared to $3,057.3 million at December 31, 1997. Total
investments decreased $227.5 million to $1,967.3 million at September 30,
1998. This decrease was primarily attributable to the sale of PMA Cayman, plus
the pay-down of loss reserves from prior accident years by the Property and
Casualty Group. All other assets increased $302.2 million, mainly due to
increases in reinsurance receivables of $271.7 million and uncollected
premiums of $42.1 million in comparison to December 31, 1997. The increase in
reinsurance receivables primarily relates to the sale of PMA Cayman, which
increased reinsurance receivables by $241.8 million and had an offsetting
decrease in invested assets. Also, the Property and Casualty Group's new
reinsurance treaty for Commercial Lines entered into during 1997 has increased
the amount of ceded losses, which increases the reinsurance receivables
balance. The increase in uncollected premiums compared to December 31, 1997
was primarily related to the cyclical nature of the premium volume and
collection patterns throughout the year. The uncollected premiums at September
30, 1998 are more comparable to the balance at September 30, 1997. Deferred
acquisition costs increased $10.7 million compared to December 31, 1997
primarily due to the cyclical nature of the premium writings throughout the
year plus increased acquisition costs at PMA Re (see "PMA Re Results of
Operations"). Additional increases in other assets of $24.4 million were
offset by a decrease in cash of $24.6 million related to settlement timing of
investment transactions at December 31, 1997. The increase in other assets at
September 30, 1998 compared to December 31, 1997 primarily relates to timing
differences in prepaid expenses and miscellaneous assets at the operating
companies.
Consolidated shareholders' equity at September 30, 1998, totaled $517.6
million or $22.19 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 $46.0 million at
September 30, 1998, compared to $18.8 million at December 31, 1997, resulting
in an increase in shareholders' equity of $27.2 million or $1.17 per share.
At September 30, 1998, the Company had $203.0 million outstanding under its
existing credit facility, with $32.0 million available for additional
borrowings. The Company also entered into an interest rate swap agreement
which is intended to manage the impact of the potential volatility of the
interest rate associated with the floating rates on the credit facility. The
interest rate swap covers a notional principal amount of $150.0 million and
effectively converts the floating rate on such portion of the credit facility
to a fixed rate of 7.24%.
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
As a consequence of the programming convention which utilized a two-digit
field rather than a four-digit field, most computers require relatively costly
reprogramming to enable them to perform correctly date operations involving
year 2000 ("Year 2000") or later (the "Year 2000 Issue"). Many
49
<PAGE>
anticipate that the Year 2000 Issue will have substantial repercussions on the
business world, since computer operations involving date calculations are
pervasive.
With the assistance of outside consulting groups, the Company began
evaluating and reprogramming its own computer systems to address the Year 2000
Issue in late 1995. As of December 31, 1998, the Company has substantially
completed all necessary programming work and will continue testing throughout
1999. Accordingly, management believes that Year 2000 Issues related to the
Company's hardware and internal software programs are not likely to result in
any material adverse disruptions in the Company's computer systems or its
internal business operations. The cost of this work through December 31, 1998
has been approximately $5.4 million, including approximately $1.6 million
incurred during 1998.
In addition to assessing Year 2000 Issues relating to computer systems, the
Company is also in the process of reviewing its use of office equipment and
facilities, which contain microprocessors or other embedded technology ("non-
IT Systems") over which it has control to ensure that they are, to the extent
reasonably necessary to conduct the Company's day-to-day operations, Year 2000
compliant. Because the Company is not materially dependent upon non-IT
Systems, the Company does not believe it has any material non-IT Systems Year
2000 exposure.
The Company is currently in the process of evaluating its relationships with
third parties with which the Company has a direct and material relationship to
determine whether they are Year 2000 compliant, such as banks, brokers,
reinsurers, third party service providers, software and other service vendors,
insureds and agents and other intermediaries. The responses by such third
parties to inquiries made by the Company as have been received to date
indicate that these third parties either are or expect to be compliant by the
Year 2000.
Even assuming that all material third parties provide a timely
representation affirming such Year 2000 compliance, however, it is not
possible to state with certainty that such representations will turn out to
have been accurate, or that the operations of such third parties will not be
materially impacted in turn by other parties with whom they themselves have a
material relationship, and who fail to timely become Year 2000 compliant.
Consequently, it is not possible to predict whether or to what extent the Year
2000 Issues may have an adverse material impact on the Company as a result of
their impact on the operations of third parties with whom the Company has a
material relationship. The failure of one or more third parties with whom the
Company has a material relationship to be Year 2000 compliant could cause
significant disruptions in the Company's ability to pay claims, receive and
deposit funds and make investments, which could have a material adverse effect
on the Company's financial condition and results of operations. The Company's
contingency plans in the event of failure of such third parties to be Year
2000 compliant include replacing the third party, performing directly the
services performed by the third party and maintaining liquidity under the
Company's Revolving Credit Facility, which may have a material impact on the
Company.
Many experts now believe that Year 2000 Issues may have a material adverse
effect on the national and global economy generally. In addition, it seems
likely that if businesses are materially damaged as a result of Year 2000
Issues, at least some such businesses may attempt to recoup their losses by
claiming coverage under various types of insurance policies. Management of the
Property and Casualty Group and Caliber One believe that under a fair reading
of the various policies issued by them, no coverage for Year 2000 Issues
should exist. In an effort to assess whether or not a material liability
relating to Year 2000 Issues exists under policies reinsured by PMA Re, the
company has developed underwriting guidelines to try to ascertain how ceding
companies are underwriting their Year 2000 exposures, including any non-IT
exposures. Some ceding companies have indicated that, in their opinion,
exposure may exist on some types of policies in certain circumstances for
defense costs, indemnification or both. PMA Re is attempting, whenever
possible, to avoid or otherwise limit
50
<PAGE>
the exposure to Year 2000 Issues through its underwriting process. However, it
is not possible to make reasonable estimates of the size or types of claims
that may be asserted against PMA Re and, accordingly, there can be no
assurance that PMA Re will not have a material exposure. In the event that
claims for Year 2000 Issues are asserted against the Property and Casualty
Group, Caliber One or PMA Re, it is not possible to predict whether or to what
extent any such coverage could ultimately be found to exist by courts in
various jurisdictions, or, if found, the effect thereof on any of such
companies or the Company. In addition, to the extent that the Property and
Casualty Group, Caliber One or PMA Re contest the assertion of Year 2000
coverage claims, it is likely that the costs of litigation could be material,
even if they are able to prevail in their coverage positions as to which no
assurance can be given.
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 or 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 $2.7 million (after income taxes of $1.4 million)
and $11.6 million (after income taxes of $6.2 million) for the three and nine
months ended September 30, 1998 and $3.3 million (after income taxes of $1.8
million) and $2.4 million (after income taxes of $1.3 million) for the three
and nine months ended September 30, 1997. The new standard requires only
additional disclosures in the consolidated financial statements; it does not
affect the Company's financial position or results of operations.
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and Related
Information" ("SFAS No. 131"), which establishes standards for the way that
public business enterprises report information about operating segments in
annual financial statements and interim financial reports issued to
shareholders. SFAS No. 131 also establishes standards for related disclosures
about products and services, geographic areas and major customers. In
connection with the adoption of SFAS No. 131, the Company has identified four
reportable segments: (i) PMA Re, which provides reinsurance products and
services; (ii) the Property and Casualty Group, which writes workers'
compensation and other standard lines of commercial insurance and includes
run-off operations; (iii) Caliber One, which writes specialty insurance
focusing on excess and surplus lines; and (iv) Corporate and Other, which is
primarily comprised of corporate overhead and the operations of the Company's
properties. The Company has excluded net realized investment gains (losses)
from the profit and loss measurement it utilizes to assess the performance of
its operating segments because (i) net realized investment gains (losses) are
unpredictable and not necessarily indicative of future performance and (ii) in
many instances, decisions to buy and sell securities are made at the parent
holding company level, and such decisions result in net realized gains
(losses) that do not relate to the operations of the individual segments.
Pursuant to the adoption of SFAS No. 131, the Company has restated the
corresponding information for 1997 for comparability, primarily related to
certain corporate expenses that were previously allocated to the operating
segments. SFAS No. 131 requires only additional disclosures in the
consolidated financial statements; it does not affect the Company's financial
position or results of operations.
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
51
<PAGE>
company should recognize a liability for guaranty-fund and other insurance
related assessments and how to measure that liability. While the Company is
presently evaluating the impact of SOP 97-3, the adoption of SOP 97-3 is
likely to result in an increase in the Company's liabilities for such
assessments, although such increase is not expected to exceed $5.0 million.
The impact of adopting SOP 97-3 will be reflected as a cumulative effect of an
accounting change in the first quarter of 1999.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"), which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities. SFAS No. 133 requires that an entity
recognize all derivatives as either assets or liabilities in the statement of
financial position and measure those instruments at fair value. If certain
conditions are met, a derivative may be specifically designated as (i) a hedge
of the exposure to changes in the fair value of a recognized asset or
liability or an unrecognized firm commitment, (ii) a hedge of the exposure to
variable cash flows of a forecasted transaction, or (iii) a hedge of the
foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a foreign-
currency-denominated forecasted transaction. The accounting for changes in the
fair value of a derivative (that is, gains and losses) depends on the intended
use of the derivative and the resulting designation. SFAS No. 133 is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. While
the Company is presently evaluating the impact of SFAS No. 133, the adoption
of SFAS No. 133 is not expected to have a material impact on the Company's
financial condition or results of operations.
Results of Operations for the Years Ended December 31, 1997, 1996 and 1995
The table below presents the major components of net income (loss) for the
years ended December 31, 1997, 1996 and 1995:
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
1997 1996 1995
------- --------- -------
<S> <C> <C> <C>
Pre-tax operating income (loss)(1)................. $16,555 $(194,378) $ 2,990
Net realized investment gains...................... 8,598 2,984 31,923
------- --------- -------
Income (loss) before income taxes.................. 25,153 (191,394) 34,913
Provision (benefit) for income taxes............... 5,400 (56,060) 10,783
------- --------- -------
Income (loss) before extraordinary loss............ 19,753 (135,334) 24,130
Extraordinary loss, net of related taxes........... (4,734) -- --
------- --------- -------
Net income (loss).................................. $15,019 $(135,334) $24,130
======= ========= =======
Per basic share:
Income (loss) before extraordinary loss.......... $ .83 $ (5.68) $ 1.01
Extraordinary loss............................... (.20) -- --
------- --------- -------
Net income (loss)................................ $ .63 $ (5.68) $ 1.01
======= ========= =======
Per diluted share:
Income (loss) before extraordinary loss.......... $ .80 $ (5.68) $ .97
Extraordinary loss............................... (.19) -- --
------- --------- -------
Net income (loss)................................ $ .61 $ (5.68) $ .97
======= ========= =======
</TABLE>
- --------
(1) Pre-tax operating income (loss) is defined as income (loss) from
continuing operations before income taxes, but excluding net realized
investment gains.
52
<PAGE>
The following table indicates the Company's pre-tax operating income (loss)
by principal business segment for the years ended December 31, 1997, 1996 and
1995:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------- --------- -------
<S> <C> <C> <C>
PMA Re........................................... $44,802 $ 42,783 $39,443
The Property and Casualty Group.................. (9,038) (219,619) (4,305)
Corporate and Other.............................. (3,441) (490) (13,414)
------- --------- -------
Pre-tax operating income (loss) before interest
expense......................................... 32,323 (177,326) 21,724
Interest expense................................. 15,768 17,052 18,734
------- --------- -------
Pre-tax operating income (loss).................. $16,555 $(194,378) $ 2,990
======= ========= =======
</TABLE>
In 1997, the Company reported consolidated pre-tax operating income of $16.6
million, or $0.69 and $0.67 per basic and diluted share, respectively,
compared to a pre-tax operating loss of $194.4 million, or $8.17 per basic and
diluted share, in 1996. The improvement in the 1997 results was due primarily
to special charges recorded in 1996, increased pre-tax operating income
generated by PMA Re and improved underwriting results by the Property and
Casualty Group. The increase in PMA Re's pre-tax operating income to $44.8
million in 1997 compared to $42.8 million in 1996, was due to higher premium
volume, improved underwriting results and higher investment income. The pre-
tax operating loss of the Property and Casualty Group decreased in 1997 to
$9.0 million compared to $219.6 million in 1996, due primarily to special
charges recorded in 1996, as well as the impact of cost savings initiatives
implemented in late 1996 and in 1997. Corporate and Other operations reported
a pre-tax operating loss of $3.4 million in 1997 compared to a pre-tax
operating loss of $500,000 in 1996. The higher operating loss for Corporate
and Other operations was due primarily to increased operating costs related to
certain corporate properties disposed of during the third quarter of 1997.
Interest expense decreased in 1997 by $1.3 million due to the refinancing of
the Company's debt with the Revolving Credit Facility. See "Liquidity and
Capital Resources" herein for further discussion.
On a consolidated basis, the Company reported pre-tax operating income of
$3.0 million, or $.13 and $.12 per basic and diluted share, respectively, in
1995 compared to the $194.4 million pre-tax operating loss discussed above for
1996. After-tax operating income was $3.4 million, or $.14 per basic and
diluted share, in 1995 compared to the $137.3 million after-tax operating loss
in 1996 mentioned above. The decrease from 1995 to 1996 was due primarily to
special charges recorded in 1996 at the Property and Casualty Group. In 1995,
PMA Re reported pre-tax operating income of $39.4 million, the Property and
Casualty Group had a pre-tax operating loss of $4.3 million and Corporate and
Other operations recorded a pre-tax operating loss of $13.4 million. The
improvement in the operating results of Corporate and Other from 1995 to 1996
was due primarily to an $8.4 million write-down in 1995 of certain real estate
properties owned by the Company as well as higher overhead expenses. Interest
expense decreased in 1996 by approximately $1.7 million as compared to 1995,
primarily reflecting lower average debt balances and the pay-down of higher
coupon debt.
Net income on a consolidated basis, before extraordinary items, was $19.8
million, or $0.83 per basic share and $0.80 per diluted share, respectively,
in 1997 compared to a net loss of $135.3 million, or $5.68 per basic and
diluted share, in 1996. On March 14, 1997, the Company refinanced
substantially all of its outstanding credit agreements not already maturing in
1997 with the Revolving Credit Facility. In connection with this refinancing,
the Company recognized an extraordinary loss from the early extinguishment of
debt of $4.7 million, or $0.20 and $0.19 per basic and diluted share,
respectively, net of tax.
Over the past three years, restructuring charges and other special items
have impacted the Company's operating results. During 1997, the Company
recorded $7.0 million of severance and other restructuring charges, primarily
related to the Property and Casualty Group and Corporate and Other
53
<PAGE>
operations. In addition, the Company recorded $2.2 million of operating costs
for certain corporate properties which were disposed of during 1997 (see
"Corporate and Other") and $2.0 million of Year 2000 expenses. See "Liquidity
and Capital Resources" for further discussion. In 1996, the Company's
operating results included a pre-tax charge of $221.3 million ($143.8 million
after tax) recorded by the Property and Casualty Group in order to strengthen
its loss and LAE reserves, to recognize restructuring costs in connection with
staff reductions and to write off certain accounts receivable. In addition,
pre-tax Year 2000 costs in 1996 were $1.8 million. In 1995, the Company
recorded a charge of $8.4 million to write down the Company's former
headquarters building and certain adjacent properties to their fair market
values less costs to carry and sell the properties. The charges over the
three-year period consisted of the following:
(DOLLAR AMOUNTS IN MILLIONS)
<TABLE>
<CAPTION>
1997 1996 1995
----- ------ ----
<S> <C> <C> <C>
Severance and other restructuring charges.................... $ 7.0 $ 7.6 $ --
Year 2000 costs.............................................. 2.0 1.8 --
Costs related to corporate properties........................ 2.2 -- --
Write-down of corporate properties........................... -- -- 8.4
Caliber One pre-opening costs................................ 0.9 -- --
Loss reserve strengthening................................... -- 191.4 --
Receivables write-down....................................... -- 17.5 --
Equipment write-down......................................... -- 4.8 --
----- ------ ----
Total pre-tax charge......................................... $12.1 $223.1 $8.4
===== ====== ====
</TABLE>
The $7.6 million of severance and restructuring charges recorded in the
fourth quarter of 1996 related to the Voluntary Early Retirement Program
("VERIP") initiated in 1996. These amounts are expected to be paid out over
time in accordance with existing retirement and post-employment obligations.
As discussed further in Note 9 of the Consolidated Financial Statements, 50
employees opted to participate in the VERIP resulting in the following charges
being recorded as of December 31, 1996:
<TABLE>
<CAPTION>
(DOLLAR AMOUNTS
IN THOUSANDS)
<S> <C>
Pension costs................................................... $4,300
Postemployment costs............................................ 2,360
Postretirement costs............................................ 975
------
Total......................................................... $7,635
======
</TABLE>
During 1997, the Property and Casualty Group recorded $5.2 million and
Corporate and Other recorded $1.8 million for severance and cost reduction
initiatives. The charges consisted primarily of costs associated with
nonvoluntary terminations of approximately 60 employees in various operational
and management positions. The cash outlays associated with these charges will
continue through 1998, and funding the cash outlays will not have a material
adverse effect on the Company's liquidity. As of December 31, 1997,
approximately $3.5 million of such charges remained in Other Liabilities on
the balance sheet.
54
<PAGE>
PMA Re Results of Operations
Summarized financial results of PMA Re for the years ended December 31,
1997, 1996 and 1995 are as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Net premiums written.............................. $177,934 $164,053 $152,760
======== ======== ========
Net premiums earned............................... $163,603 $151,974 $139,345
Net investment income............................. 52,270 48,676 45,166
-------- -------- --------
Operating revenues................................ 215,873 200,650 184,511
-------- -------- --------
Losses and LAE incurred........................... 113,931 111,937 103,947
Acquisition and operating expenses................ 57,140 45,930 41,121
-------- -------- --------
Total losses and expenses......................... 171,071 157,867 145,068
-------- -------- --------
Pre-tax operating income.......................... $ 44,802 $ 42,783 $ 39,443
======== ======== ========
GAAP loss ratio................................... 69.6% 73.7% 74.6%
GAAP combined ratio............................... 104.5% 103.9% 104.1%
SAP loss ratio.................................... 69.5% 73.7% 74.6%
SAP combined ratio................................ 103.8% 104.4% 105.5%
</TABLE>
Premium Revenues
In 1997 and 1996, net premiums written increased 8.5% and 7.4%,
respectively. The increases in 1997 and 1996 were primarily the result of
increased participation in reinsurance treaties and the writing of additional
layers and programs with existing clients. An increased number of programs
added for property lines during the second half of 1996 and during 1997 also
contributed to the aforementioned increases in net premiums written. These
increases were partially offset by the trend toward large ceding companies
increasing their retentions, which decreased PMA Re's subject premium. In
addition, highly competitive pricing conditions in the United States
reinsurance market caused PMA Re to non-renew certain existing business and to
decline certain new business opportunities.
The following table indicates PMA Re's gross and net premiums written by
major category of business for the years ended December 31, 1997, 1996 and
1995:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
% CHANGE % CHANGE
1997 1996
TO TO
1997 1996 1995 1996 1995
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Gross premiums written:
Casualty lines.................. $151,901 $143,991 $128,736 5.5 % 11.9 %
Property lines.................. 72,625 63,325 63,693 14.7 % (0.6)%
Other lines..................... 795 842 (63) (5.6)% --
-------- -------- -------- ---- ----
Total......................... $225,321 $208,158 $192,366 8.2 % 8.2 %
======== ======== ======== ==== ====
Net premiums written:
Casualty lines.................. $118,889 $122,008 $107,383 (2.6)% 13.6 %
Property lines.................. 58,257 41,240 45,440 41.3 % (9.2)%
Other lines..................... 788 805 (63) (2.1)% --
-------- -------- -------- ---- ----
Total......................... $177,934 $164,053 $152,760 8.5 % 7.4 %
======== ======== ======== ==== ====
</TABLE>
55
<PAGE>
PMA Re's net casualty premiums written decreased 2.6% in 1997 and increased
13.6% in 1996. The decrease in 1997 was primarily attributable to the purchase
of increased retrocessional protection, which offset increases in gross
casualty premiums relating to new business with existing clients and larger
lines taken on existing programs. The growth in 1996 was attributable to the
expansion of several programs covering specialty business, which included
professional liability, directors' and officers' liability and other coverages
written on a surplus lines basis.
PMA Re's net property business increased 41.3% during 1997 and decreased
9.2% during 1996. The increase in net property premiums written in 1997 was
primarily the result of additional property underwriting expertise that PMA Re
added to its underwriting staff in late 1996 to broaden its product offerings.
Such expertise enabled PMA Re to increase cross-selling opportunities with its
existing treaty reinsurance clients by offering additional and expanded
property coverages. In addition, property premiums ceded decreased primarily
related to changes in PMA Re's property retrocessional coverages in terms of
premiums and ceding commissions. The decrease in net premiums written in 1996
was primarily attributable to higher ceding company retentions, competitive
pricing conditions and higher ceded property premiums.
The property programs written by PMA Re generally contain per occurrence
limits or are not considered significantly catastrophe exposed, either because
of the locations of the insured values or the nature of the underlying
properties insured. However, as is common in property reinsurance, PMA Re is
exposed to the possibility of loss from catastrophic events due to the
aggregation of per occurrence limits and similar issues. PMA Re actively
manages this exposure through aggregate management, minimizing the writing of
catastrophe business and retrocessional protection. See "Liquidity and Capital
Resources--Capital Resources."
In 1997, PMA Re recorded $2.5 million of net facultative reinsurance
premiums, which represented 1.4% of total net premiums written for the year,
compared to $1.0 million, or 0.6%, in 1996. PMA Re commenced writing
facultative reinsurance in November 1995.
Net premiums earned increased 7.7% and 9.1% in 1997 and 1996, respectively.
These increases both correspond to the increases in net premiums written, as
net premiums earned generally follow growth patterns similar to net premiums
written adjusted for the customary lag related to the timing of premium
writings within the year.
Losses and Expenses
PMA Re's combined ratios have remained relatively stable from 1995 through
1997, ranging from 103.9% to 104.5% during the three-year period. This
relative stability is attributable to (i) consistently favorable development
of unpaid losses and LAE; (ii) prudent management of catastrophe exposures and
(iii) lower loss ratios offsetting generally increased acquisition costs
related to writing more business with ceding commissions.
The following table indicates the components of PMA Re's combined ratios
computed in accordance with GAAP for the years ended December 31, 1997, 1996
and 1995(1):
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Loss ratio.............................................. 69.6% 73.7% 74.6%
----- ----- -----
Expense ratio:
Amortization of deferred acquisition costs............ 27.6% 24.7% 24.2%
Operating expenses.................................... 7.3% 5.5% 5.3%
----- ----- -----
Total expense ratio..................................... 34.9% 30.2% 29.5%
----- ----- -----
Combined ratio-GAAP..................................... 104.5% 103.9% 104.1%
===== ===== =====
</TABLE>
- --------
(1) The combined ratio computed in accordance with GAAP is equal to the sum of
losses and LAE, amortization of deferred acquisition costs, operating
expenses and policyholders' dividends (where applicable), all divided by
net premiums earned.
56
<PAGE>
For the three years ended December 31, 1997, PMA Re's loss ratios have
declined primarily as a result of increased ceding commissions and favorable
loss reserve development. PMA Re's loss ratio decreased to 69.6% in 1997 from
73.7% and 74.6% in 1996 and 1995, respectively. For contracts written on a pro
rata basis and other contracts containing ceding commissions, premiums tend to
be higher relative to the losses when compared to contracts that do not
contain ceding commissions. In the three years ended December 31, 1997, PMA Re
has written more contracts containing ceding commissions which has contributed
to the decreases in loss ratios. For such contracts, PMA Re pays the ceding
company a commission, but in return, PMA Re receives a higher proportion of
the subject premium. In addition, net favorable development on prior years'
unpaid losses and LAE was $23.3 million, $28.6 million and $15.0 million in
1997, 1996 and 1995, respectively, primarily for accident years 1993 and
prior. Such favorable development is attributable to losses emerging at a
lower rate than was anticipated (based upon historical loss development
patterns) when the initial accident year reserves were established. While loss
emergence patterns have been trending downward for the pre-1993 accident
years, resulting in favorable loss reserve development, there can be no
assurance that such trend will continue in the future.
The ratio of amortization of deferred acquisition costs to net premiums
earned ("Acquisition Expense Ratio") increased 2.9 points to 27.6% in 1997
compared to 1996 and 0.5 points in 1996 compared to 1995. These increases
predominantly relate to the fact that PMA Re continues to write more contracts
with ceding commissions. In addition, the ceding commissions that PMA Re
received related to its retrocessional catastrophe cover were higher in 1996
than in 1997, which contributed to the lower Acquisition Expense Ratio in
1996.
The ratio of operating expenses to net premiums earned (the "Operating
Expense Ratio") increased 1.8 points to 7.3% in 1997 compared to 5.5% in 1996.
This increase was attributable to increases in certain expenses, such as
salary and facility expenses, in connection with the addition of staff and
expansion of office facilities during 1997. During the three-year period ended
December 31, 1997, PMA Re has continued to add staff in response to increased
premium volume and to increase the level of specialized services provided to
customers. Accordingly, the Operating Expense Ratio increased from 5.3% in
1995 to 7.3% in 1997.
The Company is presently undertaking a project to upgrade all of its
computer systems to be able to process records with dates beyond December 31,
1999. During 1997, PMA Re incurred costs amounting to approximately $400,000
related to the Year 2000 compliance program. Management expects that PMA Re
will incur approximately $600,000 in 1998 related to the Year 2000 compliance
program. Management expects that such project will be completed in 1998. See
"Liquidity and Capital Resources."
Net Investment Income
Net investment income increased 7.4% to $52.3 million in 1997 from $48.7
million in 1996, which represented a 7.8% increase from $45.2 million in 1995.
Such increases were primarily attributable to the overall increase in PMA Re's
invested assets, as well as changes in portfolio holdings. During 1997, PMA Re
shifted some of its holdings from government securities to high-quality
corporate securities, which generally yield higher levels of investment
income. In addition, the 1996 increase was due to a decrease in holdings of
tax-exempt securities for which pre-tax yields tend to be lower than other
investment vehicles. At amortized cost, PMA Re's cash and invested assets
increased $49.0 million, or 5.9%, and $34.9 million, or 4.4%, during 1997 and
1996, respectively.
Comparison of SAP and GAAP Results
The difference between the combined ratios presented in accordance with GAAP
compared to SAP is primarily attributable to the different accounting
treatment of acquisition costs. As PMA Re's premium volume has grown during
1997 and 1996, PMA Re has incurred additional acquisition costs, which are
deferred for GAAP. For SAP purposes, PMA Re is required to expense such costs
as incurred, resulting in an incremental expense recorded on a SAP basis
compared to GAAP.
57
<PAGE>
The Property and Casualty Group Results of Operations
Summarized financial results of the Property and Casualty Group for the
years ended December 31, 1997, 1996 and 1995 are as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- --------- --------
<S> <C> <C> <C>
Net premiums written:
Workers' compensation......................... $175,301 $ 189,338 $233,145
Commercial Lines.............................. 65,047 90,084 103,971
-------- --------- --------
Total....................................... $240,348 $ 279,422 $337,116
======== ========= ========
Net premiums earned:
Workers' compensation......................... $152,773 $ 176,380 $243,175
Commercial Lines.............................. 59,575 92,221 102,432
-------- --------- --------
Total....................................... 212,348 268,601 345,607
Net investment income........................... 82,098 82,455 92,275
Service revenues................................ 10,311 9,189 5,106
-------- --------- --------
Operating revenues.............................. 304,757 360,245 442,988
-------- --------- --------
Losses and LAE incurred......................... 193,530 424,900 319,644
Acquisition and operating expenses.............. 105,549 138,709 110,906
Policyholder dividends.......................... 14,716 16,255 16,743
-------- --------- --------
Total losses and expenses....................... 313,795 579,864 447,293
-------- --------- --------
Pre-tax operating loss.......................... $ (9,038) $(219,619) $ (4,305)
======== ========= ========
GAAP loss ratio................................. 91.1% 158.2% 92.5%
GAAP combined ratio............................. 143.3% 212.9% 127.9%
SAP loss ratio(1)............................... 84.0% 125.7% 77.3%
SAP combined ratio(1)........................... 119.0% 175.6% 115.1%
</TABLE>
- --------
(1) The SAP loss and combined ratios above relate to the operations of the
Pooled Companies only and do not include the results of other statutory
entities within the Property and Casualty Group.
Premium Revenues
Premiums for the Property and Casualty Group have decreased in the three-
year period ended December 31, 1997. Between 1997 and 1996, net premiums
written decreased 14.0%, and between 1996 and 1995, net premiums written
decreased 17.1%. Direct premiums written for workers' compensation decreased
$20.6 million and $36.5 million in 1997 and 1996, respectively. Direct
premiums written for Commercial Lines increased $11.7 million in 1997 compared
to 1996, and decreased $11.6 million in 1996 compared to 1995. Reinsurance
premiums assumed decreased $4.4 million between 1997 and 1996 and increased
$0.8 million between 1996 and 1995. Reinsurance premiums ceded increased $25.8
million in 1997 compared to 1996 and $10.4 million in 1996 compared to 1995.
Net premiums earned decreased $56.3 million between 1997 and 1996 and $77.0
million between 1996 and 1995.
The decline in premiums from 1995 to 1997 is due to a number of factors
discussed below, including the Property and Casualty Group's underwriting
decisions, competition and the impact of workers' compensation benefit reform
laws.
During the three years ended December 31, 1997, competition and manual rate
levels affected workers' compensation premium volume. During this period, the
Property and Casualty Group did not renew certain accounts due to inadequate
profit potential. Intense competition caused rates for certain accounts to be
unattractive relative to the risks assumed. Rather than match the price merely
to retain the volume, the Property and Casualty Group declined to write the
accounts. Average manual rate levels declined 25.0%, 7.0% and 3.0% in 1997,
1996, and 1995, respectively. The rate decreases had a substantially lower
proportional impact on premiums written during 1996 and 1995, because the
58
<PAGE>
Property and Casualty Group had reduced its dependence on rate-sensitive
business. The Property and Casualty Group increased its focus on rate
sensitive small account business in 1997 because it believes that the impact
of recently passed legislation in its principal marketing states, including
Act 57 in Pennsylvania, may make loss experience on such business more
predictable than it has been in recent years.
Workers' compensation premiums also declined during the three-year period
ended December 31, 1997 as a result of the enactment of workers' compensation
benefit reform laws. The decline in workers' compensation premiums has been
concentrated primarily in Pennsylvania. Direct workers' compensation premiums
for all other jurisdictions increased in 1997 compared to 1996, including an
increase of $3.8 million from new jurisdictions in 1997. The number of
workers' compensation policies increased to 3,184 in 1997 compared to 2,757 in
1996. However, the increase in policies was offset by the rate decreases
related to the benefit reform laws. These benefit reform laws also have had a
favorable impact on loss and LAE reserves for business written on policies
subject to such reform laws. See "Losses and Expenses" below. The changes in
workers' compensation benefits that were promulgated under Act 57 in
Pennsylvania were accompanied by a change in the basic premium rate structure
for workers' compensation insurance, which lowered the rates charged to
insureds by approximately 25% effective February 1997. This change in rate
structure was reviewed by an independent actuarial firm on behalf of the
Commonwealth of Pennsylvania in connection with the approval of rates under
Act 57. In addition, the Company's actuaries reviewed the effect that the
reforms would have on workers' compensation benefits paid in relation to the
changes in premiums charged. It was the opinion of both groups of actuaries
that the rate changes mandated by Act 57 were consistent with the changes in
benefits allowed under Act 57, and the effect of the rate changes would be
minimal with respect to the profitability of the business. The premium charged
on a fixed-cost policy is based upon the manual rates filed with and approved
by the state insurance department and does not increase or decrease based upon
the losses incurred during the policy period. Under policies that are subject
to dividend plans, the customer may receive a dividend based upon loss
experience during the policy period. Since the late 1980's, the Property and
Casualty Group has reduced its proportion of rate-sensitive products from over
70% to approximately 62%. As a result of the enactment of regulatory reform in
several jurisdictions in the Property and Casualty Group's marketing
territory, the Property and Casualty Group may write more rate-sensitive
accounts in such jurisdictions in the future.
Direct workers' compensation premiums were also impacted by changes in the
level of premium adjustments, primarily related to audit premiums and
retrospective policies. In 1997, such adjustments decreased premiums written
by $4.4 million ($15.8 million in audit premiums billed and $20.2 million in
retrospective premiums returned), while in 1996 such adjustments reduced
premiums written by $6.1 million ($17.1 million in audit premiums billed and
$23.2 million in retrospective premiums returned) and in 1995, such
adjustments increased premiums written by $13.1 million ($26.9 million in
audit premiums billed and $13.8 million in retrospective premiums returned).
The slightly lower impact of premium adjustments in 1997 compared to 1996 was
due primarily to a decrease in retrospectively rated premiums returned to
insureds, resulting from a lower volume of workers' compensation business
written during the three years ended December 31, 1997. The decrease in 1996
compared to 1995 was due primarily to two factors: the lower amount of billed
audit premiums, which is attributable to better estimating of the ultimate
exposure base (generally, payroll) on such risks by the Property and Casualty
Group's underwriters and the increase in retrospectively rated premiums
returned to insureds, resulting from the favorable loss experience in more
recent accident years in workers' compensation. As the Property and Casualty
Group has expanded retrospectively rated business since 1989, proportionately
more policies had mature loss data, resulting in more premium adjustments.
Changes in actuarial estimates of future premium adjustments on retrospective
policies are recorded directly in net premiums earned (see below for further
discussion), and, therefore, such retrospective adjustments returned to
insureds do not impact net premiums earned.
59
<PAGE>
Under retrospectively rated policies, the Property and Casualty Group
receives an up-front provisional premium that is adjusted based upon loss
experience of the insured. If losses are lower than expected, the insured
receives a refund, subject to a minimum premium and, if losses are higher than
expected, the insured owes additional premium, subject to a maximum premium.
Between the minimum and maximum premiums, the net impact on the Company's
operating results is negligible, because changes in loss estimates pertaining
to retrospectively rated contracts are offset by changes in premium estimates,
net of changes in estimates for accrued premium taxes and other loss-based
costs. While the premium is adjusted based upon loss experience, the Company's
profit load (or margin) portion of the premium is fixed at the policy's
inception and is not adjusted based upon loss experience, although the margin
would be impaired in the event losses exceed the maximum premium amount.
Approximately $50.1 million, $59.0 million and $85.0 million of the Property
and Casualty Group's workers' compensation premiums were derived from loss-
sensitive products in 1997, 1996 and 1995, respectively. The audit premiums
referred to above were derived from the Company's workers' compensation
insurance policies. An insured's workers' compensation premiums are determined
by two factors: aggregate payroll and employer business classification. The
Company determines its initial estimate of annual premium based on payroll
records and business classification data submitted to it by the insured. An
audit of this data is performed after the policy year ends, and an adjustment
to the premium is then made and billed to the insured.
Also reducing net premiums written is the fact that, since 1992, the
Property and Casualty Group has been increasing its focus on alternative
market workers' compensation products. These products include large-deductible
policies, offshore rent-a-captive programs and individual self-insurance
programs. Typically, the Property and Casualty Group receives a lower net
premium for these types of plans. However, under this type of business, the
insured retains a greater share of the underwriting risk than under rate-
sensitive or loss-sensitive products, which reduces the potential for
unfavorable claim activity on the accounts and encourages loss control on the
part of the insured. A substantial portion of related revenues are recorded as
service revenues rather than premiums. Such service revenues increased $1.1
million in 1997 compared to 1996 and $4.1 million in 1996 compared to 1995.
Companies writing workers' compensation in certain states generally must
share in the risk of insuring entities that cannot obtain insurance in the
voluntary market. Typically, an insurer's share of this residual market is
dependent upon its market share of direct premiums in the voluntary market,
and the assignments are accomplished either by direct assignment or by
assumption from pools. In 1997, the Property and Casualty Group's direct
assignments, which are included in direct written premiums, decreased $3.1
million compared to 1996 and decreased $15.3 million in 1996 compared to 1995.
These decreases reflect generally lower premium volume in workers'
compensation for the Property and Casualty Group, as well as increasingly
competitive conditions in the voluntary workers' compensation market which has
led to lower amounts of residual market business.
During 1997 compared to 1996, direct writings of Commercial Lines increased
$11.7 million assumed Commercial Lines premiums decreased $8.5 million and
ceded Commercial Lines premiums increased $28.2 million. The growth in direct
writings for Commercial Lines in 1997 was due primarily to rate increases on
existing business as well as additional companion commercial business
associated with new workers' compensation customers. The Property and Casualty
Group is continuing to review the profitability of these lines, and the net
growth in such lines has been limited as a result of this review and the new
reinsurance treaty discussed below. Also, market conditions have been
extremely competitive in these lines, and management has refused to compromise
underwriting standards merely to increase volume. During 1996 compared to
1995, direct writings of Commercial Lines decreased $11.6 million, assumed
Commercial Lines premiums increased $0.8 million and ceded Commercial Lines
premiums increased $3.1 million.
In 1997, the Property and Casualty Group entered into a new reinsurance
treaty that covers substantially all of the Commercial Lines casualty business
at a $175,000 per risk attachment point,
60
<PAGE>
compared to a $500,000 per risk attachment point in 1996 which accounted for
the increase in ceded Commercial Lines premiums.
Ceded premiums increased $25.8 million in 1997 compared to 1996, and
increased $10.4 million in 1996 compared to 1995. The increase in 1997
compared to 1996 was due primarily to a reinsurance treaty effected at
December 31, 1997, ceding $15.4 million of annuity reserves held by PMA Life
to a third party (the "PMA Life transaction"). Ceded premiums also increased
approximately $6.6 million due to the aforementioned lower attachment point of
the Commercial Lines casualty reinsurance treaty the Property and Casualty
Group entered into effective January 1, 1997. Finally, ceded reinsurance
premiums increased an additional $6.2 million, due to the increased direct
writings of Commercial Lines business in 1997 compared to 1996. In 1996
compared to 1995, ceded premiums decreased, although the rate of decrease was
less than the rate of decrease in direct premiums due to the increased use of
facultative reinsurance for specific risks in Commercial Lines.
Fluctuations in net premiums earned were primarily attributable to changes
in net premiums written. In addition to the impact of fluctuations in premiums
written, premiums earned were also impacted by the change in accrued
retrospective premiums. Accrued retrospective premiums, which are a component
of uncollected premiums, are based upon actuarial estimates of expected
ultimate losses and resulting estimated premium adjustments relating to
retrospectively rated policies. The estimated ultimate premium adjustments
under retrospectively rated policies are recorded in the initial policy year
based upon estimated loss experience on the underlying policies and adjusted
in subsequent periods in conjunction with revisions of the estimated
underlying losses on such policies. In addition, accrued retrospective
premiums are increased or decreased based upon retrospective policy
adjustments paid or billed. Such adjustments actually billed or paid do not
impact premium revenues because the Company records an offsetting amount
through net premiums written. The following table sets forth the components of
the change in accrued retrospective premiums for each of the three years in
the period ended December 31, 1997:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
Estimated retrospective policy adjustments
related to the current accident year........ $(12,460) $(18,767) $(12,941)
Revision of estimate of retrospective policy
adjustments related to prior accident
years....................................... (44,719) (9,888) (4,845)
Retrospective policy adjustments paid........ 20,179 23,155 13,786
Uncollectible write-off...................... -- (5,000) --
-------- -------- --------
Total........................................ $(37,000) $(10,500) $ (4,000)
======== ======== ========
</TABLE>
In 1997, 1996 and 1995, the Property and Casualty Group reduced accrued
retrospective premiums by $37.0 million, $10.5 million and $4.0 million,
respectively. The primary reason for the additional reduction in 1997 compared
to 1996 was a $44.7 million revision of estimate of accrued retrospective
premiums, primarily due to the favorable development of claims liabilities for
more recent accident years ($35.7 million) and the commutation of claims for
accident years 1991 and prior in 1997 ($9.0 million). The reduction for policy
years 1991 and prior primarily relates to the commutation program for such
years initiated in late 1996. In July 1997, the Property and Casualty Group
completed a formal program under which it commuted a large number of claims
associated with workers' compensation claims from accident years 1991 and
prior, including loss reserves associated with retrospective policies. The
commutation program resulted in current payments to claimants that were less
than the carried reserves. As a result of the differences between the current
commutation payments to claimants and carried reserves on such claims,
management reduced its estimate of amounts recoverable under retrospectively
rated policies and the Property and Casualty Group also recognized a reduction
in losses and LAE associated with such policies. See "Losses and Expenses."
61
<PAGE>
The reduction for the 1992 through 1996 policy years was related primarily to
a corresponding amount of favorable development on underlying loss reserves
for such years. The effects of the commutations on these prior loss reserves,
as well as the intent of the Property and Casualty Group to continue utilizing
early intervention techniques such as commutations on claims from more recent
accident years, have led to a re-estimation of policy liabilities for these
more recent accident years, and a re-estimation of amounts due under
retrospectively rated policies for these more recent accident years. The
reduction in amounts due under retrospectively rated policies and the
corresponding reduction in loss reserves resulting from commutation of the
carried loss reserves and re-estimation of more recent accident years resulted
in a reduction of the GAAP loss ratio for 1997 compared to 1996 and 1995. See
"Losses and Expenses." In addition, the reduction of earned premiums caused
both the GAAP expense ratio and the policyholder's dividend ratio to increase
for 1997 compared to 1996 and 1995. However, the impact of the reduction of
the accrued retrospective premiums (net of the adjustment to underlying loss
reserves) on the Company's results of operations was negligible.
The increased adjustment to prior accident years recorded in 1996 compared
to 1995 reflects additional favorable loss reserve development in the prior
three accident years.
Management believes that it has made a reasonable estimate of the Company's
accrued retrospective premiums. While the eventual ultimate receivable may
differ from the current estimates, management does not believe that the
difference will have a material effect, either adversely or favorably, on the
Company's financial position or results of operations.
Losses and Expenses
The following table reflects the components of the Property and Casualty
Group's combined ratios, computed in accordance with GAAP for the years ended
December 31, 1997, 1996 and 1995:
<TABLE>
<CAPTION>
1997 1996 1995
----- ----- -----
<S> <C> <C> <C>
Loss ratio.............................................. 91.1% 158.2% 92.5%
----- ----- -----
Expense ratio:
Amortization of deferred acquisition costs............ 22.7% 19.7% 15.5%
Operating expenses(1)................................. 22.6% 28.9% 15.1%
----- ----- -----
Total expense ratio..................................... 45.3% 48.6% 30.6%
----- ----- -----
Policyholders' dividend ratio........................... 6.9% 6.1% 4.8%
----- ----- -----
Combined ratio-GAAP..................................... 143.3% 212.9% 127.9%
===== ===== =====
</TABLE>
- --------
(1) The GAAP Operating Expense Ratio excludes $9.3 million, $8.2 million and
$5.3 million in 1997, 1996 and 1995, respectively, of PMA Management Corp.
direct expenses related to service revenues which are not included in
premiums earned.
The components of the loss and LAE ratio for the Property and Casualty Group
for the years ended December 31, 1997, 1996 and 1995 were as follows:
<TABLE>
<CAPTION>
1997 1996 1995
---- ----- ----
<S> <C> <C> <C>
Current accident year--undiscounted.................. 81.3 % 81.4 % 83.8 %
Accretion of discount for prior accident years and
discounting of current accident year................ 12.0 % 5.5 % (0.7)%
Adjustments to retrospectively rated business and net
effect of PMA Life transaction...................... (1.5)% -- --
Change in discount rate.............................. -- -- (9.8)%
Reserve (release) strengthening...................... (0.7)% 71.3 % 19.2 %
---- ----- ----
Loss and LAE ratio................................... 91.1 % 158.2 % 92.5 %
==== ===== ====
</TABLE>
62
<PAGE>
In 1997, the calendar year loss ratio was impacted by a $31.7 million net
charge, which represented the accretion of discount on workers' compensation
loss reserves for prior accident years, partially offset by discounting of
current accident year reserves, while the 1996 calendar year loss ratio was
impacted by a $15.0 million net charge for accretion of discount on prior
accident year workers' compensation loss reserves and discounting of current
accident year reserves. The increase in the net charge for discount accretion
is due primarily to higher overall reserve levels in 1997 and lower levels of
current accident year reserves being discounted in 1997 compared to 1996. The
Property and Casualty Group expects lower levels of discount associated with
current accident year reserves to continue due to benefit reforms which have
been enacted in many of the states in which it does business that reduce
claims duration. Management also expects that the net charge associated with
accretion of discount of prior years' reserves will decrease in 1998 and
forward because the accelerated payment of claims due to commutations is
expected to lower the level of discount in the Property and Casualty Group's
loss reserves. The increase in the loss ratio in 1996 compared to 1995 from
the accretion of discount was due primarily to higher overall reserves in 1996
and to lower levels of earned premium in 1996 compared to 1995. Discounting of
reserves for workers' compensation claims is established in accordance with
applicable state laws, which permit discounting the estimated claim payments
on certain claims at various rates. The Property and Casualty Group uses a
discount rate of approximately 5% per year, which is within the range of
permitted rates in the states in which it does business. Loss reserves on
other lines of business as well as LAE reserves for all lines of business are
not discounted.
In 1996 and 1995, the loss ratio included $191.4 million and $66.5 million,
respectively, of strengthening of unpaid losses and LAE of prior accident
years. For the years ended December 31, 1997, 1996 and 1995, the loss reserve
(release) strengthening, net of retrospectively rated policies and the PMA
Life transaction, was associated with the following lines of business:
(DOLLAR AMOUNTS IN MILLIONS)
<TABLE>
<CAPTION>
1997 1996 1995
----- ------ ------
<S> <C> <C> <C>
Pre-1992 workers' compensation......................... $(7.1) $110.0 $ 54.7
Asbestos and environmental............................. -- 60.4 23.4
Other lines of business................................ 5.0 21.0 (11.6)
----- ------ ------
Total reserve (release) strengthening.................. $(2.1) $191.4 $ 66.5
===== ====== ======
</TABLE>
In 1997, the Property and Casualty Group recorded a reserve release of $53.9
million on prior year losses and LAE, excluding the accretion of discount. The
release primarily relates to favorable reserve development of $9.0 million for
workers' compensation retrospectively rated policies for accident years 1991
and prior resulting from unanticipated additional savings from the Company's
1997 commutation program and favorable development of workers' compensation
reserves for accident years 1992 through 1996 of $35.1 million ($28.0 million
related to retrospectively rated policies), primarily resulting from greater
than expected savings associated with benefit reforms in Pennsylvania.
Furthermore, incurred losses on prior accident years were also affected by the
cession of prior year loss reserves included in the PMA Life transaction of
$14.8 million. See "--Premium Revenues" above. The reserve release pertaining
to the retrospectively rated policies and the PMA Life transaction were offset
in the consolidated statements of operations by a corresponding reduction in
earned premiums. The aforementioned reserve releases were partially offset by
reserve strengthening of $5.0 million in commercial multi-peril business for
accident year 1996. It is the opinion of management that these reserve
adjustments are not indicative of any future trend.
The 1996 aggregate workers' compensation adverse development was allocated
$102.0 million to Pennsylvania and $8.0 million to all other states in which
the Property and Casualty Group does business. Of the $102.0 million, the
allocation by year is as follows: prior to 1987, $16.0 million; 1987 to 1991,
$101.0 million and 1992 and subsequent years, ($15.0 million). In 1995,
substantially all of
63
<PAGE>
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 for the
increase in the paid loss development data and management obtained claim count
data that was far more detailed than had been historically utilized in the
reserve setting process. This data indicated that the paid loss development
factors were not only impacted by commutation activity, but also by a decline
in the claims closure rate in Pennsylvania. Management believes that the
decline in the closure rates was due to several interrelated factors. One
factor related to the fact that efforts to rehabilitate claimants and return
them to work were not as successful as anticipated. For accident years 1987 to
1991, in particular, extensive efforts were made by the Company to
rehabilitate claimants and return them to work at either full or modified
duty. By late 1995 and into 1996, it was recognized, by a review of a slow
down in the claims closure pattern, that these rehabilitation efforts were not
impacting the closure rates as expected. Another factor negatively impacting
claims closure rates related to the economic conditions in Pennsylvania in the
early 1990's. During the period from 1990 to 1994, economic conditions in
Pennsylvania were considered to be depressed in the Company's major industry
niches for workers' compensation insurance (construction and heavy
manufacturing). Payrolls in these industries were stagnant, and in many cases,
employment was flat or declining. The Company believes that in periods of
declining employment opportunities, there is a tendency for indemnity periods
to increase, which occurred for workers who suffered injuries in these
industries.
The above factors, when considered with the fact that the benefits period in
Pennsylvania was unlimited, caused the Company to believe that a substantial
portion of claimants from the pre-1992 period, who had already been out of
work five to nine years, would not return to work in any capacity. In late
1995 and during 1996, management undertook an effort to quantify the impact of
the declining closure rates compared to the increase in commutation activity.
During the fourth quarter of 1995, the Property and Casualty Group
strengthened its workers' compensation reserves by $54.7 million; however, the
quantification of the effect of the claims closure rate was an extremely
complex process, and as such, the data was not fully understood at that time.
As the data under analysis was more mature and refined in 1996, management
determined that the workers' compensation loss reserves for Pennsylvania for
pre-1992 accident years needed to be increased substantially; therefore, the
Property and Casualty Group increased its workers' compensation reserves by
$110.0 million.
Benefit reforms enacted by states in which the Property and Casualty Group
transacts business, most significantly Pennsylvania, have had a beneficial
impact on more recent accident year loss ratios. Prior to 1996, the principal
revisions to the Pennsylvania system included medical cost containment
measures and an expansion of the period of time during which the insurer may
require an employee to accept medical treatment from the employer's list of
designated healthcare providers. In July 1996, Pennsylvania enacted Act 57, a
workers' compensation reform bill that is expected to reduce substantially
indemnity benefit periods in Pennsylvania. In addition to regulatory reforms,
the loss ratios have been favorably impacted by the conversion to loss
sensitive and alternative market products. Such a trend is evidenced by the
fact that accident year loss ratios (losses recorded for the year in which the
event occurred expressed as a percentage of the earned premiums for that year)
for workers' compensation have been generally lower in more recent accident
years, as the following chart indicates:
64
<PAGE>
PROPERTY AND CASUALTY GROUP WORKERS' COMPENSATION UNDISCOUNTED
ACCIDENT YEAR PURE LOSS RATIOS AT DECEMBER 31, 1997
<TABLE>
<CAPTION>
ACCIDENT YEAR LOSS RATIO
------------- ----------
<S> <C>
1990 100%
1991 86%
1992 80%
1993 64%
1994 64%
1995 63%
1996 63%
1997 66%
</TABLE>
In addition, management took several steps to reduce the outstanding claims
associated with the Pennsylvania workers' compensation business written
through 1991. A formal commutation program was initiated in the fourth quarter
1996 and continued into late 1997. Commutations are agreements with claimants
whereby the claimants, in exchange for a lump sum payment, will forego their
rights to future indemnity payments from the Property and Casualty Group.
Under Pennsylvania workers' compensation laws, the claimant and the
Pennsylvania Workers' Compensation Board must approve all such commutation
arrangements. The Property and Casualty Group paid $101.1 million and $17.8
million in 1997 and the fourth quarter of 1996, respectively, to commute
workers' compensation indemnity claims. Savings associated with these claims
were consistent with management's expectations. The number of open claims for
accident years 1991 and prior was substantially reduced as a result of the
commutation program. This reduction in open claims is expected to reduce the
possibility of further adverse development on such reserves, although there
can be no assurance that the level of commutations will have a significant
impact on the future development of such reserves.
Estimating reserves for workers' compensation claims can be more difficult
than for many other lines of property and casualty insurance for several
reasons, including (i) the long payment "tail" associated with the business;
(ii) the impact of social, political and regulatory trends on benefit levels
for both medical and indemnity payments; (iii) the impact of economic trends
and (iv) the impact of changes in the mix of business. At various times, one
or a combination of such factors can make the interpretation of actuarial data
associated with workers' compensation loss development more difficult, and it
can take additional time to recognize changes in loss development patterns.
Under such circumstances, adjustments will be made to such reserves as loss
patterns develop and new information becomes available and such adjustments
may be material.
The adverse development in reserves associated with asbestos and
environmental claims is the result of a detailed analysis completed in 1996 of
loss and LAE reserves associated with asbestos and environmental liability
claims. The reserving for asbestos and environmental claims has undergone
change at both the Company and in the insurance industry in general. For
environmental and asbestos liability claims, reserving methodology has been
evolving in the recent past into accepted industry practice. The Company has
applied these methods to its asbestos and environmental loss reserves in 1997
and 1996. To reserve for environmental claims, the Company currently utilizes
a calendar year development technique known as aggregate loss development.
This technique focuses on the aggregate losses paid as of a particular date
and aggregate payment patterns associated with such claims. Several elements
including remediation studies, remediation, defense, declaratory judgment and
third party bodily injury claims were considered in estimating the costs and
payment patterns of the environmental and toxic tort losses. Prior to the
development of these techniques, there was a substantial range in estimating
reserves for environmental and toxic tort liabilities. The methods employed by
the Company prior to the review completed in 1996 included a review of
aggregate loss and LAE paid and case incurred data along with resulting
"survival ratios" to establish IBNR for
65
<PAGE>
environmental and toxic tort claims. For asbestos claims, the Company had
previously reserved costs to defend, and any indemnification payments
anticipated on, claims for which it had received notice that it was a
responsible party, plus a bulk factor applied to the estimated case reserves
to provide for potential development of indemnification and defense cost
related to such claims. In 1996, the Company performed a ground up analysis of
asbestos loss reserves using an actuarially accepted modeling technique. Using
historical information as a base and information obtained from a review of
open claims files, assumptions were made about future claims activity in order
to estimate ultimate losses. For each individual major account, projections
were made regarding new plaintiffs per year, the number of years new claims
will be reported, the average loss severity per plaintiff and the ratio of LAE
to loss. In many cases involving larger asbestos claims, the Company reserved
up to the policy limits for the applicable loss coverage parts for the
affected accounts. Policy terms and reinsurance treaties were applied in the
modeling of future losses. Estimation of obligations for asbestos and
environmental exposures continues to be more difficult than for other loss
reserves because of several factors, including: (i) evolving methodologies for
the estimation of the liabilities; (ii) lack of reliable historical claim
data; (iii) uncertainties with respect to insurance and reinsurance coverage
related to these obligations; (iv) changing judicial interpretations and (v)
changing government standards.
The Company's asbestos-related loss reserves as of December 31, 1997, 1996
and 1995 which include reserves for PMA Re of $0.3 million, $0.3 million and
$0.6 million, gross and net, at December 31, 1997, 1996 and 1995,
respectively, were as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------- -------- -------
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves............................. $80,055 $ 27,611 $13,969
Incurred losses and LAE........................ 2,435 62,854 22,482
Calendar year payments for losses and LAE...... (5,764) (10,410) (8,840)
------- -------- -------
Ending reserves.............................. $76,726 $ 80,055 $27,611
======= ======== =======
Net of reinsurance:
Beginning reserves............................. $53,300 $ 23,443 $ 8,168
Incurred losses and LAE........................ (36) 39,427 21,826
Calendar year payments for losses and LAE...... (4,686) (9,570) (6,551)
------- -------- -------
Ending reserves.............................. $48,578 $ 53,300 $23,443
======= ======== =======
</TABLE>
The Company's environmental-related loss reserves as of December 31, 1997,
1996 and 1995, which include reserves for PMA Re of $3.8 million, $2.9 million
and $2.6 million, gross and net, at December 31, 1997, 1996 and 1995,
respectively, and $13.1 million gross and zero net for Caliber One Indemnity
Company at December 31, 1997 were as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves................................ $35,626 $20,134 $20,952
Incurred losses and LAE........................... 1,130 22,143 3,516
Reserves acquired through purchase of Caliber One
Indemnity Company(1)............................. 13,060 -- --
Calendar year payments for losses and LAE......... (4,708) (6,651) (4,334)
------- ------- -------
Ending reserves................................. $45,108 $35,626 $20,134
======= ======= =======
Net of reinsurance:
Beginning reserves................................ $34,592 $20,134 $20,952
Incurred losses and LAE........................... 1,068 21,109 3,516
Calendar year payments for losses and LAE......... (3,965) (6,651) (4,334)
------- ------- -------
Ending reserves................................. $31,695 $34,592 $20,134
======= ======= =======
</TABLE>
66
<PAGE>
- --------
(1) Such acquired reserves have been reinsured by an affiliate of the former
parent. See "Liquidity and Capital Resources."
Of the total net asbestos reserves, $6.7 million, $6.8 million and $6.7
million related to established claims reserves at December 31, 1997, 1996 and
1995, respectively, and $41.9 million, $46.5 million and $16.7 million related
to IBNR losses at December 31, 1997, 1996 and 1995, respectively. Of the total
net environmental reserves, $11.2 million, $12.5 million and $10.3 million
related to established claims reserves at December 31, 1997, 1996 and 1995,
respectively, and $20.5 million, $22.1 million and $9.8 million related to
IBNR losses at December 31, 1997, 1996 and 1995, respectively. All incurred
asbestos and environmental losses were for accident years 1986 and prior.
Management believes that the Property and Casualty Group's reserves for
asbestos and environmental claims are appropriately established based upon
known facts, existing case law and generally accepted actuarial methodologies.
However, due to changing interpretations by courts involving coverage issues,
the potential for changes in federal and state standards for clean-up and
liability and other factors, the ultimate exposure to the Property and
Casualty Group for these claims may vary significantly from the amounts
currently recorded, resulting in a potential future adjustment in the claims
reserves recorded. In addition, issues involving policy provisions, allocation
of liability among participating insurers, proof of coverage and other factors
make quantification of liabilities exceptionally difficult and subject to
adjustment based upon newly available data.
In 1996, Commercial Lines experienced reserve strengthening of $21.0 million
compared to a reserve release of $11.6 million in 1995. The reserve
strengthening in 1996 was principally due to a re-estimation of loss
adjustment costs associated with general liability claims. Through 1991, the
Property and Casualty Group's mix of general liability insurance policies was
weighted towards the manufacturing classes of business. Subsequent to 1991,
the Property and Casualty Group's mix of business became more heavily weighted
towards the construction and contracting classes of business. These particular
classes of business have experienced losses due to alleged construction
defects and similar matters that have taken longer to emerge than the classes
of business previously written by the Property and Casualty Group. Defense
costs associated with these claims have also exceeded the original estimate of
the Property and Casualty Group's management, which was based on the patterns
of indemnification payments associated with the earlier classes of business
written. When this issue was discovered, the Property and Casualty Group
factored the increased defense costs and the emergence pattern in determining
a more appropriate reserve amount for loss handling costs. The release of
reserves in 1995 was due primarily to favorable loss experience in commercial
automobile business.
The 1997 expense ratio declined by 3.3 points compared to the 1996 expense
ratio. The 1997 Acquisition Expense Ratio increased by 3.0 points compared to
1996, primarily due to a 4.2 point increase related to the aforementioned
adjustment to accrued retrospective premiums in 1997 ($37.0 million) and by
the 1997 cession of premiums associated with the PMA Life transaction ($15.4
million), offset by the write-off in 1996 of $5.0 million in retrospectively
rated premiums. These actions reduced earned premiums without a commensurate
decrease in acquisition expenses. Such increase was partially offset by ceding
commissions received by the Property and Casualty Group on its reinsurance
arrangement for Commercial Lines casualty losses. Such commissions are
recorded as a reduction of acquisition expenses. In 1996, the Acquisition
Expense Ratio increased 4.2 points compared to 1995 primarily due to a change
in the mix of business to a greater proportion of alternative market products
and self-insured services, which have much lower, if any, net premium which
caused acquisition expenses to represent a larger proportion of net premiums
earned.
The 1997 Operating Expense Ratio was 22.6%, a decrease of 6.3 points as
compared to 28.9% in 1996. After adjusting for the reduction in accrued
retrospective premiums and the PMA Life
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<PAGE>
transaction, the adjusted Operating Expense Ratio would have been 18.1% in
1997. The lower adjusted Operating Expense Ratio is primarily attributable to
expense containment programs begun at the Property and Casualty Group, and the
higher levels of restructuring charges and valuation adjustments in 1996.
Operating expenses in 1997 decreased by $31.0 million compared to 1996,
despite an increase of $1.1 million in expenses associated with the Property
and Casualty Group's service revenues. The 1996 Operating Expense Ratio was
adversely impacted by several factors, including an accrual of $7.6 million
for a voluntary early retirement program ("VERIP"), a $4.8 million charge
associated with a change in depreciable lives of computer equipment and a
$10.1 million increase in premium balances written off. In 1997, the Property
and Casualty Group recorded $5.2 million for severance and related costs
associated with the continued restructuring and cost reduction initiatives.
These initiatives lowered payroll and related expenses in 1997 by $4.9
million. The 1996 Operating Expense Ratio increased 13.8 points in comparison
to 1995 primarily related to the aforementioned factors that adversely
impacted the 1996 ratio.
In 1997 and 1996, respectively, the Property and Casualty Group incurred
approximately $1.6 million and $1.8 million associated with the Year 2000
Issue. Management anticipates that the Property and Casualty Group will incur
approximately $700,000 in 1998 as a result of this conversion; it is expected
that this conversion will be completed by the end of 1998. See "Liquidity and
Capital Resources."
The policyholders' dividend ratios were 6.9%, 6.1% and 4.8% for the years
ended December 31, 1997, 1996 and 1995, respectively. The policyholders'
dividend ratio increased by 1.3 points in 1997 as a result of the adjustment
to retrospectively rated premiums and the PMA Life transaction. The ratios
have generally increased over the three-year period ended December 31, 1997
primarily because of sliding-scale dividend plans. Under such plans, the
insured receives a dividend based upon the collective loss experience of the
plan. As the loss experience for the three underwriting years ended December
31, 1997 has improved relative to the years prior to this period, the Property
and Casualty Group has incurred higher policyholders' dividends.
Net Investment Income
Net investment income was relatively flat in 1997 compared to 1996, as lower
average investment balances resulting from the pay-down of loss reserves from
prior accident years primarily related to the commutation program and
decreasing premium volume were offset by higher yields associated with the
purchase of high grade corporate bonds and asset-backed securities. Net
investment income decreased 10.6% in 1996 compared to 1995, primarily due to
lower average investment balances.
Comparison of SAP and GAAP Results
The results presented under SAP are those of the Pooled Companies. Prior to
December 31, 1996, the Pooled Companies were comprised of four domestic
insurance companies: PMAIC, Manufacturers Alliance Insurance Company,
Pennsylvania Manufacturers Indemnity Company and MASCCO. As part of a plan to
reduce the amount of indemnity reserves from accident years 1991 and prior in
the Pooled Companies, MASCCO was removed from the pooling arrangement
effective December 31, 1996, and indemnity reserves from accident years 1991
and prior were transferred to MASCCO. The other significant difference relates
to various reinsurance agreements between the Pooled Companies and certain
foreign insurance subsidiaries. Prior to December 31, 1996, Chestnut Insurance
Company, Ltd. was the reinsurer under these agreements. At December 31, 1996,
these reinsurance arrangements were novated, and the assets and liabilities
associated with such contracts were sold to PMA Cayman, a foreign affiliate.
At December 31, 1997, the Pooled Companies had reinsurance recoverables from
MASCCO and PMA Cayman of $96.2 million and $284.9 million, respectively.
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<PAGE>
In addition to the above and the different accounting treatment of
acquisition costs (see "PMA Re Results of Operations" for further discussion
of SAP to GAAP differences related to acquisition costs), the GAAP results for
the Property and Casualty Group include the results of other entities within
the Property and Casualty Group, but excluded from the aforementioned pooling
agreement, including PMA Life and other affiliated reinsurers and non-
insurance companies utilized in providing certain products and services to the
Property and Casualty Group's clients. The exclusion of such entities tends to
decrease the SAP combined ratio relative to the GAAP combined ratio.
Corporate and Other
The Corporate and Other segment is primarily comprised of corporate overhead
and the operations of the Company's properties. Corporate and Other operations
reported a pre-tax operating loss of $3.4 million in 1997 compared to a pre-
tax operating loss of $500,000 in 1996. The decline in the operating results
of Corporate and Other was due primarily to a $2.2 million increase in
operating costs related to certain corporate properties disposed of during the
third quarter of 1997. No material gain or loss was recorded in connection
with the disposal of such properties.
In 1995, management determined that the fair market values of the Company's
former headquarters building, which was disposed of in 1997, and certain
adjacent properties were less than the carrying values plus the costs to carry
and sell the properties. The Company recorded a charge of $8.4 million in 1995
to write down these properties to their fair market values less costs to carry
and sell the properties. No such charge was recorded during 1996.
During 1997, the Company incurred pre-operating charges of approximately
$900,000 in establishing Caliber One. The Corporate and Other segment also
incurred $1.8 million of severance and related restructuring costs in 1997.
Net Realized Investment Gains
Net realized investment gains amounted to $8.6 million, $3.0 million and
$31.9 million in 1997, 1996 and 1995, respectively. During the three-year
period ended December 31, 1997, the Company realized gains from investment
sales related to the following: (i) transactions to move holdings between
taxable and tax-exempt fixed-maturity investments in order to maximize after-
tax yields; (ii) transactions to expand the asset classes in which the Company
invests to capitalize on favorable yield spreads between such instruments and
U.S. Treasury securities; (iii) transactions based upon an assessment of the
interest rate environment and the shape of the yield curve and (iv) sales of
equity securities, as the Company has substantially reduced its holdings of
this asset class over the last three years. Gains and losses on the sale of
investments are recognized as a component of net income, but the timing and
recognition of such gains and losses are unpredictable and are not indicative
of future results.
In 1997, the Company repositioned its investment portfolio to improve its
pre-tax investment yield, while maintaining the maturity matching structure
between investments and liability cash flow projections. As interest rates
declined in the latter part of the year, these transactions resulted in a net
$8.6 million gain for 1997.
During 1996 and 1995, most of the investment sales activity resulted from
reducing the Company's holdings of tax-advantaged securities. Based upon an
assessment of the Company's position with respect to the alternative minimum
tax ("AMT"), the Company reduced its tax-advantaged securities positions
beginning in late 1995 and throughout 1996. In 1996, these sales resulted in a
net loss of $900,000, compared to 1995 when such transactions resulted in a
net gain of $12.1 million. In addition to gains and losses arising from the
sales of fixed maturity investments, sales of equity securities generated net
realized gains of $3.9 million and $900,000 in 1996 and 1995, respectively.
69
<PAGE>
Interest Expense and Income Taxes
Interest expense decreased $1.3 million to $15.8 million in 1997 from $17.1
million in 1996 due to the refinancing of the Company's debt with the
Revolving Credit Facility. See "Liquidity and Capital Resources" below. In
1996, interest expense decreased to $17.1 million from $18.7 million in 1995.
Such reduction related to slightly lower average debt balances in 1996. In
addition, principal payments on the Company's higher coupon senior notes for
which average coupon rate of amounts paid was 9.49% were funded with drawdowns
on the Company's Revolving Credit Facility which had an average interest rate
of 6.08% in 1996.
The Company's effective tax rates were 21.5%, (29.3)% and 30.9% in 1997,
1996 and 1995, respectively. The Company recorded a net deferred tax asset of
$70.4 million and $101.6 million in 1997 and 1996, respectively. See
"Liquidity and Capital Resources--Capital Resources." In the normal course of
business the Company is examined by various taxing authorities, including the
Internal Revenue Service. Federal tax return examinations have been completed
for the years 1992 and 1993. The examinations for years 1994 and 1995 are
currently in progress. In management's opinion, the ultimate resolution of
these matters will not have an adverse impact on the Company's financial
position or results of operations .
Liquidity and Capital Resources
Liquidity
Liquidity is a measure of an entity's ability to secure enough cash to meet
its contractual obligations and operating needs. At the holding company level,
the Company requires cash to pay debt obligations, dividends to shareholders
and taxes to the federal government, as well as to capitalize subsidiaries
from time to time. PMA Capital's primary sources of liquidity are dividends
from subsidiaries, net tax payments received from subsidiaries and borrowings.
The Company paid interest of $19.8 million, $16.6 million and $15.1 million
in 1997, 1996 and 1995, respectively. The Company made scheduled debt
repayments in 1997, 1996 and 1995 of $7.3 million, $25.1 million and $125.1
million, respectively, and paid dividends to shareholders of $8.0 million in
1997 and $7.9 million in 1996 and 1995. PMA Capital also made cash capital
contributions to its subsidiaries totaling $11.0 million, $50.0 million and
$61.0 million in 1997, 1996 and 1995, respectively. In 1995, PMA Capital also
utilized cash to settle intercompany balances with its domestic insurance
subsidiaries.
Dividends from subsidiaries were $22.5 million, $53.6 million and $103.2
million in 1997, 1996 and 1995, respectively. Net tax cash flows were $20.0
million, $12.0 million and $11.4 million in 1997, 1996 and 1995, respectively.
In addition to dividends and tax payments from subsidiaries, the Company
utilized the following sources to generate liquidity for the above needs.
During the first quarter of 1997, the Company made debt repayments of $8.0
million on the revolving credit agreement before refinancing all of its credit
agreements not already maturing in 1997 with the Revolving Credit Facility.
See "Capital Resources." During 1996, the Company financed scheduled
repayments on its senior note facilities of $25.0 million through drawdowns on
its revolving credit agreement. In 1995, the Company repaid its expiring
revolving credit agreement by issuing $107.0 million of 7.62% privately placed
senior notes. In addition, in 1995, the Company funded the scheduled debt
repayments on its existing senior notes by drawing down $18.0 million on a new
$50.0 million revolving credit agreement with a banking syndicate. At December
31, 1997, the Company had $32.0 million available on the Revolving Credit
Facility. In addition to the Revolving Credit Facility, the Company maintains
a committed facility of $50 million for letters of credit. The Letter of
Credit Facility is utilized primarily for securing reinsurance obligations of
the Company's insurance subsidiaries. As of December 31, 1997, the Company had
$46.9 million outstanding in letters of credit under the Letter of Credit
Facility.
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<PAGE>
The Company's domestic insurance subsidiaries' ability to pay dividends to
the Company is limited by the insurance laws and regulations of Pennsylvania.
Under such laws and regulations, dividends may not be paid without prior
approval of the Pennsylvania Insurance Commissioner in excess of the greater
of (i) 10% of surplus as regards policyholders as of the end of the preceding
year or (ii) SAP net income for the preceding year, but in no event to exceed
unassigned funds.
Under this standard, the Pooled Companies and PMA Reinsurance Corporation
can pay an aggregate of $48.7 million of dividends during 1998 without the
prior approval of the Pennsylvania Insurance Commissioner. As a subsidiary of
PMA Reinsurance Corporation, Caliber One Indemnity Company's dividends are not
directly available to PMA Capital. The Delaware insurance law provisions
restricting dividends by insurers are substantially similar to such provisions
under Pennsylvania insurance laws. During 1998, Caliber One Indemnity Company
may pay up to $2.5 million of dividends to PMA Reinsurance Corporation without
prior approval of the Delaware Insurance Commissioner. During 1998, no
dividends have been declared or paid by Caliber One Indemnity Company. Under
its plan of operation filed with the Pennsylvania Insurance Department, MASCCO
must maintain a ratio of unpaid losses and LAE to surplus of no more than
eight to one; as of December 31, 1997, MASCCO was in compliance with such
requirement. The Revolving Credit Facility also contains limitations on the
ability of the Company's insurance subsidiaries to pay dividends. The
Revolving Credit Facility requires the Company's insurance subsidiaries to
maintain combined statutory capital and surplus of not less than $450.0
million. At December 31, 1997, the Company's insurance subsidiaries had
combined statutory capital and surplus of $552.2 million. In addition, the
Revolving Credit Facility requires that the Pooled Companies maintain an
adjusted surplus to authorized control level ratio, as calculated under risk-
based capital rules, of not less than 220% as of December 31, 1997, 230% as of
December 31, 1998 and 240% as of December 31, 1999 and thereafter, and
requires that PMA Reinsurance Corporation maintain such ratio at 300%. At
December 31, 1997, the ratios of the Pooled Companies ranged from 293% to
324%, PMA Reinsurance Corporation's ratio was 355% and Caliber One Indemnity
Company's ratio was 1,922%.
In December 1997, PMA Reinsurance Corporation acquired 100% of the
outstanding common stock of Caliber One Indemnity Company (formerly known as
Lincoln Insurance Company) for approximately $16.0 million and made a capital
contribution of $11.3 million to Caliber One Indemnity Company. Immediately
prior to and in conjunction with this purchase, all of Caliber One Indemnity
Company's acquired loss reserves were reinsured by an affiliate of Caliber One
Indemnity Company's former parent for adverse development and uncollectible
reinsurance in the amount of the stated reserves plus $68.5 million. See Note
1 to the Consolidated Financial Statements and "Business--Loss Reserves."
Management believes that the reinsurance obtained as part of the purchase will
be adequate to cover any future adverse reserve development or uncollectible
reinsurance on the acquired reserves. PMA Re intends to maintain Caliber One
Indemnity Company's surplus at not less than $25.0 million, the minimum
capital and surplus required by many states in order to be an eligible surplus
lines carrier.
PMA Capital's dividends to shareholders are restricted by its debt
agreements. Based upon the terms of the Revolving Credit Facility, on a pro
forma basis, under the most restrictive debt covenant, PMA Capital would be
able to pay dividends of approximately $14.5 million in 1998. See "Liquidity
and Capital Resources--Capital Resources."
Management believes that the Company's sources of funds will provide
sufficient liquidity to meet short-term and long-term obligations.
Capital Resources
The Company's total assets decreased to $3,057.3 million at December 31,
1997 from $3,117.5 million at December 31, 1996. Total investments decreased
$66.6 million to $2,194.7 million at December 31, 1997. The decrease in
investments is primarily attributable to the Property and Casualty
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<PAGE>
Group's pay- down of loss reserves from prior accident years as part of the
formal commutation program that was initiated in the fourth quarter of 1996
and continued into late 1997. All other assets increased $6.4 million in 1997,
mainly due to increases in reinsurance recoverables of $74.4 million and cash
of $25.0 million. The reinsurance recoverables increase primarily relates to
the purchase of Caliber One Indemnity Company during 1997 and the PMA Life
transaction, which included approximately $32.7 million and $15.4 million,
respectively, of ceded loss reserves. The increase in cash relates to
investment security purchases that did not settle until January 1, 1998,
causing a large cash balance at year-end. The above asset increases were
partially offset by a $33.6 million decrease in uncollected premiums primarily
related to the reduction in accrued retrospective premiums by the Property and
Casualty Group, a $31.2 million decrease in deferred income taxes and a $12.2
million decrease in fixed assets primarily related to the disposal of certain
corporate properties during the third quarter of 1997. No material gain or
loss was recorded in connection with the disposal of such properties.
The Company's deferred income tax asset decreased to $70.4 million at
December 31, 1997 from $101.6 million at December 31, 1996. The $31.2 million
decrease from 1996 to 1997 resulted primarily from the $23.5 million charge
related to the fair value of Company's investments that is recorded as a
component of the deferred tax asset. The net deferred tax asset of $70.4
million reflects management's estimate of the amounts that the Company expects
to recover in future years primarily through the utilization of net operating
losses and AMT credit carryforwards. Under SFAS No. 109, a valuation allowance
should be provided to offset the effects of a deferred tax asset if management
believes that it is more likely than not that the benefit of a deferred tax
item will not be realized. Management believes that the benefit of the
Company's deferred tax asset will be fully realized, and therefore has not
provided for a valuation allowance. At December 31, 1997, the Company had
approximately $109.6 million of net operating carryforwards (expiring in
2011), approximately $7.5 million of AMT credit carryforwards (which do not
expire) and approximately $188,000 of general business credit carryforwards
(expiring in 2010 and 2011).
Unpaid losses and LAE decreased $87.9 million to $2,003.2 million at
December 31, 1997. This decrease reflects the Property and Casualty Group's
pay-down of loss reserves from prior accident years as part of the formal
commutation program which was initiated in the fourth quarter of 1996 and
continued into late 1997, partially offset by loss reserves acquired in
connection with the purchase of Caliber One Indemnity Company.
Estimating future claims costs is necessarily a complex and judgmental
process inasmuch as reserve amounts are based on management's informed
estimates and judgments using data currently available. As such, management
reviews a variety of information, and uses a number of actuarial methods
applied to historical claims data, which often produces a range of possible
results. As additional experience and other data are reviewed, these estimates
and judgments are revised, at which point reserves may be increased or
decreased accordingly. Such increases or decreases are reflected in operating
results for the time period in which the adjustments are made. While the
estimate for unpaid losses and LAE is subject to many uncertainties,
management believes that it has made adequate provision for the Company's
claims liabilities. However, if actual losses exceed the amounts recorded in
the Company's financial statements, the Company's financial condition and
results of operations could be adversely affected.
At December 31, 1997, the Company's loss reserves were stated net of $59.9
million of salvage and subrogation. $50.8 million of salvage and subrogation
related to the Property and Casualty Group, $46.0 million of which related to
workers' compensation and $4.8 million related to Commercial Lines. The
anticipated salvage and subrogation was $9.1 million for PMA Re. Incurred
salvage and subrogation (increased) reduced losses and LAE by ($18.5) million,
($0.6) million and $9.5 million in 1997, 1996 and 1995, respectively. The
Company's policy with respect to estimating the amounts and realizability of
salvage and subrogation is to develop accident year schedules of historic paid
salvage and subrogation by line of business, which are then projected to an
ultimate basis using actuarial projection techniques. The anticipated salvage
and subrogation is the estimated ultimate salvage and
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<PAGE>
subrogation less any amounts received by the Company. The realizability of
anticipated salvage and subrogation is reflected in the historical data that
is used to complete the projection, as historic paid data implicitly considers
realization and collectibility.
The Company actively manages its exposure to catastrophic events. In the
underwriting process, the Company generally minimizes the writing of insurable
values in catastrophe prone regions. Also, in writing property reinsurance
coverages, PMA Re typically requires per occurrence loss limitations for
contracts that could have catastrophe exposure. Through per risk reinsurance,
the Company also manages its net retention in each exposure. In addition, PMA
Re maintains retrocessional protection of $46.0 million excess of $2.0 million
per occurrence, and the Property and Casualty Group maintains catastrophe
reinsurance protection of $27.7 million excess of $850,000. As a result, the
Company's loss ratios have not been significantly impacted by catastrophes,
and management believes that the Company has adequate reinsurance to protect
against the estimated probable maximum gross loss from a catastrophic event;
however, although management believes it is unlikely, an especially severe
catastrophic event could exceed the Company's reinsurance and retrocessional
protection, and materially adversely impact the Company's financial position.
The Company also maintains reinsurance and retrocessional protection for
other lines of business at December 31, 1997 as follows:
<TABLE>
<CAPTION>
RETENTION LIMITS
------------ --------------
<S> <C> <C>
The Property and Casualty Group:
Per Occurrence:
Workers' compensation.................... $1.5 million $103.5 million
Per Risk:
Property lines........................... $0.5 million(1) $ 19.5 million
Auto physical damage..................... $0.5 million $ 2.0 million
Other casualty lines..................... $0.2 million(2) $ 4.8 million
PMA Re:......................................
Per Occurrence:
Casualty lines........................... $2.8 million $ 12.5 million
Workers' compensation.................... $2.0 million $ 53.0 million
Property lines........................... $2.0 million $ 48.0 million
Per Risk:
Property lines........................... $0.8 million $ 4.2 million
Casualty lines........................... $1.5 million $ 6.0 million
</TABLE>
- --------
(1) This coverage also provides protection of $48.5 million per occurrence
over its combined net retention of $0.5 million.
(2) This coverage also provides protection of $49.8 million per occurrence
over its combined net retention of $0.2 million.
PMA Re also maintains aggregate protection up to $22.3 million in excess of
$178.0 million for the current accident year. Effective January 1, 1998, PMA
Re added a new workers' compensation program which includes coverage of $98.0
million excess of $2.0 million per occurrence, $98.5 million excess of $1.5
million per program per occurrence and $18.5 million excess of $1.5 million
per person per occurrence.
The Company performs extensive credit reviews on its reinsurers, focusing
on, among other things, financial capacity, stability, trends and commitment
to the reinsurance business. Prospective and existing reinsurers failing to
meet the Company's standards are excluded from the Company's reinsurance
programs. In addition, the Company requires letters of credit to support
balances due from reinsurers not authorized to transact business in the
applicable jurisdictions.
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<PAGE>
At December 31, 1997, the Company had reinsurance recoverables due from the
following unaffiliated single reinsurers in excess of 3% of shareholders'
equity:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
GROSS AMOUNT A.M. BEST
DUE TO THE COMPANY RATING
------------------ ---------
<S> <C> <C>
United States Fidelity and Guaranty Company... $74,041 A
Essex Insurance Company....................... $36,807 A
American Re-Insurance Corporation............. $35,411 A+
Kemper Reinsurance Corporation................ $21,853 A
London Life International Reinsurance
Corporation.................................. $16,212 A+
Continental Casualty Company.................. $15,209 A
</TABLE>
The Company maintained funds held to collateralize the above balances in the
amount of $66.2 million at December 31, 1997. The Company believes that it
would have the right to offset the funds withheld from a reinsurer against the
balances due from such reinsurer in the event of insolvency. Funds held under
reinsurance treaties decreased $17.3 million in 1997, primarily due to the
commutation of a prior underwriting year for one of the reinsurance covers at
the Property and Casualty Group as well as one of the retrocessional covers at
PMA Re, partially offset by retrocessional activity at PMA Re for the current
underwriting year.
Long-term debt remained essentially constant between 1997 and 1996. As noted
previously, the Company refinanced its existing credit agreements on March 14,
1997 under the Revolving Credit Facility, replacing the following debt that
was outstanding at that time:
<TABLE>
<CAPTION>
(DOLLAR AMOUNTS IN THOUSANDS)
<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
--------
Total................... $189,428
========
</TABLE>
The early extinguishment of the senior note agreements resulted in an
extraordinary loss of $4.7 million ($7.3 million pre-tax) which was recorded
in the first quarter of 1997. The Revolving Credit Facility bears interest at
LIBOR plus 0.70% on the utilized portion and carries a 0.275% facility fee on
the unutilized portion. The margin over LIBOR is adjustable downward based
upon future reductions in the Company's debt to capitalization ratio. As of
December 31, 1997, the interest rate on the Revolving Credit Facility was
6.61% on the utilized portion. The final expiration of the Revolving Credit
Facility will be December 31, 2002, maturing in an installment of $15.5
million in 1999 and annual installments of $62.5 million commencing in 2000
through 2002. The Company also entered into an interest rate swap agreement
that manages the impact of the potential volatility of the interest rate
associated with the floating rates on the Revolving Credit Facility. The
interest rate swap covers a notional principal amount of $150.0 million and
effectively converts the floating rate on such portion of the Revolving Credit
Facility to a fixed 7.24%.
Other liabilities, including taxes, licenses and fees, decreased $9.1
million in 1997 to $81.5 million compared to 1996 primarily due to lower
operating expenses at the Property and Casualty Group during 1997.
Consolidated shareholders' equity at December 31, 1997 totaled $478.3
million, or $19.96 per share, compared to $425.8 million, or $17.86 per share,
at December 31, 1996. As a result of changes in market interest rates, the
unrealized appreciation of investments, net of tax, was $18.8 million at
December 31, 1997 compared to an unrealized depreciation of investments, net
of tax, of $24.9 million at December 31, 1996, resulting in an increase in
shareholders' equity of $43.7 million, or $1.82 per share. Consolidated
shareholders' equity decreased to $425.8 million, or $17.86 per share, at
December 31, 1996, from
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<PAGE>
$609.7 million, or $25.53 per share, at December 31, 1995. This decrease was
due primarily to the net loss of $135.3 million in 1996, a decrease in
shareholders' equity of $42.4 million, net of tax, or $1.78 per share, related
to unrealized depreciation of investments and dividends declared of $7.9
million.
At December 31, 1997, the Company's capital structure consisted of $203.0
million of long-term debt and $478.3 million of shareholders' equity. The
Company utilizes long-term debt in its capital structure to fund internal
expansion through capital contributions to subsidiaries, to pursue investment
opportunities and to refinance existing debt. Due to the inherent risks
associated with the insurance industry, management strives to maintain a
relatively conservative capital structure. Management believes that a certain
amount of debt is necessary in order to enhance returns on shareholders'
equity; however, the level of debt must be appropriate in terms of the
availability of dividends from subsidiaries, operating income and the overall
capital structure. In determining the appropriate level of long-term debt,
management focuses on the following statistics: statutory dividends to
interest expense, earnings (loss) before interest and taxes to interest
expense, pre-tax operating income (loss) before interest to interest expenses
and debt to capitalization ratio. The following table indicates the Company's
status with respect to these statistics:
<TABLE>
<CAPTION>
1997 1996 1995
---- ----- ----
<S> <C> <C> <C>
Statutory dividends to interest expense (times)...... 1.4 3.1 3.8
Earnings (loss) before interest and taxes to interest
expense (times)..................................... 2.6 (10.2)(1) 2.9
Pre-tax operating income (loss) before interest to
interest expense (times)............................ 2.0 (10.4)(1) 1.2
Debt to total capitalization (excluding SFAS No. 115
adjustment)......................................... 30.6% 31.2% 25.6%
</TABLE>
- --------
(1) Relates to the loss before interest and taxes and the pre-tax operating
loss of $191.4 million and $194.4 million, respectively, in 1996.
INVESTMENTS
The Company's investment policy objectives are to (i) seek competitive
after-tax income and total return, (ii) maintain very high-grade asset quality
and marketability, (iii) maintain maturity distribution commensurate with the
Company's business objectives, (iv) provide portfolio flexibility for changing
business and investment climates and (v) provide liquidity to meet operating
objectives. The Company has established strategies, asset quality standards,
asset allocations and other relevant criteria for its fixed maturity and
equity portfolios. In addition, maturities are structured after projecting
liability cash flows with actuarial models. The Company also does not invest
in various types of investments, including speculative derivatives. The
Company's portfolio does not contain any significant concentrations in single
issuers (other than U.S. Treasury and agency obligations), industry segments
or geographic regions.
The Company's Board of Directors is responsible for the Company's investment
policy objectives. The Company retains outside investment advisers to provide
investment advice and guidance, supervise the Company's portfolio and arrange
securities transactions through brokers and dealers. The Executive and Finance
Committees of the Company's Board of Directors meet periodically with the
investment advisers to review the performance of the investment portfolio and
to determine what actions should be taken with respect to the Company's
investments. Investments by the Pooled Companies, MASCCO and PMA Re must
comply with the insurance laws and regulations of the Commonwealth of
Pennsylvania and investments for Caliber One Indemnity Company must comply
with the insurance laws and regulations of the State of Delaware. The
Company's capital not allocated to the Pooled Companies, MASCCO, PMA Re and
Caliber One Indemnity Company may be invested in securities and other
investments that are not subject to such insurance laws, but nonetheless
conform to the Company's investment policy.
75
<PAGE>
The following table summarizes the Company's investments by carrying value
as of September 30, 1998 and as of December 31, 1997 and 1996:
(DOLLAR AMOUNTS IN MILLIONS)
<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, ---------------------------------
1998 1997 1996
---------------- ---------------- ----------------
CARRYING CARRYING CARRYING
VALUE(1) PERCENT VALUE(1) PERCENT VALUE(1) PERCENT
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
INVESTMENT
U.S. Treasury securities
and obligations of U.S.
Government agencies....... $ 962.6 48.9% $1,119.5 51.0% $1,602.8 70.8%
Obligations of states and
political subdivisions.... 13.8 0.7% -- -- 76.5 3.4%
Corporate debt securities.. 673.7 34.3% 687.7 31.3% 372.8 16.5%
Mortgage backed
securities................ 225.9 11.5% 122.3 5.6% 74.0 3.3%
Equity securities.......... -- -- -- -- 0.3 --
Short-term investments..... 91.3 4.6% 265.2 12.1% 135.0 6.0%
-------- ----- -------- ----- -------- -----
Total...................... $1,967.3 100.0% $2,194.7 100.0% $2,261.4 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
- --------
(1) Carrying value is equal to market value.
The Company has no investments which are not dollar denominated as of
September 30, 1998.
The following table indicates the composition of the Company's fixed
maturities portfolio at carrying value, excluding short-term investments, by
rating as of September 30, 1998 and as of December 31, 1997 and 1996:
(DOLLAR AMOUNTS IN MILLIONS)
<TABLE>
<CAPTION>
DECEMBER 31,
SEPTEMBER 30, ---------------------------------
1998 1997 1996
---------------- ---------------- ----------------
CARRYING CARRYING CARRYING
VALUE(2) PERCENT VALUE(2) PERCENT VALUE(2) PERCENT
-------- ------- -------- ------- -------- -------
<S> <C> <C> <C> <C> <C> <C>
RATINGS(1)
U.S. Treasury securities
and AAA................... $1,412.8 75.3% $1,449.0 75.1% $1,882.4 88.5%
AA......................... 116.2 6.2% 150.0 7.8% 95.8 4.5%
A.......................... 247.0 13.2% 282.2 14.6% 147.9 7.0%
BBB........................ 100.0 5.3% 48.3 2.5% -- --
-------- ----- -------- ----- -------- -----
Total...................... $1,876.0 100.0% $1,929.5 100.0% $2,126.1 100.0%
======== ===== ======== ===== ======== =====
</TABLE>
- --------
(1) Ratings as assigned by Standard & Poor's. Such ratings are generally
assigned at the time of the issuance of the securities, subject to
revision on the basis of ongoing evaluations.
(2) Carrying value is equal to market value.
76
<PAGE>
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 September 30, 1998. Expected maturities will
differ from contractual maturities because the issuers may have the right to
call or prepay obligations with or without call or prepayment penalties:
(DOLLAR AMOUNTS IN MILLIONS)
<TABLE>
<CAPTION>
CARRYING VALUE(1) PERCENT
----------------- -------
<S> <C> <C>
1 year or less..................................... $ 268.0 14.3%
Over 1 year through 5 years........................ 489.5 26.1%
Over 5 years through 10 years...................... 228.6 12.2%
Over 10 years through 20 years..................... 132.9 7.1%
Over 20 years...................................... 531.1 28.3%
Mortgage backed securities......................... 225.9 12.0%
-------- -----
Total.............................................. $1,876.0 100.0%
======== =====
</TABLE>
- --------
(1) Carrying value is equal to market value.
The following table reflects the Company's investment results for the nine
months ended September 30, 1998 and for each year in the three-year period
ended December 31, 1997:
(DOLLAR AMOUNTS IN MILLIONS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED YEAR ENDED DECEMBER 31,
SEPTEMBER 30, ----------------------------
1998 1997 1996 1995
------------- -------- -------- --------
<S> <C> <C> <C> <C>
Average invested assets(1)......... $2,081.0 $2,247.7 $2,366.8 $2,395.8
Net investment income(2)........... $ 94.4 $ 136.7 $ 133.9 $ 139.4
Net effective yield(3)............. 6.05% 6.09% 5.66% 5.82%
Net realized investment gains(4)... $ 15.4 $ 8.6 $ 3.0 $ 31.9
</TABLE>
- --------
(1) Average of beginning and ending amounts of cash and investments for the
period at carrying value (market value).
(2) After investment expenses, excluding net realized investment gains.
(3) Net investment income for the period divided by average invested assets
for the same period. The net effective yield for the nine months ended
September 30, 1998 has been annualized.
(4) Excludes loss on sale of PMA Cayman of $2.4 million. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
As of September 30, 1998 and December 31, 1997, the effective duration of
the Company's investments was approximately 5.1 years and 5.3 years,
respectively, and the effective duration of its liabilities was approximately
5.1 years at both dates.
During 1997, the Company established a securities lending program through
which securities are loaned from the Company's portfolio to qualifying third
parties, subject to certain limits, via a lending agent for short periods of
time. Borrowers of these securities must provide collateral equal to a minimum
of 102% of the market value and accrued interest of the loaned securities.
Acceptable collateral may be in the form of either cash or securities. Cash
received as collateral is invested in short-term investments, and all
securities received as collateral are of similar quality to those securities
lent by the Company. In addition, the Company limits securities lending to 40%
of statutory admitted assets of its insurance subsidiaries, with a 2% limit on
statutory admitted assets to any individual borrower. The Company receives
either a fee from the borrower or retains a portion of the income earned on
the collateral. Under the terms of the securities lending program, the Company
is
77
<PAGE>
indemnified against borrower default, with the lending agent responsible to
the Company for any deficiency between the cost of replacing a security that
was not returned and the amount of collateral held by the Company. In the nine
month period ended September 30, 1998 and the year ended December 31, 1997,
respectively, the Company recognized income from securities lending
transactions of approximately $684,000 and $524,000, net of lending fees,
which was included in investment income. The Company had approximately $516.2
million and $175.0 million, respectively, of securities on loan as of
September 30, 1998 and December 31, 1997.
78
<PAGE>
BUSINESS
COMPANY OVERVIEW
The Company is an insurance holding company, whose subsidiaries operate in
three distinct segments of the property and casualty insurance industry: (i)
reinsurance, through PMA Re, which commenced business in 1980; (ii) standard
commercial lines of insurance, with an emphasis on workers' compensation
through the Property and Casualty Group, which has been in business since 1915
and (iii) specialty insurance products, focusing on excess and surplus lines,
through the Company's recently-formed operation, Caliber One. PMA Re writes a
broad range of property and casualty reinsurance products with an emphasis on
risk-exposed casualty excess of loss reinsurance and operates in the United
States domestic brokered market. The Property and Casualty Group offers a full
range of workers' compensation products and services, as well as other
standard commercial lines, including commercial general liability, commercial
automobile and commercial multi-peril, primarily in nine contiguous
jurisdictions in the Mid- Atlantic and Southern regions of the United States,
utilizing the PMA Group trade name. In 1998, Caliber One commenced writing
excess and surplus lines of property and casualty insurance, including
commercial general liability, automobile and certain property exposures on a
non-admitted basis. For the nine months ended September 30, 1998, the
Company's net premiums written of $369.1 million were derived 46.7% from PMA
Re, 52.6% from the Property and Casualty Group and 0.7% from Caliber One. Net
income for the Company for the nine months ended September 30, 1998 and the
year ended December 31, 1997 was $32.0 million and $15.0 million,
respectively. As of September 30, 1998, the Company had total assets of
$3,131.9 million and shareholders' equity of $517.6 million.
The Company's insurance subsidiaries have the following ratings from A.M.
Best: PMA Reinsurance Corporation, A+ ("Superior"); the Pooled Companies, A-
("Excellent") and Caliber One Indemnity Company, A ("Excellent"). Management
believes that ratings from A.M. Best are material to its operations and that a
downgrade from the present rating classifications could have an adverse effect
on the Company's ability to market its products. A.M. Best's ratings are based
upon an assessment of an insurance company's perceived financial strength
regarding its ability to pay obligations to its policyholders and are not
directed toward the protection of investors.
After a period of rapid growth in the late 1980's, the Company's
consolidated total net premiums written declined from $552.0 million in 1992
to $418.3 million in 1997. Since 1993, PMA Re's premium volume expanded as a
result of the increased demand for reinsurance in the markets in which PMA Re
participates as well as trends towards ceding companies restricting the number
of reinsurers with which they will do business. PMA Re has also obtained
additional business as a result of a target marketing program commenced in
1996 as well as from business displaced in the recent consolidation of the
United States reinsurance industry. Those trends have facilitated PMA Re's
increased participation on reinsurance treaties with its existing clients, the
writing of additional layers and programs with existing clients, and to a
lesser extent, the addition of business from new ceding companies. During this
period, the market for the products written by the Property and Casualty Group
was very competitive. The Property and Casualty Group restricted its premium
volume, rather than write business at rates that were not commensurate with
the risks assumed, and introduced loss-sensitive coverages and large-
deductible programs, under which insureds pay less premium but bear a greater
portion of loss exposure. Beginning in 1992, premiums written were also
reduced as a result of the Property and Casualty Group's re- underwriting of
its book of business and, commencing in 1993, rate reductions associated with
workers' compensation benefit reform laws. Management believes that recent
initiatives undertaken and workers' compensation reforms enacted in recent
years, including the restructuring and the loss reserve strengthening of
$257.9 million in 1995 and 1996, afford the Property and Casualty Group an
opportunity to increase its core business, workers' compensation insurance, on
terms acceptable to it. See "The Property and Casualty Group--Background and
Recent Developments" below.
79
<PAGE>
In 1996, the Company restructured the Property and Casualty Group with the
goal of restoring its profitability after three years of operating losses. The
losses resulted primarily from unfavorable underwriting experience and adverse
reserve development related to accident years 1987 through 1991, when the
Property and Casualty Group wrote a much higher volume of business than its
current volume. The principal components of the restructuring were: (i)
strengthening loss reserves; (ii) initiating a commutation program to settle a
significant number of open claims from the 1987 to 1991 period; (iii)
designating PMA Cayman and MASCCO as separate run-off companies to alleviate
the SAP impact on the Pooled Companies of the loss reserve strengthening and
to manage the capital deployed in running off pre-1992 workers' compensation
claims; (iv) initiating an expense reduction program and (v) implementing
management changes, including the appointment of a new Chief Operating Officer
and the creation of the position of, and appointment of, a Chief Underwriting
Officer. Effective July 1, 1998, the Company sold PMA Cayman. Largely as a
result of the restructuring, the Property and Casualty Group recorded pre-tax
operating income of $8.4 million for the nine months ended September 30, 1998,
compared to pre-tax operating losses of $5.0 million for the nine months ended
September 30, 1997 and $3.7 million, $215.7 million (including restructuring
and other special charges of $223.1 million) and $3.9 million for the years
ended December 31, 1997, 1996 and 1995, respectively.
The composition of the Company's net premiums written for the nine months
ended September 30, 1998 and the year ended December 31, 1997 was as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED YEAR ENDED
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------- ------------------
NET NET
PREMIUMS % OF PREMIUMS % OF
WRITTEN TOTAL WRITTEN TOTAL
---------- ------- ---------- -------
<S> <C> <C> <C> <C>
PMA Re................................. $ 172,595 46.7% $ 177,934 42.5%
The Property and Casualty Group:
Workers' compensation................ 147,502 40.0% 175,301 41.9%
Other commercial lines............... 46,829 12.6% 65,047 15.6%
---------- ------- ---------- -------
Total.............................. 194,331 52.6% 240,348 57.5%
---------- ------- ---------- -------
Caliber One............................ 2,577 0.7% -- --
Eliminations........................... (369) -- -- --
---------- ------- ---------- -------
Total.................................. $ 369,134 100.0% $ 418,282 100.0%
========== ======= ========== =======
</TABLE>
PMA RE
BACKGROUND
According to data provided by the RAA, as of September 30, 1998, PMA
Reinsurance Corporation was the 23rd largest reinsurer in the United States in
terms of statutory capital and surplus and 18th largest in terms of net
premiums written. PMA Re writes a broad range of property and casualty
reinsurance products with an emphasis on risk-exposed casualty excess of loss
reinsurance within the United States domestic brokered market. Management
believes that PMA Re competes on the basis of its ability to offer prompt and
responsive service and specialized products to its clients and its excellent
long-term relationships in the broker and ceding company communities.
In the brokered reinsurance market, the products (reinsurance coverages) are
distributed to the ultimate customer (ceding companies) through reinsurance
intermediaries, known as brokers. In exchange for providing such distribution
services, the brokers are paid commissions, known as brokerage, which is
typically based upon a percentage of the premiums ceded under a particular
contract. The brokered reinsurance market differs from the direct reinsurance
market in which
80
<PAGE>
reinsurers maintain their own sales forces and distribute their products
directly to their ceding company clients.
During the five-year period ended December 31, 1997, PMA Re has expanded its
premium base without changing its underwriting standards. From 1992 to 1997,
PMA Re reported premium volume growth that exceeded that of the overall
reinsurance industry. During such period, PMA Re's compound annual growth rate
for net premiums written was 13.2%, while it is estimated that the reinsurance
industry's compound annual growth rate was 8.2% for the same period based upon
information published by the RAA. PMA Re's premium volume increases have
largely taken the form of increased participation levels on clients' existing
programs, as well as writing of additional layers and programs with current
clients. To a lesser extent, volume growth has been attributable to business
written with new ceding company clients. Management believes that the
expansion of PMA Re's premium base has been attributable to several factors.
First, PMA Re's volume was impacted by industry trends between 1992 and 1995
that tended to increase the demand for reinsurance. Specifically, much of the
growth that occurred in the primary insurance market in those years was
attributable to regional and niche companies. Typically, these companies
demand more reinsurance than their larger counterparts. Second, management
believes that PMA Re has benefited from the greater selectivity of ceding
companies that have restricted the number of reinsurers with which they will
transact business. In addition, commencing in 1996, PMA Re initiated a target
marketing program, under which certain existing accounts and new accounts
identified as having certain desirable characteristics (such as quality
management and underwriting) were pursued for additional or new business.
Finally, PMA Re has been able to write business for customers that was
formerly written by reinsurers in the brokered market that have been acquired
by other reinsurers. These factors have more than offset the recent trends in
1996 and 1997 of ceding companies retaining more of their business and highly
competitive conditions, which caused PMA Re to non-renew certain accounts
amounting to $66.9 million of in-force premium in the 21 months ended
September 30, 1998 and not accept certain new business opportunities for
underwriting or pricing reasons.
REINSURANCE PRODUCTS
The following table indicates PMA Re's gross and net premiums written by
major category of business for the periods indicated:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
----------------- ---------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Gross premiums
written(1)
Casualty............... $152,465 $117,620 $151,901 $143,991 $128,736 $107,001 $ 94,482
Property............... 58,379 58,705 72,625 63,325 63,693 36,592 28,217
Other.................. 809 707 795 842 (63) 837 1,854
-------- -------- -------- -------- -------- -------- --------
Total.................. $211,653 $177,032 $225,321 $208,158 $192,366 $144,430 $124,553
======== ======== ======== ======== ======== ======== ========
Net premiums written(2)
Casualty............... $124,457 $ 93,862 $118,889 $122,008 $107,383 $ 88,585 $ 82,016
Property............... 47,365 46,760 58,257 41,240 45,440 23,929 18,407
Other.................. 773 676 788 805 (63) 837 1,854
-------- -------- -------- -------- -------- -------- --------
Total................... $172,595 $141,298 $177,934 $164,053 $152,760 $113,351 $102,277
======== ======== ======== ======== ======== ======== ========
</TABLE>
- --------
(1) For the nine months ended September 30, 1998, gross premiums written
include $4.9 million of facultative reinsurance comprised of $2.1 million
of property and $2.8 million of casualty. For the nine months ended
September 30, 1997, gross premiums written include $4.3 million of
facultative reinsurance comprised of the following: property, $2.0
million, casualty, $2.2 million, and other lines, $100,000. For the years
ended December 31, 1997 and 1996, gross premiums
81
<PAGE>
written include $5.8 million and $3.5 million of facultative reinsurance,
respectively, comprised of the following: property, $2.4 million and $1.1
million, respectively; casualty, $3.4 million and $2.3 million,
respectively, and other lines, $100,000 in 1996.
(2) For the nine months ended September 30, 1998, net premiums written include
$1.8 million of facultative reinsurance comprised of $1.2 million of
property and $600,000 of casualty. For the nine months ended September 30,
1997, net premiums written include $1.8 million of facultative reinsurance
comprised of the following: Property, $1.3 million, casualty $500,000, and
other lines, less than $100,000. In 1997 and 1996, net premiums written
include $2.5 million and $1.0 million of facultative reinsurance,
respectively, comprised of the following: property, $1.7 million and
$500,000, respectively; casualty, $800,000 and $500,000, respectively, and
other lines, less than $0.1 million in 1997 and 1996.
CASUALTY BUSINESS
Casualty business accounted for 72.1% and 66.4% of net premiums written for
the nine months ended September 30, 1998 and the year ended December 31, 1997,
respectively. In the five-year period ended December 31, 1997, casualty
business has increased at a compound annual growth rate of 7.2%. The following
table indicates the mix of casualty business by class on the basis of net
premiums written:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
------------------ ------------------------------------------
1998 1997 1997 1996 1995 1994 1993
--------- -------- -------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
Umbrella................ $ 20,263 $ 28,257 $ 30,967 $ 40,307 $ 51,558 $38,743 $34,189
Errors and Omissions.... 18,810 13,342 13,813 19,866 7,149 7,281 4,033
General Liability....... 15,325 10,945 15,174 11,702 7,460 8,936 8,665
Medical Malpractice..... 9,890 6,204 7,373 7,411 6,835 6,355 6,657
Directors' and
Officers'.............. 5,855 4,827 5,897 6,210 4,586 4,156 1,815
Miscellaneous
Liability.............. 24,556 8,166 16,431 12,811 10,350 6,006 3,690
Auto Liability.......... 23,031 15,910 22,268 17,056 13,032 10,134 12,616
Workers' Compensation... 6,727 6,211 6,966 6,645 6,412 6,974 10,351
--------- -------- -------- -------- -------- ------- -------
Total................... $ 124,457 $ 93,862 $118,889 $122,008 $107,382 $88,585 $82,016
========= ======== ======== ======== ======== ======= =======
</TABLE>
Due to the competitive conditions in the casualty market, management has
maintained a relatively conservative growth posture for casualty business in
the five-year period. PMA Re has generally focused on other liability
coverages (which include general liability, products liability, professional
liability and other more specialized liability coverages), while maintaining a
relatively stable level of auto liability premiums and de-emphasizing workers'
compensation coverages. In 1998, casualty premiums increased primarily as a
result of the addition of certain large general liability and auto liability
programs. The decrease in 1997 casualty net premiums was primarily
attributable to increased retrocessional protection purchased which offset
increases in gross casualty premiums relating to new business with existing
clients and larger lines taken on existing programs. In 1998, 1997, 1996 and
1995, PMA Re decreased the amount of its excess and umbrella business as rates
and terms for this type of business were no longer as attractive as they had
been. Much of the growth in 1995 and 1996 related to the expansion and
addition of several programs covering specialty business (which includes
professional liability, directors' and officers' liability, environmental
impairment liability, employment practices liability and other miscellaneous
specialized coverages). Such specialty business now accounts for approximately
53.1% of in-force casualty treaty business. In 1994, the growth in other
liability was primarily attributable to excess and umbrella business as PMA Re
added several significant programs.
PROPERTY BUSINESS
Property business accounted for 27.4% and 33.1% of net premiums written for
the nine months ended September 30, 1998 and the year ended December 31, 1997,
respectively. In the five-year
82
<PAGE>
period ended December 31, 1997, property business has increased at a compound
annual growth rate of 40.4%. The increases in net property premiums written
have been primarily the result of additional property underwriting expertise
that PMA Re added to its underwriting staff in late 1996 to broaden its
product offerings. Such expertise enabled PMA Re to increase cross-selling
opportunities with its existing treaty reinsurance clients by offering
additional and expanded property coverages. In addition, property premiums
ceded decreased primarily related to changes in PMA Re's property
retrocessional coverages in terms of premiums and ceding commissions. The
decrease in net premiums written in 1996 was primarily attributable to higher
ceding company retentions, competitive pricing conditions and higher ceded
property premiums. The growth in net property business in 1995 and 1994 of
89.9% and 30.0%, respectively, was attributable to the expansion of several
programs covering auto physical damage, inland marine risks and certain
specialty property coverages written on a surplus lines basis.
PMA Re has generally de-emphasized catastrophe coverages. As of September
30, 1998 and December 31, 1997, catastrophe business accounted for
approximately 4.0% of property premiums in force. The property programs
written by PMA Re generally contain per occurrence limits or are not
considered significantly catastrophe exposed, either because of the locations
of the insured values or the nature of the underlying properties insured.
However, as is common in property reinsurance, PMA Re is exposed to the
possibility of loss from catastrophic events due to the aggregation of per
occurrence limits and similar issues. PMA Re actively manages this exposure
through aggregate management, minimizing writings of catastrophe business and
retrocessional protection. As of September 30, 1998, PMA Re maintained
catastrophe retrocessional protection of $48 million excess of $2 million.
Management believes that PMA Re's catastrophe retrocessional coverage is
adequate to protect PMA Re against its probable maximum loss from a
significant catastrophe; however, an especially severe catastrophic event
could exceed PMA Re's retrocessional protection and materially and adversely
affect the Company's financial position and results of operations. See "Risk
Factors--Certain Risks Affecting the Property and Casualty Industry,"
"Underwriting" and "The Company's Reinsurance Ceded."
FACULTATIVE REINSURANCE
Facultative reinsurance is a form of reinsurance coverage that is placed on
a risk-by-risk basis, and the reinsurer retains the right to accept or reject
each individual risk submitted by the ceding company.
Facultative reinsurance differs from treaty reinsurance in that treaty
reinsurance typically covers multiple risks within a particular
classification, the reinsurer does not retain the right to accept or reject
individual risks as long as such risks conform to the contract stipulations,
and the ceding company is obligated to cede the risks to the reinsurer.
Companies typically purchase facultative reinsurance for several reasons,
including to (i) cover unusual risks; (ii) cover high hazard risks; (iii)
protect a ceding company's net retention and treaty reinsurers; (iv) obtain
additional capacity beyond that provided by a company's treaty reinsurers; (v)
cover risks excluded under a company's treaties and (vi) cover risks under a
company's new line of business.
There are some facultative products that are variations of the above general
concept, such as automatic and semi-automatic facultative contracts. Under
automatic facultative arrangements (sometimes known as facultative obligatory
treaties), the cession is not obligatory from the ceding company's point of
view, but the acceptance of the risk is automatic from the reinsurer's
standpoint. For semi-automatic facultative contracts, the cession is not
obligatory, but the acceptance of the risk is obligatory, unless the risk
falls outside certain stipulated criteria. If the risk falls outside such
criteria, the reinsurer has the option of either: (i) accepting the risk, (ii)
declining the risk or (iii) repricing the risk.
For the nine months ended September 30, 1998, PMA Re recorded $1.8 million
of net facultative reinsurance premiums that represented 1.1% of total net
premiums written. For the year ended
83
<PAGE>
December 31, 1997, PMA Re recorded $2.5 million of net facultative reinsurance
premiums which represented 1.4% of total net premiums written for the year,
compared to $1.0 million, or 0.6%, for the year ended December 31, 1996. PMA
Re offers facultative products as a complement to existing treaty business, as
well as offering such products to companies with whom PMA Re does not
presently have a relationship. The products offered include traditional
facultative certificates and automatic or semi-automatic programs for both
property and casualty exposures.
MARKETING AND DISTRIBUTION
PMA Re operates primarily through the domestic brokered reinsurance market
in which it has developed relationships with major reinsurance brokers
enabling it to gain access to a wide range of ceding companies with varying
reinsurance and related service needs. Brokers that accounted for more than 7%
of PMA Re's gross premiums in force for the periods indicated were as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED FOR YEAR ENDED
SEPTEMBER 30, 1998 DECEMBER 31, 1997
------------------- -------------------
GROSS GROSS
PREMIUMS PERCENTAGE PREMIUMS PERCENTAGE
IN FORCE OF TOTAL IN FORCE OF TOTAL
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
Aon Reinsurance......................... $100,100 34.3% $99,151 35.7%
Guy Carpenter & Company................. 95,603 32.7% 64,803 23.3%
E. W. Blanch............................ 41,593 14.2% 38,267 13.8%
Sedgwick Payne Company(1)............... -- -- % 27,322 9.8%
Towers Perrin Re........................ 29,936 10.3% 22,669 8.2%
</TABLE>
- --------
(1) For 1998, Sedgwick Payne Company's gross premiums in-force were included
with Guy Carpenter & Company's gross premiums in-force due to the
acquisition of Sedgwick Group plc by Marsh & McLennan Companies, the
parent of Guy Carpenter & Company, in 1998.
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 September 30, 1998, PMA Re had approximately 221 clients, with no
individual client accounting for more than 6.6% of gross premiums in force .
UNDERWRITING
In reinsurance, underwriting involves the selection of risks and determining
whether the market pricing is adequate given expected losses and estimated
volatility of such losses. Given the present soft-pricing environment,
maintaining underwriting discipline is more difficult and more critical to the
maintenance of acceptable results of operations. PMA Re's underwriting
management averages 21 years of experience in the property and casualty
industry.
PMA Re's underwriting process has two principal aspects: underwriting the
specific program to be reinsured and underwriting the ceding company.
Underwriting the specific program to be reinsured involves, in addition to
pricing, a review of the type of program, the total risk and the ceding
company's policy forms. Underwriting the ceding company involves an evaluation
of the expected future performance of the ceding company through an
examination of that company's management, financial strength, claims handling
and underwriting abilities. PMA Re generally conducts underwriting and claim
reviews at the offices of prospective ceding companies before entering into a
major treaty, as well as throughout the life of the reinsurance contract.
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<PAGE>
In underwriting excess-of-loss business, PMA Re has typically sought to
write treaties that are exposed to loss on a per occurrence basis within the
original policy limits of the ceding company. Management believes these layers
in general lend themselves more effectively to actuarial pricing techniques.
PMA Re's underwriters and actuaries work closely together to evaluate the
particular reinsurance program. Using the information provided by the broker,
the actuaries employ pricing models to estimate the ultimate exposure to the
treaty. The pricing models that are utilized employ various experience rating
and exposure rating techniques and are tailored in each case to the risk
exposures underlying each treaty. The underwriters then weigh the results of
the pricing models with the terms and conditions being offered to determine
PMA Re's selected price.
As noted above, PMA Re typically requires per occurrence limits for property
coverages and requires that the underlying insured values not be catastrophe
exposed. Also, PMA Re minimizes catastrophe reinsurance coverages and has
historically maintained sufficient retrocessional protection. Recent natural
catastrophes did not have a significant adverse impact on PMA Re's combined
ratio and earnings inasmuch as PMA Re has minimized assuming catastrophe
reinsurance business or catastrophe-exposed coverages and it has had
sufficient retrocessional arrangements.
The following table indicates PMA Re's gross, ceded and net losses from
recent catastrophes as of December 31, 1997:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
INDUSTRY
INCURRED PMA RE PMA RE PMA RE
CATASTROPHE YEAR LOSS(1) GROSS LOSS CEDED LOSS NET LOSS
- ----------- ---- ----------- ---------- ---------- --------
<S> <C> <C> <C> <C> <C>
Hurricane Hugo................. 1989 $ 4,200,000 $13,200 $11,400 $1,800
San Francisco Earthquake....... 1989 1,000,000 2,300 1,000 1,300
Oakland Fires.................. 1991 1,700,000 2,700 1,400 1,300
Hurricane Andrew............... 1992 15,500,000 22,800 20,700 2,100
Hurricane Iniki................ 1992 1,600,000 4,100 2,900 1,200
Northridge, CA Earthquake...... 1994 12,500,000 17,600 11,700 5,900
Hurricane Fran................. 1996 1,500,000 1,300 900 400
</TABLE>
- --------
(1) Source: Property Claims Services.
PMA Re has no significant obligations to its reinsurers as a result of the
above catastrophes.
CLAIMS ADMINISTRATION
PMA Re's claims department evaluates loss exposures, establishes individual
claim reserves, pays claims, provides claims-related services to PMA Re's
clients, audits the claims activities of current clients and assists in the
underwriting process by evaluating the claims departments of prospective
clients. PMA Re's claims department's evaluation of loss exposure includes
reviewing loss reports received from ceding companies to confirm that claims
are covered under the terms of the relevant reinsurance contract, establishing
reserves on an individual case basis and monitoring the adequacy of those
reserves. The claims department monitors the progress and ultimate outcome of
the claims to determine that subrogation, salvage and other cost recovery
opportunities have been adequately explored. The claims department performs
these functions in coordination with PMA Re's actuarial and underwriting
departments.
In addition to evaluating and adjusting claims, the claims department
conducts claims audits at the offices of prospective ceding companies.
Satisfactory audit results are required in order for reinsurance coverage to
be written by PMA Re. Also, the claims department conducts annual claims
audits for many current and former client ceding companies.
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Management believes that PMA Re has been at the forefront of several service
initiatives in the brokered reinsurance market, involving improved timeliness
of claims remittances, including fastrack claims and electronic data
interchange. Fastrack claims involve the pre-approval of payment of certain
claims provided the claims meet predetermined criteria and electronically
disbursing funds to the clients. Electronic data interchange involves the
electronic transmission of data associated with transactions between PMA Re
and the client.
THE PROPERTY AND CASUALTY GROUP
BACKGROUND
The Property and Casualty Group provides workers' compensation insurance,
other commercial property and casualty insurance coverages and related
services to entities located primarily in nine contiguous jurisdictions in the
Mid-Atlantic and Southern regions of the United States, utilizing the PMA
Group trade name. As a result primarily of the Property and Casualty Group's
underwriting decisions, the introduction of loss-sensitive coverages and large
deductible programs, competition and the impact of workers' compensation
benefit reform laws, the Property and Casualty Group's statutory net premiums
written declined from $434.7 million in 1993 to $240.3 million in 1997. For
the nine months ended September 30, 1998, net written premiums were $194.3
million compared to $174.5 million for the nine months ended September 30,
1997.
The operating results of the Property and Casualty Group improved in 1997
compared to 1996, primarily as a result of reserve strengthening that the
Property and Casualty Group effectuated in 1996 and expense initiatives
instituted by the Property and Casualty Group in 1997. This improvement has
continued through the first nine months of 1998. In 1996, the Property and
Casualty Group strengthened its loss reserves by $191.4 million. Of this
amount, $110.0 million related to workers' compensation, $60.4 million related
to asbestos and environmental claims and $21.0 million related to other lines
and LAE. The adverse development arising from workers' compensation had
reduced the Property and Casualty Group's earnings by a cumulative $251.6
million between 1992 and 1995. The reform legislation enacted in Pennsylvania,
the Property and Casualty Group's principal marketing territory, in 1993 and
1996 has introduced various controls and limitations on disability and medical
benefits. Management believes that the reforms and more stringent underwriting
standards adopted by the Property and Casualty Group since 1991 have had and
continue to have a beneficial effect on the Property and Casualty Group's
accident year loss ratios. The strengthening recorded for asbestos and
environmental claims was based upon a detailed loss analysis that examined
data on an account-by-account and site-by-site basis for asbestos, and an
actuarial calendar year aggregate loss development technique for environmental
claims. The Property and Casualty Group's net survival ratio was 7.4 years at
December 31, 1997 (8.2 years at December 31, 1996). At September 30, 1998, the
Property and Casualty Group's net survival ratio was 7.7 years. In 1997 and
through the first nine months of 1998, the Property and Casualty Group did not
record any adverse loss reserve development and, in addition, the impact of a
lower expense base has contributed to improved operating results for the
Property and Casualty Group. See "Loss Reserves."
In 1997, the Property and Casualty Group completed a formal commutation
program in which it paid approximately $118.9 million, of which $17.8 million
was paid in the fourth quarter of 1996, to injured workers in exchange for a
release from any future indemnity payments. Commutations are agreements with
claimants whereby the claimants, in exchange for a lump sum payment, release
their rights to future indemnity payments from the Property and Casualty
Group. Under Pennsylvania workers' compensation law, the claimant, who is
generally represented by legal counsel and the Pennsylvania Workers'
Compensation Board, must approve all such commutation agreements. Savings
associated with these claims were consistent with management's expectations.
The number of open claims for accident years 1991 and prior was substantially
reduced as a result of the
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commutation program. This reduction in open claims is expected to reduce the
possibility of further adverse development on such reserves, although there
can be no assurance that the level of commutations will have a significant
impact on the future development of such reserves. As a result of the success
of this formal commutation program, the Property and Casualty Group has
continued its efforts to commute additional claims from accident years 1991
and prior and also has started to commute claims for accident years 1992
through 1996. During the nine months ended September 30, 1998, the Property
and Casualty Group paid approximately $71.1 million to injured workers in
exchange for a release from any future indemnity payments.
The Property and Casualty Group continues to emphasize its traditional core
business, workers' compensation. Management believes that it can capitalize on
the recent regulatory reforms, attract additional business based upon the
Property and Casualty Group's expertise in workers' compensation and reduce
acquisition expenses, because acquisition costs are lower for workers'
compensation than for other lines of commercial insurance. In addition, the
Property and Casualty Group has aligned itself with network health care
providers in order to offer medical cost containment practices to its
insureds.
In Pennsylvania, the Property and Casualty Group will seek to expand and
retain more of its premium base in territories that meet the Property and
Casualty Group's underwriting and actuarial criteria. Recent regulatory
reforms in Pennsylvania (Acts 44 and 57) have made workers' compensation
business more attractive from an underwriting perspective than it had been in
the early 1990's. The workers' compensation system in certain other states in
which the Property and Casualty Group does business (specifically, New Jersey,
North Carolina and Virginia) has also improved in recent years. It is
management's intention to seek to recapture a portion of the workers'
compensation market share in those states where the Property and Casualty
Group has lost market share since the early 1990's.
In addition, the Property and Casualty Group intends to expand into certain
new territories. In 1997, the Property and Casualty Group began writing
business in Georgia, and, in 1996, in New York and South Carolina. In all new
territories, the Property and Casualty Group will undertake a target marketing
effort by identifying profiles of entities that it desires to insure. These
profiles will be communicated to the key producers in these states. It is also
contemplated that the Property and Casualty Group will seek to expand its
relationships with larger national and regional brokerage operations in both
its existing and new states. However, no assurance can be given that the
Property and Casualty Group will be able to accomplish these marketing
objectives.
The Property and Casualty Group intends to continue writing other lines of
property and casualty insurance, but generally only if such writings are
supported by its core workers' compensation business. Effective January 1,
1997, the Property and Casualty Group reduced its retention on commercial
casualty lines of business to $175,000 per risk from $500,000 per risk.
BUSINESS WRITTEN
The following table sets forth net premiums written for the Property and
Casualty Group for the periods indicated:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
----------------- ---------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Workers' Compensation... $147,502 $108,614 $138,301 $187,698 $232,742 $266,033 $338,684
Commercial Auto......... 19,432 23,324 28,938 35,224 39,834 38,984 48,108
Commercial Multi-Peril.. 22,844 32,707 41,713 35,108 40,659 31,123 27,306
General Liability and
Umbrella............... 2,326 7,479 8,751 8,204 11,370 12,691 16,788
Other................... 2,227 2,338 (14,355) 6,245 8,511 3,320 324
-------- -------- -------- -------- -------- -------- --------
Total................... $194,331 $174,462 $203,348 $272,479 $333,116 $352,151 $431,210
======== ======== ======== ======== ======== ======== ========
</TABLE>
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<PAGE>
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 (1998), the Property and Casualty Group is the fourth largest private
writer of workers' compensation insurance in Pennsylvania and between the 2nd
and 12th largest writer of workers' compensation insurance in the other
jurisdictions listed in the table below (except for North Carolina). The
Property and Casualty Group has focused on these jurisdictions based upon its
knowledge of their workers' compensation systems and the Property and Casualty
Group's assessment of their business, economic and regulatory climates. Rate
adequacy, regulatory climate, economic conditions and other factors in each
state are closely monitored and taken into consideration in the underwriting
process. Management intends to employ similar analyses in determining whether
and to what extent the Property and Casualty Group will offer its products in
additional jurisdictions. See "Underwriting." The following table sets forth
statutory direct workers' compensation business written by jurisdiction for
the five years ended December 31, 1997 and for the nine months ended September
30, 1998 and 1997.
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
----------------- --------------------------------------------
1998 1997 1997 1996 1995 1994 1993
-------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Pennsylvania.... $ 67,945 $ 77,214 $ 91,126 $134,171 $142,234 $169,448 $224,067
New Jersey...... 26,184 21,416 26,327 17,995 24,388 31,287 47,745
Virginia........ 17,499 16,721 19,552 17,449 26,395 29,938 31,545
Maryland........ 15,167 13,901 16,538 11,406 17,993 14,391 15,318
North Carolina.. 8,106 7,594 9,501 8,195 14,035 11,649 21,216
Delaware........ 6,905 5,173 7,041 7,545 5,763 4,831 4,274
Other........... 14,155 9,245 11,470 5,403 7,889 4,864 7,165
-------- -------- -------- -------- -------- -------- --------
Total........... $155,961 $151,264 $181,555 $202,164 $238,697 $266,408 $351,330
======== ======== ======== ======== ======== ======== ========
</TABLE>
Management of the Property and Casualty Group believes that conditions in
the workers' compensation market have been improving in the last several years
with respect to the ability to manage and control loss costs, while at the
same time, pricing for workers' compensation products continues to be
competitive. In addition, several states, including Pennsylvania, have enacted
reforms to the workers' compensation benefit system.
In 1993, Pennsylvania enacted Act 44, which introduced medical cost
containment measures to the workers' compensation benefit system and expanded
the period of time during which the insurer may require an employee to accept
medical treatment from the employer's list of designated health care providers
from 14 to 30 days. Act 44 also reduced the minimum wage replacement benefit
to injured workers, introduced a credit for unemployment compensation
benefits, restored the right of subrogation against tort recoveries in work-
related automobile accidents and created new anti-fraud measures. In June
1996, Pennsylvania enacted Act 57, which further reformed the workers'
compensation system in the state. Among other provisions, Act 57: (i) imposes
application of American Medical Association Impairment Guidelines for the
assessment of permanent and total claims after the first two years of total
disability compensation payments and limits indemnity benefits to an
additional 500 weeks for workers who are not at least 50% disabled (as
measured by those guidelines);
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(ii) contains certain Social Security and pension benefit offsets; (iii)
further increases the time frame for directed medical treatment; (iv)
addresses certain inequities in the average weekly wage calculation; (v)
increases the ability of employers to demonstrate that injured workers have
earning capacity and (vi) facilitates the use of full and final settlements of
employers' workers' compensation obligations on particular claims.
To date, Act 44 has had a favorable impact on medical loss costs in
Pennsylvania and Act 57 has had a favorable impact on indemnity loss costs. In
recognition of these developments, in the respective first years following the
enactments of Act 44 and Act 57, the average manual rate level in Pennsylvania
decreased approximately 10% in 1994 and approximately 25% in 1997. The benefit
reforms, management's re-underwriting of the Property and Casualty Group's
book of business and the use of loss-sensitive and alternative market products
have had a favorable impact on the Property and Casualty Group's accident year
loss ratios, as evidenced by the table below:
PROPERTY AND CASUALTY GROUP'S WORKERS' COMPENSATION UNDISCOUNTED ACCIDENT YEAR
PURE LOSS RATIOS AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
ACCIDENT
YEAR LOSS RATIO
-------- ----------
<S> <C>
1990............................................................ 100%
1991............................................................ 86%
1992............................................................ 80%
1993............................................................ 64%
1994............................................................ 64%
1995............................................................ 63%
1996............................................................ 63%
1997............................................................ 66%
</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." Set forth below is percentage
information on the voluntary workers' compensation direct premiums written by
product type for the policy years indicated:
<TABLE>
<CAPTION>
1998(1) 1997 1996 1995 1994 1993 1992 1991 1990
------- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Rate-sensitive
products............... 60% 62% 57% 52% 50% 54% 53% 54% 60%
Loss-sensitive
products............... 32% 27% 30% 34% 39% 40% 46% 46% 40%
Alternative market
products............... 8% 11% 13% 14% 11% 6% 1% 0% 0%
--- --- --- --- --- --- --- --- ---
Total................... 100% 100% 100% 100% 100% 100% 100% 100% 100%
=== === === === === === === === ===
</TABLE>
- --------
(1) 1998 data is through September 30, 1998.
RATE-SENSITIVE WORKERS' COMPENSATION PRODUCTS
Rate-sensitive products include fixed-cost policies and dividend paying
policies. The premium charged on a fixed-cost policy is based upon the manual
rates filed with and approved by the state
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<PAGE>
insurance department and does not increase or decrease based upon the losses
incurred during the policy period. Under policies that are subject to dividend
plans, the customer may receive a dividend based upon loss experience during
the policy period. With the enactment of regulatory reform in several states
in which the Property and Casualty Group does business, the Property and
Casualty Group has become more interested in this type of business and
increased its writings of rate-sensitive accounts in such jurisdictions in
1997 and 1998.
LOSS-SENSITIVE WORKERS' COMPENSATION PRODUCTS
The Property and Casualty Group's loss-sensitive products adjust the amount
of the insured's premiums after the policy period expires based upon the
insured's actual losses incurred during the policy period. These loss-
sensitive products are generally subject to less price regulation than rate-
sensitive products and reduce, but do not eliminate, risk to the insurer.
Under these types of policies, claims professionals and actuaries periodically
evaluate the reserves on losses after the policy period expires to determine
whether additional premiums or refunds are owed under the policy. Such
policies are typically open for adjustments for an average of five years after
policy expiration. The Property and Casualty Group generally restricts such
loss-sensitive products to accounts developing minimum annual premiums in
excess of $100,000.
ALTERNATIVE MARKET WORKERS' COMPENSATION PRODUCTS
Since 1992, the Property and Casualty Group has developed a variety of
alternative market products for larger accounts, including large deductible
policies and offshore captive programs. Typically, the Property and Casualty
Group receives a lower up-front premium for these types of alternative market
product plans. However, under this type of business, the insured retains a
greater share of the underwriting risk than under rate-sensitive or loss-
sensitive products, which reduces the potential for unfavorable claim activity
on the accounts and encourages loss control on the part of the insured. For
example, under a large deductible policy, the customer is responsible for
paying its own losses up to the amount of the deductible for each occurrence.
The deductibles under such policies generally range from $250,000 to $1.0
million. In addition to these products, the Property and Casualty Group offers
certain workers' compensation services to its clients unbundled from the
insurance products. See "PMA Management Corp."
PMA ONE
In 1997, the Property and Casualty Group developed PMA One, a new product
that provides for group integrated occupational and non-occupational
disability coverages, and began marketing PMA One in 1998. The Property and
Casualty Group believes that it can be successful in this product line as it
will utilize its expertise in managed care to reduce disability periods. The
Property and Casualty Group recorded premiums of $1.9 million for the nine
months ended September 30, 1998 for PMA One.
WORKERS' COMPENSATION RESIDUAL MARKET BUSINESS
Workers' compensation insurers doing business in certain states are required
to provide insurance for risks which are not otherwise written on a voluntary
basis by the private market ("residual market business"). This system exists
in all of the states in which the Property and Casualty Group does business,
except Pennsylvania and Maryland. In these two states, separate governmental
entities write all of the workers' compensation residual market business. In
1997, the Property and Casualty Group wrote $5.2 million of residual market
business, which constituted approximately 3% of its voluntary net workers'
compensation premiums written. The Property and Casualty Group wrote $2.9
million of residual market business for the nine months ended September 30,
1998 compared to $3.7 million for the nine months ended September 30, 1997.
Based upon data for policy year 1997 reported by the National Council on
Compensation Insurance, the percentage for the industry as a whole, in all
states, was 9.7%.
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COMMERCIAL LINES
The Property and Casualty Group writes property and liability coverages for
larger and middle market accounts that satisfy its underwriting standards. See
"Underwriting" below. These coverages feature package, umbrella and commercial
automobile business. During the present soft market, prices for commercial
coverages have been particularly competitive. The Property and Casualty Group
intends to continue offering these products, but generally only if they
support the core workers' compensation business. As a result, the Property and
Casualty Group has been selectively non-renewing accounts that do not meet its
underwriting standards. In addition, effective January 1, 1997, the Property
and Casualty Group has reduced its retention on commercial casualty lines of
business to $175,000 per risk from $500,000 per risk. See "The Company's
Reinsurance Ceded" below.
HOME OFFICE AND FIELD OPERATIONS
As of September 30, 1998, 232 employees worked in the home office located in
Blue Bell, Pennsylvania, and 647 employees were assigned to field offices
located throughout the states in which the Property and Casualty Group does
business.
Senior executives, financial operations, management information systems,
human resources, actuarial services and legal services are headquartered in
the home office. The definition of overall underwriting standards and major
account and alternative market underwriting support also take place in the
home office. The home office works in conjunction with senior managers from
the field to establish the Property and Casualty Group's business plan and
underwriting standards, which are then implemented by the field organization.
The field organization currently consists of three regional offices in
Valley Forge, Pennsylvania, Harrisburg, Pennsylvania and Richmond, Virginia,
as well as branch offices in each of Georgia, Maryland, New Jersey,
Pennsylvania, Virginia and North Carolina. In addition, the Property and
Casualty Group operates smaller satellite offices in Ohio and New York. The
branch offices deliver a full range of services directly to customers located
in their service territory, and the satellite offices offer primarily
underwriting and claim adjustment services.
DISTRIBUTION
The Property and Casualty Group distributes its products through
approximately 20 direct sales employees and approximately 240 independent
brokers and agents. The direct sales employees are generally responsible for
certain business located in Pennsylvania. For the year ended December 31,
1997, these employees produced $39.2 million in direct premiums written,
constituting 13% of the Property and Casualty Group's direct written business.
For the nine months ended September 30, 1998, these employees produced $26.9
million in direct premiums written, constituting 12% of the Property and
Casualty Group's direct written business. The brokers and agents write
business throughout the marketing territory. In 1997, the top ten brokers and
agents accounted for 28% of the Property and Casualty Group's business, the
largest of which accounted for not more than 8% of its business. All brokers
and agents are required to submit business to the Property and Casualty
Group's underwriting process before business may be accepted.
The Property and Casualty Group monitors several statistics relating to its
producer force, including the number of years the producer has been associated
with the Property and Casualty Group, the percentage of the producer's
business that is underwritten by the Property and Casualty Group, the ranking
of the Property and Casualty Group within the producer's business, and the
profitability of the producer's business. The distribution network generally
consists of large regional agents and brokers, local agents and national
brokers that specialize in larger to middle market accounts that require the
variety of workers' compensation, commercial lines and alternative market
products offered by the Property and Casualty Group.
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<PAGE>
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 certain property exposures, certain
hazardous products and activities and certain environmental coverages. The
home office establishes the overall business goals and the underwriting
authority for each regional and branch office. It also identifies specific
types of business that must be referred to home office underwriting
specialists and actuaries for individual pricing; including large accounts
over a specified dollar limit and alternative market workers' compensation
products. In 1997, the Property and Casualty Group changed the reporting
structure so that underwriters and risk-control professionals in the field
report functionally to the Chief Underwriting Officer rather than to branch
managers with marketing responsibilities; however, underwriters also work as a
team with the field marketing force to identify business that meets prescribed
underwriting standards and to develop specific strategies to write the desired
business. In performing this assessment, the field office professionals also
consult with actuaries who have been assigned to the specific field office
regarding loss trends and pricing and utilize actuarial loss rating models to
assess the projected underwriting results of accounts. The Property and
Casualty Group's underwriting management averages 22 years of experience in
the property and casualty industry.
The Property and Casualty Group also employs credit analysts. These
employees review the financial strength and stability of customers whose
business is written on loss-sensitive and alternative market products and
specify the type and amount of collateral that customers must provide under
these arrangements.
REHABILITATION AND MANAGED CARE
The Property and Casualty Group uses a variety of managed care techniques to
reduce costs and losses. Disability management coordinators and point-of-
service case managers, all of whom are registered nurses, work together with
claims professionals to provide expeditious medical and disability management
to injured workers and to investigate injuries. The case managers and
professionals also help employers identify opportunities that allow injured
employees to make a gradual transition to full-time, full-duty jobs. The
Property and Casualty Group also has contracts with First Health Group, Inc.
for most of its marketing territory and with other preferred provider networks
consisting of medical practitioners and hospitals selected for their expertise
in treating injured workers. Specialties include occupational medicine,
physical medicine, orthopedics and neurology. There are also preferred
pharmacy networks to reduce the cost of medication. In addition, the Property
and Casualty Group uses an outside network to check medical bills for
accuracy, duplication, unrelated charges and overcharges. Questionable bills
are forwarded to the Cost Containment Unit, which is staffed by registered
nurses and resolves disputed or suspect charges.
CLAIMS ADMINISTRATION
Claims services are delivered to customers primarily through employees in
the field offices. Certain specialized matters, such as asbestos and
environmental claims, are referred to a special unit in the home office. The
Property and Casualty Group maintains a centralized call center for loss
reporting and has automated and centralized the processing of claims payments
in its Allentown, Pennsylvania facility. This centralization allows the claims
adjusters to reduce substantially the time that they spend with clerical and
repetitive functions. The Property and Casualty Group also employs in-house
attorneys who represent customers in workers' compensation cases and other
insurance matters.
The Property and Casualty Group has a separate, anti-fraud unit that
investigates suspected false claims and other irregularities and cooperates
with regulatory and law enforcement officials in prosecuting violators.
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PMA MANAGEMENT CORP.
PMA Management Corp. offers claims, risk management and related services
primarily to self-insureds on an unbundled basis. In addition, PMA Management
Corp. offers "rent-a-captive" products for certain insureds and associations.
The purpose of a rent-a-captive program is to offer a customer an alternative
method of managing its loss exposures by obtaining many of the benefits of a
captive insurer without establishing and capitalizing its own captive; in
effect, the insured is "renting" a captive facility that the Company has
already established. Under this arrangement, the client purchases an insurance
policy from the Pooled Companies and chooses a participation level. The Pooled
Companies then cede this portion of the premium and loss exposures to a
Bermuda subsidiary of PMA Capital. The client participates in the loss and
investment experience of the portion ceded to the Bermuda subsidiary through a
dividend mechanism. The client is responsible for any loss that may arise
within its participation level, and such potential obligation is typically
secured through a letter of credit or similar arrangement. The Company's
principal sources of income from its rent-a-captive program are the premium
income on the excess risk retained by the Pooled Companies and captive
management fees earned by PMA Management Corp.
RUN-OFF OPERATIONS
As a part of the Property and Casualty Group's 1996 restructuring plan, the
Property and Casualty Group established the Run-off Operations principally to
manage the capital supporting workers' compensation loss reserves from
accident years 1992 and prior. Such reserves primarily relate to the period of
time from 1987 to 1991 when the Property and Casualty Group wrote a much
higher volume of business and experienced poor underwriting results. The
reserves are mainly indemnity related and are relatively mature. The Run-off
Operations consist of MASCCO, PMA Life and PMA Cayman (which was sold
effective July 1, 1998--see below for further discussion).
MASCCO is a Pennsylvania insurance company and a wholly owned subsidiary of
the Company. Prior to December 31, 1996, MASCCO was a party to a pooling
agreement with the Pooled Companies. Effective December 31, 1996, and with the
approval of the Pennsylvania Insurance Commissioner MASCCO withdrew from the
pooling agreement and ceased writing any new business. The Pooled Companies
also ceded to MASCCO the indemnity portion of Pennsylvania workers'
compensation claims for accident years 1991 and prior. Pursuant to a surplus
maintenance agreement between PMA Capital and the Pennsylvania Insurance
Commissioner, MASCCO is required to discount its reserves utilizing a rate of
not more than 5%, maintain a reserve to surplus ratio not in excess of 8 to 1
and continue to invest its assets only in investment grade securities. At
September 30, 1998, MASCCO had $93.7 million in total assets and $74.4 million
in total reserves and its reserve to surplus ratio was 5 to 1. Substantially
all of MASCCO's assets are held in trust for the benefit of the Pooled
Companies.
PMA Cayman was incorporated in Grand Cayman, and had no material operations
until 1996. In 1996, the Pooled Companies ceded to PMA Cayman substantially
all of their remaining liability for workers' compensation claims for accident
years 1991 and prior. In 1997, the Pooled Companies also ceded to PMA Cayman a
portion of their workers' compensation reserves from accident years 1992 to
1996. Effective July 1, 1998, the Company sold PMA Cayman to a third party for
a purchase price of $1.8 million and recorded an after-tax loss of $1.6
million. In addition, the Company transferred to the buyer $231.5 million in
cash and invested assets and recorded reinsurance receivables of $241.8
million as of September 30, 1998 related to the existing reinsurance
agreements with PMA Cayman. If the actual claim payments in the aggregate
exceed the estimated payments upon which the loss reserves have been
established, the Company has agreed to indemnify the buyer, up to a maximum of
$15.0 million. If the actual claim payments in the aggregate are less than the
estimated payments upon which the loss reserves have been established, the
Company will participate in such favorable loss reserve development.
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<PAGE>
PMA Life derived all of its insurance revenues from intercompany structured
settlement annuity transactions with the Pooled Companies. In 1997, the
Property and Casualty Group reinsured substantially all of PMA Life's
insurance liabilities with a third party reinsurer and the Property and
Casualty Group no longer places insurance business with PMA Life. At September
30, 1998, PMA Life had assets of $22.6 million and $17.4 million in total
reserves.
The following table reflects the components of the Property and Casualty
Group--Run-off Operations' operating results for the nine months ended
September 30, 1998 and 1997 and for the year ended December 31, 1997:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED YEAR
SEPTEMBER 30, ENDED
---------------- DECEMBER
1998 1997 31, 1997
------- -------- --------
<S> <C> <C> <C>
Net investment income........................... $12,780 $ 22,133 $ 28,131
Net premiums earned............................. -- (36,186)(1) (51,622)
------- -------- --------
Total operating revenues........................ $12,780 (14,053) (23,491)
------- -------- --------
Losses and LAE incurred......................... 10,642 (16,513) (27,460)
Operating expenses.............................. 2,097 2,568 4,042
------- -------- --------
Total expenses.................................. $12,739 $(13,945) $(23,418)
------- -------- --------
Pre-tax operating income (loss)................. $ 41 $ (108) $ (73)
======= ======== ========
</TABLE>
- --------
(1) Amount represents net premiums earned during the first nine months of 1997
for PMA Life prior to the reinsurance transaction mentioned above, after
which PMA Life was placed into run-off.
CALIBER ONE
In 1997, the Company established a specialty insurance operation, Caliber
One. In starting Caliber One, the Company's intention was to expand PMA
Capital's access to the insurance market by offering products and marketing to
classes of business in which neither PMA Re nor the Property and Casualty
Group were involved. The Company has hired an experienced senior underwriting
professional to be the Chief Operating Officer of this unit as well as other
individuals with experience in underwriting and claims management for
specialty insurance. See "Management."
PRODUCTS, UNDERWRITING AND DISTRIBUTION
Caliber One's present focus is on excess and surplus lines of insurance for
difficult risks that are typically declined by the standard market. Caliber
One offers liability coverages for low frequency/high severity classes,
including pharmaceuticals, chemicals, machinery manufacturers, toy makers,
medical product manufacturers and other difficult-to-insure product liability
risks. In addition, Caliber One markets environmental impairment liability
coverages, clinical trials coverage for emerging biotechnology products and
intellectual property rights liability coverages as well as property coverages
for unprotected and vacant buildings. Caliber One's policy forms contain
appropriate and flexible manuscript endorsements and exclusions, and in some
cases, will contain defense costs within the policy limits rather than
offering such coverage on an unlimited basis. Through September 30, 1998,
Caliber One had $4.2 million and $2.6 million in gross premiums written and
net premiums written, respectively.
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<PAGE>
The underwriting of these specialty products involves a significant amount
of judgment. The senior underwriters that Caliber One has hired have a
significant amount of experience in dealing with esoteric high severity risks,
and average 16 years of specialty insurance experience. The underwriting
process involves reviewing the claim experience of an account, if any, the
claim experience of the particular class or similar classes and responding to
special risks that an account has through the use of policy features that can
be changed for the circumstances, such as retentions, exclusions and
endorsements. Caliber One's underwriting teams for casualty products have been
divided into three regions within the United States, each led by a regional
underwriting vice president who reports to the Chief Operating Officer. For
property products, one underwriting team supports the activities of the three
regions.
Caliber One distributes its excess and surplus lines products on a
nationwide basis through approximately 45 appointed surplus lines brokers. For
most product offerings, Caliber One does not grant underwriting or binding
authority to its brokers.
ACQUISITION OF CALIBER ONE INDEMNITY COMPANY
In December 1997, PMA Re acquired 100% of the common stock of a Delaware
domiciled insurance company which it renamed Caliber One Indemnity Company.
PMA Re paid $16.0 million to acquire the company and made an $11.3 million
capital contribution to bring Caliber One Indemnity Company's statutory
surplus to $25.0 million, the minimum surplus level required by several states
to be an authorized excess and surplus lines carrier. Caliber One Indemnity
Company was essentially a shell company, as affiliates of the former parent
had taken over the business that had been previously written. In addition, an
affiliate of the former parent entered into a reinsurance transaction
immediately prior to the acquisition whereby such company assumed all of
Caliber One Indemnity Company's existing loss reserves and is providing
protection against adverse loss reserve development and uncollectible
reinsurance of up to $68.5 million. See "Loss Reserves" below. Also, PMA Re
has entered into a surplus maintenance agreement with Caliber One Indemnity
Company whereby PMA Re will maintain Caliber One Indemnity Company's statutory
surplus such that the amount is not less than $25.0 million and so that the
net premiums written to surplus ratio does not exceed 1.0 to 1.0.
Caliber One Indemnity Company is presently authorized as an excess and
surplus lines carrier in 41 states, and it is management's intention to be
authorized in 49 states so that products can be offered on a national basis.
Caliber One Indemnity Company has obtained an "A" (Excellent) rating from A.M.
Best.
THE COMPANY'S REINSURANCE CEDED
The Company follows the customary insurance practice of reinsuring with
other insurance companies a portion of the risks under the policies written by
the Insurance Subsidiaries. This reinsurance is maintained to protect the
Insurance Subsidiaries against the severity of losses on individual claims and
unusually serious occurrences in which a number of claims produce an aggregate
extraordinary loss. Although reinsurance does not discharge the Insurance
Subsidiaries from their primary liabilities to their policyholders for losses
insured under the insurance policies, it does make the assuming reinsurer
liable to the Insurance Subsidiaries for the reinsured portion of the risk.
The Insurance Subsidiaries' reinsurance ceded agreements generally may be
terminated at their annual anniversary by either party upon 30 to 90 days'
notice. In general, the reinsurance agreements are of the treaty variety,
which cover all underwritten risks of the types specified in the treaties.
Presently, the maximum gross lines that PMA Re will write are $5.0 million for
property covers, $1.0 million for property catastrophe covers and $7.5 million
for casualty covers. Net retentions on any one claim are $750,000 for property
covers and $1.5 million for casualty covers.
95
<PAGE>
PMA Re maintains property catastrophe retrocession programs in an aggregate
amount of $48.0 million in excess of $2.0 million for multiple claims arising
from two or more risks in a single occurrence or event.
PMA Re also maintains casualty retrocession programs. PMA Re has a casualty
retrocession contract, written on a funds withheld basis, which covers
individual casualty losses and provides low-layer clash protection. For
individual losses, the contract covers $6.0 million in excess of $1.5 million
on a per occurrence basis. The contract has clash limits for losses arising
from two or more risks of $1.3 million in excess of $1.5 million. The term of
the contract is three years, and the term aggregate limit is $25.0 million
plus the amount of funds withheld.
In addition to the above programs, PMA Re maintains casualty clash
protection of $17.5 million in excess of $2.8 million per occurrence.
Effective January 1, 1998, PMA Re's workers' compensation program was
modified to include coverage of $98.0 million excess of $2.0 million per
occurrence, $98.5 million excess of $1.5 million per program per occurrence
and $18.5 million excess of $1.5 million per person per occurrence.
The Property and Casualty Group has its own ceded reinsurance program, and
carries excess-of-loss per occurrence reinsurance for $103.5 million over a
net retention of $1.5 million on workers' compensation. The Property and
Casualty Group also carries excess-of-loss per risk reinsurance for $4.8
million ($49.8 million per occurrence) over a net retention of $175,000 on
other casualty lines; $2.0 million on automobile physical damage and $19.5
million ($48.5 million per occurrence) on property claims over its combined
net retention of $500,000. A property catastrophe program with a per
occurrence limit of $27.7 million in excess of an $850,000 retention is
maintained to provide protection for multiple property losses involved in one
occurrence. The Property and Casualty Group also maintains reinsurance
protection for its umbrella risks at $9.0 million over a net retention of $1.0
and purchases facultative reinsurance for certain other risks.
Caliber One is fully reinsured by an affiliate of its former parent for all
business written prior to its acquisition by PMA Re in December, 1997. See
"Acquisition of Caliber One Indemnity Company" above.
Effective January 1, 1998, Caliber One maintains reinsurance protection for
casualty business of $4.5 million excess $500,000 per occurrence. The casualty
reinsurance is written on an excess of loss basis for primary coverages and on
a surplus share basis for excess coverages.
Effective July 1, 1998, Caliber One maintains reinsurance protection for
property business of $4.8 million excess of $200,000 per occurrence. The
property reinsurance is written on a quota share basis for the first $1.0
million and on an excess of loss basis for $4.0 million excess $1.0 million.
Effective January 1, 1998, Caliber One entered into a surplus maintenance
reinsurance agreement with its parent, PMA Re, whereby PMA Re will provide
reinsurance if Caliber One's statutory combined ratio exceeds 105.0% or if its
statutory net written premium to surplus ratio exceeds 1.0 to 1.0. See
"Acquisition of Caliber One Indemnity Company" above.
The Company actively manages its exposure to catastrophic events. In the
underwriting process, the Company generally minimizes the accumulation of
insurable values in catastrophe prone regions. Also, in writing property
reinsurance coverages, PMA Re typically requires per occurrence loss
limitations for contracts that could have catastrophe exposure. Through per
risk reinsurance, the Company also manages its net retention in each exposure.
As a result, the Company's loss ratios have not been significantly impacted by
catastrophes, and management believes that the Company has adequate
reinsurance to protect against the estimated probable maximum gross loss from
a
96
<PAGE>
catastrophic event; however, an especially severe catastrophic event could
exceed the Company's reinsurance and retrocessional protection and materially
adversely impact the Company's financial position.
The Company performs extensive credit reviews on its reinsurers, focusing
on, among other things, financial capacity, stability, trends and commitment
to the reinsurance business. Prospective and existing reinsurers failing to
meet the Company's standards are excluded from the Company's reinsurance
programs. In addition, the Company requires letters of credit to support
balances due from reinsurers not authorized to transact business in the
applicable jurisdictions.
LOSS RESERVES
In many cases significant periods of time, ranging up to several years or
more, may elapse between the occurrence of an insured loss, the reporting of
the loss to the insurer and the insurer's payment of that loss. Liabilities
for reinsurers generally become known more slowly than for primary insurers
and are generally subject to more unforeseen development.
To recognize liabilities for unpaid losses, insurers establish reserves,
which are balance sheet liabilities representing estimates of future amounts
needed to pay claims with respect to insured events which have occurred,
including events that have not been reported to the insurer. Reserves are also
established for LAE representing the estimated expenses of settling claims,
including legal and other fees, and general expenses of administering the
claims adjustment process.
When a claim is reported, claims personnel establish a case reserve for the
estimated amount of the ultimate payment. The estimate reflects the informed
judgment of such personnel, based on general corporate reserving practices and
the experience and knowledge of such personnel regarding the nature and value
of the specific type of claim. Reserves are also established on an aggregate
basis to provide for losses incurred but not yet reported to the insurer, for
the overall adequacy of case reserves and the estimated expenses of settling
claims. Such reserves are estimated using various generally accepted actuarial
techniques.
As part of the reserving process, historical data is reviewed and
consideration is given to the anticipated impact of various factors such as
legal developments, changes in social attitudes and economic conditions,
including the effects of inflation. This process relies on the basic
assumption that past experience, adjusted for the effect of current
developments and likely trends, is an appropriate basis for predicting future
events. The reserving process provides implicit recognition of the impact of
inflation and other factors affecting claims payments by taking into account
changes in historic payment patterns and perceived probable trends. There is
generally no precise method, however, for subsequently evaluating the adequacy
of the consideration given to inflation or to any other specific factor, since
the eventual deficiency or redundancy of reserves is affected by many factors,
some of which are interdependent.
Estimating the Company's ultimate claims liability is necessarily a complex
and judgmental process as the amounts are based on management's informed
estimates and judgments using data currently available. As additional
experience and data become available regarding claims payment and reporting
patterns, legislative developments and economic conditions, the estimates are
revised accordingly. If the Company's ultimate net losses prove to be
substantially greater than the amounts recorded in the financial statements,
the related adjustments could have a material adverse impact on the Company's
financial condition and results of operations.
The components of the Company's incurred losses and LAE for prior accident
years as of December 31, 1997, 1996 and 1995, excluding accretion of discount,
are as follows (favorable loss reserve development is denoted by the bracketed
figures):
97
<PAGE>
(DOLLAR AMOUNTS IN MILLIONS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
PMA Re.............................................. $ (32.1) $ (35.3) $ (15.0)
The Property and Casualty Group:
Workers' compensation............................. (44.1) 110.0 54.7
Asbestos and environmental........................ -- 60.4 23.4
PMA Life.......................................... (14.8) -- --
Other losses and LAE.............................. 5.0 21.0 (11.6)
------- ------- -------
Total........................................... (53.9) 191.4 66.5
------- ------- -------
Total............................................... $ (86.0) $ 156.1 $ 51.5
======= ======= =======
</TABLE>
The following table shows the composition of changes in the reserves for
losses and LAE for each of the three years ended December 31, 1997:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Balance at beginning of period............. $2,091,072 $2,069,986 $2,103,714
Less: Reinsurance recoverable on unpaid
losses and LAE............................ 256,576 261,492 247,856
---------- ---------- ----------
Net balance at beginning of period....... 1,834,496 1,808,494 1,855,858
---------- ---------- ----------
Losses and LAE incurred, net:
Current period........................... 341,880 323,069 357,787
Prior periods............................ (86,006) 156,074 51,491
Accretion of discount (includes ($35,000)
effect of the change in the discount
rate for the Property and Casualty
Group's workers' compensation unpaid
losses from 4% to 5% in 1995)........... 51,407 57,480 13,300
---------- ---------- ----------
Total losses and LAE incurred, net......... 307,281 536,623 422,578
---------- ---------- ----------
Losses and LAE paid, net:
Current period........................... (72,399) (72,194) (71,126)
Prior periods............................ (398,475) (438,427) (398,816)
---------- ---------- ----------
Total losses and LAE paid, net: (470,874) (510,621) (469,942)
---------- ---------- ----------
Net balance at end of period............... 1,670,903 1,834,496 1,808,494
Reinsurance recoverable on unpaid losses
and LAE................................... 332,284 256,576 261,492
---------- ---------- ----------
Balance at end of period................... $2,003,187 $2,091,072 $2,069,986
========== ========== ==========
</TABLE>
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<PAGE>
The following table shows how the Company's losses have been paid and
reserves re-estimated over time compared to the liability initially estimated:
(DOLLAR AMOUNTS IN MILLIONS)
CONSOLIDATED LOSS AND LOSS ADJUSTMENT EXPENSE DEVELOPMENT
<TABLE>
<CAPTION>
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997
------ ------ ------ ------ ------ ------ ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Initial estimated
liability for unpaid
losses and LAE net of
reinsurance
recoverables........... $1,246 $1,457 $1,632 $1,735 $1,824 $1,941 $1,932 $1,856 $1,809 $1,835 $1,671
Amount of reserve paid,
net of reinsurance
through:
-one year later........ 305 322 445 471 491 442 408 399 438 399 --
-two years later....... 504 601 772 842 849 779 746 764 780
-three years later..... 692 826 1,043 1,134 1,127 1,067 1,056 1,073
-four years later...... 834 1,011 1,258 1,353 1,365 1,329 1,331
-five years later...... 956 1,166 1,421 1,539 1,585 1,574
-six years later....... 1,063 1,284 1,553 1,715 1,789
-seven years later..... 1,143 1,380 1,685 1,882
-eight years later..... 1,214 1,479 1,817
-nine years later...... 1,288 1,584
-ten years later....... 1,367
Reestimated liability,
net of reinsurance as
of:
-one year later........ 1,280 1,468 1,696 1,795 1,967 1,998 1,932 1,907 1,965 1,749 --
-two years later....... 1,304 1,512 1,743 1,950 2,068 2,007 1,983 2,073 1,867
-three years later..... 1,339 1,553 1,876 2,034 2,082 2,061 2,164 1,987
-four years later...... 1,359 1,607 1,938 2,041 2,135 2,258 2,078
-five years later...... 1,368 1,652 1,935 2,123 2,302 2,170
-six years later....... 1,391 1,649 1,985 2,273 2,209
-seven years later..... 1,393 1,684 2,098 2,205
-eight years later..... 1,425 1,784 2,052
-nine years later...... 1,504 1,752
-ten years later....... 1,485
Indicated deficiency
(redundancy)........... $239 $294 $420 $471 $385 $229 $146 $131 $58 $(86) --
Net liability--
December 31............ $1,932 $1,856 $1,809 $1,835 $1,671
Reinsurance
recoverables........... 219 248 262 257 332
Gross liability--
December 31............ $2,151 $2,104 $2,070 $2,091 $2,003
Reestimated net
liability.............. $2,078 $1,987 $1,867 $1,749 $1,671
Reestimated reinsurance
recoverables........... 178 221 254 251 332
Reestimated gross
liability.............. $2,256 $2,208 $2,120 $1,999 $2,003
</TABLE>
The columns in the above exhibit are not mutually exclusive. For example, if
a reserve established in 1987 for a claim incurred during that year had been
re-estimated during 1989, the re-estimate would be reflected in the table for
each of the statement years from 1987 and 1988 during calendar years 1989
through 1997. Conditions and trends that have affected the reserve development
reflected in the table may change and care should be exercised in making
conclusions about the relative adequacy of reserves from such development.
For PMA Re, gross favorable loss reserve development on prior years' unpaid
losses and LAE was $32.1 million, $35.3 million and $15.0 million in 1997,
1996 and 1995, respectively, primarily for
99
<PAGE>
accident years 1993 and prior. Such favorable loss reserve development is
attributable to losses emerging at a lower rate than was anticipated (based
upon historical loss development patterns) when the initial accident year
reserves were established. While loss emergence patterns have been trending
downward for the pre-1993 accident years, resulting in favorable loss reserve
development, there can be no assurance that such trend will continue in the
future.
In 1997, the Property and Casualty Group recorded a release of $53.9 million
on prior year losses and LAE, excluding the accretion of discount. The release
primarily relates to favorable reserve development of $9.0 million for
workers' compensation retrospectively rated policies for accident years 1991
and prior, resulting from unanticipated additional savings from the Company's
1997 commutation program and favorable development of workers' compensation
reserves for accident years 1992 through 1996 of $35.1 million ($28.0 million
related to retrospectively related policies), primarily resulting from greater
than expected savings associated with benefit reforms in Pennsylvania.
Furthermore, incurred losses on prior accident years were also affected by the
cession of prior year loss reserves included in the PMA Life transaction of
$14.8 million. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations." The reserve release pertaining to the
retrospectively rated policies and the PMA Life transaction were offset in the
consolidated statements of operations by a corresponding reduction in earned
premiums. The aforementioned reserve releases were partially offset by reserve
strengthening of $5.0 million in commercial multi-peril business for accident
year 1996. It is the opinion of management that these reserve adjustments are
not indicative of any future trend.
The 1996 aggregate workers' compensation adverse development was allocated
$102.0 million to Pennsylvania and $8.0 million to all other states in which
the Company does business. Of the $102.0 million, the allocation by year is as
follows: prior to 1987: $16.0 million; 1987 to 1991: $101.0 million and 1992
and subsequent years: ($15.0 million). In 1995, substantially all of the
workers' compensation adverse development related to accident years 1987 to
1991 in Pennsylvania. For accident years prior to 1992, the traditional paid
loss development schedules for workers' compensation had begun to exhibit an
increasing trend in loss development factors by 1993. This trend was initially
attributed to an increase in commutation activity. In 1995, management began
to question whether loss data was developing in a manner that was consistent
with the conclusion that the loss development trends were impacted solely by
commutation activity. As a result, management began to accumulate additional
data in order to determine whether there were additional causes of the
increase in the paid loss development data, and management obtained claim
count data that was far more detailed than had been historically utilized in
the reserve setting process. This data indicated that the paid loss
development factors were not only impacted by commutation activity, but also
by a decline in the claims closure rate in Pennsylvania. Management believes
that the decline of the closure rates was due to several interrelated factors.
One factor related to the fact that efforts to rehabilitate claimants and
return them to work were not as successful as anticipated. For accident years
1987 to 1991, in particular, extensive efforts were made by the Company to
rehabilitate claimants and return them to work at either full or modified
duty. By late 1995 and into 1996, it was recognized by a review of a slow down
in the claims closure pattern that these rehabilitation efforts were not
impacting the closure rates as expected. Another factor negatively impacting
claims closure rates related to the economic conditions in Pennsylvania in the
early 1990's. During the period from 1990 to 1994, economic conditions in
Pennsylvania were considered to be depressed in the Company's major industry
niches for workers' compensation insurance (construction and heavy
manufacturing). Payrolls in these industries were stagnant, and in many cases,
employment was flat or declining. The Company believes that in periods of
declining employment opportunities, there is a tendency for indemnity periods
to increase, which occurred for workers who suffered injuries in these
industries.
The above factors, when considered with the fact that the benefits period in
Pennsylvania was unlimited, caused the Company to believe that a substantial
portion of claimants from the pre-1992
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<PAGE>
period, who had already been out of work five to nine years, would not return
to work in any capacity. In late 1995 and during 1996, management undertook an
effort to quantify the impact of the declining closure rates versus the
increase in commutation activity. During the fourth quarter of 1995,
management strengthened the Property and Casualty Group's workers'
compensation reserves by $54.7 million; however, the quantification of the
effect of the claims closure rate was an extremely complex process and as
such, the data was not fully understood at that time. As the data under
analysis was more mature and refined in 1996, management determined that the
workers' compensation loss reserves for Pennsylvania in the pre-1992 accident
years needed to be increased substantially; therefore, the Property and
Casualty Group increased its workers' compensation reserves by $110.0 million.
Benefit reforms enacted by states in which the Property and Casualty Group
transacts business, most significantly Pennsylvania, have had a beneficial
impact on more recent accident year loss ratios. Prior to 1996, the principal
revisions of the Pennsylvania system included medical cost containment
measures and an expansion of the period of time during which the insurer may
require an employee to accept medical treatment from the employer's list of
designated health care providers. In July 1996, Pennsylvania enacted Act 57, a
workers' compensation reform bill which is expected to reduce substantially
indemnity benefit periods in Pennsylvania. In addition to regulatory reforms,
the loss ratios have been favorably impacted by the conversion to loss-
sensitive and alternative market products. Such a trend is evidenced by the
fact that accident year pure loss ratios (losses recorded for the year in
which the event occurred expressed as a percentage of the earned premiums for
that year) for workers' compensation have been generally lower in more recent
accident years, as the following chart indicates:
PROPERTY AND CASUALTY GROUP'S WORKERS' COMPENSATION UNDISCOUNTED ACCIDENT YEAR
PURE LOSS RATIOS AS OF DECEMBER 31, 1997
<TABLE>
<CAPTION>
ACCIDENT YEARS LOSS RATIOS
-------------- -----------
<S> <C>
1990......................................................... 100%
1991......................................................... 86%
1992......................................................... 80%
1993......................................................... 64%
1994......................................................... 64%
1995......................................................... 63%
1996......................................................... 63%
1997......................................................... 66%
</TABLE>
In addition, management took several steps to reduce the outstanding claims
associated with the Pennsylvania workers' compensation business written
through 1991. A formal commutation program was initiated in the fourth quarter
of 1996 and continued into late 1997. Commutations are agreements with
claimants whereby the claimants, in exchange for a lump sum payment, release
their rights to future indemnity payments from the Property and Casualty
Group. Under Pennsylvania workers' compensation laws, the claimant and the
Pennsylvania Workers' Compensation Board must approve all such commutation
arrangements. The Property and Casualty Group paid $101.1 million and $17.8
million in 1997 and the fourth quarter of 1996, respectively, to commute
workers' compensation indemnity claims. Savings associated with these claims
were consistent with management's expectations. The number of open claims for
accident years 1991 and prior was substantially reduced as a result of the
commutation program. This reduction in open claims is expected to reduce the
possibility of any further adverse development on such reserves, although
there can be no assurance that the level of commutations will have a
significant impact on the future development of such reserves.
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<PAGE>
Estimating reserves for workers' compensation claims can be more difficult
than many other lines of property and casualty insurance for several reasons,
including (i) the long payment "tail" associated with the business; (ii) the
impact of social, political and regulatory trends on benefit levels for both
medical and indemnity payments; (iii) the impact of economic trends and (iv)
the impact of changes in the mix of business. At various times, one or a
combination of such factors can make the interpretation of actuarial data
associated with workers' compensation loss development more difficult, and it
can take additional time to recognize changes in loss development patterns.
Under such circumstances, adjustments will be made to such reserves as loss
patterns develop and new information becomes available and such adjustments
may be material.
The adverse development in reserves associated with asbestos and
environmental claims is the result of a detailed analysis completed in 1996 of
loss and LAE reserves associated with asbestos and environmental liability
claims. The reserving for asbestos and environmental claims has undergone
change at both the Company and in the insurance industry in general. For
environmental and asbestos liability claims, reserving methodology has been
evolving into accepted industry practice in the recent past. The Company's
actuaries were able to apply these methods to the Company's loss reserves in
1997 and 1996. To reserve for environmental claims, the Company currently
utilizes a calendar year development technique known as aggregate loss
development. This technique focuses on the aggregate losses paid as of a
particular date and aggregate payment patterns associated with such claims.
Several elements including remediation studies, remediation, defense,
declaratory judgment and third party bodily injury claims were considered in
estimating the costs and payment patterns of the environmental and toxic tort
losses. Prior to the development of these techniques, there was a substantial
range in the method of reserving for environmental and toxic tort liabilities.
The methods employed by the Company prior to the review performed in 1996
included a review of aggregate loss and loss adjustment paid and case incurred
data along with resulting "survival ratios" to establish IBNR for
environmental and toxic tort claims. For asbestos claims, the Company had
previously reserved costs to defend, and any indemnification payments
anticipated on, claims for which it had received notice that it was a
responsible party, plus a bulk factor applied to the estimated case reserves
to provide for potential development of indemnification and defense cost
related to such claims. In 1996, the Company performed a ground up analysis of
asbestos loss reserves using an actuarially accepted modeling technique. Using
historical information as a base and information obtained from a review of
open claims files, assumptions were made about future claims activity in order
to estimate ultimate losses. For each individual major account, projections
were made regarding new plaintiffs per year, the number of years new claims
will be reported, the average loss severity per plaintiff and the ratio of
loss adjustment expense to loss. In many cases involving larger asbestos
claims, the Company reserved up to the policy limits for the applicable loss
coverage parts for the affected accounts. Policy terms and reinsurance
treaties were applied in the modeling of future losses. Estimation of
obligations for asbestos and environmental exposures continues to be more
difficult than for other loss reserves because of several factors, including:
(i) evolving methodologies for the estimation of the liabilities; (ii) lack of
reliable historical claim data; (iii) uncertainties with respect to insurance
and reinsurance coverage related to these obligations; (iv) changing judicial
interpretations and (v) changing government standards.
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The Company's asbestos-related loss reserves for the years ended December
31, 1997, 1996 and 1995 were as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------- -------- -------
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves................................ $80,055 $ 27,611 $13,969
Incurred losses and LAE........................... 2,435 62,854 22,482
Calendar year payments for losses and LAE......... (5,764) (10,410) (8,840)
------- -------- -------
Ending reserves................................... $76,726 $ 80,055 $27,611
======= ======== =======
Net of reinsurance:
Beginning reserves................................ $53,300 $ 23,443 $ 8,168
Incurred losses and LAE........................... (36) 39,427 21,826
Calendar year payments for losses and LAE......... (4,686) (9,570) (6,551)
------- -------- -------
Ending reserves................................... $48,578 $ 53,300 $23,443
======= ======== =======
</TABLE>
The Company's environmental-related loss reserves for the years ended
December 31, 1997, 1996 and 1995 were as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1997 1996 1995
------- ------- -------
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves................................ $35,626 $20,134 $20,952
Incurred losses and LAE........................... 1,130 22,143 3,516
Reserves acquired through purchase of Caliber One
Indemnity Company(1)............................. 13,060 -- --
Calendar year payments for losses and LAE......... (4,708) (6,651) (4,334)
------- ------- -------
Ending reserves................................... $45,108 $35,626 $20,134
======= ======= =======
Net of reinsurance:
Beginning reserves................................ $34,592 $20,134 $20,952
Incurred losses and LAE........................... 1,068 21,109 3,516
Calendar year payments for losses and LAE......... (3,965) (6,651) (4,334)
------- ------- -------
Ending reserves................................... $31,695 $34,592 $20,134
======= ======= =======
</TABLE>
- --------
(1) Such acquired reserves have been reinsured by an affiliate of the former
parent. See "Caliber One."
Of the total net asbestos reserves, $6.7 million, $6.8 million and $6.7
million related to established claims reserves at December 31, 1997, 1996 and
1995, respectively, and $41.9 million, $46.5 million and $16.7 million related
to IBNR at December 31, 1997, 1996 and 1995, respectively. Of the total net
environmental reserves, $11.2 million, $12.5 million and $10.3 million related
to established claims reserves at December 31, 1997, 1996 and 1995,
respectively, and $20.5 million, $22.1 million and $9.8 million related to
IBNR at December 31, 1997, 1996 and 1995, respectively. All incurred asbestos
and environmental losses were for accident years 1986 and prior.
Management believes that the Property and Casualty Group's reserves for
asbestos and environmental claims are appropriately established based upon
known facts, existing case law and generally accepted actuarial methodologies.
However, due to changing interpretations by courts involving coverage issues,
the potential for changes in federal and state standards for clean-up and
liability and other factors, the ultimate exposure to the Property and
Casualty Group for these claims
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may vary significantly from the amounts currently recorded, resulting in a
potential future adjustment in the claims reserves recorded. In addition,
issues involving policy provisions, allocation of liability among
participating insurers, proof of coverage and other factors make
quantification of liabilities exceptionally difficult and subject to
adjustment based upon newly available data.
In 1996, Commercial Lines experienced reserve strengthening of $21.0 million
compared to a reserve release of $11.6 million in 1995. The reserve
strengthening in 1996 was principally due to a re-estimation of loss
adjustment costs associated with general liability claims. Through 1991, the
Property and Casualty Group's mix of general liability insurance policies were
weighted towards the manufacturing classes of business. Subsequent to 1991,
the Property and Casualty Group's mix of business became more heavily weighted
towards the construction and contracting classes of business. These particular
classes of business have experienced losses due to construction defects and
similar matters that have taken longer to emerge than the classes of business
previously written by the Property and Casualty Group. Defense costs
associated with these claims have also exceeded the original estimate of the
Property and Casualty Group's management, which was based on the patterns of
indemnification payments associated with the earlier classes of business
written. When this issue was discovered, the Property and Casualty Group
factored the increased defense costs and the emergence pattern in determining
a more appropriate reserve amount for loss handling costs. The release of
reserves in 1995 was primarily due to favorable loss experience in commercial
automobile business.
Unpaid losses on workers' compensation claims for the Company were
approximately $816.0 million and $1,012.0 million, net of discount of $460.2
million and $514.2 million, at December 31, 1997 and 1996, respectively. The
approximate discount rate utilized was 5.0% at December 31, 1997 and 1996. In
1995, the Property and Casualty Group's domestic insurance subsidiaries
changed the discount rate with respect to their workers' compensation unpaid
losses from approximately 4% to 5% for SAP and GAAP purposes. This change was
approved and is permitted by the Pennsylvania Insurance Department. The effect
on losses incurred in 1995 was a reduction of $35.0 million. Loss reserves on
other lines of business as well as reserves for LAE for all lines of business
are not discounted.
For the nine-month periods ended September 30, 1998 and 1997, respectively,
accretion of discount amounted to $17.2 million and $35.0 million. As of
September 30, 1998, the total discount was approximately $209.4 million,
comprised as follows: the Pooled Companies, $114.7 million; MASCCO, $52.5
million, other Property and Casualty Group entities, $6.9 million and PMA Re,
$35.3 million.
PMA Re has reported net favorable development of unpaid losses and LAE of
$23.3 million in 1997, $28.6 million in 1996 and $15.0 million in 1995
primarily for accident years 1993 and prior. Such favorable development is
attributable to losses emerging at a lower rate than was anticipated (based
upon historical loss development patterns) when the initial accident year
reserves were established. While loss emergence patterns have been trending
downward for the pre-1993 accident years, resulting in favorable loss reserve
development, there can be no assurance that such trend will continue in the
future.
Immediately prior to and in conjunction with the acquisition of Caliber One
Indemnity Company (see "Caliber One"), all of Caliber One Indemnity Company's
acquired loss reserves were reinsured by an insurance affiliate of its former
parent (the "Reserve Guarantee"). The Reserve Guarantee covers adverse
development and uncollectible reinsurance in an amount equal to the stated
amount of the reserves acquired, plus an additional $68.5 million. Upon the
purchase of Caliber One Indemnity Company, management of the Company valued
the amount of the Reserve Guarantee at approximately $5.0 million in excess of
the stated acquired reserves. Management of the Company
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believes that the Reserve Guarantee will be adequate to cover any future
adverse reserve development or uncollectible reinsurance on the acquired
reserves. At December 31, 1997, $36.8 million was recoverable under the
Reserve Guarantee, which is included in reinsurance receivables as of that
date. The Company is accounting for the Reserve Guarantee in conformity with
EITF Topic D-54, "Accounting by the Purchaser for a Seller's Guarantee of the
Adequacy of Liabilities for Losses and Loss Adjustment Expenses of an
Insurance Enterprise Acquired in a Purchase Business Combination," and
accordingly, any future revisions to the estimates of the amount of underlying
loss reserves and the amount recoverable under the Reserve Guarantee will be
recognized in losses and loss adjustment expenses in the period in which the
estimates are changed.
At December 31, 1997, the Company's loss reserves were stated net of $59.9
million of salvage and subrogation, of which $50.8 million related to the
Property and Casualty Group, which was comprised of $46.0 million related to
workers' compensation and $4.8 million related to Commercial Lines. The
anticipated salvage and subrogation was $9.1 million for PMA Re. Incurred
salvage and subrogation (increased) reduced losses and LAE by ($18.5) million,
($0.6) million and $9.5 million in 1997, 1996 and 1995, respectively. The
Company's policy with respect to estimating the amounts and realizability of
salvage and subrogation is to develop accident year schedules of historic paid
salvage and subrogation by line of business, which are then projected to an
ultimate basis using actuarial projection techniques.
The anticipated salvage and subrogation is the estimated ultimate salvage
and subrogation less any amounts received by the Company. The realizability of
anticipated salvage and subrogation is reflected in the historical data that
is used to complete the projection, as historic paid data implicitly considers
realization and collectibility.
RECENT DEVELOPMENTS
PMA Re and the Property and Casualty Group posted favorable loss reserve
development during the nine-month period ended September 30, 1998 of $12.5
million and $2.4 million ($2.3 million excluding Run-off Operations),
respectively.
PMA Re's favorable loss reserve development is attributable to losses
emerging at a lesser rate than was expected when the reserves for the
applicable accident years were established, resulting in downward revisions of
loss reserve estimates.
The favorable development of the Property and Casualty Group's loss reserves
is primarily attributable to recently established programs to control medical
costs further and reductions in LAE for workers' compensation. Medical costs
have improved primarily due to the Property and Casualty Group's affiliation
with a national preferred provider organization, which became effective
January 1998. This affiliation has enabled the Property and Casualty Group to
lower its cost in providing medical benefits to injured workers. Loss
adjustment expenses have decreased primarily due to continued use of certain
claims resolution practices. By using techniques such as managed care and
commutations, the Property and Casualty Group has reduced the amount and
number of outstanding claims and the amount of time that a claim remains open,
which in turn has lowered costs associated with managing open claims.
COMPETITION
The domestic property and casualty insurance and reinsurance industries are
very competitive and consist of many companies, with no one company dominating
the market. In addition, the degree and nature of competition varies from
state to state for a variety of reasons, including the regulatory climate and
other market participants in each state. In addition to competition from other
insurance companies, the Property and Casualty Group and Caliber One compete
with certain alternative market
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arrangements, such as captive insurers, risk- sharing pools and associations,
risk retention groups, and self-insurance programs. PMA Re competes with other
reinsurers in the brokered market as well as reinsurers that directly
underwrite reinsurance business. Many of the Company's competitors are larger
and have greater financial resources than the Company.
The main factors upon which entities in the Company's markets compete are
price, service, product capabilities and financial security. The Property and
Casualty Group, PMA Re and Caliber One attempt to price their products in such
a way that the prices charged to their clients are commensurate with the
overall marketplace while still meeting return targets. Given the present soft
pricing environment, competing solely on the basis of price has become
increasingly difficult for the Property and Casualty Group and PMA Re, and
both have had to reject risks submitted and non-renew certain accounts in
recent years, as the market rates for such risks did not provide the
opportunity to achieve what management considers to be an acceptable return.
In terms of service, management maintains service standards to ensure that
clients are satisfied with the products and services provided by the Company.
Such standards have been designed to emphasize prompt turn-around time for
underwriting submissions, access to information, claims handling and the
quality of other services. Management periodically participates in surveys of
intermediaries and clients to gain an understanding of the perceptions of the
Company's service compared to its competitors.
Management attempts to design products that meet the needs of clients in the
Company's markets. In recent years, the Property and Casualty Group has
developed products that reflect the evolving nature of the workers'
compensation market. Specifically, management has increased its focus on
rehabilitation and managed care to keep workers' compensation costs lower for
the employers. In addition, the Property and Casualty Group has introduced and
refined alternative market products, as well as unbundled risk management and
claims administration services. See "The Property and Casualty Group." PMA Re
has also expanded its product line in recent years to satisfy the needs of its
client base. Products introduced by PMA Re in the last two years include
facultative reinsurance, finite risk reinsurance and integrated capital
management (which involves providing reinsurance as well as some type of
direct investment in a ceding company). See "PMA Re." For Caliber One, it is
management's intention to design products that meet the needs of new classes
of business and that cover emerging risks. See "Caliber One." Management
continues to review new product opportunities for the Property and Casualty
Group, PMA Re and Caliber One.
For many intermediaries and clients, financial security is measured by the
ratings assigned by independent rating agencies. Therefore, management
believes that the ratings assigned by independent rating agencies,
particularly A.M. Best, are material to the Company's operations. A.M. Best
has currently assigned an "A+" (Superior) rating to PMA Reinsurance
Corporation, an "A-" (Excellent) rating to the Pooled Companies and an "A"
(Excellent) to Caliber One Indemnity Company. In addition, Moody's has rated
PMA Reinsurance Corporation A3 ("Good") and the Pooled Companies Baa2
("Adequate"). The Company is also presently seeking ratings of its insurance
subsidiaries from Standard & Poor's. The ratings from these rating agencies
are generally based on an analysis of an insurance company's perceived
financial strength and its ability to pay obligations to its policyholders and
are not directed toward the protection of investors. No assurance can be given
that PMA Reinsurance Corporation, the Pooled Companies and Caliber One
Indemnity Company can maintain these ratings. In addition, there can be no
assurance that ratings to be received from Standard & Poor's will not have a
detrimental effect on the Company's competitive position.
EMPLOYEES
As of September 30, 1998, the Company had 1,005 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.
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PROPERTIES
The Company's headquarters are located in 78,000 square feet of leased space
in Mellon Bank Center, Philadelphia, Pennsylvania. The Property and Casualty
Group's headquarters are located in a four story, 110,000 square foot building
in Blue Bell, Pennsylvania.
Through various wholly owned subsidiaries, the Company also owns and
occupies additional office facilities in three other locations and rents
additional office space for its insurance operations in 15 other locations.
The Company believes that such properties are suitable and adequate for its
current business operations.
LEGAL PROCEEDINGS
The Company's insurance subsidiaries are defendants in actions arising out
of their insurance business and from time to time are involved in various
governmental and administrative proceedings. These actions include lawsuits
seeking coverage for alleged damages relating to exposure to asbestos and
other toxic substances and environmental clean-up actions under federal and
state law. In the opinion of management, the resolution of these matters will
not have a material adverse effect on the Company's financial condition,
results of operations or cash flows. See "Business--Loss Reserves" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
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SUPERVISION AND REGULATION
GENERAL
PMA Reinsurance Corporation is licensed or accredited to transact its
reinsurance business in, and is subject to regulation and supervision by 50
states and the District of Columbia. The Pooled Companies are licensed to
transact insurance business in, and are subject to regulation and supervision
by 45 states and the District of Columbia. Caliber One Indemnity Company is
licensed in one state and is approved as a surplus lines carrier in 38 states,
Puerto Rico and the District of Columbia. The Company's insurance subsidiaries
are authorized and regulated in all jurisdictions where they conduct insurance
business. Inasmuch as PMA Reinsurance Corporation and the Pooled Companies are
domiciled in Pennsylvania, however, the Pennsylvania Insurance Department
exercises principal regulatory jurisdiction over them, and the Delaware
Insurance Department exercises principal jurisdiction over Caliber One
Indemnity Company. The extent of regulation by the states varies, but in
general, most jurisdictions have laws and regulations governing standards of
solvency, adequacy of reserves, reinsurance, capital adequacy and standards of
business conduct. In addition, statutes and regulations usually require the
licensing of insurers and their agents, the approval of policy forms and
related material and, for certain lines of insurance, including all lines of
business written by the Pooled Companies, the approval of rates. Property and
casualty reinsurers and excess and surplus lines carriers are generally not
subject to filing or other regulatory requirements applicable to primary
standard lines insurers with respect to rates, policy forms or contract
wording. The form and content of statutory financial statements are regulated.
State insurance departments in jurisdictions in which the Company's insurance
subsidiaries do business also conduct periodic examinations of their
respective operations and accounts and require the filing of annual and other
reports relating to their financial condition.
Approximately once every three to five years as part of their routine
regulatory oversight process, state insurance departments conduct detailed
examinations of the books, records and accounts of insurance companies
domiciled in their states. Such examinations are generally conducted in
cooperation with the departments of two or three other states under guidelines
promulgated by the NAIC. The Pennsylvania Insurance Department last issued
examinations reports for PMA Reinsurance Corporation and the Pooled Companies
as of December 31, 1992, and the Delaware Department of Insurance last
conducted an examination of Caliber One Indemnity Company as of December 31,
1996. No adjustments to previously filed statutory financial statements were
required as a result of such examinations. In addition, there were no
substantive qualitative matters indicated in the examination reports that had
or are expected to have a material adverse impact on the operations of PMA
Reinsurance Corporation, the Pooled Companies or Caliber One Indemnity
Company. The Pennsylvania Insurance Department is currently conducting
examinations of PMA Reinsurance Corporation and the Pooled Companies as of
December 31, 1997. The Pennsylvania Insurance Department has raised no
material issues in connection with the pending examination. In supervising and
regulating insurance companies, including reinsurers, state insurance
departments, charged primarily with protecting policyholders and the public
rather than investors, enjoy broad authority and discretion in applying
applicable insurance laws and regulations for the protection of policyholders
and the public.
Every state in which the Company's insurance subsidiaries are licensed
administers a guaranty fund, which provides for assessments of licensed
insurers for the protection of policyholders of insolvent insurance companies.
There has been an increase in the number of insurance companies that are under
supervision that has resulted in an increase in the amount of assessments to
cover losses to policyholders of such companies. The Company's insurance
subsidiaries have made accruals for their portion of assessments related to
such insolvencies based upon the most current information furnished by the
guaranty associations. During the five years ended December 31, 1997 and the
nine months ended September 30, 1998, the amount of such insolvency
assessments paid by
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the Company's insurance subsidiaries has not been material. Management cannot
reasonably predict the amount of future assessments, if any.
Recently, the insurance regulatory framework has been placed under increased
scrutiny by various states, the federal government and the NAIC. Various
states have considered or enacted legislation which changes, and in many cases
increases, the state's authority to regulate insurance companies. Although
legislation has been under consideration for several years in Congress, which,
if enacted, would result in the federal government assuming some role in the
regulation of insurance companies, management does not expect the current
Congress to enact federal insurance regulation. The NAIC, in conjunction with
the state regulators, has been reviewing existing insurance laws and
regulations. The NAIC recently approved and recommended to the states for
adoption and implementation several regulatory initiatives designed to reduce
the risk of insurance company insolvencies. Through the NAIC accreditation
program, these recommendations for state legislation have taken an increased
significance. Two such initiatives that have been adopted by the NAIC are
risk- based capital standards ("RBC") and a model investment law.
INSURANCE HOLDING COMPANY REGULATION
The Company and its insurance subsidiaries are subject to regulation
pursuant to the insurance holding company laws of Pennsylvania and Delaware.
These state insurance holding company laws generally require an insurance
holding company and insurers and reinsurers that are members of such insurance
holding company's system to register with the state regulatory authorities, to
file with those authorities certain reports disclosing information including
their capital structure, ownership, management, financial condition, certain
intercompany transactions including material transfers of assets and
intercompany business agreements, and to report material changes in such
information. Such laws also require that intercompany transactions be fair and
reasonable and that an insurer's surplus as regards policyholders following
any dividends or distributions to shareholder affiliates be reasonable in
relation to the insurer's outstanding liabilities and adequate for its
financial needs.
Under Pennsylvania and Delaware law, no person may acquire, directly or
indirectly, a controlling interest in the capital stock of the Company unless
such person, corporation or other entity has obtained prior approval from the
Commissioner(s) for such acquisition of control. Pursuant to Pennsylvania and
Delaware law, any person acquiring, controlling or holding with the power to
vote, directly or indirectly, ten percent or more of the voting securities of
an insurance company, is presumed to have "control" of such company. This
presumption may be rebutted by a showing that control does not exist in fact.
The respective Commissioner(s), however, may find that "control" exists in
circumstances in which a person owns or controls a smaller amount of voting
securities. To obtain approval from the Commissioner(s) of any acquisition of
control of an insurance company, the proposed acquirer must file with the
Commissioner(s) an application containing information regarding the identity
and background of the acquirer and its affiliates, the nature, source and
amount of funds to be used to effect the acquisition, the financial statements
of the acquirer and its affiliates, any potential plans for disposition of the
securities or business of the insurer, the number and type of securities to be
acquired, any contracts with respect to the securities to be acquired, any
agreements with broker-dealers and other matters.
Other jurisdictions in which the Company's insurance subsidiaries are
licensed to transact business may have requirements for prior approval of any
acquisition of control of an insurance or reinsurance company licensed or
authorized to transact business in such jurisdictions. Additional requirements
in such jurisdictions may include re-licensing or subsequent approval for
renewal of existing licenses upon an acquisition of control. As further
described below, laws also govern the holding company structure payment of
dividends by the Company's insurance subsidiaries to the Company.
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RESTRICTIONS ON SUBSIDIARIES' DIVIDENDS AND OTHER PAYMENTS
PMA Capital is an insurance holding company whose assets consist principally
of all of the outstanding common stock of its insurance subsidiaries. PMA
Capital's ongoing ability to pay dividends to its shareholders and meet its
other obligations, including operating expenses and any principal and interest
on debt (including the Junior Subordinated Debentures), is primarily dependent
on the receipt of sufficient funds from its insurance subsidiaries in the form
of dividends, net payments under a tax-sharing agreement between PMA Capital
and its subsidiaries and loans. The payment of dividends by PMA Capital's
subsidiaries to PMA Capital is regulated under the insurance laws of
Pennsylvania and Delaware (such laws are substantially similar). In addition,
to the extent tax-sharing payments and loans exceed certain threshold amounts,
notice to and non-disapproval by the Pennsylvania Insurance Commissioner would
be required. Under Pennsylvania law, PMA Capital's Pennsylvania-domiciled
subsidiaries (PMA Reinsurance Corporation and the Pooled Companies) may pay
dividends only from unassigned surplus and future earnings arising from their
businesses and must receive prior approval of the Pennsylvania Insurance
Commissioner to pay a dividend if such dividend would exceed certain statutory
limitations. The current statutory limitation is the greater of (i) of 10% of
the insurer's policyholders' surplus, as shown on its last annual statement on
file with the Pennsylvania Insurance Commissioner or (ii) the insurer's
statutory net income for the previous calendar year. Pennsylvania law gives
the Pennsylvania Insurance Commissioner broad discretion to disapprove
requests for dividends in excess of these limits. Based upon this limitation
and the 1997 statutory results of PMA Reinsurance Corporation and the Pooled
Companies, PMA Reinsurance Corporation and the Pooled Companies have the legal
capacity to pay $48.7 million in dividends in the aggregate to PMA Capital in
1998 without obtaining the approval of the Pennsylvania Insurance
Commissioner. For the year ended December 31, 1998, $35.5 million of dividends
have been declared and paid. Pennsylvania law also provides that following the
payment of any dividend, the insurer's policyholders' surplus must be
reasonable in relation to its outstanding liabilities and adequate for its
financial needs, and permits the Pennsylvania Insurance Commissioner to bring
an action to rescind a dividend which violates these standards.
Caliber One Indemnity Company is a Delaware-domiciled insurance subsidiary
of PMA Reinsurance Corporation. As a subsidiary of PMA Reinsurance
Corporation, Caliber One Indemnity Company's dividends are not directly
available to PMA Capital. As noted above, the Delaware insurance law
provisions restricting dividends by insurers are substantially similar to such
provisions under Pennsylvania insurance laws. During 1998, Caliber One
Indemnity Company may pay up to $2.5 million of dividends to PMA Reinsurance
Corporation without the prior approval of the Delaware Insurance Commissioner.
During 1998, no dividends have been declared or paid by Caliber One Indemnity
Company.
In the event that the ability of either the Pooled Companies or PMA
Reinsurance Corporation to pay dividends or make other payments to PMA Capital
in the future is reduced or eliminated, PMA Capital's ability to pay principal
and interest on and redeem the Junior Subordinated Debentures could be
materially and adversely affected, depending upon the extent of such
reduction. The Pennsylvania Insurance Commissioner could use his or her broad
discretionary authority to seek to require PMA Capital to apply payments
received from one insurance subsidiary for the benefit of another insurance
subsidiary of PMA Capital.
In addition to regulatory restrictions on dividends, the Company's Revolving
Credit Facility also impose restrictions on the ability of the Company's
insurance subsidiaries to pay dividends. Under these restrictions, the
statutory surplus of PMA Capital's insurance subsidiaries (as measured each
calendar quarter) must not be less than $450 million and such subsidiaries
must annually maintain certain minimum ratios of adjusted surplus to risk-
based capital (300% for PMA Reinsurance Corporation and 230% for the Pooled
Companies in 1998, increasing to 240% thereafter). As of September 30, 1998,
the Company's insurance subsidiaries reported combined statutory surplus of
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$565.5 million, and, as of December 31, 1997, PMA Reinsurance Corporation's
risk-based capital ratio was 355% and the Pooled Companies' ratios ranged from
293% to 324%.
RISK-BASED CAPITAL
The NAIC has adopted risk-based capital requirements for property/casualty
insurance companies to evaluate the adequacy of statutory capital and surplus
in relation to investment and insurance risks such as asset quality, asset and
liability matching, loss reserve adequacy and other business factors.
Under RBC requirements, regulatory compliance is determined by the ratio of
a Company's total adjusted capital, as defined by the NAIC, to its authorized
control level, also as defined by the NAIC. Companies below prescribed trigger
points in terms of such ratio are classified as follows:
<TABLE>
<S> <C>
Company action level.................................................. 200%
Regulatory action level............................................... 150%
Authorized control level.............................................. 100%
Mandatory control level............................................... 70%
</TABLE>
At December 31, 1997, the ratios of the Pooled Companies ranged from 293% to
324%, PMA Reinsurance Corporation's ratio was 355% and Caliber One Indemnity
Company's ratio was 1,922%. As a result, the RBC requirements are not expected
to have an adverse impact on the operations, financial condition or operating
results of the Company's insurance subsidiaries.
RBC requirements for property and casualty insurance companies allow a
discount for workers' compensation reserves to be included in the adjusted
surplus calculation. However, the calculation for RBC requires the phase-out
of non-tabular reserve discount previously taken for workers' compensation
reserves by 1998. As a result, this phase-out negatively impacts the RBC
ratios of companies that write workers' compensation insurance and discount
such reserves on a non-tabular basis to companies that write other types of
property and casualty insurance. Management believes that the Pooled Companies
will be able to maintain their RBC in excess of regulatory requirements
through prudent underwriting and claims handling, investing and capital
management. However, no assurances can be given that developments affecting
the Property and Casualty Group, many of which could be outside of
management's control, including but not limited to changes in the regulatory
environment, economic conditions and competitive conditions in the
jurisdictions in which the Property and Casualty Group writes business, will
cause the Pooled Companies' RBC to fall below required levels resulting in a
corresponding regulatory response.
IRIS RATIOS
One method utilized by state insurance regulators to monitor the solvency of
insurers are twelve financial ratios (the "IRIS ratios") developed by the
NAIC. The IRIS ratios were developed by insurance regulators, in conjunction
with other regulatory and financial monitoring systems (such as risk-based
capital), to provide an early warning system for determining whether an
insurer is experiencing financial difficulties. The general categories of IRIS
ratios are operating leverage and growth, liquidity, surplus/surplus quality,
historical profitability and loss reserves. The ratios are formula-driven
based upon line items in an insurer's annual statement provided to state
insurance regulators, and each ratio has a guideline which stipulates the
range of reported values considered to be normal. Such guideline ranges are
the same for all companies. Generally, if a company reports four of more
ratios outside of the normal ranges (i.e., "unusual values"), it prompts
additional inquiries from state insurance regulators.
In 1997 and 1996, the Pooled Companies and MASCCO reported unusual values in
certain IRIS ratios primarily resulting from the reserve strengthening and
restructuring charges recorded during
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<PAGE>
1996 and the establishment of the Run-off Operations. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
In 1997, the Pooled Companies reported unusual values for three of the
twelve IRIS ratios: the Two-year Overall Operating Ratio, its Two-year Reserve
Development to Surplus Ratio and Estimated Current Reserve Deficiency to
Surplus Ratio. During 1996, the Pooled Companies reported unusual values in
five IRIS ratios, which included the One-year Reserve Development to Surplus
Ratio and Change in Surplus Ratio in addition to the IRIS ratios for which the
Pooled Companies reported unusual values in 1997.
The Two-year Overall Operating Ratio is the sum of a company's two-year loss
ratio and two-year expense ratio (underwriting expenses divided by net
premiums written) offset by its two-year investment income ratio (net
investment income divided by net premiums earned). The Pooled Companies'
results for the Two-year Overall Operating Ratio ranged from 123% to 130% at
December 31, 1997, compared to the guideline ratio of 100%. These unusual
values resulted from the reserve strengthening and restructuring charges
recorded during 1996.
The Two-year Reserve Development to Surplus Ratio, which is the average of
the prior two years' development of loss reserves divided by surplus, ranged
from 20% to 21% for the Pooled Companies at December 31, 1997 or slightly in
excess of the guideline ratio of 20%. These unusual values resulted from the
aforementioned reserve strengthening which occurred during 1996.
The Estimated Current Reserve Deficiency to Surplus Ratio is the difference
between a formula driven estimate of loss reserves (which is based on paid
losses compared to earned premiums and is not an actuarial calculation) and
the reserves carried on the financial statements, divided by surplus. The
Pooled Companies' ratios ranged from 50% to 64% at December 31, 1997 compared
to a guideline ratio range of 25%. These unusual values resulted from the
commutation program initiated by the Pooled Companies in 1997, which
accelerated loss payments in 1997 compared to earned premiums in prior years.
In 1996, in addition to reporting unusual values for the above three IRIS
ratios, the Pooled Companies had unusual values for two additional IRIS
ratios, Change in Surplus Ratio (the difference in surplus between the current
and prior year divided by the prior year's surplus) and One-year Reserve
Development to Surplus Ratio (one-year loss reserve development divided by
surplus), due to the reserve strengthening and restructuring charges recorded
in 1996.
In 1997 and 1996, MASCCO reported unusual values for three of the twelve
IRIS ratios. The Two-year Overall Operating Ratio and Change in Surplus Ratio
reflected unusual values for both years. MASCCO's Two-year Overall Operating
Ratio was 159% and 117% for 1997 and 1996, respectively, compared to a
guideline ratio of 100%, and MASCCO's Change in Surplus Ratio was -13% and
132% for 1997 and 1996, respectively, compared to a guideline range of -10% to
50%. These unusual values were the result of an intercompany reinsurance
agreement which was consummated at the end of 1996 relating to the
establishment of the Run-off Operations. During 1997, the ratio for Change in
Net Writings was -99% compared to a guideline ratio of -33% resulting from the
discontinuance of premium writings in MASCCO at December 31, 1996.
During 1996, Investment Yield for MASCCO was lower than the guideline range
due to a large increase in investments in December of 1996 that resulted from
an intercompany transfer of investments and loss reserves related to the
aforementioned intercompany reinsurance agreement.
The reporting of the above unusual values did not result in any significant
unresolved issues with insurance regulators.
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MANAGEMENT
The executive officers and directors of the Company are as follows:
<TABLE>
<CAPTION>
NAME AGE POSITION
---- --- --------
<S> <C> <C>
Frederick W. Anton III....... 64 Chairman of the Board
John W. Smithson............. 52 President and Chief Executive Officer
Francis W. McDonnell......... 42 Senior Vice President, Chief Financial
Officer and Treasurer
Vincent T. Donnelly.......... 46 President and Chief Operating Officer--The
Property and Casualty Group
Stephen G. Tirney............ 45 President and Chief Operating Officer--PMA Re
Ronald S. Austin............. 41 President and Chief Operating Officer--
Caliber One
Paul I. Detwiler, Jr......... 65 Director
Joseph H. Foster............. 70 Director
Anne S. Genter............... 63 Director
James F. Malone III.......... 55 Director
A. John May.................. 70 Director
Louis N. McCarter III........ 69 Director
John W. Miller, Jr., M.D..... 64 Director
Edward H. Owlett............. 71 Director
Louis I. Pollock............. 68 Director
Roderic H. Ross.............. 68 Director
L.J. Rowell, Jr.............. 66 Director
</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.
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<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 Caliber One. From 1988 to 1997, Mr. Austin served as an officer and
director of General Star Management Company, a member of the General
Reinsurance Group.
Paul I. Detwiler, Jr., a director since 1984, has served as Chairman of the
Board of New Enterprise Stone & Lime Co., a quarrying and construction
company, since 1990. 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 2001.
John W. Miller, Jr., M.D., a director since 1988, has been a physician and
has served as President of Ear, Nose and Throat Associates of Lancaster since
1970. Dr. Miller's current term as a director of the Company expires in 2001.
Edward H. Owlett, a director since 1964, has been a partner of Owlett, Lewis
& Ginn, P.C., a law firm, since 1981. From 1960 to 1981, Mr. Owlett served as
a partner of Cox, Wilcox, Owlett & Lewis, a law firm. Mr. Owlett's current
term as a director of the Company expires in 2001. Mr. Owlett is also a
director of Citizens and Northern Corporation.
Louis I. Pollock, a director since 1984, has served as President and Chief
Executive Officer of Morris Coupling Company, a manufacturer of pipe and
tubing, since 1957. Mr. Pollock's current term as a director of the Company
expires in 2001.
Roderic H. Ross, a director since 1981, has served as Chairman of the Board
and Chief Executive Officer of Keystone State Life Insurance Company since
1985. Prior to 1985, Mr. Ross held various positions at Philadelphia Life
Insurance Company and was an employee of Philadelphia Life Insurance Company
from 1970 to 1984. Mr. Ross' current term as a director of the Company expires
in 1999. Mr. Ross is also a director of Hunt Manufacturing Co. and PNC Bank
Corp.
L. J. Rowell, Jr., a director since 1992, was Chairman, President and Chief
Executive Officer of Provident Mutual Life Insurance Company from 1992 until
his retirement in July 1996. Prior to 1992, Mr. Rowell held various positions
at Provident Mutual and was an employee of Provident Mutual from 1980 until
July 1996. Mr. Rowell's current term as a director of the Company expires in
2000.
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<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.
DESCRIPTION OF THE CAPITAL SECURITIES
The trust agreement between PMA Capital as Depositor and The Bank of New
York (Delaware), as Delaware Trustee, authorized and created the Issuer. The
Amended and Restated Trust Agreement among PMA Capital as Depositor, The Bank
of New York (Delaware) as Delaware Trustee and The Bank of New York as
Property Trustee and the Administrative Trustees named therein is referred to
herein as the "Trust Agreement". The Trust Agreement will be qualified under
the Trust Indenture Act. The Property Trustee, The Bank of New York, will act
as the indenture trustee for purposes of compliance with the provisions of the
Trust Indenture Act. The Capital Securities and the Common Securities
(together, the "Trust Securities") will be issued by the Administrative
Trustees on behalf of the Issuer pursuant to the terms of the Trust Agreement.
The Capital Securities represent undivided beneficial interests in the Issuer
and entitle the holders thereof to a preference in certain circumstances with
respect to distributions and amounts payable on redemption or liquidation over
the Common Securities, as well as other benefits as described in the Trust
Agreement. The following statements relating to the provisions of the Trust
Agreement summarize the material provisions of the Trust Agreement. Reference
is made to the provisions of the Trust Agreement, the form of which is filed
as an exhibit to the Registration Statement of which this Prospectus forms a
part, and the Trust Indenture Act for a more complete description of the
provisions summarized herein, and each such statement shall be deemed
qualified in its entirety by such reference. Wherever particular sections of
the Trust Agreement are referred to, such sections are incorporated herein by
reference. Section references used herein are references to provisions of the
Trust Agreement, unless otherwise noted.
GENERAL
The Issuer is a Delaware statutory business trust. PMA Capital, the
Depositor, will own, directly or indirectly, all of the outstanding Common
Securities of the Trust. The Common Securities rank pari passu, and payments
will be made thereon pro rata, with the Capital Securities except as described
under "--Subordination of Common Securities." (Section 4.03.) The Junior
Subordinated Debentures will be owned by the Property Trustee and held in
trust for the benefit of the Trust and the holders of the Trust Securities.
(Section 2.09.) Pursuant to the Guarantee, PMA Capital fully and
unconditionally guarantees the payment of distributions (as defined below) and
amounts payable on redemption of the Capital Securities or liquidation of the
Issuer, but does not guarantee such payments when the Issuer does not have
funds available to pay such amounts.
THE TRUSTEES
Pursuant to the Trust Agreement, the number of the Issuer's trustees (the
"Trustees") initially will be four. (Section 8.17.) In addition to the
Property Trustee, the Issuer initially will have three Administrative Trustees
who will be officers or employees of, or otherwise affiliated with PMA
Capital. The Administrative Trustees are authorized and directed to conduct
the affairs of the Issuer and to
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<PAGE>
operate the Issuer such that the Issuer will not be deemed to be an
"investment company" required to be registered under the Investment Company
Act or fail or cease to qualify as a grantor trust for United States federal
income tax purposes and so that the Junior Subordinated Debentures will be
treated as indebtedness of PMA Capital for United States federal income tax
purposes. In this connection, PMA Capital and the Administrative Trustees are
authorized to take any action, not inconsistent with applicable law, the
certificate of trust of the Issuer or the Trust Agreement, that each of PMA
Capital and the Administrative Trustees determines in its discretion to be
necessary or desirable for such purposes, as long as such action does not
adversely affect, in any material respect, the interests of the holders of the
Capital Securities. (Section 2.07(d).)
Subject to the specific authority and duties of the Property Trustee, the
Trust Agreement provides the Administrative Trustees with exclusive and
complete authority to operate and carry out the purposes of the Issuer. As
among the Trustees, the Administrative Trustees have the power, duty and
authority to act on behalf of the Issuer with respect to (A) the issuance and
sale of the Trust Securities, (B) to cause the Issuer to enter into, and to
execute, deliver and perform on behalf of the Issuer, certain agreements
necessary or desirable in connection with the purposes and function of the
Trust, (C) assisting in any registration of the Capital Securities under the
Securities Act and under state securities or blue sky laws, and the
qualification of the Trust Agreement under the Trust Indenture Act, (D)
assisting in any quotation or listing of the Capital Securities upon the
Nasdaq National Market or such securities exchange or exchanges as determined
by PMA Capital and the registration of the Capital Securities under the
Securities Exchange Act, and the preparation and filing of all periodic and
other reports and other documents pursuant to the foregoing, (E) the sending
of notices (other than notices of default) and other information regarding the
Trust Securities and the Junior Subordinated Debentures to the holders of
Trust Securities, (F) the consent to the appointment of certain agents in
accordance with the Trust Agreement and (G) certain other functions relating
to the registration of stock transfers, the winding up and liquidation of the
Issuer and the execution of documents and actions incidental to the foregoing.
As set forth in greater detail below, the Property Trustee has the power, duty
and authority to act on behalf of the Issuer with respect to (A) establishment
of a payment account, (B) the receipt of the Junior Subordinated Debentures,
(C) the collection and distribution of amounts due under the Junior
Subordinated Debentures, (D) the exercise of all of the rights, powers and
privileges of a holder of the Junior Subordinated Debentures, (E) the sending
of notices of default and other information regarding the Trust Securities and
the Junior Subordinated Debentures to the holders of the Trust Securities, (F)
the distribution of the Trust Property in accordance with the Trust Agreement
and certain other functions relating to the winding up and liquidation of the
Issuer and the protection and conservation of the Trust Property after an
Event of Default (as defined below). (Section 2.07(a).)
The Property Trustee, other than during the occurrence and continuance of an
Event of Default, undertakes to perform only such duties as are specifically
set forth in the Trust Agreement and pursuant to the Trust Indenture Act and,
after such Event of Default, must exercise the same degree of care and skill
as a prudent person would exercise or use in the conduct of his or her own
affairs. Subject to this provision, the Property Trustee is under no
obligation to exercise any of the powers vested in it by the Trust Agreement
at the request of any holder of Capital Securities unless it is offered
reasonable indemnity against the costs, expenses and liabilities that might be
incurred thereby. (Section 8.01(a) and (c).) If no Event of Default has
occurred and is continuing and the Property Trustee is required to decide
between alternative causes of action, construe ambiguous provisions in the
Trust Agreement or is unsure of the application of any provision of the Trust
Agreement, and the matter is not one on which holders of Capital Securities
are entitled under the Trust Agreement to vote, then the Property Trustee
shall take such action as is directed by PMA Capital and if not so directed,
shall take such action as it deems advisable and in the best interests of the
holders of the Trust Securities and will have no liability except for its own
bad faith, negligence or willful misconduct. (Section 8.03.)
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<PAGE>
DISTRIBUTIONS
The Capital Securities represent undivided beneficial interests in the
assets of the Issuer, and the distributions on each Capital Security will be
payable at a rate per annum of % of the stated amount of $1,000 per Capital
Security (the "Liquidation Amount"). The amount of distributions payable for
any period will be computed on the basis of a 360-day year of twelve 30-day
months. (Section 4.01(a).) See "Description of the Junior Subordinated
Debentures--Interest" and "Description of the Junior Subordinated Debentures--
Option to Extend Interest Payment Period."
Distributions on the Capital Securities will be cumulative, will accumulate
from the date of original issuance and will be payable semi-annual in arrears,
on and of each year, commencing , 1999 (each a "Distribution
Date"). In the event that any date on which distributions are otherwise
payable on the Capital Securities is not a Business Day, payment of the
distribution payable on such date will be made on the next succeeding day that
is a Business Day (and without any additional distribution or other payment in
respect of any such delay) except that, if such Business Day is in the next
succeeding calendar year, payment of such distribution shall be made on the
immediately preceding Business Day, in each case with the same force and
effect as if made on the date such payment was originally payable. "Business
Day" means any day other than a Saturday or Sunday, or a day on which banking
institutions in The City of New York are authorized or required by law or
executive order to remain closed or a day on which the principal office of the
Property Trustee or Debenture Trustee (as defined below) is closed for
business. (Section 4.01(a).)
PMA Capital has the right under the Indenture pursuant to which it will
issue the Junior Subordinated Debentures, so long as no Event of Default under
the Indenture (also referred to herein as a "Debenture Event of Default" and
defined below, see "Description of the Junior Subordinated Debentures--
Debenture Events of Default and Consequent Rights of Certain Holders") has
occurred and is continuing, to defer the payment of interest at any time and
from time to time on the Junior Subordinated Debentures for a period not
exceeding 10 consecutive semi-annual periods with respect to each deferral
period (each, an "Extension Period"), provided that no Extension Period may
extend beyond 2028, the Stated Maturity of the Junior Subordinated Debentures.
As a consequence of any such election, the Issuer will defer semi-annual
distributions on the Capital Securities during any such Extension Period.
Distributions to which holders of the Capital Securities are entitled will
accumulate additional distributions thereon at a rate per annum of % thereof,
compounded semi-annually from the relevant payment date for such
distributions. The term, "distributions" as used herein shall include any such
additional distributions. In the event that PMA Capital exercises this right,
during such Extension Period PMA Capital may not, and shall cause any
subsidiary of PMA Capital not to, (i) declare or pay any dividends or
distributions on, or redeem, purchase, acquire or make a liquidation payment
with respect to, any of PMA Capital's capital stock or (ii) make any payment
of principal, interest or premium, if any, on or repay, repurchase or redeem
any debt securities of PMA Capital that rank pari passu with or junior in
interest to the Junior Subordinated Debentures or make any guarantee payments
with respect to any guarantee by PMA Capital of the debt securities of any
subsidiary of PMA Capital that by their terms rank pari passu or junior in
interest to the Junior Subordinated Debentures (other than (a) dividends or
distributions in Common Stock or Class A Common Stock of PMA Capital, (b)
payments under the Guarantee, and (c) purchases of Common Stock or Class A
Common Stock of PMA Capital related to the issuance of Common Stock or Class A
Common Stock of PMA Capital under any of PMA Capital's benefit plans for its
directors, officers or employees). Prior to the termination of any such
Extension Period, PMA Capital may further extend the interest payment period,
provided that no Extension Period together may exceed 10 consecutive semi-
annual periods or extend beyond the Stated Maturity of the Junior Subordinated
Debentures. Upon the termination of any Extension Period and the payment of
all amounts then accrued and unpaid (together with interest thereon at the
rate of % per annum compounded semi-annually to the extent permitted by
applicable law), PMA Capital may elect to begin a new Extension Period. There
is no limitation on the number of times that PMA Capital may elect to begin an
Extension Period. See "Description of the Junior
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Subordinated Debentures--Interest" and "Description of the Junior Subordinated
Debentures--Option to Extend Interest Payment Period."
It is anticipated that the income of the Issuer available for distribution
to the holders of the Capital Securities will be limited to payments under the
Junior Subordinated Debentures in which the Issuer will invest the proceeds
from the issuance and sale of the Capital Securities and the Common
Securities. See "Description of the Junior Subordinated Debentures." If PMA
Capital does not make interest payments on the Junior Subordinated Debentures,
the Property Trustee will not have funds available to pay distributions on the
Capital Securities. The payment of distributions (if and to the extent the
Issuer has funds legally available for the payment of such distributions and
cash sufficient to make such payment therefor at such time) is guaranteed by
PMA Capital as set forth herein under "Description of the Guarantee."
Distributions on the Capital Securities will be payable to the holders
thereof as they appear on the register of the Issuer on the relevant record
dates, which, as long as the Capital Securities remain in book-entry-only
form, will be one Business Day prior to the relevant Distribution Date.
Subject to any applicable laws and regulations and the provisions of the Trust
Agreement, each such payment will be made as described under "--Book-Entry-
Only Issuance--The Depository Trust Company" below. In the event the Capital
Securities do not remain in book-entry-only form, the relevant record date
shall be the date 15 days prior to the relevant Distribution Date. (Section
4.01(b).)
REDEMPTION
MANDATORY REDEMPTION
Upon the repayment or redemption, in whole or in part, of the Junior
Subordinated Debentures at Stated Maturity or upon earlier redemption as
provided in the Indenture (each, a "Redemption Date"), the proceeds from such
repayment or redemption shall be applied by the Trustee to redeem a Like
Amount of Capital Securities, upon not less than 30 nor more than 60 days'
notice. See "Description of the Junior Subordinated Debentures--Optional
Redemption." "Like Amount" means (i) with respect to a redemption of Trust
Securities, Trust Securities having a Liquidation Amount equal to the
principal amount of Junior Subordinated Debentures to be contemporaneously
redeemed in accordance with the Indenture and the proceeds of which will be
used to pay the Redemption Price of such Trust Securities, and (ii) with
respect to a distribution of Junior Subordinated Debentures to holders of
Trust Securities in connection with a dissolution or liquidation of the
Issuer, Junior Subordinated Debentures having a principal amount equal to the
Liquidation Amount of the Trust Securities of the holder to whom such Junior
Subordinated Debentures are distributed. If less than all of the Junior
Subordinated Debentures are to be repaid or redeemed on a redemption date then
the proceeds from such repayment or redemption shall be allocated to the
redemption pro-rata of the Capital Securities and the Common Securities. The
amount of the premium, if any, paid by PMA Capital upon the redemption of all
or any part of the Junior Subordinated Debentures to be repaid or redeemed on
a Redemption Date shall be allocated to the redemption pro rata of the Capital
Securities and the Common Securities (Section 4.02).
PMA Capital has the right to redeem the Junior Subordinated Debentures (i)
on or after , 2009, in whole at any time or in part from time to time,
subject to the conditions described under "Description of Junior Subordinated
Debentures--Optional Redemption", or (ii) at any time prior to , 2009,
in whole but not in part, within 90 days following the occurrence of a Tax
Event or an Investment Company Event (each, as defined below, a "Special
Event") and subject to the further conditions described under "Description of
the Junior Subordinated Debentures--Optional Redemption."
The Redemption Price, in the case of a redemption under (i) above (which
includes redemption at Stated Maturity), shall equal the following prices
expressed in percentages of the Liquidation Amount
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<PAGE>
together with accrued distributions to but excluding the Redemption Date. If
redeemed during the 12- month period beginning 1:
<TABLE>
<CAPTION>
YEAR REDEMPTION PRICE
---- ----------------
<S> <C>
2009...................................................... 10x.xxxx%
2010...................................................... 10x.xxxx%
2011...................................................... 10x.xxxx%
2012...................................................... 10x.xxxx%
2013...................................................... 10x.xxxx%
2014...................................................... 10x.xxxx%
2015...................................................... 10x.xxxx%
2016...................................................... 10x.xxxx%
2017...................................................... 10x.xxxx%
2018...................................................... 10x.xxxx%
</TABLE>
and 100% on and after 1, 2019.
SPECIAL EVENT REDEMPTION OR DISTRIBUTION OF JUNIOR SUBORDINATED DEBENTURES
If prior to , 2009 a Special Event shall occur and be continuing, PMA
Capital has the right within 90 days following the occurrence of such Special
Event to redeem the Junior Subordinated Debentures in whole (but not in part)
and thereby cause a mandatory redemption of the Capital Securities and Common
Securities in whole (but not in part) at the Redemption Price set forth below.
If a Special Event were to occur, there can be no assurance that PMA Capital
would have sufficient funds to effectuate an optional redemption of the Junior
Subordinated Debentures and pay the Redemption Price. PMA Capital's ability to
exercise its option to redeem the Junior Subordinated Debentures may be
limited by the terms of its then-existing borrowing and other agreements. At
any time, PMA Capital has the right to terminate the Issuer and, after
satisfaction of the liabilities of creditors of the Issuer as provided by
applicable law, cause a Like Amount (defined above) of the Junior Subordinated
Debentures to be distributed to the holders of the Capital Securities and
Common Securities in liquidation of the Issuer (after which such Capital
Securities and Common Securities will no longer be deemed to be outstanding).
If PMA Capital does not elect either option described above, the Capital
Securities will remain outstanding and, in the event a Tax Event has occurred
and is continuing, Additional Sums (as defined below) may be payable on the
Junior Subordinated Debentures. "Additional Sums" means the additional amounts
as may be necessary in order that the amount of distributions then due and
payable by the Issuer on the outstanding Capital Securities and Common
Securities shall not be reduced as a result of any additional taxes, duties
and other governmental charges to which the Issuer has become subject as a
result of a Tax Event.
"Investment Company Event" means the receipt by the Issuer of an opinion of
counsel experienced in such matters to the effect that, as a result of the
occurrence of a change in law or regulation or a change in interpretation or
application of law or regulation by any legislative body, court, governmental
agency or regulatory authority (a "Change in 1940 Act Law"), the Issuer is or
will be considered an "investment company" that is required to be registered
under the Investment Company Act of 1940, as amended (the "Investment Company
Act"), which Change in 1940 Act Law becomes effective on or after the date of
original issuance of the Junior Subordinated Debentures. PMA Capital has the
right, within 90 days following the occurrence of an Investment Company Event,
to redeem the Junior Subordinated Debentures in whole (but not in part).
"Tax Event" means the receipt by the Issuer of an opinion of counsel
experienced in such matters to the effect that, as a result of (a) any
amendment to, clarification of, or change (including any announced prospective
change) in, the laws (or any regulations thereunder) of the United States or
any political subdivision or taxing authority thereof or therein, or (b) any
official administrative
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pronouncement (including any private letter ruling, technical advice
memorandum or field service advice) or regulatory procedure ("an
Administrative Action") or judicial determination, regardless of whether such
judicial decision or Administrative Action is issued to or in connection with
a proceeding involving PMA Capital or the Issuer and whether or not subject to
review or appeal, which amendment, clarification, change, Administrative
Action or decision is enacted, promulgated or announced, in each case, on or
after the date of issuance of the Junior Subordinated Debentures, there is
more than an insubstantial risk that (i) the Issuer is, or will be within 90
days of the date of such opinion, subject to United States federal income tax
with respect to interest income received or accrued on the Junior Subordinated
Debentures, (ii) interest payable by PMA Capital on the Junior Subordinated
Debentures is not, or within 90 days of the date of such opinion, will not be,
deductible by PMA Capital, in whole or in part, for United States federal
income tax purposes or (iii) the Issuer is, or will be within 90 days of the
date of such opinion, subject to more than a de minimis amount of other taxes,
duties or other governmental charges. PMA Capital has the right, within 90
days following the occurrence of a Tax Event, to redeem the Junior
Subordinated Debentures in whole (but not in part).
The Redemption Price, in the case of a redemption following a Special Event
prior to 1, 2009 (as described above) shall equal for each Capital
Security, the Make-Whole Amount for a corresponding $1,000 principal amount of
Junior Subordinated Debentures together with accrued distributions to but
excluding the Redemption Date. The "Make-Whole Amount" shall be equal to the
greater of (i) 100% of the principal amount of such Junior Subordinated
Debentures or (ii) as determined by a Quotation Agent (as defined below), the
sum of the present values of the principal amount and premium payable as part
of the Redemption Price with respect to an optional redemption of such Junior
Subordinated Debentures on 1, 2009, together with scheduled payments of
interest from the Redemption Date to 1, 2009 (the "Remaining Life"), in
each case discounted to the Redemption Date on a semi-annual basis (assuming a
360-day year consisting of 30-day months) at the Adjusted Treasury Rate (as
defined below).
"Adjusted Treasury Rate" means, with respect to any Redemption Date, the
Treasury Rate (as defined below) plus (i) % if such Redemption Date occurs on
or before 1, 2000 or (ii) % if such Redemption Date occurs after
1, 2000.
"Treasury Rate" means (i) the yield, under the heading which represents the
average for the immediately prior week, appearing in the most recently
published statistical release designated "H.15(519)" or any successor
publication which is published weekly by the Federal Reserve and which
establishes yields on actively traded United States Treasury securities
adjusted to constant maturity under the caption "Treasury Constant
Maturities," for the maturity corresponding to the Remaining Life (if no
maturity is within three months before or after the Remaining Life, yields for
the two published maturities most closely corresponding to the Remaining Life
shall be determined and the Treasury Rate shall be interpolated or
extrapolated from such yields on a straight-line basis, rounding to the
nearest month) or (ii) if such release (or any successor release) is not
published during the week preceding the calculation date or does not contain
such yields, the rate per annum equal to the semi-annual equivalent yield to
maturity of the Comparable Treasury Issue, calculated using a price for the
Comparable Treasury Issue (expressed as a percentage of its principal amount)
equal to the Comparable Treasury Price for such Redemption Date. The Treasury
Rate shall be calculated on the third Business Day preceding the Redemption
Date.
"Comparable Treasury Issue" means, with respect to any Redemption Date, the
United States Treasury security selected by the Quotation Agent as having a
maturity comparable to the Remaining Life that would be utilized, at the time
of selection and in accordance with customary financial practice, in pricing
new issues of corporate debt securities of comparable maturity to the
Remaining Life. If no United States Treasury security has a maturity which is
within a period from three months before to three months after 1, 2009,
the two most closely corresponding United States Treasury
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securities shall be used as the Comparable Treasury Issue, and the Treasury
Rate shall be interpolated or extrapolated on a straight-line basis, rounding
to the nearest month using such securities.
"Quotation Agent" means Goldman, Sachs & Co. and their successors; provided,
however, that if the foregoing shall cease to be a primary United States
Government securities dealer in New York City (a "Primary Treasury Dealer"),
PMA Capital shall substitute therefor another Primary Treasury Dealer.
"Reference Treasury Dealer" means (i) the Quotation Agent and (ii) any other
Primary Treasury Dealer selected by the Debenture Trustee after consultation
with PMA Capital.
"Comparable Treasury Price" means (A) the average of five Reference Treasury
Dealer Quotations for such Redemption Date, after excluding the highest and
lowest such Reference Treasury Dealer Quotations or (B) if the Debenture
Trustee obtains fewer than three such Reference Treasury Dealer Quotations,
the average of all such Quotations.
"Reference Treasury Dealer Quotations" means, with respect to each Reference
Treasury Dealer and any Redemption Date, the average, as determined by the
Debenture Trustee, of the bid and asked prices for the Comparable Treasury
Issue (expressed in each case, as a percentage of its principal amount) quoted
in writing to the Debenture Trustee by such Reference Treasury Dealer at 5:00
p.m., New York City time, on the third Business Day preceding such Redemption
Date.
With certain limited exceptions, after the liquidation date fixed for any
distribution of Junior Subordinated Debentures to holders of Capital
Securities (the "Liquidation Date") (i) the Capital Securities will no longer
be deemed to be outstanding, (ii) The Depository Trust Company ("DTC") or its
nominee, as the record holder of the Capital Securities, will receive a
registered global certificate or certificates representing the Junior
Subordinated Debentures to be delivered upon such distribution, (iii) any
certificates representing Capital Securities not held by DTC or its nominee
will be deemed to represent Junior Subordinated Debentures having a principal
amount equal to the stated Liquidation Amount of the Capital Securities, and
bearing accrued and unpaid interest in an amount equal to the accumulated and
unpaid distributions on such Capital Securities until such certificates are
surrendered and (iv) all rights of the holders of Capital Securities will
cease, except the right of such holders to receive Junior Subordinated
Debentures upon surrender of the certificates representing Capital Securities.
(Section 9.04(c).)
There can be no assurance as to the market prices for the Capital Securities
or the Junior Subordinated Debentures that may be distributed in exchange for
Capital Securities if a termination and liquidation of the Issuer were to
occur. Accordingly, the Capital Securities that an investor may purchase, or
the Junior Subordinated Debentures that the investor may receive upon
termination and liquidation of the Issuer, may trade at a discount to the
price that the investor paid to purchase the Capital Securities offered
hereby.
REDEMPTION PROCEDURES
Capital Securities redeemed on each Redemption Date shall be redeemed at the
Redemption Price stated above with the proceeds from the contemporaneous
redemption of Junior Subordinated Debentures. Redemptions of the Capital
Securities shall be made and the Redemption Price shall be payable on each
Redemption Date only to the extent that the Issuer has funds available for the
payment of such Redemption Price. (Section 4.02(c).) See also "--Subordination
of Common Securities."
If the Property Trustee gives a notice of redemption in respect of Capital
Securities, then, by 12:00 noon, New York time, on the Redemption Date, to the
extent that funds are available, the Property
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Trustee will, so long as the Capital Securities are in book-entry-only form,
irrevocably deposit with DTC funds sufficient to pay the applicable Redemption
Price and will give DTC irrevocable instructions and authority to pay the
Redemption Price to the holders of the Capital Securities. See "--Book-Entry-
Only Issuance--The Depository Trust Company." If the Capital Securities are no
longer in book-entry-only form, the Property Trustee, to the extent funds are
available, will irrevocably deposit with the paying agent for the Capital
Securities funds sufficient to pay the applicable Redemption Price and will
give such paying agent irrevocable instructions and authority to pay the
Redemption Price to the holders thereof upon surrender of their certificates
representing Capital Securities. Notwithstanding the foregoing, distributions
payable on or prior to the Redemption Date for any Capital Securities called
for redemption shall be payable to the holders of such Capital Securities on
the relevant record dates for the related Distribution Dates. If notice of
redemption shall have been given and funds deposited as required, then upon
the Redemption Date, all rights of holders of such Capital Securities so
called for redemption will cease, except the right of the holders of such
Capital Securities to receive the Redemption Price, including any
distributions payable in respect of the Capital Securities on or prior to the
Redemption Date but without interest on such Redemption Price, and such
Capital Securities will cease to be outstanding. In the event that any date
fixed for redemption of Capital Securities is not a Business Day, then payment
of the Redemption Price payable on such date will be made on the next
succeeding day that is a Business Day (and without any interest or other
payment in respect of any such delay), except that, if such Business Day falls
in the next calendar year, such payment shall be made on the immediately
preceding Business Day in each case, with the same force and effect as if made
on such date. In the event that payment of the Redemption Price in respect of
any Capital Securities called for redemption is improperly withheld or refused
and not paid either by the Issuer or by PMA Capital pursuant to the Guarantee
described under "Description of the Guarantee," distributions on such Capital
Securities will continue to accumulate, at the then applicable rate, from the
original Redemption Date to the date of payment, in which case the actual
payment date will be the date fixed for redemption for purposes of calculating
the Redemption Price. (Section 4.02(d).)
Payment of the Redemption Price on the Capital Securities and distribution
of Junior Subordinated Debentures to holders of Capital Securities shall be
made to the record holders thereof as they appear on the register for the
Capital Securities on the relevant record date, which shall be one Business
Day prior to the relevant Redemption Date or Liquidation Date, as applicable;
provided, however, that in the event that the Capital Securities do not remain
in book- entry-only form, the relevant record date shall be the date 15 days
prior to the Redemption Date or Liquidation Date, as applicable. (Section
4.02(e).)
If less than all the outstanding Trust Securities are to be redeemed on a
Redemption Date, then the aggregate Liquidation Amount of Trust Securities to
be redeemed shall be allocated pro rata among the Common Securities and the
Capital Securities according to their relative aggregate Liquidation Amounts.
The particular Capital Securities to be redeemed shall be selected on a pro
rata basis (based upon Liquidation Amounts) not more than 60 days prior to the
Redemption Date by the Property Trustee from the outstanding Capital
Securities not previously called for redemption, by such method (including,
without limitation, by lot) as the Property Trustee shall deem fair and
appropriate and which may provide for the selection for redemption of portions
(equal to $1,000 or an integral multiple of $1,000 in excess thereof) of the
Liquidation Amount of Capital Securities of a denomination larger than $1,000.
See "--Book-Entry Only Issuance--The Depository Trust Company." The Property
Trustee shall promptly notify the Securities Registrar in writing of the
Capital Securities selected for redemption and, in the case of any Capital
Securities selected for partial redemption, the Liquidation Amount thereof to
be redeemed. For all purposes of the Trust Agreement, unless the context
otherwise requires, all provisions relating to the redemption of Capital
Securities shall relate, in the case of any Capital Securities redeemed or to
be redeemed only in part, to the portion of the Liquidation Amount of Capital
Securities which has been or is to be redeemed. The Bank of New York is the
initial Securities Registrar. (Sections 4.02(f) and 5.04.)
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Subject to applicable law (including, without limitation, United States
federal securities law), PMA Capital or its subsidiaries may at any time and
from time to time purchase outstanding Capital Securities by tender, in the
open market or by private agreement.
SUBORDINATION OF COMMON SECURITIES
Payment of distributions on, and the Redemption Price of, the Trust
Securities, as applicable, shall be made pro rata based on the Liquidation
Amount of the Trust Securities; provided, however, that if on any Distribution
Date, Redemption Date or Liquidation Date any Event of Default (as defined
below, see "--Events of Default; Notice") under the Trust Agreement resulting
from a Debenture Event of Default (as defined below) shall have occurred and
be continuing, no payment of any distribution on, or Redemption Price of, or
Liquidation Distribution (as defined below) in respect of any Common Security,
and no other payment on account of the redemption, liquidation or other
acquisition of Common Securities, shall be made unless payment in full in cash
of all accumulated and unpaid distributions on all outstanding Capital
Securities for all distribution periods terminating on or prior thereto, or in
the case of payment of the Redemption Price the full amount of such Redemption
Price on all outstanding Capital Securities, or in the case of payment of the
Liquidation Distribution the full amount of such Liquidation Distribution on
all outstanding Capital Securities, shall have been made or provided for, and
all funds available to the Property Trustee shall first be applied to the
payment in full in cash of all distributions on, or the Redemption Price of,
Capital Securities then due and payable. (Section 4.03(a).)
In the case of the occurrence of any Event of Default under the Trust
Agreement resulting from a Debenture Event of Default, the holder of the
Common Securities will be deemed to have waived any right to act with respect
to any such Event of Default under the Trust Agreement with respect to the
Common Securities until the effect of all such Events of Default have been
cured, waived or otherwise eliminated. Until any such Events of Default under
the Trust Agreement with respect to the Capital Securities have been cured,
waived or otherwise eliminated, the Property Trustee shall act solely on
behalf of the holders of the Capital Securities and not the holder of the
Common Securities, and only the holders of the Capital Securities will have
the right to direct the Property Trustee to act on their behalf. (Section
4.03(b).)
LIQUIDATION DISTRIBUTION UPON TERMINATION
Pursuant to the Trust Agreement, the Issuer shall be terminated by the
Trustees on the first to occur of: (i) the expiration of the term of the
Issuer; (ii) the occurrence of certain events of bankruptcy or insolvency in
respect of, or the dissolution or liquidation of, PMA Capital; (iii) the
distribution of the Junior Subordinated Debentures to the holders of Capital
Securities and Common Securities if PMA Capital, as Depositor, has given
written direction to the Property Trustee to terminate the Issuer (which
direction is optional and wholly within the discretion of PMA Capital, as
Depositor); (iv) the redemption of all of the Trust Securities and (v) the
entry of an order for dissolution of the Issuer by a court of competent
jurisdiction. (Sections 9.01 and 9.02.)
If a termination event specified in clause (ii), (iii) or (v) above occurs,
the Issuer shall be liquidated by the Trustees as expeditiously as the
Trustees determine to be possible by distributing, after satisfaction of
liabilities to creditors of the Trust as provided by applicable law, to each
holder of Capital Securities and Common Securities a Like Amount of Junior
Subordinated Debentures, unless such distribution is determined by the
Property Trustee not to be practical, in which event such holders will be
entitled to receive out of the assets of the Issuer available for distribution
to holders after satisfaction of liabilities to creditors, an amount equal to,
in the case of the Capital Securities, the aggregate of the Liquidation Amount
plus accumulated and unpaid distributions thereon to the date of payment (such
amount being the "Liquidation Distribution"). If such Liquidation Distribution
can be paid only in part because the Issuer has insufficient assets available
to pay in full the aggregate Liquidation
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Distribution, then, subject to the next succeeding sentence, the amounts
payable by the Issuer on the Capital Securities shall be paid on a pro rata
basis (based on Liquidation Amounts). The holder of the Common Securities will
be entitled to receive Liquidation Distributions upon any such liquidation pro
rata with the holders of the Capital Securities, except that if a Debenture
Event of Default has occurred and is continuing, the Capital Securities shall
have a priority over the Common Securities. (Sections 9.04(a)and 9.04(d).)
EVENTS OF DEFAULT; NOTICE
Any one of the following events constitutes an "Event of Default" under the
Trust Agreement with respect to the Capital Securities issued thereunder
(whatever the reason for such Event of Default and whether it shall be
voluntary or involuntary or be effected by operation of law or pursuant to any
judgment, decree or order of any court or any order, rule or regulation of any
administrative or governmental body):
(i) the occurrence of a Debenture Event of Default under the Indenture
(as defined in "Description of Junior Subordinated Debentures--Debenture
Events of Default and Consequent Rights of Certain Holders"); or
(ii) default by the Property Trustee in the payment of any distribution,
other than payment of principal, when it becomes due and payable, and
continuation of such default for a period of 30 days; or
(iii) default by the Property Trustee in the payment of any Redemption
Price of any Trust Security when it becomes due and payable; or
(iv) default in the performance, or breach, in any material respect, of
any covenant or warranty of the Trustees in the Trust Agreement (other than
a covenant or warranty a default in the performance of which or the breach
of which is dealt with in clause (ii) or (iii) above), and continuation of
such default or breach for a period of 60 days after there has been given,
by registered or certified mail, to the defaulting Trustee or Trustees by
the holders of at least 25% in aggregate Liquidation Amount of the
outstanding Capital Securities a written notice specifying such default or
breach and requiring it to be remedied and stating that such notice is a
"Notice of Default" under the Trust Agreement; or
(v) The occurrence of certain events of bankruptcy or insolvency with
respect to the Property Trustee and the failure by PMA Capital to appoint a
successor Property Trustee within 60 days thereof. (Section 1.01.)
Within five Business Days after the occurrence of any Event of Default, the
Property Trustee shall transmit notice of any Event of Default actually known
to the Property Trustee to the holders of Trust Securities, the Administrative
Trustees and PMA Capital, as Depositor, unless such Event of Default shall
have been cured or waived. (Section 8.02.) Each of PMA Capital, as Depositor,
and the Administrative Trustees on behalf of the Trust is required to provide
annually to the Property Trustee a certificate as to whether or not they are
in compliance with all of the conditions and covenants applicable to them
under the Trust Agreement. (Section 8.15.)
If a Debenture Event of Default has occurred and is continuing, the Capital
Securities shall have a preference over the Common Securities as described
above. See "--Liquidation Distribution Upon Termination." The existence of an
Event of Default does not entitle the holders of Capital Securities to
accelerate the maturity thereof.
REMOVAL OF TRUSTEES
Unless a Debenture Event of Default shall have occurred and be continuing
the holder of the Common Securities may remove any Trustee at any time. The
holders of at least a majority in
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aggregate Liquidation Amount of the outstanding Capital Securities may remove
the Property Trustee or if a Debenture Event of Default has occurred and is
continuing, the Property Trustee, may be removed at such time by the holders
of a majority in aggregate Liquidation Amount of the outstanding Capital
Securities with or without cause. In no event will the holders of the Capital
Securities have the right to vote to appoint, remove or replace the
Administrative Trustees, which voting rights are vested exclusively in PMA
Capital as the holder of the Common Securities. No resignation or removal of
any Trustee and no appointment of a successor Trustee shall be effective until
the acceptance of appointment by the successor Trustee in accordance with the
applicable provisions of the Trust Agreement. (Section 8.10.)
MERGER OR CONSOLIDATION OF TRUSTEES
Any entity into which the Property Trustee, the Delaware Trustee or any
Administrative Trustee that is not a natural person may be merged or converted
or with which it may be consolidated, or any entity resulting from any merger,
conversion or consolidation to which any such Trustee shall be a party, or any
entity succeeding to all or substantially all of the corporate trust business
of any such Trustee, shall be the successor of such Trustee under the Trust
Agreement, provided such entity shall be otherwise qualified and eligible.
(Section 8.12.)
MERGER, CONSOLIDATION, AMALGAMATION OR REPLACEMENT OF THE ISSUER
The Issuer may not merge consolidate amalgamate with or into, or be replaced
by, or convey, transfer or lease its properties and assets substantially as an
entirety to any corporation or other entity, except as described below. The
Issuer may, at the request of PMA Capital, with the consent of the
Administrative Trustees and with the consent of the holders of at least a
majority in aggregate Liquidation Amount of the Capital Securities or the
Property Trustee, merge, consolidate, or amalgamate with or into, or be
replaced by or convey, transfer or lease its properties and assets
substantially as an entirety to a trust organized as such under the laws of
any state; provided, that (i) such successor entity either (a) expressly
assumes all of the obligations of the Issuer with respect to the Capital
Securities or (b) substitutes for the Capital Securities other securities
having substantially the same terms as the Capital Securities (the "Successor
Securities") so long as the Successor Securities rank the same as the Capital
Securities rank in priority with respect to distributions and payments upon
liquidation, redemption and otherwise, (ii) PMA Capital expressly appoints a
trustee of such successor entity possessing the same powers and duties as the
Property Trustee as the holder of the Junior Subordinated Debentures, (iii)
the Successor Securities are listed or quoted, or any Successor Securities
will be listed or quoted upon notification of issuance, on any national
securities exchange, the Nasdaq National Market or other organization on which
the Capital Securities are then listed or quoted, if any, (iv) such merger,
consolidation, amalgamation, replacement, conveyance, transfer or lease does
not cause the Capital Securities (including any Successor Securities) to be
downgraded by any nationally recognized statistical rating organization, (v)
such merger, consolidation, amalgamation, replacement, conveyance, transfer or
lease does not adversely affect the rights, preferences and privileges of the
holders of the Capital Securities (including any Successor Securities) in any
material respect, (vi) such successor entity has a purpose identical to that
of the Issuer, (vii) prior to such merger, consolidation, amalgamation,
replacement, conveyance, transfer or lease, PMA Capital has received an
opinion from independent counsel to the Issuer experienced in such matters to
the effect that (a) such merger, consolidation, amalgamation, replacement,
conveyance, transfer or lease does not adversely affect the rights,
preferences and privileges of the holders of the Capital Securities (including
any Successor Securities) in any material respect and (b) following such
merger, consolidation, amalgamation, replacement, conveyance, transfer or
lease, neither the Issuer nor such successor entity will be required to
register as an investment company under the Investment Company Act and (viii)
PMA Capital or any permitted successor or assignee owns all of the Common
Securities of such successor entity and guarantees the obligations of such
successor entity under the Successor
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Securities at least to the extent provided by the Guarantee. Notwithstanding
the foregoing, the Issuer shall not, except with the consent of holders of
100% in Liquidation Amount of the Capital Securities, consolidate, amalgamate,
or merge with or into or be replaced by or convey, transfer or lease its
properties and assets substantially as an entirety to any other entity or
permit any other entity to consolidate, amalgamate merge with or into, or
replace it if such consolidation, amalgamation, merger, replacement,
conveyance, transfer or lease would cause the Issuer or the successor entity
to be classified as other than a grantor trust for United States federal
income tax purposes. (Section 9.05.)
VOTING RIGHTS
Except as provided below and under "Description of the Guarantee--Amendments
and Assignment" and "Description of the Junior Subordinated Debentures--
Modification of the Indenture" and as otherwise required by law and the Trust
Agreement, the holders of the Capital Securities will have no voting rights.
(Section 6.01(a).)
The Trust Agreement may be amended from time to time by PMA Capital, the
Property Trustee and the Administrative Trustees, without the consent of the
holders of the Capital Securities (i) to cure any ambiguity, correct or
supplement any provision in the Trust Agreement that may be inconsistent with
any other provision or to make any other provisions with respect to matters or
questions arising under the Trust Agreement, which shall not be inconsistent
with the other provisions of the Trust Agreement or (ii) to modify, eliminate
or add to any provisions of the Trust Agreement to such extent as shall be
necessary to ensure that the Issuer will be classified for United States
federal income tax purposes as a grantor trust at all times that any Trust
Securities are outstanding or to ensure that the Issuer will not be required
to register as an "investment company" under the Investment Company Act;
provided, however, that in the case of either clause (i) or clause (ii), such
action shall not adversely affect in any material respect the interests of any
holder of Capital Securities, and any amendments of such Trust Agreement shall
become effective when notice thereof is given to the holders of Trust
Securities. The Trust Agreement may be amended by PMA Capital, the Property
Trustee and the Administrative Trustees with (i) the consent of holders
representing not less than a majority (based upon Liquidation Amounts) of the
outstanding Trust Securities and (ii) receipt by the Trustees of an opinion of
counsel to the effect that such amendment or the exercise of any power granted
to the Trustees in accordance with such amendment will not affect the Issuer's
status as a grantor trust for United States federal income tax purposes or the
Issuer's exemption from status as an "investment company" under the Investment
Company Act, provided that without the consent of each affected holder of
Trust Securities, such Trust Agreement may not be amended to (i) change the
amount or timing of any distribution on the Trust Securities or otherwise
adversely affect the amount of any distribution required to be made in respect
of the Trust Securities as of a specified date or (ii) restrict the right of a
holder of Trust Securities to institute suit for the enforcement of any such
payment on or after such date. (Section 10.03.)
So long as any Junior Subordinated Debentures are held by the Property
Trustee, the Trustees shall not (i) direct the time, method and place of
conducting any proceeding for any remedy available to the Debenture Trustee,
or executing any trust or power conferred on the Debenture Trustee with
respect to the Junior Subordinated Debentures, (ii) waive any past default
that is waivable under Section 513 of the Indenture, (iii) exercise any right
to rescind or annul a declaration that the principal of all the Junior
Subordinated Debentures shall be due and payable or (iv) consent to any
amendment, modification or termination of the Indenture or the Junior
Subordinated Debentures, where such consent shall be required, without, in
each case, obtaining the prior approval of the holders of at least a majority
in Liquidation Amount of the outstanding Capital Securities; provided,
however, that where a consent under the Indenture would require the consent of
each holder of Junior Subordinated Debentures affected thereby, no such
consent shall be given by the Property Trustee without the prior consent of
each holder of Capital Securities. The Trustees shall not revoke any action
previously authorized or approved by a vote of the holders of Capital
Securities except by subsequent vote of the
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holders of Capital Securities. The Property Trustee shall notify all holders
of the Capital Securities of any notice of default received from the Debenture
Trustee. In addition to obtaining the foregoing approvals of the holders of
the Capital Securities, prior to taking any of the foregoing actions, the
Trustees shall, at the expense of PMA Capital, obtain an opinion of counsel
experienced in such matters to the effect that the Issuer will not fail to be
classified as a grantor trust for United States federal income tax purposes on
account of such action. (Section 6.01(b).)
Any required approval of holders of Capital Securities may be given at a
separate meeting of holders of Capital Securities convened for such purpose or
pursuant to written consent. The Administrative Trustees will cause a notice
of any meeting at which holders of Capital Securities are entitled to vote, or
of any matter upon which action by written consent of such holders is to be
taken, to be given to each holder of record of the outstanding Capital
Securities in the manner set forth in the Trust Agreement. (Sections 6.02 and
6.06.)
No vote or consent of the holders of Capital Securities will be required for
the Issuer to redeem and cancel Capital Securities in accordance with the
Trust Agreement. Notwithstanding that holders of Capital Securities are
entitled to vote or consent under any of the circumstances described above,
any of the Capital Securities that are owned by PMA Capital, any Trustee or
any affiliate of PMA Capital or any Trustee, shall, for purposes of such vote
or consent, be treated as if they were not outstanding. (Section 1.01.)
CO-TRUSTEES AND SEPARATE TRUSTEE
Unless an Event of Default under the Trust Agreement shall have occurred and
be continuing, at any time or times, for the purpose of meeting the legal
requirements of the Trust Indenture Act or of any jurisdiction in which any
part of the Trust Property may at the time be located, the Administrative
Trustees and PMA Capital shall have power to appoint, and upon the written
request of the Administrative Trustees, PMA Capital, as Depositor, shall for
such purpose join with the Administrative Trustees in the execution, delivery,
and performance of all instruments and agreements necessary or proper to
appoint one or more persons or entities approved by the Property Trustee
either to act as co-trustee, jointly with the Property Trustee, of all or any
part of such Trust Property, or to act as separate trustee of any such
property, in either case with such powers as may be provided in the instrument
of appointment, and to vest in such person(s) or entity(s) in such capacity,
any property, title, right or power deemed necessary or desirable, subject to
the provisions of the Trust Agreement. If the Depositor does not join in such
appointment within 15 days after the receipt by it of a request so to do, or
in case a Debenture Event of Default has occurred and is continuing, the
Property Trustee alone shall have power to make such appointment. (Section
8.09.) "Trust Property" means (a) the Junior Subordinated Debentures, (b) any
cash on deposit in, or owing to, the payment account maintained by the
Property Trustee, (c) all proceeds and rights in respect of the foregoing and
any other property and assets for the time being held or deemed to be held by
the Property Trustee pursuant to the trusts of the Trust Agreement and (d) the
rights of the Property Trustee under the Guarantee. (Section 1.01.)
BOOK-ENTRY ONLY ISSUANCE--THE DEPOSITORY TRUST COMPANY
DTC will act as securities depositary for the Capital Securities. The
Capital Securities will be issued only as fully registered securities
registered in the name of Cede & Co. (DTC's nominee). One or more fully
registered global Capital Security certificates will be issued, representing
in the aggregate the total number of Capital Securities, and will be deposited
with DTC. (Section 5.11.)
DTC is a limited purpose trust company organized under the New York Banking
Law, a "banking organization" within the meaning of the New York Banking Law,
a member of the Federal Reserve System, a "clearing corporation" within the
meaning of the New York Uniform Commercial Code, and a "clearing agency"
registered pursuant to the provisions of Section 17A of the Exchange Act. DTC
holds securities that its participants ("Participants") deposit with DTC. DTC
also facilitates the
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settlement among Participants through electronic computerized book-entry
changes in Participants' accounts, thereby eliminating the need for physical
movement of securities certificates. Direct Participants include securities
brokers and dealers, banks, trust companies, clearing corporations, and
certain other organizations ("Direct Participants"). DTC is owned by a number
of its Direct Participants and by the New York Stock Exchange Inc. (the "New
York Stock Exchange"), the American Stock Exchange, Inc. and the National
Association of Securities Dealers, Inc. Access to the DTC system is also
available to others such as securities brokers and dealers, banks and trust
companies that clear through or maintain custodial relationships with Direct
Participants, either directly or indirectly ("Indirect Participants"). The
rules applicable to DTC and its Participants are on file with the Commission.
Purchases of Capital Securities within the DTC system must be made by or
through Direct Participants, which will receive a credit for the Capital
Securities on DTC's records. The ownership interest of each actual purchaser
of each Capital Security ("Beneficial Owner") is in turn to be recorded on the
Direct and Indirect Participants' records. Beneficial Owners will not receive
written confirmation from DTC of their purchases, but Beneficial Owners are
expected to receive written confirmations providing details of the
transactions, as well as periodic statements of their holdings, from the
Direct or Indirect Participants through which the Beneficial Owners purchased
Capital Securities. Transfers of ownership interests in the Capital Securities
are to be accomplished by entries made on the books of Participants acting on
behalf of Beneficial Owners. Beneficial Owners will not receive certificates
representing their ownership interests in Capital Securities, unless use of
the book-entry system for the Capital Securities is discontinued.
DTC has no knowledge of the actual Beneficial Owners of the Capital
Securities; DTC's records reflect only the identity of the Direct Participants
to whose accounts such Capital Securities are credited, which may or may not
be the Beneficial Owners. The Participants will remain responsible for keeping
account of their holdings on behalf of their customers.
Conveyance of notices and other communications by DTC to Direct
Participants, by Direct Participants to Indirect Participants, and by Direct
Participants and Indirect Participants to Beneficial Owners and the voting
rights of Direct Participants, Indirect Participants and Beneficial Owners
will be governed by arrangements among them, subject to any statutory or
regulatory requirements as may be in effect from time to time.
Redemption notices shall be sent to Cede & Co. If less than all of the
Capital Securities are being redeemed, DTC will reduce the amount of the
interest of each Direct Participant in such Capital Securities in accordance
with its procedures. DTC's current practice is to determine by lot the amount
of the interest of each Direct Participant to be redeemed.
Although voting with respect to the Capital Securities is limited to the
holders of record of the Capital Securities, in those cases where a vote is
required, neither DTC nor Cede & Co. will itself consent or vote with respect
to Capital Securities. Under its usual procedures, DTC would mail an omnibus
proxy to the Property Trustee as soon as possible after the record date. The
omnibus proxy assigns Cede & Co.'s consenting or voting rights to those Direct
Participants to whose accounts the Capital Securities are credited on the
record date (identified in a listing attached to the omnibus proxy).
The Issuer will make distribution payments on the Capital Securities to DTC.
DTC's practice is to credit Direct Participants' accounts on the relevant
payment date in accordance with their respective holdings shown on DTC's
records unless DTC has reason to believe that it will not receive payments on
such payment date. Payments by Participants to Beneficial Owners will be
governed by standing instructions and customary practices and will be the
responsibility of such Participant and not of DTC, the Issuer or PMA Capital,
subject to any statutory or regulatory requirements as may be in effect from
time to time. Payment of distributions to DTC is the responsibility of the
Issuer, disbursement of such payments to Direct Participants is the
responsibility of DTC, and disbursements of such payments to the Beneficial
Owners is the responsibility of Direct and Indirect Participants.
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A global security shall be exchangeable for Capital Securities registered in
the names of persons other than DTC or its nominee only if (i) DTC properly
notifies PMA Capital, the Trustees, and the Registrar and Transfer Agent that
it is unwilling or unable to continue as a depositary for such global security
and no successor depositary shall have been appointed, or if at any time, DTC
ceases to be a clearing agency registered under the Exchange Act, at a time
when DTC is required to be so registered to act as such depositary, (ii) the
Issuer in its sole discretion determines that such global security shall be so
exchangeable or (iii) there shall have occurred and be continuing a Debenture
Event of Default. Any global security that is exchangeable pursuant to the
preceding sentence shall be exchangeable for definitive certificates
registered in such names, as DTC shall direct. It is expected that such
instructions will be based upon directions received by DTC from its
Participants with respect to ownership of beneficial interests in such global
security. In the event that Capital Securities are issued in definitive form,
such Capital Securities will be in denominations of $1,000 and integral
multiples thereof and may be transferred or exchanged at the offices described
below.
In the event Capital Securities are issued in certificated form, the
Liquidation Amount and distributions will be payable, the transfer of the
Capital Securities will be registrable and Capital Securities will be
exchangeable for Capital Securities of other denominations of a like aggregate
Liquidation Amount, at the corporate office of the Property Trustee, or at the
offices of any paying agent or transfer agent; provided that payment of any
distribution may be made at the option of the Administrative Trustees by check
mailed to the address of the persons entitled thereto or by wire transfer. In
addition, if the Capital Securities are issued in certificated form, the
record dates for payment of distributions will be the date 15 days prior to
the relevant Distribution Date (whether or not a Business Day).
The information in this section concerning DTC and DTC's book-entry system
has been obtained from sources that the Issuer and PMA Capital believe to be
reliable. Neither the Issuer nor PMA Capital has any responsibility for the
performance by DTC or its Participants of their respective obligations as
described hereunder or under the rules and procedures governing their
respective operations.
REGISTRAR AND TRANSFER AGENT
The Bank of New York will act as Securities Registrar and Transfer Agent for
the Capital Securities. (Section 5.04.)
Registration of transfers and exchanges of Capital Securities will be
effected without charge by or on behalf of the Issuer, but the Securities
Registrar may require payment (with the giving of such indemnity as the Issuer
or PMA Capital may require) of a sum sufficient to cover any tax or other
governmental charge that may be imposed in connection with any transfer or
exchange. The Securities Registrar will not be required to register the
transfer of any Capital Securities that have been called for redemption.
(Section 5.04.)
MISCELLANEOUS
PAYMENT AND PAYING AGENCY
Payments in respect of the Capital Securities shall be made to DTC (so long
as the Capital Securities are held by DTC), which shall credit the relevant
participants' accounts at DTC on the applicable Distribution Dates or, if the
Capital Securities are not held by DTC, such payments shall be made at the
corporate office of the Property Trustee, or at the offices of any paying
agent or transfer agent; provided that payment of any distribution may be made
at the option of the Administrative Trustees by check mailed to the address of
the person entitled thereto as such address shall appear on the Security
Register or by wire transfer. The Paying Agent shall initially be The Bank of
New York, and any co-paying agent chosen by The Bank of New York and
acceptable to the Administrative
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Trustees and PMA Capital. The Paying Agent shall be permitted to resign as
Paying Agent upon 30 days' written notice to the Administrative Trustees, the
Property Trustee and PMA Capital. In the event that The Bank of New York shall
no longer be the Paying Agent or a successor Paying Agent shall resign or its
authority to act be revoked, the Administrative Trustees shall appoint a
successor to act as Paying Agent (which shall be a bank or trust company
acceptable to the Property Trustee and PMA Capital). (Sections 4.04 and 5.09.)
Holders of the Capital Securities have no preemptive or similar rights.
(Section 5.14(a).)
The Issuer may not borrow money or issue debt (other than the Capital
Securities and the Common Securities) or mortgage or pledge any of its assets.
(Section 2.07(b).)
DESCRIPTION OF THE GUARANTEE
Set forth below is a summary of the material provisions of the Guarantee
that will be executed and delivered by PMA Capital for the benefit of the
holders from time to time of the Capital Securities. The Guarantee will be
qualified under the Trust Indenture Act, and The Bank of New York will act as
indenture trustee (the "Guarantee Trustee") under the Guarantee for purposes
of compliance with the Trust Indenture Act. The terms of the Guarantee will be
those set forth in such Guarantee and those made part of such Guarantee by the
Trust Indenture Act. Reference is made to the provisions of the Guarantee, the
form of which is filed as an exhibit to the Registration Statement of which
this Prospectus forms a part, and the Trust Indenture Act for a more complete
description of the provisions summarized herein, and each statement set forth
below shall be deemed qualified in its entirety by such reference. Whenever
particular provisions in the Guarantee are referred to herein, such provisions
are incorporated by reference herein. Section references used herein are
references to provisions of the Guarantee unless otherwise noted. The
Guarantee Trustee will hold the Guarantee for the benefit of the holders of
the Capital Securities.
GENERAL
PMA Capital will irrevocably and unconditionally agree, to the extent set
forth herein, to pay the Guarantee Payments (as defined below) in full to the
holders of the Capital Securities (without duplication of amounts theretofore
paid by or on behalf of the Issuer), as and when due, regardless of any
defense, right of set-off or counterclaim which the Issuer may have or assert
other than the defense of payment. The following payments with respect to
Capital Securities, to the extent not paid by or on behalf of the Issuer (the
"Guarantee Payments"), will be subject to the Guarantee: (i) any accumulated
and unpaid distributions required to be paid on the Capital Securities, to the
extent the Issuer shall have funds available therefor at such time, (ii) the
Redemption Price with respect to any Capital Securities called for redemption
by the Issuer, to the extent the Issuer shall have funds available therefor at
such time and (iii) upon a voluntary or involuntary dissolution, winding-up or
termination of the Issuer (other than in connection with a redemption of all
of the outstanding Capital Securities or the distribution of Junior
Subordinated Debentures to the holders of Capital Securities as provided in
the Trust Agreement), the lesser of (a) the aggregate of the Liquidation
Amount and all accumulated and unpaid distributions on the Capital Securities
to the date of payment to the extent the Issuer shall have funds available
therefor at such time and (b) the amount of assets of the Issuer remaining
available for distribution to holders of Capital Securities after satisfaction
of liabilities to creditors of the Issuer as required by applicable law. PMA
Capital's obligation to make a Guarantee Payment may be satisfied by direct
payment of the required amounts by PMA Capital to the holders of Capital
Securities or by causing the Issuer to pay such amounts to such holders.
(Section 5.01.)
The Guarantee will be a full and unconditional guarantee on a subordinated
basis with respect to the Capital Securities issued by the Issuer from the
time of issuance of the Capital Securities, but will
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apply only to the extent that the Issuer has sufficient funds to make such
payments, and is not a guarantee of collection of payment. (Sections 5.01 and
5.05.) If PMA Capital does not make interest payments on the Junior
Subordinated Debentures held by the Issuer, it is expected that the Issuer
will not pay distributions on the Capital Securities and will not have funds
available therefor. The Guarantee will rank subordinate and junior in right of
payment to all Senior Debt of PMA Capital.
"Senior Debt" means the principal of (and premium, if any) and interest, if
any (including interest accruing on or after the filing of any petition in
bankruptcy or for reorganization relating to PMA Capital whether or not such
claim for post-petition interest is allowed in such proceeding), on Debt,
whether incurred on or prior to the date of the Guarantee or thereafter
incurred, unless, in the instrument creating or evidencing the same or
pursuant to which the same is outstanding, it is provided that such
obligations are not superior in right of payment to the Guarantee or to other
Debt which is pari passu with, or subordinated to, the Guarantee; provided,
however, that Senior Debt shall not be deemed to include (i) any Debt of PMA
Capital which, when incurred and without respect to any election under Section
1111(b) of the Bankruptcy Code, was without recourse to PMA Capital, (ii) any
Debt of PMA Capital to any of its subsidiaries, (iii) Debt to any employee of
PMA Capital, (iv) trade accounts payable of PMA Capital, (v) accrued
liabilities of PMA Capital or any of its subsidiaries arising in the ordinary
course of business of PMA Capital, (vi) the Junior Subordinated Debentures,
and (vii) the Guarantee. (Section 1.01.) "Debt" for purposes of the Guarantee,
has the same meaning as that specified under "Description of the Junior
Subordinated Debentures--Subordination" below.
PMA Capital's obligations under the Trust Agreement, the Guarantee, the
Indenture, the Junior Subordinated Debentures and the Expense Agreement taken
together provide a full, irrevocable, and unconditional guarantee on a
subordinated basis by PMA Capital of all of the Issuer's obligations under the
Capital Securities. See "--Status of the Guarantee."
PMA Capital is an insurance holding company and substantially all of the
operating assets of PMA Capital are owned by its consolidated subsidiaries,
principally PMA Reinsurance Corporation and the Pooled Companies. PMA Capital
relies primarily on the receipt of sufficient funds from PMA Re and the Pooled
Companies in the form of dividends, net payments under tax-sharing agreements
or loans to meet its obligations for payment of principal and interest on
outstanding debt obligations (including the Junior Subordinated Debentures)
and corporate expenses. Accordingly, PMA Capital's obligations under the
Guarantee will be effectively subordinated to all existing and future
liabilities of PMA Capital's subsidiaries, and claimants should look only to
the assets of PMA Capital for payments thereunder. Pennsylvania law limits the
payment of dividends by PMA Reinsurance Corporation and the Pooled Companies.
PMA Reinsurance Corporation and the Pooled Companies have the ability to loan
funds to PMA Capital subject to certain regulatory restrictions. See "Risk
Factors--Subordination of the Guarantee and the Junior Subordinated
Debentures," "--Holding Company Structure and Restrictions on Subsidiary
Dividends" and "Supervision and Regulation".
CERTAIN COVENANTS OF PMA CAPITAL
In the Guarantee, PMA Capital will covenant that, so long as any Capital
Securities remain outstanding, PMA Capital will not, and will cause its
subsidiaries not to, (a) declare or pay any dividends or distributions on
(other than dividends or distributions in Common Stock or Class A Common Stock
of PMA Capital), or redeem, purchase, acquire or make a liquidation payment
with respect to, any of PMA Capital's outstanding capital stock or (b) make
any payment of principal, interest or premium, if any, on or repay, repurchase
or redeem any debt securities that rank pari passu with or junior to the
Junior Subordinated Debentures or make any guarantee payments with respect to
the foregoing if at such time (i) PMA Capital shall be in default with respect
to its Guarantee Payments under the Guarantee, (ii) there shall have occurred
and be continuing any Debenture Event of Default or (iii) PMA Capital shall
have given notice of its selection of an Extension Period and such period, or
any extension thereof, is continuing. (Section 6.01.)
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AMENDMENTS AND ASSIGNMENT
Except with respect to any changes that do not materially adversely affect
the rights of holders of Capital Securities (in which case no consent of
holders of Capital Securities will be required), the terms of the Guarantee
may be amended only with the prior approval of the holders of not less than a
majority of the Liquidation Amount of the outstanding Capital Securities.
(Section 8.02.) All guarantees and agreements contained in the Guarantee shall
bind the successors, assigns, receivers, trustees and representatives of PMC
and shall inure to the benefit of the holders of the Capital Securities then
outstanding. (Section 8.01.)
EVENTS OF DEFAULT
An event of default under the Guarantee (a "Guarantee Event of Default")
will occur upon the failure of PMA Capital to perform any of its payment
obligations thereunder or the failure to perform any non-payment obligations
thereunder if any such non-payment obligation remains unremedied for 30 days.
(Section 1.01.) The holders of a majority in Liquidation Amount of the Capital
Securities have the right to direct the time, method and place of conducting
any proceeding for any remedy available to the Guarantee Trustee in respect of
the Guarantee or exercising any trust or power conferred upon the Guarantee
Trustee under the Guarantee. (Section 5.04.)
Any holder of Capital Securities may institute a legal proceeding directly
against PMA Capital to enforce the holder's rights under such Guarantee
without first instituting a legal proceeding against the Issuer, the Guarantee
Trustee or any other person or entity. (Section 5.04.)
PMA Capital will be required to provide annually to the Guarantee Trustee an
officer's certificate as to PMA Capital's compliance with all conditions and
covenants under the Guarantee. PMA Capital will also be required to provide
annually to the Guarantee Trustee an officer's certificate as to PMA Capital's
compliance with all conditions precedent, if any, provided for in the
Guarantee that relate to any action to be taken by the Guarantee Trustee at
PMA Capital's request. (Sections 2.04 and 2.05.)
INFORMATION CONCERNING THE GUARANTEE TRUSTEE
The Guarantee Trustee, other than during the occurrence and continuance of a
Guarantee Event of Default, undertakes to perform only such duties as are
specifically set forth in the Guarantee and, in case a Guarantee Event of
Default has occurred (that has not been cured or waived), the Guarantee
Trustee must exercise such of the rights and powers vested in it by the
Guarantee, and use the same degree of care and skill in its exercise thereof,
as a prudent individual would exercise or use under the circumstances in the
conduct of his or her own affairs. (Section 3.01(c).) Subject to this
provision, the Guarantee Trustee is under no obligation to exercise any of the
powers vested in it by the Guarantee at the request of any holder of Capital
Securities unless it is provided with reasonable indemnity against the costs,
expenses and liabilities that might be incurred thereby. (Section 3.02.
(a)(v).)
TERMINATION OF THE GUARANTEE
The Guarantee will terminate and be of no further force and effect upon (i)
full payment of the Redemption Price of all Capital Securities, (ii) the
distribution of Junior Subordinated Debentures to holders of Capital
Securities in exchange for all of the Capital Securities or (iii) payment in
full of the amounts payable in accordance with the Trust Agreement upon
liquidation of the Issuer. Notwithstanding the foregoing, the Guarantee will
continue to be effective or will be reinstated, as the case may be, if at any
time any holder of Capital Securities must restore payment of any sums paid
with respect to the Capital Securities or the Guarantee. (Section 7.01.)
STATUS OF THE GUARANTEE
The Guarantee will constitute an unsecured obligation of PMA Capital and
will rank (i) subordinate and junior in right of payment to all Senior Debt of
PMA Capital in the same manner as the Junior
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Subordinated Debentures, (ii) pari passu with any similar guarantee agreements
issued by PMA Capital on behalf of the holders of capital securities issued by
a business trust or similar entity whose common securities are owned, directly
or indirectly, by PMA Capital and (iii) senior to PMA Capital's Common Stock
and the Class A Common Stock. The Trust Agreement provides that each holder of
Trust Securities by acceptance thereof accepts the subordination provisions
and other terms of the Guarantee. (Sections 6.02 and 6.03.) The Guarantee will
constitute a guarantee of payment and not of collection (i.e., the guaranteed
party may institute a legal proceeding directly against PMA Capital to enforce
its rights under the Guarantee without first instituting a legal proceeding
against any other person or entity). (Section 5.05.)
The Guarantee will be held for the benefit of the holders of the Capital
Securities. The Guarantee will not be discharged except by payment of the
Guarantee Payments in full to the extent not paid by the Issuer or upon
distribution to the holders of the Capital Securities of the Junior
Subordinated Debentures. The Guarantee does not place a limitation on the
amount of additional Senior Debt that may be incurred by PMA Capital. PMA
Capital expects from time to time to incur additional indebtedness
constituting Senior Debt. (Sections 3.01(a) and 5.05.)
GOVERNING LAW
The Guarantee Agreement will be governed by, and construed in accordance
with, the laws of the State of New York. (Section 8.06.)
THE EXPENSE AGREEMENT
Pursuant to the Expense Agreement entered into by PMA Capital under the
Trust Agreement (the "Expense Agreement"), PMA Capital will irrevocably and
unconditionally guarantee to each person or entity to whom the Issuer is or
becomes indebted or liable, the full payment of any and all indebtedness,
expenses or liabilities of the Issuer including, without limitation, the fees,
expenses and indemnities of the Trustees, other than obligations of the Issuer
to pay to the holders of any Capital Securities or other similar interests in
the Issuer of the amounts due such holders pursuant to the terms of the
Capital Securities or such other similar interests, as the case may be. The
Expense Agreement will be enforceable by third parties.
DESCRIPTION OF THE JUNIOR SUBORDINATED DEBENTURES
Set forth below is a summary of the material terms of the Junior
Subordinated Debentures in which the Issuer will invest the proceeds of the
issuance and sale of the Trust Securities. The Junior Subordinated Debentures
will be qualified under the Trust Indenture Act. Reference is made to the
provisions in the Indenture, (the "Indenture"), between PMA Capital and The
Bank of New York, as trustee with respect to the Junior Subordinated
Debentures (the "Debenture Trustee"), the form of which is filed as an exhibit
to the Registration Statement of which this Prospectus forms a part, and the
Trust Indenture Act for a more complete description of the provisions
summarized herein, and each such statement shall be deemed qualified in its
entirety by such reference. Whenever particular provisions in the Indenture
are referred to herein, such provisions are incorporated by reference herein.
Section references used herein are references to provisions of the Indenture
unless otherwise noted.
Under certain circumstances involving the termination of the Issuer, after
satisfaction of liabilities to creditors of the Issuer as required under
applicable law, Junior Subordinated Debentures may be distributed to the
holders of the Capital Securities in exchange for the Capital Securities in
liquidation of the Issuer. See "Description of the Capital Securities--
Redemption--Special Event Redemption or Distribution of Junior Subordinated
Debentures" and "Description of the Capital Securities--Liquidation
Distribution upon Termination."
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GENERAL
The Junior Subordinated Debentures will be limited in aggregate principal
amount to a sum equal to the aggregate stated Liquidation Amount of the
Capital Securities plus PMA Capital's concurrent investment in the Common
Securities. The Junior Subordinated Debentures will be unsecured subordinated
obligations of PMA Capital which rank junior to all PMA Capital's Senior Debt
(as defined below).
The Junior Subordinated Debentures will initially mature on , 2029
(the "Stated Maturity").
PMA Capital is an insurance holding company and substantially all of the
operating assets of PMA Capital are owned by its consolidated subsidiaries,
principally PMA Reinsurance Corporation and the Pooled Companies. PMA Capital
relies primarily on the receipt of sufficient funds from PMA Reinsurance
Corporation and the Pooled Companies in the form of dividends, net payments
under tax-sharing agreements or loans to meet its obligations for payment of
principal and interest on its outstanding debt obligations (including the
Junior Subordinated Debentures) and corporate expenses. Accordingly, PMA
Capital's obligations under the Junior Subordinated Debentures will be
effectively subordinated to all existing and future liabilities of PMA
Capital's subsidiaries, and claimants should look only to the assets of PMA
Capital for payments thereunder. Pennsylvania law limits the payment of
dividends by PMA Reinsurance Corporation and the Pooled Companies. PMA
Reinsurance Corporation and the Pooled Companies have the ability to loan
funds to PMA Capital subject to certain regulatory restrictions. See "Risk
Factors--Subordination of the Guarantee and the Junior Subordinated
Debentures", "--Restrictions on Subsidiary Dividends and Other Payments" and
"Supervision and Regulation."
OPTIONAL REDEMPTION
The Junior Subordinated Debentures are redeemable prior to maturity at the
option of PMA Capital (i) on or after , 2009, in whole at any time or
in part from time to time, or (ii) prior to , 2009, in whole (but not
in part) and within 90 days following the occurrence of a Special Event, in
each case at the Redemption Price described below.
The Redemption Price in the case of a redemption under (i) above shall equal
the following prices, expressed in percentages of the principal amount,
together with accrued interest to but excluding the Redemption Date. If
redeemed during the 12-month period beginning 1:
<TABLE>
<CAPTION>
YEAR REDEMPTION PRICE
---- ----------------
<S> <C>
2009...................................................... 10x.xxxx%
2010...................................................... 10x.xxxx%
2011...................................................... 10x.xxxx%
2012...................................................... 10x.xxxx%
2013...................................................... 10x.xxxx%
2014...................................................... 10x.xxxx%
2015...................................................... 10x.xxxx%
2016...................................................... 10x.xxxx%
2017...................................................... 10x.xxxx%
2018...................................................... 10x.xxxx%
</TABLE>
and 100% on and after 1, 2019. (Section 1207.)
The Redemption Price, in the case of a redemption following a Special Event
as described under (ii) above, shall equal the Make-Whole Amount (as defined
under "Description of the Capital Securities--Redemption"), together with
accrued interest to but excluding the Redemption Date. (Section 1207.)
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Junior Subordinated Debentures in denominations larger than $1,000.00 may be
redeemed in part but only in integral multiples of $1,000. (Section 1203.)
Unless PMA Capital defaults in payment of the Redemption Price, on and after
the Redemption Date, interest ceases to accrue on such Junior Subordinated
Debentures or portions thereof called for redemption. (Section 1206.)
For so long as the Issuer is the holder of all the outstanding Junior
Subordinated Debentures, the proceeds of any such redemption described above
will be used by the Issuer to redeem Capital Securities in accordance with
their terms. PMA Capital may not redeem the Junior Subordinated Debentures in
part unless all accrued and unpaid interest has been paid in full on all
outstanding Junior Subordinated Debentures for all semi-annual interest
periods terminating on or prior to the Redemption Date. (Section 1207.)
Notice of any redemption will be mailed at least 45 days but not more than
75 days before the Redemption Date to each holder of Junior Subordinated
Debentures to be redeemed at its registered address. (Section 1204.)
DISTRIBUTION OF JUNIOR SUBORDINATED DEBENTURES
Under certain circumstances involving the termination of the Issuer, Junior
Subordinated Debentures may be distributed to the holders of the Capital
Securities in liquidation of the Issuer after the satisfaction of liabilities
to creditors of the Issuer as provided by applicable law. If distributed to
holders of Capital Securities in liquidation, the Junior Subordinated
Debentures will initially be issued in the form of one or more global
securities and DTC, or any successor depositary for the Capital Securities
will act as depositary for the Junior Subordinated Debentures. (Section 904.)
It is anticipated that the depositary arrangements for the Junior Subordinated
Debentures would be substantially identical to those in effect for the Capital
Securities. There can be no assurance as to the market price of any Junior
Subordinated Debentures that may be distributed to the holders of the Capital
Securities. See "Description of the Capital Securities--Redemption--Special
Event Redemption or Distribution of Junior Subordinated Debentures" and
"Description of the Capital Securities--Liquidation Distribution upon
Termination." For a description of DTC and the terms of the depositary
matters, see "Description of the Capital Securities--Book-Entry-Only
Issuance--The Depositary Trust Company."
INTEREST
The Junior Subordinated Debentures shall bear interest at the rate of % per
annum. Such interest is payable semi-annual in arrears on 1 and 1
of each year (each, an "Interest Payment Date"), commencing 1, 1999, to
the person in whose name each Junior Subordinated Debenture is registered at
the close of business on the Business Day next preceding such Interest Payment
Date. (Sections 301 and 307.) It is anticipated that, until the liquidation,
if any, of the Issuer, each Junior Subordinated Debenture will be held in the
name of the Property Trustee in trust for the benefit of the Issuer and the
holders of the Capital Securities.
The amount of interest payable for any period will be computed on the basis
of a 360-day year of twelve 30-day months. (Section 310). In the event that
any date on which interest is payable on the Junior Subordinated Debentures is
not a Business Day (as defined above), then payment of the interest payable on
such date will be made on the next succeeding day that is a Business Day (and
without any interest or other payment in respect of any such delay), except
that, if such Business Day is in the next succeeding calendar year, such
payment shall be made on the immediately preceding Business Day, in each case
with the same force and effect as if made on the date the payment was
originally payable. Accrued interest that is not paid on the applicable
Interest Payment Date will bear additional interest on the amount thereof (to
the extent permitted by law) at the rate per annum of % thereof, compounded
semi-annually. The term "interest" as used herein shall include semi-annual
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interest payments, interest on semi-annual interest payments not paid on the
applicable Interest Payment Date and Additional Sums (as described below), as
applicable. (Section 301.)
OPTION TO EXTEND INTEREST PAYMENT PERIOD
So long as no Event of Default under the Indenture has occurred and is
continuing, PMA Capital shall have the right at any time during the term of
the Junior Subordinated Debentures to defer the payment of interest on such
Junior Subordinated Debentures from time to time for a period not exceeding 10
consecutive semi-annual periods (each, an "Extension Period"), provided that
no Extension Period may extend beyond the Stated Maturity of the Junior
Subordinated Debentures. PMA Capital shall have the right to make partial
payments of interest on any Interest Payment Date. At the end of any such
Extension Period, PMA Capital must pay all interest then accrued and unpaid
(together with interest thereon at the rate of % per annum, compounded semi-
annually, to the extent permitted by applicable law). During an Extension
Period, interest will continue to accrue and holders of Junior Subordinated
Debentures (or holders of Capital Securities while outstanding) will be
required to accrue interest income for United States federal income tax
purposes. See "United States Federal Income Taxation--Original Issue
Discount." However, during any such Extension Period, PMA Capital shall not,
and shall cause any subsidiary of PMA Capital not to, (a) declare or pay any
dividends or distributions on, or redeem, purchase, acquire or make a
liquidation payment with respect to, any of PMA Capital's capital stock or (b)
make any payment of principal, interest or premium, if any, on or repay,
repurchase or redeem any debt securities of PMA Capital that rank pari passu
with or junior in interest to the Junior Subordinated Debentures or make any
guarantee payments with respect to any guarantee by PMA Capital of the debt
securities of any subsidiary of PMA Capital that by their terms rank pari
passu or junior in interest to the Junior Subordinated Debentures (other than
(a) dividends or distributions in Common Stock or Class A Common Stock of PMA
Capital, (b) payments under the Guarantee and (c) purchases of Common Stock or
Class A Common Stock of PMA Capital related to the issuance of Common Stock or
Class A Common Stock of PMA Capital under any of PMA Capital's benefit plans
for its directors, officers or employees). Prior to the termination of any
such Extension Period, PMA Capital may further extend the interest payment
period, provided that such Extension Period, together with all such previous
and further extensions thereof, shall not exceed 10 consecutive semi-annual
periods or extend beyond the Stated Maturity of the Junior Subordinated
Debentures. Upon the termination of any Extension Period and the payment of
all interest then accrued and unpaid (together with interest thereon at the
rate of % per annum, compounded semi-annually, to the extent permitted by
applicable law), PMA Capital may elect to begin a new Extension Period,
subject to the above requirements. No interest shall be due and payable during
an Extension Period, except at the end thereof. PMA Capital must give the
Debenture Trustee and the Administrative Trustees notice of its election to
begin any Extension Period at least one Business Day prior to the earliest of
(i) the date interest on the Junior Subordinated Debentures would have been
payable except for the election to begin such Extension Period or (ii) the
date the distributions on the Capital Securities are payable or (iii) the date
the Administrative Trustees are required to give notice to the New York Stock
Exchange, the Nasdaq National Market or other applicable self-regulatory
organization or to holders of the Capital Securities of the record date or the
date such distributions are payable, but in any event not less than one
Business Day prior to such record date. The Debenture Trustee shall give
notice of PMA Capital's election to begin any Extension Period to the holders
of the outstanding Capital Securities. There is no limitation on the number of
times that PMA Capital may elect to begin an Extension Period. (Section 301.)
SET-OFF
Notwithstanding anything to the contrary in the Indenture, PMA Capital shall
have the right to set-off any payment it is otherwise required to make
thereunder with respect to any Junior Subordinated Debenture and to the extent
PMA Capital has theretofore made, or is concurrently on the date of such
payment making, a payment under the Guarantee or under the provisions of the
Indenture which
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permit any holder of the Capital Securities, upon the occurrence of a
Debenture Event of Default (as defined below) relating to nonpayment of
interest or principal on the Junior Subordinated Debentures to institute suit
for the enforcement of the payment of interest or principal. (Section 311.)
This provision prevents double collection from PMA Capital of identical
amounts due under the various provisions of the Indenture and the Guarantee.
To the extent PMA Capital makes a payment of unpaid distributions to holders
of Capital Securities under the Guarantee, PMA Capital is not then also
required to make a like payment of interest on the Junior Subordinated
Debentures (since such interest payment would be paid out to such holders as
the same unpaid distribution). Likewise, if holders of Capital Securities
bring an action directly against PMA Capital under the Indenture and collect
unpaid distributions in such action, PMA Capital may deduct the amounts so
paid from any aggregate amount it owes on the Junior Subordinated Debentures.
Therefore, to the extent PMA Capital makes payments directly to holders of
Capital Securities under the Guarantee or the Indenture, the Property Trustee
may not also collect such amounts under the Junior Subordinated Debentures.
SUBORDINATION
The Junior Subordinated Debentures are subordinate and junior in right of
payment to all Senior Debt (as defined below) of PMA Capital as provided in
the Indenture. No payment or distribution on account of principal of (or
premium, if any) or interest, if any, on, the Junior Subordinated Debentures
or on account of the purchase or other acquisition of Junior Subordinated
Debentures by PMA Capital or any subsidiary may be made (a) in the event and
during the continuation of any default in the payment of principal of (or
premium, if any) or interest on any Senior Debt, or if the maturity of any
Senior Debt has been accelerated because of a default until such event of
default shall have been cured or waived or shall have ceased to exist and such
acceleration shall have been rescinded or annulled or (b) in the event of any
judicial proceeding with respect to any such default in payment or such event
of default. (Section 1104.) In the case of the pendency of any liquidation,
reorganization, bankruptcy, insolvency, receivership, arrangement, adjustment,
composition or other judicial proceeding relative to PMA Capital, all
principal of, and premium, if any, and interest, if any, on all Senior Debt
must be paid in full or provision must be made for such payment in cash or
cash equivalents or otherwise in a manner satisfactory to the holders of
Senior Debt, before the holders of the Junior Subordinated Debentures are
entitled to receive or retain any payment or distribution thereon. (Section
1102.)
In the event that, notwithstanding the foregoing, any payment or
distribution of cash, property or securities shall be received or collected by
a holder of the Junior Subordinated Debentures in contravention of the
foregoing provisions, such payment or distribution shall be held for the
benefit of and shall be paid over to the holders of Senior Debt or their
representative or representatives or to the trustee or trustees under any
indenture under which any instrument evidencing Senior Debt may have been
issued, as their respective interests may appear, to the extent necessary to
pay in full all Senior Debt then due, after giving effect to any concurrent
payment to the holders of Senior Debt, but only to the extent that the holders
of the Senior Debt (or their representative or representatives) notify the
Trustees in writing, within 90 days of such payment, of the amounts then due
and owing on such Senior Debt and only the amounts specified in such notice to
the Trustees shall be paid to the holders of such Senior Debt. (Section 1104.)
Subject to the prior payment of all Senior Debt, the rights of the holders of
the Junior Subordinated Debentures will be subrogated to the rights of the
holders of Senior Debt to the extent of the payments or distributions made to
the holders of such Senior Debt until all amounts owing on the Junior
Subordinated Debentures are paid in full. (Section 1106.)
"Debt" means with respect to any entity, whether recourse is to all or a
portion of the assets of such entity and whether or not contingent, (i) every
obligation of such entity for money borrowed; (ii) every obligation of such
entity evidenced by bonds, debentures, notes or other similar instruments,
including obligations incurred in connection with the acquisition of property,
assets or businesses; (iii) every reimbursement obligation of such entity with
respect to letters of credit, bankers' acceptances or
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similar facilities issued for the account of such entity; (iv) every
obligation of such entity issued or assumed as the deferred purchase price of
property or services (but excluding trade accounts payable or accrued
liabilities arising in the ordinary course of business); (v) every capital
lease obligation of such entity; and (vi) every obligation of the type
referred to in clauses (i) through (v) of another entity and all dividends of
another entity the payment of which, in either case, such entity has
guaranteed or is responsible or liable for, directly or indirectly, as obligor
or otherwise. (Section 101.)
"Senior Debt" means the principal of (and premium, if any) and interest, if
any (including interest accruing on or after the filing of any petition in
bankruptcy or for reorganization relating to PMA Capital whether or not such
claim for post-petition interest is allowed in such proceeding), on Debt,
whether incurred on or prior to the date of the Indenture or thereafter
incurred, unless, in the instrument creating or evidencing the same or
pursuant to which the same is outstanding, it is provided that such
obligations are not superior in right of payment to the Junior Subordinated
Debentures or to other Debt which is pari passu with, or subordinated to, the
Junior Subordinated Debentures; provided, however, that Senior Debt shall not
be deemed to include (i) any Debt of PMA Capital which, when incurred and
without respect to any election under Section 1111(b)of the Bankruptcy Code,
was without recourse to PMA Capital, (ii) any Debt of PMA Capital to any of
its subsidiaries, (iii) Debt to any employee of PMA Capital, (iv) trade
accounts payable of PMA Capital, (v) accrued liabilities arising in the
ordinary course of business of PMA Capital, (vi) the Junior Subordinated
Debentures, and (vii) the Guarantee.
PMA Capital is an insurance holding company and substantially all of the
operating assets of PMA Capital are owned by its consolidated subsidiaries,
principally PMA Reinsurance Corporation and the Pooled Companies. PMA Capital
relies primarily on the receipt of sufficient funds from PMA Reinsurance
Corporation and the Pooled Companies in the form of dividends, net payments
under tax-sharing agreements or loans to meet its obligations for payment of
principal and interest on outstanding debt obligations (including to Junior
Subordinated Debentures) and corporate expenses. Accordingly, PMA Capital's
obligations under the Junior Subordinated Debentures will be effectively
subordinated to all existing and future liabilities of PMA Capital's
subsidiaries, and claimants should look only to the assets of PMA Capital for
payments thereunder. Pennsylvania insurance law limits the payment of
dividends by PMA Reinsurance Corporation and the Pooled Companies. PMA
Reinsurance Corporation and the Pooled Companies have the ability to loan
funds to PMA Capital subject to certain regulatory restrictions. See "Risk
Factors--Subordination of the Guarantee and the Junior Subordinated
Debentures," and "--Holding Company Structure--Restrictions on Subsidiary
Dividends and Other Payments" and "Supervision and Regulation".
The Indenture does not limit the aggregate amount of Senior Debt that may be
issued. After the completion of this Offering and the repayment of debt with
the proceeds thereof, PMA Capital will have approximately $104.5 million of
principal amount of indebtedness for borrowed money constituting Senior Debt.
PMA Capital expects from time to time to incur additional indebtedness
constituting Senior Debt.
CERTAIN COVENANTS OF PMA CAPITAL
PMA Capital will covenant in the Indenture that if and so long as (i) the
Issuer is the holder of all of the outstanding Junior Subordinated Debentures,
(ii) a Tax Event (as defined above) has occurred and is continuing and (iii)
PMA Capital has not redeemed the Junior Subordinated Debentures pursuant to
the Indenture or terminated the Issuer pursuant to the Trust Agreement, PMA
Capital will pay to the Issuer, for so long as the Issuer is the registered
holder of any Junior Subordinated Debentures, such additional amounts as may
be necessary in order that the amount of distributions then due and payable by
the Issuer on the outstanding Capital Securities and Common Securities of the
Issuer shall not be reduced as a result of any additional taxes, duties and
other governmental charges to which the Issuer has become subject from time to
time as a result of a Tax Event (the "Additional Sums"). (Section 1005). PMA
Capital will also covenant that it will not, and it will not permit
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any subsidiary to, (a) declare or pay any dividends or distributions on, or
redeem, purchase, acquire or make a liquidation payment with respect to, any
of PMA Capital's outstanding capital stock or (b) make any payment of
principal, interest or premium, if any, on or repay, repurchase or redeem any
debt securities that rank pari passu with or junior to the Junior Subordinated
Debentures or make any guarantee payments with respect to any guarantee by PMA
Capital of the debt securities of any subsidiary of PMA Capital that by their
terms rank pari passu or junior in interest to the Junior Subordinated
Debentures, (other than (a) dividends or distributions in Common Stock or
Class A Common Stock of PMA Capital, (b) payments under the Guarantee, and (c)
purchases of Common Stock or Class A Common Stock of PMA Capital related to
the issuance of Common Stock or Class A Common Stock of PMA Capital under any
of PMA Capital's benefit plans for its directors, officers or employees) if at
such time (i) there shall have occurred and be continuing any event that, with
the giving of notice or the lapse of time, or both, would constitute a
Debenture Event of Default and in respect of which PMA Capital shall not have
taken reasonable steps to cure, (ii) PMA Capital shall be in default with
respect to its payment of any obligations under the Guarantee or (iii) PMA
Capital shall have given notice of its selection of an Extension Period as
provided in the Indenture and shall not have rescinded such notice and such
Extension Period, or any extension thereof, shall be continuing (Section
1006.) PMA Capital will also covenant (i) to maintain directly or indirectly
100% ownership of the Common Securities of the Issuer (provided, however, that
any permitted successor of PMA Capital may succeed to such ownership), (ii)
not to voluntarily dissolve, wind-up or terminate the Issuer, except in
connection with a distribution of the Junior Subordinated Debentures to the
holders of the Capital Securities in exchange for the Capital Securities and
in liquidation of the Issuer or in connection with certain mergers,
consolidations or amalgamations permitted by the Trust Agreement and (iii) to
use its reasonable efforts, consistent with the terms and provisions of the
Trust Agreement, to cause the Issuer to remain a business trust and to be
classified as a grantor trust for United States federal income tax purposes,
except in connection with a distribution of the Junior Subordinated Debentures
to the holders of the Capital Securities in liquidation of the Issuer.
(Section 1006.)
DEBENTURE EVENTS OF DEFAULT AND CONSEQUENT RIGHTS OF CERTAIN HOLDERS
The Indenture provides that any one or more of the following described
events, that has occurred and is continuing constitutes an "Event of Default"
(also referred to herein as a "Debenture Event of Default") with respect to
the Junior Subordinated Debentures:
(a) failure for 30 days to pay interest on the Junior Subordinated
Debentures when due (subject to the deferral of any due date in the case of
an Extension Period); or
(b) failure to pay principal (or premium, if any) on the Junior
Subordinated Debentures when due whether at Stated Maturity, upon
redemption, by declaration or otherwise; or
(c) failure to observe or perform in any material respect any other
covenant contained in the Indenture for 90 days after written notice to PMA
Capital from the Debenture Trustee or the holders of at least 25% in
aggregate principal amount of the outstanding Junior Subordinated
Debentures; or
(d) Certain events in bankruptcy, insolvency or reorganization of PMA
Capital. (Section 501.)
Each of the above events is a Debenture Event of Default regardless of the
reason for such Event of Default and whether it shall be voluntary or
involuntary or be effected by operation of law or pursuant to any judgment,
decree or order of any court or any order, rule or regulation of any
administrative or governmental body. (Section 501.) There is no requirement
that any such event must be declared by anyone to be a Debenture Event of
Default.
The holders of a majority in principal amount of the outstanding Junior
Subordinated Debentures have the right to direct the time, method and place of
conducting any proceeding for any remedy available to the Debenture Trustee,
under certain conditions. (Section 512.)
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ACCELERATION OF MATURITY; RESCISSION AND ANNULMENT
The Debenture Trustee or the holders of not less than 25% in principal
amount of the outstanding Junior Subordinated Debentures may declare the
principal of all the Junior Subordinated Debentures due and payable
immediately upon the occurrence and continuation of a Debenture Event of
Default, and should the Debenture Trustee or such holders of Junior
Subordinated Debentures fail to make such declaration, the holders of at least
25% in aggregate Liquidation Amount of Capital Securities then outstanding
shall have such right. The holders of a majority in principal amount of the
outstanding Junior Subordinated Debentures may rescind and annul such
declaration. If the holders of a majority in principal amount of the
outstanding Junior Subordinated Debentures fail to annul such declaration and
its consequences, the holders of a majority in aggregate Liquidation Amount of
the Capital Securities may rescind and annul such declaration and its
consequences. (Section 502.)
WAIVER OF DEFAULTS
Subject to certain limitations, the holders of not less than a majority in
aggregate principal amount of the outstanding Junior Subordinated Debentures
affected thereby may, on behalf of the holders of all the Junior Subordinated
Debentures, waive any past default under the Indenture and its consequences,
except a default in the payment of principal of or interest on any Junior
Subordinated Debentures (unless such default has been cured and a sum
sufficient to pay all matured installments of interest and principal due
otherwise than by acceleration has been deposited with the Debenture Trustee)
or a default in respect of a covenant or provision of the Indenture which
under the Indenture cannot be modified or amended without the consent of the
holder of each outstanding Junior Subordinated Debenture affected. If the
holders of such Junior Subordinated Debentures fail to waive such default, the
holders of a majority in aggregate Liquidation Amount of the Capital
Securities shall have such right. (Section 513.) PMA Capital is required to
deliver annually to the Debenture Trustee a certificate stating whether or not
to the best knowledge of the signers thereof PMA Capital is in default in the
performance, observance or fulfillment of or compliance with any of the
material terms, provisions, covenants and conditions of the Indenture (without
regard to any period of grace or requirement of notice provided under the
Indenture) and, if PMA Capital shall be in default, specifying all such
defaults and the nature and status thereof of which they may have knowledge.
(Section 1004.)
CREDITOR'S RIGHTS OF THE DEBENTURE TRUSTEE
In case a Debenture Event of Default shall occur and be continuing, the
Debenture Trustee will have the right to declare the principal (or specific
portions thereof) of and the interest on the Junior Subordinated Debentures,
and any other amount payable under the Indenture, to be forthwith due and
payable and to enforce its other rights as a creditor with respect to the
Junior Subordinated Debentures. (Sections 502 and 503.) If the Debenture
Trustee obtains a judgment against PMA Capital following the occurrence of a
Debenture Event of Default, the provisions of Pennsylvania law regulating
insurance holding companies would limit the ability of the Debenture Trustee
to realize upon the assets of PMA Capital by conveying or transferring the
capital stock of PMA Reinsurance Corporation or the Pooled Companies owned by
PMA Capital. Any conveyance, transfer, assignment, or alienation of a ten
percent or greater interest in the voting shares of PMA Reinsurance
Corporation or any of the Pooled Companies would require the prior approval of
the Pennsylvania Commissioner. See "Supervision and Regulation."
RIGHTS OF HOLDERS OF CAPITAL SECURITIES TO DIRECT ACTION
As explained more fully above (see "--Debenture Events of Default and
Consequent Rights of Certain Holders" and--Waiver of Defaults"), holders of
less than all of the outstanding Junior Subordinated Debentures or holders of
less than all of the Capital Securities may waive any past default (with
certain limited exceptions identified above). If so waived, any such Debenture
Event of Default shall cease to be "continuing" for purposes of the Indenture.
However, such holders may not
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waive any default in the payment of principal of or interest on any Junior
Subordinated Debentures unless such default has been cured and a sum
sufficient to pay all matured installments of interest and principal due
otherwise than by acceleration has been deposited with the Debenture Trustee.
If a Debenture Event of Default has occurred and is continuing and such event
is attributable to the failure of PMA Capital for 30 days to pay interest on
or the failure of PMA Capital to pay principal of the Junior Subordinated
Debentures on the date such interest or principal is otherwise payable, any
holder of Capital Securities may institute a suit directly against PMA Capital
for enforcement of payment to such holder of the principal of and interest on
such Junior Subordinated Debentures having a principal amount equal to the
aggregate Liquidation Amount of the Capital Securities of such holder (a
"Direct Action") (Section 508). PMA Capital may not amend the Indenture to
remove the foregoing right to bring a Direct Action without the prior written
consent of the holders of all of the outstanding Capital Securities. (Section
902). If the right to bring a Direct Action is removed, the Issuer may become
subject to the regulatory obligations under the Exchange Act.
The holders of the Capital Securities would not be able to exercise directly
any remedies other than those set forth in the preceding paragraph available
to the holders of the Junior Subordinated Debentures unless there shall have
been a Debenture Event of Default and the holders of the Junior Subordinated
Debentures fail to exercise such remedies. See "--Debenture Events of Default
and Consequent Rights of Certain Holders" "--Acceleration of Maturity;
Rescission and Annulment" and "Debenture Events of Default and Consequent
Rights of Certain Holders", and--"Waiver of Defaults".
FORM, EXCHANGE AND TRANSFER
The Junior Subordinated Debentures will be issuable only in registered form,
without coupons, and only in denominations of $1,000 and integral multiples
thereof. (Section 302.)
Subject to the terms of the Indenture, Junior Subordinated Debentures may be
presented for registration of transfer (duly endorsed or with the form of
transfer endorsed thereon duly executed) at the office of the Security
Registrar or at an office or agency of PMA Capital designated by PMA Capital
for such purpose. No service charge will be made to a holder of Junior
Subordinated Debentures for any registration of transfer or exchange of Junior
Subordinated Debentures, but PMA Capital or the Security Registrar may require
payment of a sum sufficient to cover any tax or other governmental charge that
may be imposed in connection therewith. Such transfer or exchange will be
effected upon the Securities Registrar or PMA Capital, as the case may be,
being satisfied with the documents of title and identity of the person making
the request. PMA Capital has appointed the Debenture Trustee as Securities
Registrar. (Section 305.) PMA Capital may at any time designate additional
transfer agents or rescind the designation of any transfer agent or approve a
change in the office through which any transfer agent acts. (Section 1002.)
Neither PMA Capital nor the Securities Registrar will be required (i) to
issue, transfer or exchange any Junior Subordinated Debenture during a period
beginning at the opening of business 15 days before the day of selection for
redemption of any such Junior Subordinated Debentures pursuant to the
Indenture and ending at the close of business on the day of mailing of notice
of redemption or (ii) to transfer or exchange any Junior Subordinated
Debentures so selected for redemption, in whole or in part, except the
unredeemed portion of any such Junior Subordinated Debentures being redeemed
in part. (Section 305.)
PAYMENT AND PAYING AGENTS
Payment of interest on a Junior Subordinated Debenture on any Interest
Payment Date will be made to the person in whose name such Junior Subordinated
Debenture (or predecessor security) is registered at the close of business on
the Business Day next preceding such Interest Payment Date except in the case
of interest which is payable but is not paid or provided for on such Interest
Payment Date. (Section 307.)
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Principal of and any interest on the Junior Subordinated Debentures will be
payable at the office of such Paying Agent or Paying Agents as PMA Capital may
designate for such purpose from time to time, provided, however, that at the
option of PMA Capital, payment of any interest may be made (i) by check mailed
to the address of the person entitled thereto as such address shall appear in
the Securities Register or (ii) by wire transfer in immediately available
funds at such place and to such account as may be designated by the person
entitled thereto as specified in the Securities Register. The Bank of New York
will act as Paying Agent with respect to the Junior Subordinated Debentures.
PMA Capital may at any time designate additional Paying Agents or rescind the
designation of any Paying Agent or approve a change in the office through
which any Paying Agent acts. (Section 301.)
MODIFICATION OF THE INDENTURE
From time to time, PMA Capital and the Debenture Trustee may, without the
consent of the holders of Junior Subordinated Debentures, amends waive or
supplement the Indenture for specified purpose, including, among other things,
curing ambiguities, defects or inconsistencies (provided that any such action
does not materially adversely affect the interest of the holders of any Junior
Subordinated Debentures or the holders of Capital Securities so long as they
remain outstanding) and qualifying, or maintaining the qualification of, the
Indenture under the Trust Indenture Act. The Indenture contains provisions
permitting PMA Capital and the Debenture Trustee, with the consent of the
holders of not less than a majority in principal amount of the outstanding
Junior Subordinated Debentures, to modify the Indenture in a manner adversely
affecting the rights of the holders of the Junior Subordinated Debentures;
provided that no such modification may, without the consent of the holder of
each outstanding Junior Subordinated Debenture affected thereby, (i) except as
set forth in "--Option to Extend Interest Payment Period" above, change the
Stated Maturity of, the principal of, or any installment of interest on, any
Junior Subordinated Debenture or reduce the principal amount thereof, or the
rate of interest thereon or reduce any premium payable upon the redemption
thereof or change the place of payment where, or the coin or currency in
which, any Junior Subordinated Debenture or interest thereon is payable, or
impair the right to institute suit for the enforcement of any such payment on
or after the Stated Maturity thereof (or in the case of redemption, on or
after the Redemption Date), or modify the provisions of the Indenture with
respect to the subordination of the Junior Subordinated Debentures in a manner
adverse to the holders thereof (except such change or extension as is
contemplated thereby, (ii) reduce the percentage in principal amount of the
outstanding Junior Subordinated Debentures, the consent of the holders of
which is required for any waiver provided for in the Indenture or (iii) modify
certain provisions of the Indenture providing for waiver of defaults, waiver
of covenants and modification of the Indenture, except to increase the
percentage or to provide that certain other provisions of the Indenture cannot
be modified or waived without the consent of the holder of each outstanding
Junior Subordinated Debenture affected thereby; provided, that, so long as any
of the Capital Securities remains outstanding, (a) no such modification may be
made that adversely affects the holders of the Capital Securities in any
material respect, and no termination of the Indenture may occur, and no waiver
of any Debenture Event of Default or compliance with any covenant under the
Indenture shall be effective, without the prior consent of the holders of at
least a majority of the aggregate Liquidation Amount of the outstanding
Capital Securities unless and until the principal of and any premium on the
Junior Subordinated Debentures and all accrued and unpaid interest thereon
have been paid in full and (b) where a consent under the Indenture would
require the consent of each holder of Junior Subordinated Debentures, no such
consent will be given by the Property Trustee without the prior consent of
each holder of the Capital Securities. (Section 902.)
CONSOLIDATION, MERGER AND SALE
PMA Capital, without the consent of the holders of any outstanding Junior
Subordinated Debentures, may consolidate with or merge into, or convey,
transfer or lease its properties and assets substantially as an entirety to
any person, and may permit any person to consolidate with or merge into, or
convey,
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transfer or lease its properties and assets substantially as an entirety to
PMA Capital, provided (i) that any successor person must be a corporation,
partnership, trust or other entity organized and validly existing under the
laws of any domestic jurisdiction and must expressly assume PMA Capital's
obligations on the Junior Subordinated Debentures and under the Indenture,
(ii) that immediately after giving effect to the transaction no Debenture
Event of Default, and no event which, after notice or lapse of time or both,
would become a Debenture Event of Default, shall have occurred and be
continuing, (iii) that such transaction is permitted under the Trust Agreement
and the Guarantee and does not give rise to any breach or violation of, the
Trust Agreement or the Guarantee and (iv) that certain other conditions as
prescribed by the Indenture are met. (Section 801).
The general provisions of the Indenture do not afford holders of Junior
Subordinated Debentures protection in the event of a highly leveraged or other
transaction involving PMA Capital that may adversely affect holders of the
Junior Subordinated Debentures. Since the Indenture does not limit the
aggregate amount of Senior Debt that may be issued and the Junior Subordinated
Debentures are subordinate to all Senior Debt, including such Debt incurred
after the date of the Indenture (see "--Subordination" above), if the PMA
Capital chooses to engage in a highly leveraged transaction whereby it would
incur a substantial amount of Debt, the obligations under the Junior
Subordinated Debentures would become more deeply subordinated and the holders
of the Junior Subordinated Debentures would not be able to avoid this
consequence provided that the conditions set forth in the immediately
preceding paragraph are met. Similarly, PMA Capital could be involved in a
reorganization, restructuring, merger or similar transaction that could
adversely affect the holders of the Junior Subordinated Debentures but,
provided that the conditions set forth in the immediately preceding paragraph
are met, such holders could not avoid such adverse affects.
SATISFACTION AND DISCHARGE
Under the terms of the Indenture, the Indenture will cease to be of further
effect and PMA Capital will be deemed to have satisfied and discharged the
Indenture (except as to PMA Capital's obligations to pay all other sums due
pursuant to the Indenture and to provide the officers' certificates and
opinions of counsel described therein), if all Junior Subordinated Debentures
not previously delivered to the Debenture Trustee for cancellation have become
due and payable, or will become due and payable at their Stated Maturity
within one year of the date of deposit, and PMA Capital deposits with the
Debenture Trustee, in trust, cash, or cash equivalents in an amount sufficient
to pay all the principal of, premium, if any, and interest on the Junior
Subordinated Debentures to the date of such deposit or to the Stated Maturity,
as the case may be. (Section 401.)
GOVERNING LAW
The Indenture and the Junior Subordinated Debentures will be governed by,
and construed in accordance with, the laws of the State of New York. (Section
112.)
MISCELLANEOUS
PMA Capital will have the right of all times to assign any of its rights or
obligations under the Indenture to a direct or indirect wholly-owned
subsidiary of PMA Capital, provided that, in the event of any such assignment,
PMA Capital will remain liable for all such obligations. The Issuer may not
assign any of its rights under the Indenture without the prior written consent
of PMA Capital. The Indenture is not otherwise assignable by the parties
thereto. Subject to the foregoing, the Indenture will be binding upon and
inure to the benefit of the parties thereto and their respective successors
and assigns. (Section 109.)
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RELATIONSHIP AMONG THE CAPITAL SECURITIES, THE JUNIOR
SUBORDINATED DEBENTURES AND THE GUARANTEE
FULL AND UNCONDITIONAL GUARANTEE
Payments of distributions and other amounts due on the Capital Securities
(to the extent the Issuer has funds available for the payment of such
distributions) are irrevocably guaranteed by PMA Capital as and to the extent
set forth under "Description of the Guarantee." Taken together, PMA Capital's
obligations under the Junior Subordinated Debentures, the Indenture, the Trust
Agreement, the Expense Agreement, and the Guarantee provide, in the aggregate,
a full, irrevocable and unconditional guarantee of payments of distributions
and other amounts due on the Capital Securities. No single document standing
alone or operating in conjunction with fewer than all of the other documents
constitutes such guarantee. It is only the combined operation of these
documents that has the effect of providing a full, irrevocable and
unconditional guarantee of the Issuer's obligations under the Capital
Securities. If and to the extent that PMA Capital does not make payments on
the Junior Subordinated Debentures, the Issuer will not pay distributions or
other amounts due on its Capital Securities. The Guarantee does not cover
payment of distributions when the Issuer does not have sufficient funds to pay
such distributions. In such event, the remedy of a holder of Capital
Securities is to institute a legal proceeding directly against PMA Capital
under the terms of the Indenture for enforcement of payment of such
distributions to such holder. The Indenture likewise provides for such a
direct action by holders of the Junior Subordinated Debentures. The
obligations of PMA Capital under the Guarantee are subordinate and junior in
right of payment to all Senior Debt of PMA Capital.
SUFFICIENCY OF PAYMENTS
As long as payments of interest and other payments are made when due on the
Junior Subordinated Debentures, such payments will be sufficient to cover
distributions and other payments due on the Capital Securities, primarily
because (i) the aggregate principal amount of the Junior Subordinated
Debentures will be equal to the sum of the aggregate stated Liquidation Amount
of the Capital Securities and the Common Securities; (ii) the interest rate
and interest and other payment dates on the Junior Subordinated Debentures
will match the distribution rate and distribution and other payment dates for
the Capital Securities; (iii) PMA Capital shall pay for all and any costs,
expenses and liabilities of the Issuer except the Issuer's obligations to
holders of its Capital Securities under the Capital Securities and (iv) the
Trust Agreement further provides that the Issuer will not engage in any
activity that is not consistent with its limited purposes.
Notwithstanding anything to the contrary in the Indenture, PMA Capital has
the right to set-off any payment it is otherwise required to make thereunder
with and to the extent PMA Capital has theretofore made, or is concurrently on
the date of such payment making, a payment under the Guarantee. See
"Description of the Junior Subordinated Debentures--Set-Off."
ENFORCEMENT RIGHTS OF HOLDERS OF CAPITAL SECURITIES
A holder of any Capital Security may, to the extent permissible under
applicable law, institute a legal proceeding directly against PMA Capital to
enforce its rights under the Guarantee without first instituting a legal
proceeding against the Guarantee Trustee, the Issuer or any other person or
entity.
A default or event of default under any Senior Debt of PMA Capital would not
constitute a default or Debenture Event of Default under the Indenture.
However, in the event of payment defaults under, or acceleration of Senior
Debt of PMA Capital, the subordination provisions of the Indenture provide
that no payments may be made in respect of the Junior Subordinated Debentures
until such Senior Debt has been paid in full or any payment default thereunder
has been cured or waived. Failure to make required payments on Junior
Subordinated Debentures would constitute a Debenture Event of Default.
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LIMITED PURPOSE OF ISSUER
The Issuer's Capital Securities evidence a beneficial interest in the
Issuer, and the Issuer exists for the sole purpose of issuing its Capital
Securities and Common Securities and investing the proceeds thereof in the
Junior Subordinated Debentures. A principal difference between the rights of a
holder of a Capital Security and a holder of a Junior Subordinated Debenture
is that a holder of a Junior Subordinated Debenture is entitled to receive
from PMA Capital the principal amount of and interest accrued on the Junior
Subordinated Debentures held, while a holder of Capital Securities is entitled
to receive distributions from the Issuer (or, to the extent such distributions
are not made by or on behalf of the Issuer, from PMA Capital under the
Guarantee) if and to the extent the Issuer has funds available for payment of
such distributions.
RIGHTS UPON TERMINATION
Upon any voluntary or involuntary dissolution, winding-up or termination of
the Issuer, after satisfaction of the liabilities of the Issuer to creditors
as required by applicable law, the holders of Capital Securities will be
entitled to receive, out of assets available for distribution to holders, the
Liquidation Distribution in cash or Junior Subordinated Debentures. See
"Description of the Capital Securities--Liquidation Distribution upon
Termination." Upon any voluntary or involuntary liquidation or bankruptcy of
PMA Capital, the Property Trustee, as holder of the Junior Subordinated
Debentures, would be a subordinated creditor of PMA Capital, subordinated in
right of payment to all Senior Debt, but entitled to receive payment in full
of principal, premium, if any, and interest, before any shareholders of PMA
Capital receive payments or distributions. Since PMA Capital is Guarantor
under the Guarantee and has agreed, under the Expense Agreement, to pay for
all indebtedness, expenses and liabilities of the Issuer (other than the
Issuer's obligations to Capital Security holders under the Capital
Securities), the positions of a holder of Capital Securities and a holder of
Junior Subordinated Debentures relative to other creditors and to shareholders
of PMA Capital in the event of liquidation or bankruptcy of PMA Capital would
be substantially the same.
UNITED STATES FEDERAL INCOME TAXATION
GENERAL
In the opinion of Duane, Morris & Heckscher LLP, counsel to PMA Capital, the
following discussion summarizes the material United States federal income tax
consequences of the purchase, ownership and disposition of Capital Securities.
Unless otherwise stated, this summary deals only with Capital Securities held
as capital assets by a holder that purchases the Capital Securities upon
original issuance at their original issue price and that is (i) a citizen or
resident of the United States, (ii) a domestic corporation, (iii) an estate
the income of which is subject to the United States federal income tax without
regard to its source or (iv) a trust if a United States court is able to
exercise primary supervision over administration of the trust and one or more
United States persons have authority to control all substantial decisions of
the trust (a "United States Holder"). This summary does not address all the
tax consequences that may be relevant to holders that may be subject to
special tax treatment such as, for example, banks, real estate investment
trusts, regulated investment companies, insurance companies, dealers in
securities or currencies, traders that elect to mark to market, tax-exempt
investors, persons whose functional currency is other than the United States
dollar, persons who hold Capital Securities as part of a straddle, hedging,
conversion or other integrated investment transaction or, except as
specifically described herein, foreign taxpayers. In addition, this summary
does not address (a) the income tax consequences to shareholders in, or
partners or beneficiaries of, a holder of the Capital Securities, (b) the
United States federal alternative minimum tax consequences of the purchase,
ownership or disposition of the Capital Securities or (c) any aspects of
state, local or foreign laws of the purchase, ownership or disposition of the
Capital Securities. This summary is based on the Internal Revenue Code of
1986, as amended (the "Code"), Treasury regulations promulgated
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thereunder and administrative and judicial interpretations thereof, as of the
date hereof, all of which are subject to change, possibly on a retroactive
basis. Duane, Morris & Heckscher urges each holder to consult its tax advisor
as to its particular tax consequences of acquiring, holding, and disposing of
the Capital Securities, including the tax consequences under state, local and
foreign laws.
CLASSIFICATION OF THE JUNIOR SUBORDINATED DEBENTURES
It is a condition to the issuance of the Capital Securities that Duane,
Morris & Heckscher LLP, counsel to PMA Capital, render its opinion to the
effect that, under current United States federal income tax law, the Junior
Subordinated Debentures held by the Trust will be classified for United States
federal income tax purposes as indebtedness of PMA Capital. Accordingly,
corporate United States Holders of Capital Securities will not be entitled to
a dividends-received deduction with respect to any income recognized with
respect to the Capital Securities.
CLASSIFICATION OF THE TRUST
Duane, Morris & Heckscher LLP, counsel to PMA Capital and the Trust, has
rendered its opinion to the effect that, under current United States federal
income tax law, the Trust will be classified for United States federal income
tax purposes as a grantor trust and not as an association taxable as a
corporation. Accordingly, for United States federal income tax purposes, each
United States Holder of Capital Securities will generally be considered the
owner of an undivided interest in the Junior Subordinated Debentures, and each
United States Holder will be required to include in its gross income any
interest paid or accrued or any original issue discount ("OID") accrued with
respect to its allocable share of those Junior Subordinated Debentures.
Investors should be aware that the foregoing opinions of Duane, Morris &
Heckscher LLP will not be confirmed by the Internal Revenue Service by private
ruling or otherwise, and will not be binding on the Service or the courts. By
its acceptance of a Capital Security, a holder agrees to treat the Capital
Security and the Junior Subordinated Debentures consistently with the
foregoing opinions.
INTEREST INCOME AND ORIGINAL ISSUE DISCOUNT
PMA Capital has the option, under the terms of the Junior Subordinated
Debentures, to defer payments of interest by extending interest payments for
up to 10 semi-annual periods. See "Description of the Junior Subordinated
Debentures--Option to Extend Interest Payment Period." Under applicable
Treasury regulations (the "Regulations"), a contingency that stated interest
will not be timely paid that is "remote", because of the terms of the relevant
debt instrument, will be ignored in determining whether such debt instrument
is issued with OID. As a result of the terms and conditions of the Junior
Subordinated Debentures that prohibit certain payments with respect to PMA
Capital's capital stock and indebtedness if PMA Capital elects to extend
interest payment periods, PMA Capital believes that the likelihood of its
exercising its option to defer payments is remote. See "Description of the
Junior Subordinated Debentures--Option to Defer Interest Payment Period."
Based on the foregoing, PMA Capital believes that the Junior Subordinated
Debentures will not be considered to be issued with OID at the time of their
original issuance and, accordingly, a United States Holder should include in
gross income such holder's allocable share of interest on the Junior
Subordinated Debentures in accordance with such holder's normal method of
accounting for tax purposes.
If the option to defer any payment of interest was determined not to be
"remote" or if PMA Capital exercises its option to defer any payment of
interest, the Junior Subordinated Debentures would be treated as issued with
OID at the time of issuance or at the time of such exercise, as the case may
be, and all stated interest on the Junior Subordinated Debentures would
thereafter be treated as OID as long as the Junior Subordinated Debentures
remained outstanding. In such event, all of a United States Holder's taxable
interest income with respect to the Junior Subordinated Debentures would be
accounted for as OID on a constant yield method regardless of such holder's
method of tax accounting, and actual distributions of stated interest would
not be reported as taxable income.
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Consequently, a United States Holder would be required to include OID in gross
income even though PMA Capital would not make any actual cash payments during
an Extension Period.
The IRS has not addressed the Regulations in any rulings or other
interpretations, and it is possible that the IRS could take a position
contrary to the interpretation herein.
Because income on the Capital Securities will constitute interest or OID,
corporate United States Holders of the Capital Securities will not be entitled
to a dividends received deduction with respect to any income recognized with
respect to the Capital Securities.
MARKET DISCOUNT AND PREMIUM
United States Holders of Capital Securities other than holders that
purchased the Capital Securities upon original issuance at their original
issue price may be considered to have acquired their undivided interest in the
Junior Subordinated Debentures with market discount, amortizable bond premium
or acquisition premium as such terms are defined for United States federal
income tax purposes. Such holders are urged to consult their tax advisors as
to the income tax consequences of the acquisition, ownership and disposition
of the Capital Securities.
RECEIPT OF JUNIOR SUBORDINATED DEBENTURES OR CASH UPON LIQUIDATION OF THE
TRUST
Under certain circumstances, as described under the caption "Description of
the Capital Securities--Redemption--Special Event Redemption or Distribution
of Junior Subordinated Debentures" and "Description of the Capital
Securities--Liquidation Distribution upon Termination," Junior Subordinated
Debentures may be distributed to holders in exchange for the Capital
Securities and in liquidation of the Trust. Such a distribution would
generally be a non-taxable event to each United States Holder, and each United
States Holder would have an aggregate tax basis in the Junior Subordinated
Debentures equal to such holder's aggregate tax basis in its Capital
Securities. A United States Holder's holding period in the Junior Subordinated
Debentures so received in liquidation of the Trust would include the period
during which such holder held the Capital Securities. If, however, the
liquidation of the Trust were to occur because the Trust is subject to United
States federal income tax with respect to income accrued or received on the
Junior Subordinated Debentures, as would be the case if, for example, the
Trust were treated as an association taxable as a corporation, the
distribution of Junior Subordinated Debentures to a United States Holder by
the Trust would be a taxable event to the Trust and each United States Holder,
and each United States Holder would recognize a gain or loss as if the United
States Holder had exchanged its Capital Securities for the Junior Subordinated
Debentures it received upon liquidation of the Trust. A United States Holder
will include interest in income in respect of Junior Subordinated Debentures
received from the Trust in the manner described above under "--Interest Income
and Original Issue Discount."
Under certain circumstances described herein (see "Description of the
Capital Securities"), the Junior Subordinated Debentures may be redeemed for
cash and the proceeds of such redemption distributed to holders in redemption
of their Capital Securities. Such a redemption would be a taxable event to
each United States Holder, and a United States Holder would recognize gain or
loss as if it sold such redeemed Capital Securities for cash. See "--Sales of
Capital Securities."
SALES OF CAPITAL SECURITIES
A United States Holder that sells Capital Securities will recognize gain or
loss equal to the difference between such holder's adjusted tax basis in the
Capital Securities and the amount realized on the sale of such Capital
Securities. Assuming that PMA Capital does not exercise its option to defer
payment of interest on the Junior Subordinated Debentures, and the Junior
Subordinated Debentures are not considered issued with OID, a holder's
adjusted tax basis in the Capital Securities generally
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will be its initial purchase price. If the Junior Subordinated Debentures are
deemed to be issued with OID, a holder's adjusted tax basis in the Capital
Securities generally will be its initial purchase price, increased by OID
previously includible in such holder's gross income to the date of disposition
and decreased by distributions or other payments received on the Capital
Securities since and including the date the Junior Subordinated Debentures
were treated as issued with OID. Such gain or loss will generally be capital
gain or loss and will generally be long-term capital gain or loss if the
Capital Securities have been held for more than one year. Long-term capital
gain of a non-corporate United States Holder is generally subject to a maximum
tax rate of 20%.
The Capital Securities may trade at prices that do not accurately reflect
the value of accrued but unpaid interest with respect to the underlying Junior
Subordinated Debentures. A United States Holder that disposes of Capital
Securities between record dates for payments of distributions thereon will be
required to include accrued but unpaid interest on the Junior Subordinated
Debentures through the date of disposition in income as ordinary income, and
to add such amount to such holder's adjusted tax basis in the pro rata share
of the underlying Junior Subordinated Debentures deemed disposed of. To the
extent that the selling price is less than such holder's adjusted tax basis
(so determined) a United States Holder will recognize a capital loss. Subject
to certain limited exceptions, capital losses cannot be applied to offset
ordinary income for United States federal income tax purposes.
UNITED STATES ALIEN HOLDERS
For purposes of this discussion, a "United States Alien Holder" is any
corporation, individual, partnership, estate or trust that is, for United
States federal income tax purposes, a foreign corporation, a nonresident alien
individual, a foreign partnership, or a nonresident fiduciary of a foreign
estate or trust. The discussion assumes that income with respect to the
Capital Securities is not effectively connected with a trade or business in
the United States in which the United States Alien Holder is engaged.
Under current United States federal income tax law, and subject to the
discussion of backup withholding in the following section: (1) payments with
respect to principal and interest (including OID) by the Trust or any of its
paying agents to any holder of Capital Securities that is a United States
Alien Holder will not be subject to withholding of United States federal
income tax; provided that, in the case of interest, (a) the beneficial owner
of the Capital Securities does not actually or constructively own 10% or more
of the total combined voting power of all classes of stock of PMA Capital
entitled to vote, (b) the beneficial owner of the Capital Securities is not a
controlled foreign corporation that is related, directly or indirectly, to PMA
Capital through stock ownership and (c) either (A) the beneficial owner of the
Capital Securities certifies to the Trust or its agent, under penalties of
perjury, that it is a United States Alien Holder and provides its name and
address or (B) a securities clearing organization, bank or other financial
institution that holds customers' securities in the ordinary course of its
trade or business (a "Financial Institution"), and holds the Capital
Securities in such capacity, certifies to the Trust or its agent, under
penalties of perjury, that such statement has been received from the
beneficial owner by it or by a Financial Institution between it and the
beneficial owner and furnishes the Trust or its agent with a copy thereof and
(2) a United States Alien Holder of Capital Securities will generally not be
subject to withholding of United States federal income tax on any gain
realized upon the sale or other disposition of a Capital Securities (however,
gains recognized by an individual United States Alien Holder that holds the
Capital Securities as a capital asset and is in the United States for 183 or
more days in the taxable year of sale may be subject to United States federal
income tax).
BACKUP WITHHOLDING TAX AND INFORMATION REPORTING
Under current United States federal income tax law, information reporting
requirements apply to interest (including OID) and principal payments made to,
and to the proceeds of sales before maturity by, certain non-corporate
persons. In addition, a 31% backup withholding tax applies if a non-corporate
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person (i) fails to furnish such person's Taxpayer Identification Number
("TIN") (which, for an individual, would be his or her Social Security Number)
to the payor in the manner required, (ii) furnishes an incorrect TIN and the
payor is so notified by the Service, (iii) is notified by the Service that
such person has failed properly to report payments of interest and dividends
or (iv) in certain circumstances, fails to certify, under penalties of
perjury, that such person has not been notified by the Service that such
person is subject to backup withholding for failure properly to report
interest and dividend payments. Backup withholding does not apply with respect
to payments made to certain exempt recipients, such as corporations and tax-
exempt organizations.
In the case of a United States Alien Holder, backup withholding and
information reporting do not apply to payments of principal and interest with
respect to a Capital Security with respect to which such Holder has provided
the required certification under penalties of perjury that such Holder is a
United States Alien Holder or has otherwise established an exemption, provided
that certain conditions are satisfied.
In general, (i) principal or interest payments with respect to a Capital
Security collected outside the United States by a foreign office of a
custodian, nominee or other agent acting on behalf of a beneficial owner of a
Capital Security and (ii) payments on the sale, exchange or retirement of a
Capital Security to or through a foreign office of a broker are not subject to
backup withholding or information reporting. However, if such custodian,
nominee, agent or broker is (i) a United States person, (ii) a controlled
foreign corporation for United States federal income tax purposes, (iii) a
foreign person 50% or more of whose gross income is effectively connected with
the conduct of a United States trade or business for a specified three-year
period or (iv) with respect to payments made after December 31, 1999, a
foreign partnership, if at any time during its tax year, one or more of its
partners are United States persons (as defined in United States Treasury
regulations) who in the aggregate hold more than 50% of the income or capital
interest in the partnership or if at any time during its tax year, such
foreign partnership is engaged in a United States trade or business, such
custodian, nominee, agent or broker may be subject to certain information
reporting (but not backup withholding) requirements with respect to such
payments.
Backup withholding tax is not an additional tax. Rather, any amounts
withheld from a payment to a person under the backup withholding rules are
allowed as a refund or a credit against such person's United States federal
income tax, provided that the required information is furnished to the
Service.
POSSIBLE TAX LAW CHANGES
Prospective investors should be aware that legislation has been proposed by
the Clinton Administration in the past that, if enacted, would have denied an
interest deduction to issuers of instruments such as the Junior Subordinated
Debentures. No such legislation is currently pending. There can be no
assurance, however, that similar legislation will not ultimately be enacted
into law, or that other developments will not occur on or after the date
hereof that would adversely affect the tax treatment of the Junior
Subordinated Debentures or the Trust. Such changes also could give rise to a
Tax Event, which would permit PMA Capital to cause a redemption of the Capital
Securities, as described more fully under "Description of the Capital
Securities--Redemption--Special Event Redemption or Distribution of Junior
Subordinated Debentures."
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CERTAIN ERISA CONSIDERATIONS
Each fiduciary of a pension, profit-sharing or other employee benefit plan
subject to the Employee Retirement Income Security Act of 1974, as amended
("ERISA") (a "Plan"), should consider the fiduciary standards of ERISA in the
context of the Plan's particular circumstances before authorizing an
investment in the Capital Securities. Accordingly, among other factors, the
fiduciary should consider whether the investment would satisfy the prudence
and diversification requirements of ERISA and would be consistent with the
documents and instruments governing the Plan.
Section 406 of ERISA and Section 4975 of the Code prohibit Plans, as well as
individual retirement accounts and Keogh plans subject to Section 4975 of the
Code (also "Plans"), from engaging in certain transactions involving "plan
assets" with persons who are "parties in interest" under ERISA or
"disqualified persons" under the Code ("Parties in Interest") with respect to
such Plan. A violation of these "prohibited transaction" rules may result in
an excise tax or other liabilities under ERISA and/or Section 4975 of the Code
for such persons, unless exemptive relief is available under an applicable
statutory or administrative exemption. Employee benefit plans that are
governmental plans (as defined in Section 3(32) of ERISA), certain church
plans (as defined in Section 3(33) of ERISA) and foreign plans (as described
in Section (4)(b)(5) of ERISA are not subject to the requirements of ERISA or
Section 4975 of the Code; governmental plans may be subject to similar
provisions under applicable state laws.
Under a regulation (the "Plan Assets Regulation") issued by the U.S.
Department of Labor (the "DOL"), the assets of the Issuer would be deemed to
be "plan assets" of a Plan for purposes of ERISA and Section 4975 of the Code
if "plan assets" of the Plan were used to acquire an equity interest in the
Issuer and no exception were applicable under the Plan Assets Regulation. An
"equity interest" is defined under the Plan Assets Regulation as any interest
in an entity other than an instrument which is treated as indebtedness under
applicable local law and which has no substantial equity features and
specifically includes a beneficial interest in a trust.
Pursuant to an exception contained in the Plan Assets Regulation, the assets
of the Issuer would not be deemed to be "plan assets" of investing Plans if,
immediately after the most recent acquisition of any equity interest in the
Issuer, less than 25% of the value of each class of equity interests in the
Issuer were held by Plans, other employee benefit plans not subject to ERISA
or Section 4975 of the Code (such as governmental, church and foreign plans),
and entities holding assets deemed to be "plan assets" of any Plan
(collectively, "Benefit Plan Investors"), or if the Capital Securities were
"publicly-offered securities" for purposes of the Plan Assets Regulation. No
assurance can be given that the value of the Capital Securities held by
Benefit Plan Investors will be less than 25% of the total value of such
Capital Securities at the completion of the initial offering or thereafter,
and no monitoring or other measures will be taken with respect to the
satisfaction of the conditions to this exception. In addition, no assurance
can be given that the Capital Securities would be considered to be "publicly-
offered securities" under the Plan Assets Regulation. All of the Common
Securities will be purchased and initially held by PMA Capital.
Certain transactions involving the Issuer could be deemed to constitute
direct or indirect prohibited transactions under ERISA and Section 4975 of the
Code with respect to a Plan if the Capital Securities were acquired with "plan
assets" of such Plan and the assets of the Issuer were deemed to be "plan
assets" of such Plan and the assets were deemed to be "plan assets" of Plans
investing in the Issuer. For example, if PMA Capital is a Party in Interest
with respect to an investing Plan (either directly or by reason of its
ownership of its subsidiaries), extensions of credit between PMA Capital and
the Issuer (as represented by the Junior Subordinated Debentures and the
Guarantee) would likely be prohibited by Section 406(a)(1)(B) of ERISA and
Section 4975(c)(1)(B) of the Code unless exemptive relief were available under
an applicable administrative exemption (see below). In addition, if PMA
Capital were considered to be a fiduciary with respect to the Issuer as a
result of certain powers it holds (such as
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the powers to remove and replace the Property Trustee and the Administrative
Trustee), the optional redemption or acceleration of the Junior Subordinated
Debentures could be considered to be prohibited transactions under Section
406(b) of ERISA and Section 4975(c)(1)(E) of the Code. In order to avoid such
prohibited transactions, each investing Plan by purchasing the Capital
Securities will be deemed to have directed the Issuer to invest in the Junior
Subordinated Debentures and to have appointed the Property Trustee.
The DOL has issued five prohibited transaction class exemptions ("PTCEs")
that may provide exemptive relief if required for direct or indirect
prohibited transactions that may arise from the purchase or holding of the
Capital Securities if assets of the Issuer were deemed to be "plan assets" of
Plans investing in the Issuer as described above. Those class exemptions are
PTCE 96- 23 (for certain transactions determined by in-house asset managers),
PTCE 95-60 (for certain transactions involving insurance company general
accounts), PTCE 91-38 (for certain transactions involving bank collective
investment funds), PTCE 90-1 (for certain transactions involving insurance
company separate accounts), and PTCE 84-14 (for certain transactions
determined by independent qualified professional asset managers).
Because the Capital Securities may be deemed to be equity interests in the
Issuer for purposes of applying ERISA and Section 4975 of the Code, the
Capital Securities may not be purchased or held by any Plan, any entity whose
underlying assets include "plan assets" by reasons of any Plan's investment in
the entity (a "Plan Asset Entity") or any person investing "plan assets" of
any Plan, unless such purchaser or holder is eligible for the exemptive relief
available under PTCE 96-23, 95-60, 91-38, 90-1 or 84-14 or another applicable
exemption. Any purchaser or holder of the Capital Securities or any interest
therein will be deemed to have represented by its purchase and holding thereof
that it either (a) is not a Plan or a Plan Asset Entity and is not purchasing
such securities on behalf of or with "plan assets" of any Plan or (b) is
eligible for the exemptive relief available under PTCE 96-23, 95-60, 91-38,
90-1 or 84-14 or another applicable exemption with respect to such purchase or
holding. If a purchaser or holder of the Capital Securities that is a Plan or
a Plan Asset Entity elects to rely on an exemption other than PTCE 96-23, 95-
60, 91-38, 90-1 or 84-14, PMA Capital and the Issuer may require a
satisfactory opinion of counsel or other evidence with respect to the
availability of such exemption for such purchase and holding.
Due to the complexity of these rules and the penalties that may be imposed
upon persons involved in non-exempt prohibited transactions, it is
particularly important that fiduciaries or other persons considering
purchasing the Capital Securities on behalf of or with "plan assets" of any
Plan consult with their counsel regarding the potential consequences if the
assets of the issuer were deemed to be "plan assets" and the availability of
exemptive relief under PTCE 96-23, 95-60, 91-38, 90-1 or 84-14 or any other
applicable exemption.
VALIDITY OF SECURITIES
Certain matters of Delaware law relating to the validity of the Capital
Securities, the enforceability of the Trust Agreement and the formation of the
Issuer will be passed upon by Duane, Morris & Heckscher LLP, counsel to PMA
Capital and the Issuer. The validity of the Guarantee and the Junior
Subordinated Debentures will be passed upon for PMA Capital by Duane, Morris &
Heckscher LLP and for the Underwriters by Sullivan & Cromwell, New York, New
York. Sullivan & Cromwell will rely on the opinions of Duane, Morris &
Heckscher LLP as to matters of Delaware and Pennsylvania law. Certain matters
relating to the United States federal income tax considerations will be passed
upon for PMA Capital by Duane, Morris & Heckscher LLP. A John May, a director
of the Company, is a member of Duane, Morris & Heckscher LLP. Mr. May
beneficially owns an aggregate of 257,200 shares of the Company's Common Stock
and 60,086 shares of the Company's Class A Common Stock. Of these shares,
11,250 shares of Common Stock and 2,650 shares of Class A Common Stock are
owned
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jointly by Mr. May and his wife; 17,250 shares of Class A Common Stock are
held by a partnership of which Mr. May is a general partner. Members of Duane,
Morris & Heckscher LLP, including Mr. May, hold an aggregate of 259,700 shares
of Common Stock and 64,686 shares of Class A Common Stock of the Company.
UNDERWRITING
Subject to the terms and conditions of an underwriting agreement (the
"Underwriting Agreement"), PMA Capital and the Issuer have agreed that the
Issuer will sell to each of the Underwriters named below, and each of such
Underwriters, for whom Goldman, Sachs & Co., Merrill Lynch, Pierce, Fenner &
Smith Incorporated and First Union Capital Markets, a division of Wheat First
Securities, Inc. are acting as representatives, has severally agreed to
purchase from the Issuer, the respective number of Capital Securities set
forth opposite its name below:
<TABLE>
<CAPTION>
NUMBER OF
CAPITAL
SECURITIES
UNDERWRITER PURCHASED
----------- ----------
<S> <C>
Goldman, Sachs & Co. .............................................
Merrill Lynch, Pierce, Fenner & Smith Incorporated................
First Union Capital Markets.......................................
----
====
</TABLE>
Under the terms and conditions of the Underwriting Agreement, the
Underwriters are committed to take and pay for all the Capital Securities
offered hereby, if any are taken.
The Underwriters propose to offer the Capital Securities in part directly to
the public at the initial public offering price set forth on the cover page of
this Prospectus and in part to certain securities dealers at such price less a
concession of $ per Capital Security. The Underwriters may allow, and such
dealers may reallow, a concession not in excess of $ per Capital Security to
certain brokers and dealers. After the Capital Securities are released for
sale to the public, the offering price and other selling terms may from time
to time be varied by the representatives.
In view of the fact that the proceeds from the sale of the Capital
Securities will be used to purchase the Junior Subordinated Debentures issued
by PMA Capital, the Underwriting Agreement provides that PMA Capital will pay
as Underwriters' Compensation for the Underwriters' arranging the investment
therein of such proceeds an amount of $ per Capital Security for the
accounts of the several Underwriters.
In connection with the Offering, the Underwriters may purchase and sell the
Capital Securities in the open market. These transactions may include over-
allotment and stabilizing transactions and purchases to cover short positions
created by the Underwriters in connection with the Offering. Stabilizing
transactions consist of certain bids or purchases for the purpose of
preventing or retarding a decline in the market price of the Capital
Securities, and short positions created by the Underwriters involve the sale
by the Underwriters of a greater number of the Capital Securities than they
are required to purchase from PMA Capital in the Offering. The Underwriters
may also impose a penalty bid, whereby selling concessions allowed to broker-
dealers in respect of the Capital Securities sold in the offering may be
reclaimed by the Underwriters if such Capital Securities are repurchased by
the Underwriters in stabilizing or covering transactions. These activities may
stabilize, maintain or otherwise affect the market price of the Capital
Securities, which may be higher than the price that
152
<PAGE>
might otherwise prevail in the open market, and these activities, if
commenced, may be discontinued at any time. These transactions may be effected
in the over-the-counter market or otherwise.
Because the National Association of Securities Dealers, Inc. ("NASD") is
expected to view the Capital Securities offered hereby as interests in a
direct participation program, the Offering is being made in compliance with
Rule 2810 of the NASD's Conduct Rules. Offers and sales of Capital Securities
will be made only to (i) "qualified institutional buyers", as defined in Rule
144A under the Securities Act of 1933, as amended (the Act") or (ii)
institutional "accredited investors", as defined in Rule 501(a)(1)-(3) of
Regulation D under the Act. Sales to discretionary accounts may not be made
without the prior written approval of the customer.
PMA Capital and the Issuer have agreed that, during the period beginning
from the date of this Prospectus and continuing to and including the earlier
of (i) the termination of trading restrictions on the Capital Securities, as
determined by the Underwriters, or (ii) 30 days after the closing date, they
will not offer, sell, contract to sell, or otherwise dispose of any Capital
Securities, any other interests of the Issuer, or any capital stock or any
other securities of the Issuer or PMA Capital which are substantially similar
to the Capital Securities, including but not limited to any guarantee of such
security, or any securities convertible into or exchangeable for or
representing the right to receive, Capital Securities, preferred stock or such
substantially similar securities of either the Issuer or PMA Capital, without
the prior written consent of Goldman, Sachs & Co., except for the Capital
Securities offered in connection with this Offering, the Common Securities and
the Guarantee.
There is no established public trading market for the Capital Securities.
The Underwriters have advised PMA Capital that they intend to make a market in
the Capital Securities, but are not obligated to do so and may discontinue
market making at any time without notice. No assurance can be given as the
liquidity of the trading market for the Capital Securities.
The Issuer, PMA Capital and PMA Reinsurance Corporation have agreed to
indemnify the several Underwriters against certain liabilities, including
liabilities under the Act.
Certain of the Underwriters or their affiliates have provided from time to
time, and expect to provide in the future, investment or commercial banking
services to PMA Capital and its affiliates, for which such Underwriters or
their affiliates have received or will receive customary fees and commissions.
EXPERTS
The consolidated financial statements and schedules of the Company as of
December 31, 1997 and 1996 and for each of the years in the three-year period
ended December 31, 1997, have been included herein and in the Registration
Statement in reliance upon the reports of PricewaterhouseCoopers LLP,
independent accountants, appearing elsewhere herein, and upon the authority of
said firm as experts in accounting and auditing.
153
<PAGE>
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
The following documents have been previously filed by the Company with the
Commission and are hereby incorporated by reference in this Prospectus as of
their respective dates:
(i) The Company's Annual Report on Form 10-K for the year ended December
31, 1997 (filed March 23, 1998);
(ii) The Company's Quarterly Reports on Form 10-Q for the quarters ended
March 31, 1998 (filed May 15, 1998), June 30, 1998 (filed August 13, 1998)
and September 30, 1998 (filed November 13, 1998);
(iii) information included under the captions "Beneficial Ownership of
Common Stock," "Section 16(a) Beneficial Reporting Compliance," "Election
of Directors," "Information Regarding Management" (except for information
under "Report of Compensation Committee on the Compensation of Executive
Officers of the Company for the Year Ended December 31, 1997" and
"Comparison of Total Return on the Company's Class A Common Stock with
Certain Indices" which shall not be deemed incorporated by reference in
this Prospectus) and "Certain Transactions" of the Company's definitive
proxy statement (filed March 26, 1998); and
(iv) The Company's Current Reports on Form 8-K dated February 5, 1998,
February 9, 1998, and December 7, 1998.
In addition, all documents filed by the Company with the Commission pursuant
to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act subsequent to the
date of this Prospectus and prior to the termination of the Offering shall be
deemed to be incorporated by reference in this Prospectus and to be a part
hereof from the date of filing of such documents. Any statement or information
contained herein or in a document incorporated by reference herein shall be
deemed to be modified or superseded for purposes of this Prospectus to the
extent that a statement or information contained herein or in any other
subsequently filed document that is also incorporated by reference herein
modifies or replaces such a statement or such information. Any such statement
or information so modified or replaced shall not be deemed, except as so
modified or replaced, to be a part of this Prospectus.
The Company will furnish without charge, including any beneficial owner, to
each person to whom this Prospectus is delivered, upon written or oral
request, a copy of any and all of the documents that have been incorporated by
reference in this Prospectus, other than exhibits to such documents, unless
such exhibits are specifically incorporated by reference into the documents
that this Prospectus incorporates. Requests should be submitted by telephone
to (215) 665-5046 or in writing to PMA Capital Corporation, 1735 Market
Street, Philadelphia, Pennsylvania, 19103-7590, Attention: Investor Relations.
154
<PAGE>
GLOSSARY OF CERTAIN INSURANCE AND OTHER DEFINED TERMS
Actuarial analysis........... Evaluation of risks in order to attempt to
assure that premiums and loss reserves
adequately reflect expected future loss
experience and claims payments; in evaluating
risks, mathematical models are used to predict
future loss experience and claims payments
based on past loss ratios and loss development
patterns and other relevant data and
assumptions.
Affiliate.................... With respect to any Person, any other person
which directly or indirectly controls, is
controlled by or is under common control with
such Person.
Adverse...................... loss development Increases in losses and ALAE
exceeding anticipated loss and ALAE experience
over a given period of time.
Aggregate excess reinsurance
arrangements................ Reinsurance arrangements under which a
reinsurer assumes the risks and/or loss
reserves of certain business of a ceding
company in their entirety.
Allocated loss adjustment
expenses ("ALAE")........... Allocated loss adjustment expenses include all
legal expenses and other expenses incurred by a
company in connection with the investigation,
adjustment, settlement or litigation of claims
or losses under business covered. ALAE does not
include costs of "in house" counsel, claims
staff or other overhead or general expense of
the reinsured.
A.M. Best.................... A.M. Best Company, Inc. A.M. Best financial
condition ratings are opinions of an insurance
company's financial strength, operating
performance and ability to meet its obligations
to policyowners. Such ratings are based upon a
comprehensive review of a company's financial
performance, which is supplemented by certain
data, including responses to A.M. Best's
questionnaires, quarterly NAIC filings, state
insurance department examination reports, loss
reserve reports, annual reports and reports
filed with state insurance departments. A.M.
Best undertakes a quantitative evaluation based
on profitability, leverage and liquidity and a
qualitative evaluation based upon a company's
book of business or spread of risk, the amount,
appropriateness and soundness of reinsurance,
the quality, diversification and estimated
market value of its assets, the adequacy of its
loss reserves and policyowners' surplus and the
experience and competence of its management.
A.M. Best Company, Inc. uses the following
rating scale:
<TABLE>
<S> <C>
A++ and A+ Superior
A and A- Excellent
B++ and B+ Very Good
</TABLE>
155
<PAGE>
<TABLE>
<S> <C>
B and B- Adequate
C++ and C+ Fair
C and C- Marginal
D Very Vulnerable
E Under State Supervision
F In Liquidation
</TABLE>
Annualized premium........... The expected premium payment for a 12-month
period for each policy, excluding single
premium policies. Actual premium payments may
be higher or lower than annualized premiums.
Attachment point............. The amount of losses above which excess of loss
reinsurance becomes operative.
Automatic facultative
arrangements................ Facultative insurance contracts whereby the
ceding company has the right, but not the
obligation, to cede risks to a reinsurer and
the reinsurer is obligated to accept such risks
pursuant to the contract terms.
Broker; intermediary......... One who negotiates contracts of reinsurance
between a primary insurer or other reinsured
and a reinsurer on behalf of the primary
insurer or reinsured. The broker receives from
the reinsurer a commission for placement and
other services rendered.
Broker reinsurer............. A reinsurer that markets and sells reinsurance
through brokers rather than through its own
employees.
Case reserves................ Loss reserves established with respect to
individual reported claims.
Casualty insurance and/or
reinsurance................. Insurance and/or reinsurance that is concerned
primarily with the losses caused by injuries to
third persons (in other words, persons other
than the policyholder) and the legal liability
imposed on the insured resulting therefrom.
Catastrophe reinsurance...... A form of excess of loss property reinsurance
that, subject to a specified limit, indemnifies
the ceding company for the amount of loss in
excess of a specified retention with respect to
an accumulation of losses resulting from a
catastrophic event. The actual reinsurance
document is called a "catastrophe cover."
Cede; ceding company;
cedent...................... When a company reinsures its risk with another,
it "cedes" business and is referred to as the
"ceding company" or the "cedent".
Claim closure rate........... The number of closed lost time workers'
compensation claims divided by total reported
lost time workers' compensation claims by
accident year as of a given evaluation date.
156
<PAGE>
Clash cover.................. A form of excess of loss casualty reinsurance
policy covering losses arising from a single
set of circumstances covered by more than one
primary policy. For example, if an insurer
covers both motorists involved in an accident,
a clash cover would protect the insurer from
suffering a net loss in the full amount of both
parties. The clash cover would pay to the
insurer a portion of the loss in excess of the
coverage of one of the two parties.
Combined ratio............... A combination of the underwriting expense
ratio, the loss and LAE ratio, and the
policyholder dividend ratio. The loss and LAE
ratio measures the ratio of net incurred losses
and LAE to net earned premiums. The
underwriting expense ratio measures the ratio
of underwriting expenses to net premiums
written. The policyholder dividend ratio
measures policyholder dividends as a percent of
net premiums earned. Generally, companies that
write predominately long-tailed liability risks
will have a higher combined ratio than those
companies writing predominately property risks.
Commutation.................. An agreement with a claimant whereby the
claimant, in exchange for a lump sum payment,
releases his or her rights to future indemnity
payments.
Direct reinsurer, direct
underwriter, direct
writer...................... A reinsurer that markets and sells reinsurance
directly to its reinsureds without the
assistance of brokers.
Excess and surplus lines..... Surplus lines risks are those risks not fitting
normal under-writing patterns, involving a
degree of risk that is not commensurate with
standard rates and/or policy forms, or that
will not be written by standard carriers
because of general market conditions. Excess
insurance refers to coverage that attaches for
an insured over the limits of a primary policy
or a stipulated self-insured retention.
Policies are bound or accepted by carriers not
licensed in the jurisdiction where the risk is
located, and generally are not subject to
regulations governing premium rates or policy
language.
Excess of loss reinsurance... The generic term describing reinsurance that
indemnifies the reinsured against all or a
specified portion of losses on underlying
insurance policies in excess of a specified
dollar amount, called a "layer" or "retention."
Also known as nonproportional reinsurance or
stop loss coverage.
Facultative reinsurance...... The reinsurance of all or a portion of the
insurance provided by a single policy. Each
policy reinsured is separately negotiated.
GAAP......................... United States generally accepted accounting
principles for property and casualty insurance
companies
Gross premiums written.......
Total premiums for direct insurance and
reinsurance assumed during a given period.
157
<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 estimated losses that have been
incurred 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.
158
<PAGE>
Moody's...................... Moody's Investors Service, Inc. Moody's
financial strength ratings are opinions of an
operating insurance company's ability to
discharge senior policyowner claims and
obligations pursuant to its insurance policies.
Moody's financial strength ratings are based on
information provided by the company and federal
and state regulators. Moody's Investors
Service, Inc. uses the following rating scale:
<TABLE>
<S> <C>
Aaa Exceptional
Aa1, Aa2 and Aa3 Excellent
A1, A2 and A3 Good
Baa1, Baa2 and Baa3 Adequate
Ba1, Ba2 and Ba3 Questionable
B1, B2 and B3 Poor
Caa Very Poor
Ca Extremely Poor
C Lowest
</TABLE>
NAIC......................... The National Association of Insurance
Commissioners, an association of the chief
insurance supervisory officials of each state,
territory and insular possession of the United
States.
Net leverage................. Sum of net premiums written and liabilities
divided by surplus.
Net premiums earned.......... The portion of net premiums written that is
recognized for accounting purposes as income
during a period.
Net premiums written......... Gross premiums written for a given period less
premiums ceded to reinsurers during such
period.
Non-admitted basis........... Refers to the fact that a company marketing
excess and surplus lines of insurance in a
particular jurisdiction is not required to be
fully licensed in such jurisdiction buy may
write insurance on an excess and surplus lines
basis in that jurisdiction. In addition, unlike
standard lines of insurance, premium rates and
policy forms for coverages written on a non-
admitted basis do not require the approval of
the insurance department of the jurisdiction.
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.
Premium......................
Payments received on insurance policies issued
or reinsured by an insurance company.
159
<PAGE>
Primary insurer.............. An insurance company that issues insurance
policies to the general public or to certain
noninsurance entities.
Pro rata reinsurance......... A generic term describing all forms of
reinsurance in which the reinsurer shares a
proportional part of the original premiums and
losses of the reinsured. Pro rata reinsurance
also is known as proportional reinsurance,
quota share reinsurance and participating
reinsurance.
Property insurance and/or
reinsurance................. Insurance and/or reinsurance that indemnifies a
person with an insurable interest in tangible
property for his property loss, damage or loss
of use.
Pure loss ratio.............. See "Loss ratio/pure loss ratio" above.
Reinsurance.................. The practice whereby one party, called the
reinsurer or assuming company, in consideration
of a premium paid to such party, agrees to
indemnify another party, called the reinsured,
for part or all of the liability assumed by the
reinsured under a policy or policies of
insurance that it has issued. The reinsured may
be referred to as the original or primary
insurer, the direct writing company or the
ceding company. Reinsurance provides a primary
insurer with three major benefits: it reduces
net liability on individual risks; it helps to
protect against catastrophic losses and it
helps to maintain acceptable surplus and
reserve ratios. Reinsurance provides a primary
insurer with additional underwriting capacity
in that the primary insurer can accept larger
risks and can expand the volume of business it
writes without increasing its capital base. The
ceding company remains liable on its
obligations under the policies reinsured if the
reinsurer fails to pay claims on a reinsured
policy.
Rent-a-captive............... Refers to an arrangement pursuant to which an
insurer's client purchases a policy from the
insurer and chooses a participation level. The
insurer, in turn, cedes the portion of the
premium and loss exposure representative of the
participation level to an affiliate, typically
located in an offshore jurisdiction, such as
Bermuda. The client then participates in the
loss and investment experience within the
participation level, generally through a
dividend mechanism. The client is responsible
for any losses that may arise within its
participation level, and such potential
obligation is typically secured through a
letter of credit or similar collateral.
Reserves..................... Liabilities established by insurers to reflect
the estimated discounted present value of costs
of claims, payments or contract liabilities and
the related expenses that the insurer will
ultimately be required to pay in respect of
insurance it has written.
160
<PAGE>
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.
Risk-based capital
requirements or RBC......... Regulatory and rating agency targeted surplus
based on the relationship of statutory surplus,
with certain adjustments, to the sum of stated
percentages of each element of a specified list
of company risk exposures.
Risk-exposed................. Reinsurance coverages that attach within the
underlying policy limits of the ceding company,
which differs from catastrophe reinsurance and
clash coverages.
Semiautomatic facultative
arrangements................ Facultative reinsurance contracts where the
ceding company has the right, but not the
obligation to cede risks to a reinsurer and the
reinsurer is obligated to accept such risks as
long as they are within stated criteria. If a
risk falls outside such criteria, the reinsurer
has the option of either: (i) accepting the
risk, (ii) declining the risk, or (iii)
repricing the risk.
SFAS......................... Statement of Financial Accounting Standards.
Standard & Poor's............ Standard & Poor's Ratings Group. Standard &
Poor's claims-paying ability ratings are
opinions of an operating insurance company's
financial ability to meet its obligations under
its insurance policies. Standard & Poor's
claims-paying ability ratings are based on
current information provided by the subject
insurance company and other reliable sources.
Standard & Poor's Rating Group uses the
following rating scale:
<TABLE>
<S> <C>
AAA Superior
AA+, AA and AA- Excellent financial security
A+, A and A- Good financial security
BBB+, BBB and BBB- Adequate
BB+, BB and BB- Financial security may be
adequate
B+, B and B- Vulnerable
CCC Extremely Vulnerable
R Regulatory actions
A pi , BBB pi ,BB pi and B pi Qualified solvency ratings
</TABLE>
161
<PAGE>
Statutory accounting
principles("SAP")........... Recording transactions and preparing financial
statements in accordance with the rules and
procedures prescribed or permitted by state
insurance regulatory authorities including the
NAIC, which in general reflect a liquidating,
rather than going concern, concept of
accounting.
Statutory reserves........... Monetary amounts established by state insurance
law that an insurer must have available to
provide for future obligations with respect to
all policies. Statutory reserves are
liabilities on the balance sheet of financial
statements prepared in conformity with SAP.
Statutory or policyholder's
surplus; statutory capital
and surplus................. The excess of statutory admitted assets over
statutory liabilities (including loss reserves)
as shown on an insurer's statutory financial
statements.
Stop loss.................... See "Excess of loss reinsurance".
Survival ratio............... For asbestos and environmental (A&E) claims,
the survival ratio is equal to the average
normalized loss and LAE payments for A&E over
three years divided by loss reserves
established for A&E.
Treaty reinsurance........... The reinsurance of a specified type or category
of risks defined in a reinsurance agreement (a
"treaty") between a primary insurer or other
reinsured and a reinsurer. Typically, in treaty
reinsurance, the primary insurer or reinsured
is obligated to offer and the reinsurer is
obligated to accept a specified portion of all
such type or category of risks originally
written by the primary insurer or reinsured.
Underwriting................. The insurer's process of reviewing applications
submitted for insurance coverage, deciding
whether to accept all or part of the coverage
requested and determining the applicable
premiums.
Underwriting cycle........... An historical pattern in which property and
casualty insurance and reinsurance premiums,
profits and availability of coverage rise and
fall with some regularity over time.
Underwriting expenses........ The aggregate of policy acquisition costs,
including commissions, and the portion of
administrative, general and other expenses
attributable to underwriting operations.
Unearned premium............. The portion of a premium representing the
unexpired portion of the exposure period as of
a certain date.
Unearned premium reserve..... Liabilities established by insurers and
reinsurers to reflect unearned premiums that
are refundable to policyholders if an insurance
or reinsurance contract is canceled prior to
expiration of the contract term.
162
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
INDEX TO FINANCIAL STATEMENTS AND SCHEDULES
<TABLE>
<S> <C>
CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Consolidated Balance Sheet at September 30, 1998.......................... F-2
Consolidated Statements of Operations for the three and nine months ended
September 30, 1998 and 1997.............................................. F-3
Consolidated Statements of Comprehensive Income for the three and nine
months ended September 30, 1998 and 1997................................. F-4
Consolidated Statements of Cash Flows for the nine months ended September
30, 1998 and 1997........................................................ F-5
Notes to Consolidated Financial Statements................................ F-6
AUDITED CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Financial Statements:
Report of Independent Accountants....................................... F-11
Consolidated Balance Sheets at December 31, 1997 and 1996............... F-12
Consolidated Statements of Operations for each of the three years in the
period ended December 31, 1997......................................... F-13
Consolidated Statements of Changes in Shareholders' Equity for each of
the three years in the period ended December 31, 1997.................. F-14
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1997......................................... F-16
Notes to Consolidated Financial Statements.............................. F-17
</TABLE>
Effective December 7, 1998, Pennsylvania Manufacturers Corporation changed its
name to PMA Capital Corporation. PMA Capital Corporation may be referred to
herein as "Pennsylvania Manufacturers Corporation," "PMC," or the "Company."
F-1
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
-------------
<S> <C>
ASSETS
(IN THOUSANDS, EXCEPT SHARE DATA)
Investments:
Fixed maturities available for sale, at fair value (amortized
cost of $1,805,137).......................................... $1,875,910
Equity securities, at fair value (cost of $5)................. 15
Short-term investments, at amortized cost which approximates
fair value................................................... 91,328
----------
Total investments........................................... 1,967,253
Cash............................................................ 7,595
Investment income due and accrued............................... 23,674
Uncollected premiums (net of allowance for uncollectible
accounts of $18,545)........................................... 294,534
Reinsurance receivables (net of allowance for uncollectible
reinsurance of $2,168)......................................... 604,108
Property and equipment (net of accumulated depreciation of
$50,910)....................................................... 37,088
Deferred income taxes, net...................................... 49,907
Deferred acquisition costs...................................... 55,958
Other assets.................................................... 91,805
----------
Total assets................................................ $3,131,922
==========
LIABILITIES
Unpaid losses and loss adjustment expenses...................... $1,951,497
Unearned premiums............................................... 253,216
Long-term debt.................................................. 203,000
Dividends to policyholders...................................... 9,605
Funds held under reinsurance treaties........................... 75,678
Taxes, licenses and fees, and other expenses.................... 53,622
Other liabilities............................................... 67,724
----------
Total liabilities........................................... 2,614,342
----------
SHAREHOLDERS' EQUITY
Common stock, $5 par value (40,000,000 shares authorized;
14,615,587 shares issued and 14,179,580 outstanding)........... 73,078
Class A common stock, $5 par value (40,000,000 shares
authorized; 9,827,358 shares issued and 9,146,028
outstanding)................................................... 49,136
Additional paid-in capital--Class A common stock................ 339
Retained earnings............................................... 367,999
Accumulated other comprehensive income.......................... 46,009
Notes receivable from officers.................................. (198)
Treasury stock, at cost:
Common stock (436,007 shares)................................. (5,582)
Class A common stock (681,330 shares)......................... (13,201)
----------
Total shareholders' equity.................................. 517,580
----------
Total liabilities and shareholders' equity.................. $3,131,922
==========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-2
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS
ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------ ------------------
1998 1997 1998 1997
(IN THOUSANDS, EXCEPT PER SHARE DATA) -------- -------- -------- --------
<S> <C> <C> <C> <C>
Revenues:
Net premiums written.................. $120,653 $ 67,475 $369,134 $315,760
Change in net unearned premiums....... (6,636) (4,505) (33,541) (30,389)
-------- -------- -------- --------
Net premiums earned................. 114,017 62,970 335,593 285,371
Net investment income................. 29,163 34,353 94,363 102,812
Net realized investment gains......... 4,099 5,531 15,362 3,600
Service revenues...................... 2,192 2,674 7,282 7,712
-------- -------- -------- --------
Total revenues...................... 149,471 105,528 452,600 399,495
-------- -------- -------- --------
Losses and expenses:
Losses and loss adjustment expenses... 83,473 47,785 256,230 240,919
Acquisition expenses.................. 25,985 20,093 77,748 66,562
Operating expenses.................... 18,154 18,765 55,654 55,670
Dividends to policyholders............ 5,507 3,566 13,637 10,183
Interest expense...................... 3,768 3,803 11,231 12,025
-------- -------- -------- --------
Total losses and expenses........... 136,887 94,012 414,500 385,359
-------- -------- -------- --------
Income before income taxes and
extraordinary loss..................... 12,584 11,516 38,100 14,136
Provision (benefit) for income taxes:
Current............................... (424) (741) 267 (1,094)
Deferred.............................. 2,456 4,913 5,836 2,609
-------- -------- -------- --------
Total............................... 2,032 4,172 6,103 1,515
-------- -------- -------- --------
Income before extraordinary loss...... 10,552 7,344 31,997 12,621
Extraordinary loss from early
extinguishment of debt (net of income
tax benefit of $2,549)............... -- -- -- (4,734)
-------- -------- -------- --------
Net income.............................. $ 10,552 $ 7,344 $ 31,997 $ 7,887
======== ======== ======== ========
Income per basic and diluted share:
Basic:
Income before extraordinary loss.... $ 0.45 $ 0.31 $ 1.35 $ 0.53
Extraordinary loss.................. -- -- -- (0.20)
-------- -------- -------- --------
Net income.............................. $ 0.45 $ 0.31 $ 1.35 $ 0.33
======== ======== ======== ========
Diluted:
Income before extraordinary loss.... $ 0.43 $ 0.30 $ 1.30 $ 0.51
Extraordinary loss.................. -- -- -- (0.19)
-------- -------- -------- --------
Net income.............................. $ 0.43 $ 0.30 $ 1.30 $ 0.32
======== ======== ======== ========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-3
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------- ----------------
1998 1997 1998 1997
(IN THOUSANDS) ------- ------- ------- -------
<S> <C> <C> <C> <C>
Net income................................. $10,552 $ 7,344 $31,997 $ 7,887
------- ------- ------- -------
Other comprehensive income, net of tax:
Unrealized gains on securities:
Holding gains arising during the
period................................ 22,363 28,185 38,761 19,955
Less: reclassification adjustment for
gains included in net income.......... (2,651) (3,334) (11,558) (2,384)
------- ------- ------- -------
Other comprehensive income .............. 19,712 24,851 27,203 17,571
------- ------- ------- -------
Comprehensive income ...................... $30,264 $32,195 $59,200 $25,458
======= ======= ======= =======
</TABLE>
See accompanying notes to the consolidated financial statements.
F-4
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
1998 1997
(IN THOUSANDS) ----------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net income......................................... $ 31,997 $ 7,887
Adjustments to reconcile net income to net cash
flows used by operating activities:
Depreciation..................................... 4,155 7,117
(Accretion) amortization......................... (878) 3,832
Provision for deferred income taxes.............. 5,836 2,609
Extraordinary loss from early extinguishment of
debt............................................ -- (4,734)
Net realized investment gains.................... (15,362) (3,600)
Change in uncollected premiums and unearned
premiums, net................................... (348) 23,523
Change in dividends to policyholders............. (595) (1,820)
Change in reinsurance receivables................ (54,165) (36,523)
Change in unpaid losses and loss adjustment
expenses........................................ (51,690) (101,912)
Change in investment income due and accrued...... 144 (313)
Other, net....................................... 7,671 14,275
----------- -----------
Net cash flows used in operating activities.......... (73,235) (89,659)
----------- -----------
Cash flows from investing activities:
Fixed maturity investments available for sale:
Purchases........................................ (1,377,422) (1,462,705)
Maturities or calls.............................. 108,013 122,974
Sales............................................ 1,175,526 1,432,258
Equity Securities:
Sales............................................ -- 3
Net sales (purchases) of short-term investments.... 162,296 (7,047)
Proceeds from sale of corporate properties......... 21 7,145
Proceeds from sale of subsidiary................... 2,902 --
Net purchases of property and equipment............ (2,622) (2,245)
----------- -----------
Net cash flows provided by investing activities...... 68,714 90,383
----------- -----------
Cash flows from financing activities:
Dividends paid to shareholders..................... (6,086) (5,966)
Proceeds from long-term debt....................... -- 210,000
Repayments of long-term debt....................... -- (211,699)
Repayments of notes receivable from officers....... -- 1,034
Treasury stock transactions, net................... (13,946) 626
----------- -----------
Net cash flows used in financing activities.......... (20,032) (6,005)
----------- -----------
Net decrease in cash................................. (24,553) (5,281)
Cash January 1....................................... 32,148 7,176
----------- -----------
Cash September 30.................................... $ 7,595 $ 1,895
=========== ===========
Supplementary cash flow information:
Cash received for income taxes..................... $ (616) $ (19,312)
Cash paid for interest............................. $ 11,150 $ 15,637
</TABLE>
See accompanying notes to the consolidated financial statements.
F-5
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
1. GENERAL
The accompanying consolidated financial statements include the accounts of
Pennsylvania Manufacturers Corporation ("PMC") and its wholly and majority
owned subsidiaries (the "Company"). PMC is an insurance holding company that
sells property and casualty reinsurance and insurance through its insurance
subsidiaries. PMC's insurance subsidiaries are domiciled in Pennsylvania,
except for its excess and surplus lines affiliate which is domiciled in
Delaware, and certain foreign subsidiaries.
Reinsurance--PMC's reinsurance operations ("PMA Re"), including PMA
Reinsurance Corporation, emphasize risk-exposed, excess of loss reinsurance
and operate 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. Caliber One writes
primarily casualty business through surplus lines brokers on a nationwide
basis. Caliber One's excess and surplus lines insurance affiliate, Caliber One
Indemnity Company, is presently authorized as a surplus lines carrier in 41
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
reduced by $3.0 million and $37.0 million for the three and nine months ended
September 30, 1998, respectively, representing estimated retrospective policy
adjustments related to the current accident year and retrospective policy
adjustments paid. These adjustments to net premiums written were made for
presentation purposes only and had previously been reflected in the Company's
reported revenues, financial position and results of operations.
Operating results for the three and nine months ended September 30, 1998,
are not necessarily indicative of the results to be expected for the full
year. For further information, refer to the December 31, 1997 audited
consolidated financial statements and footnotes thereto included elsewhere in
this Prospectus.
2. PER SHARE DATA
In February 1997, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 128, "Earnings Per Share" ("SFAS No.
128"), which supersedes Accounting Principles Board Opinion No. 15, "Earnings
Per Share," and Related Interpretations. The Company adopted SFAS No. 128
during 1997. In accordance with SFAS No. 128, all prior period data presented
has been restated to conform with the provisions of this statement. SFAS No.
128 replaces the presentation of primary earnings per share with a
presentation of basic earnings per share and
F-6
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
SEPTEMBER 30, 1998
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:
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------- -----------------------
1998 1997 1998 1997
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Numerator:
Control number--income before
extraordinary loss.......... $ 10,552 $ 7,344 $ 31,997 $ 12,621
Denominator:
Basic shares--weighted
average
Common and Class A common
shares outstanding.......... 23,573,472 23,870,089 23,704,376 23,845,194
Dilutive stock options......... 1,043,105 639,843 945,028 661,544
----------- ----------- ----------- -----------
Total diluted shares....... 24,616,577 24,509,932 24,649,404 24,506,738
=========== =========== =========== ===========
</TABLE>
Basic earnings per share: For the three and nine months ended September 30,
1998 and 1997, basic earnings per share calculations were based upon the
weighted average number of common and Class A common shares outstanding for
the periods.
Diluted earnings per share: For the three and nine months ended September
30, 1998 and 1997, diluted earnings per share calculations were based upon the
weighted average number of common and Class A common shares outstanding for
the periods and the assumed exercise price of dilutive stock options, less the
number of treasury shares assumed to be purchased from the proceeds using the
average market price of the Company's Class A common stock.
3. ACCOUNTING PRONOUNCEMENTS
As of January 1, 1998, the Company adopted Statement of Financial Accounting
Standards No. 130, "Comprehensive Income" ("SFAS No. 130"), which establishes
standards for the reporting and disclosure of comprehensive income and its
components (revenues, expenses, gains and losses). SFAS No. 130 requires that
all items required to be recognized under accounting standards as components
of comprehensive income be reported in a financial statement that is displayed
with the same prominence as other financial statements. Comprehensive income
includes a reclassification adjustment for net realized investment gains
included in net income of $2.7 million (after income taxes of $1.4 million)
and $11.6 million (after income taxes of $6.2 million) for the three and nine
months ended September 30, 1998, respectively, and $3.3 million (after income
taxes of $1.8 million) and $2.4 million (after income taxes of $1.3 million)
for the three and nine months ended September 30, 1997, respectively. 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.
F-7
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
SEPTEMBER 30, 1998
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. The Company has
excluded net realized investment gains (losses) from the profit and loss
measurement it utilizes to assess the performance of its operating segments
because (i) net realized investment gains (losses) are unpredictable and not
necessarily indicative of future performance and (ii) in many instances,
decisions to buy and sell securities are made at the parent holding company
level, and such decisions result in net realized gains (losses) that do not
relate to the operations of the individual segments. Pursuant to the adoption
of SFAS No. 131, the Company has restated the information for the three and
nine-month periods ended September 30,1997 for comparability, primarily
related to certain corporate expenses that were previously allocated to the
operating segments. SFAS No. 131 requires only additional disclosures in the
consolidated financial statements; it does not affect the Company's financial
position or results of operations. Supplemental financial information for the
annual periods prior to the date of adoption of SFAS No. 131 are as follows:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1997 1996 1995
------- --------- -------
<S> <C> <C> <C>
Pre-tax operating income (loss):
PMA Re........................................ $45,957 $ 44,807 $39,793
The Property and Casualty Group:
Excluding Run-off Operations.................. (3,607) (215,669) (3,885)
Run-off Operations............................ (73) -- --
------- --------- -------
Total....................................... (3,680) (215,669) (3,885)
Corporate and Other............................. (9,954) (6,464) (14,184)
------- --------- -------
Total pre-tax operating income (loss)....... $32,323 $(177,326) $21,724
======= ========= =======
</TABLE>
The difference between this supplemental financial information and the
information in the Company's audited financial statements included elsewhere
in this Prospectus is primarily related to certain corporate expenses that
were previously allocated to the operating segments. The amount of this
adjustment was $6.5 million ($1.1 million allocated to PMA Re and $5.4 million
to the Property and Casualty Group), $6.0 million ($2.0 million allocated to
PMA Re and $4.0 million to the Property and Casualty Group) and $770,000
($350,000 allocated to PMA Re and $420,000 to the Property and Casualty Group)
for the years ended December 31, 1997, 1996, and 1995, respectively. Amounts
for previous years were not material; accordingly, no adjustments have been
made.
F-8
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
SEPTEMBER 30, 1998
The following table indicates the Company's pre-tax operating income (loss)
by principal business segment for the three and nine months ended September
30, 1998 and 1997:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
JUNE 30, SEPTEMBER 30,
---------------- ----------------
1998 1997(1) 1998 1997(1)
------- ------- ------- -------
<S> <C> <C> <C> <C>
PMA Re.................................... $11,930 $11,487 $34,882 $34,674
The Property and Casualty Group:
Excluding Run-off Operations............ 3,389 (76) 8,343 (4,857)
Run-off Operations...................... (387) 999 41 (108)
------- ------- ------- -------
Total................................. 3,002 923 8,384 (4,965)
Caliber One............................... (247) -- (1,317) --
Corporate and Other....................... (2,432) (2,622) (7,980) (7,148)
------- ------- ------- -------
Pre-tax operating income before interest
expense.................................. 12,253 9,788 33,969 22,561
Interest expense.......................... 3,768 3,803 11,231 12,025
------- ------- ------- -------
Pre-tax operating income.................. 8,485 5,985 22,738 10,536
Net realized investment gains............. 4,099 5,531 15,362 3,600
------- ------- ------- -------
Income before income taxes and
extraordinary loss....................... 12,584 11,516 38,100 14,136
Provisions for income taxes............... 2,032 4,172 6,103 1,515
------- ------- ------- -------
Income before extraordinary loss.......... 10,552 7,344 31,997 12,621
Extraordinary loss........................ -- -- -- (4,734)
------- ------- ------- -------
Net income................................ $10,552 $ 7,344 $31,997 $ 7,887
======= ======= ======= =======
</TABLE>
- --------
(1) Pre-tax operating income (loss) by business segment has been reclassified
for 1997 to reflect the changes related to the implementation of SFAS No.
131. (See Note 3 to the Consolidated Financial Statements for further
discussion).
The following table indicates the Company's total assets by principal
business segment at September 30, 1998:
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
1998
----------
<S> <C>
PMA Re........................................................... $1,223,315
The Property and Casualty Group:
Excluding Run-off Operations................................... 1,722,177
Run-off Operations............................................. 116,242
----------
Total........................................................ 1,838,419
Caliber One...................................................... 63,725
Corporate and Other.............................................. 6,463
----------
Total assets................................................. $3,131,922
==========
</TABLE>
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
F-9
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
SEPTEMBER 30, 1998
Enterprises for Insurance-Related Assessments" ("SOP 97-3"). SOP 97-3, which
is effective for fiscal years beginning after December 15, 1998, provides
guidance for determining when an insurance company should recognize a
liability for guaranty fund and other insurance related assessments and how to
measure that liability. While the Company is presently evaluating the impact
of SOP 97-3, the adoption of SOP 97-3 is likely to result in an increase in
the Company's liabilities for such assessments, although such increase is not
expected to exceed $5.0 million. The impact of adopting SOP 97-3 will be
reflected as a cumulative effect of an accounting change in the first quarter
of 1999.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("SFAS No. 133"), which establishes accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
"derivatives") and for hedging activities. SFAS No. 133 requires that an
entity recognize all derivatives as either assets or liabilities in the
statement of financial position and measure those instruments at fair value.
If certain conditions are met, a derivative may be specifically designated as
(i) a hedge of the exposure to changes in the fair value of a recognized asset
or liability or an unrecognized firm commitment, (ii) a hedge of the exposure
to variable cash flows of a forecasted transaction, or (iii) a hedge of the
foreign currency exposure of a net investment in a foreign operation, an
unrecognized firm commitment, an available-for-sale security, or a foreign-
currency-denominated forecasted transaction. The accounting for changes in the
fair value of a derivative (that is, gains and losses) depends on the intended
use of the derivative and the resulting designation. SFAS No. 133 is effective
for all fiscal quarters of fiscal years beginning after June 15, 1999. While
the Company is presently evaluating the impact of SFAS No. 133, the adoption
of SFAS No. 133 is not expected to have a material impact on the Company's
financial condition or results of operations.
4. SALE OF SUBSIDIARY
Effective July 1, 1998, the Company sold PMA Insurance, Cayman Ltd. ("PMA
Cayman"), one of the entities included in the Property and Casualty Group's
Run-off Operations, which reinsures claims for certain policies written by
Pennsylvania Manufacturers' Association Insurance Company, Manufacturers
Alliance Insurance Company and Pennsylvania Manufacturers Indemnity Company
(the "Pooled Companies"), to a third party for a purchase price of $1.8
million and recorded an after-tax loss of $1.6 million. In addition, the
Company transferred to the buyer $231.5 million in cash and invested assets
and recorded reinsurance receivables of $241.8 million as of September 30,
1998 related to the existing reinsurance agreements with PMA Cayman. If the
actual claim payments in the aggregate exceed the estimated payments upon
which the loss reserves have been established, the Company has agreed to
indemnify the buyer, up to a maximum of $15.0 million. If the actual claim
payments in the aggregate are less than the estimated payments upon which the
loss reserves have been established, the Company will participate in such
favorable loss reserve development.
5. COST REDUCTION INITIATIVES
During 1997, the Company recorded a $7.0 million charge in operating
expenses for costs associated with nonvoluntary terminations of approximately
60 employees in various operational and management positions. During 1998, the
Company recorded additional charges of approximately $500,000 in operating
expenses for such terminations. As of September 30, 1998, approximately $2.0
million of such charges remained in Other Liabilities on the balance sheet.
F-10
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Shareholders
PMA Capital Corporation:
We have audited the accompanying consolidated balance sheets of PMA Capital
Corporation (formerly, Pennsylvania Manufacturers Corporation) and
subsidiaries as of December 31, 1997 and 1996, and the related consolidated
statements of operations, shareholders' equity and cash flows for each of the
three years in the period ended December 31, 1997. These consolidated
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of PMA Capital Corporation and subsidiaries as of December 31, 1997 and 1996,
and the consolidated results of their operations and their cash flows for each
of the three years in the period ended December 31, 1997, in conformity with
generally accepted accounting principles.
/s/ PricewaterhouseCoopers LLP
One South Market Square
Harrisburg, Pennsylvania
February 6, 1998
F-11
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, DECEMBER 31,
1997 1996
------------ ------------
<S> <C> <C>
ASSETS
Investments:
Fixed maturities available for sale, at fair value
(amortized cost:
1997--$1,900,594; 1996--$2,164,391)............... $1,929,518 $2,126,120
Equity securities, at fair value (cost: 1997--$5;
1996--$259)....................................... 13 262
Short-term investments, at amortized cost which
approximates fair value........................... 265,207 134,971
---------- ----------
Total investments................................ 2,194,738 2,261,353
Cash................................................. 32,148 7,176
Investment income due and accrued.................... 23,818 30,268
Uncollected premiums (net of allowance for
uncollectible accounts:
1997--$18,406; 1996--$18,877)....................... 252,425 285,982
Reinsurance receivables (net of allowance for
uncollectible reinsurance:
1997--$2,096; 1996--$3,901)......................... 332,406 257,983
Property and equipment (net of accumulated
depreciation: 1997--$42,771; 1996--$41,219)......... 38,621 50,861
Deferred income taxes, net........................... 70,391 101,642
Deferred acquisition costs........................... 45,288 44,006
Other assets......................................... 67,423 78,245
---------- ----------
Total assets..................................... $3,057,258 $3,117,516
---------- ----------
LIABILITIES
Unpaid losses and loss adjustment expenses........... $2,003,187 $2,091,072
Unearned premiums.................................... 211,455 205,982
Long-term debt....................................... 203,000 204,699
Dividends to policyholders........................... 10,200 12,524
Funds held under reinsurance treaties................ 69,545 86,804
Taxes, licenses and fees, and other expenses......... 49,410 39,226
Other liabilities.................................... 32,114 51,381
---------- ----------
Total liabilities................................ 2,578,911 2,691,688
---------- ----------
Commitments and contingencies (Note 13)
SHAREHOLDERS' EQUITY
Common stock, $5 par value (40,000,000 shares
authorized; 15,286,263 shares issued and 14,850,789
outstanding--1997; 16,095,416 shares issued and
15,670,052 outstanding--1996)....................... 76,431 80,477
Class A common stock, $5 par value (40,000,000 shares
authorized; 9,156,682 shares issued and 9,117,735
outstanding--1997; 8,247,804 shares issued and
8,173,023 outstanding--1996)........................ 45,783 41,239
Additional paid-in capital--Class A common stock..... 339 --
Retained earnings.................................... 343,368 336,921
Unrealized gain (loss) on investments (net of
deferred income taxes: 1997--$(10,126); 1996--
$13,394)............................................ 18,806 (24,874)
Notes receivable from officers....................... (198) (1,162)
Treasury stock, at cost:
Common stock (1997--435,474 shares; 1996--425,364
shares)........................................... (5,572) (5,408)
Class A common stock (1997--38,947 shares; 1996--
74,781 shares).................................... (610) (1,365)
---------- ----------
Total shareholders' equity....................... 478,347 425,828
---------- ----------
Total liabilities and shareholders' equity....... $3,057,258 $3,117,516
========== ==========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-12
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
Revenues:
Net premiums written.................... $ 418,282 $ 443,475 $ 489,876
Change in net unearned premiums......... (5,331) (12,400) (924)
Change in accrued retrospective
premiums............................... (37,000) (10,500) (4,000)
---------- ----------- ----------
Net premiums earned................... 375,951 420,575 484,952
Net investment income................... 136,698 133,936 139,355
Net realized investment gains........... 8,598 2,984 31,923
Service revenues........................ 10,311 9,189 5,106
---------- ----------- ----------
Total revenues........................ 531,558 566,684 661,336
---------- ----------- ----------
Losses and expenses:
Losses and loss adjustment expenses
(includes $(35,000) effect of the
change in discount rate on the Property
and Casualty Group's workers'
compensation unpaid losses from 4% to
5% in 1995)............................ 307,281 536,623 422,578
Amortization of deferred acquisition
costs.................................. 93,501 90,292 87,207
Operating expenses...................... 75,139 97,856 81,161
Dividends to policyholders.............. 14,716 16,255 16,743
Interest expense........................ 15,768 17,052 18,734
---------- ----------- ----------
Total losses and expenses............. 506,405 758,078 626,423
---------- ----------- ----------
Income (loss) before income taxes and
extraordinary item....................... 25,153 (191,394) 34,913
---------- ----------- ----------
Provision (benefit) for income taxes:
Current................................. (4,506) (44,572) (4,570)
Deferred................................ 9,906 (11,488) 15,353
---------- ----------- ----------
Total................................. 5,400 (56,060) 10,783
---------- ----------- ----------
Income (loss) before extraordinary
item................................... 19,753 (135,334) 24,130
Extraordinary loss from early
extinguishment of debt (net of income
tax benefit of $2,549)................. (4,734) -- --
---------- ----------- ----------
Net income (loss)......................... $ 15,019 $ (135,334) $ 24,130
---------- ----------- ----------
Earnings (loss) per common and equivalent
share:
Basic:
Earnings (loss) before extraordinary
item................................. $ 0.83 $ (5.68) $ 1.01
Extraordinary item.................... (0.20) -- --
---------- ----------- ----------
Net earnings (loss)....................... $ 0.63 $ (5.68) $ 1.01
---------- ----------- ----------
Diluted:
Earnings (loss) before extraordinary
item................................. $ 0.80 $ (5.68) $ 0.97
Extraordinary item.................... (0.19) -- --
---------- ----------- ----------
Net earnings (loss)....................... $ 0.61 $ (5.68) $ 0.97
========== =========== ==========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-13
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
ADDITIONAL
PAID IN UNREALIZED
CLASS A CAPITAL- GAIN NOTES
COMMON STOCK COMMON STOCK CLASS A (LOSS) RECEIVABLE
------------------- ----------------- COMMON REATINED ON FROM
SHARES AMOUNTS SHARES AMOUNTS STOCK EARNINGS INVESTMENTS OFFICERS
---------- ------- --------- ------- ---------- --------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance--January 1,
1995................... 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 66,976
Unrealized gain on
investments available
for sale (net of tax
effect of $(36,063))..
Repayment of notes..... 478
Purchase of treasury
shares, net...........
Effect of other
treasury stock
transactions..........
---------- ------- --------- ------- ---- --------- -------- -------
Balance--December 31,
1995................... 17,044,580 85,223 7,298,640 36,493 -- 480,181 17,511 (3,896)
Net loss............... (135,334)
Common stock dividends
declared ($.32 per
share)................ (5,138)
Class A common stock
dividends declared
($.36 per share)...... (2,788)
Conversion of common
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 $22,823).... (42,385)
Repayment of notes..... 2,734
Purchase of treasury
shares, net...........
---------- ------- --------- ------- ---- --------- -------- -------
Balance--December 31,
1996................... 16,095,416 80,477 8,247,804 41,239 -- 336,921 (24,874) (1,162)
Net income............. 15,019
Common stock dividends
declared ($.32 per
share)................ (4,842)
Class A common stock
dividends declared
($.36 per share)...... (3,147)
Conversion of common
stock into Class A
common stock.......... (809,153) (4,046) 809,153 4,046 339
Class A common stock
issued under stock
option plans and other
issuances of Class A
common stock.......... 99,725 498 43,680
Unrealized gain on
investments available
for sale (net of tax
effect of $(23,520))..
Repayment of notes.....
(Purchase) reissuance
of treasury shares,
net................... (583) 964
---------- ------- --------- ------- ---- --------- -------- -------
Balance--December 31,
1997................... 15,286,263 $76,431 9,156,682 $45,783 $339 $ 343,368 $ 18,806 $ (198)
========== ======= ========= ======= ==== ========= ======== =======
</TABLE>
See accompanying notes to the consolidated financial statements.
F-14
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY--(CONTINUED)
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
TREASURY STOCK, AT COST
----------------------------------
CLASS A
COMMON STOCK COMMON STOCK
--------------- -----------------
SHARES AMOUNTS SHARES AMOUNTS TOTAL
------- ------- -------- ------- ---------
<S> <C> <C> <C> <C> <C>
Balance--January 1, 1995........ 388,514 $(4,706) 200,498 $(2,261) $ 524,862
Net income..................... 24,130
Common stock dividends declared
($.32 per share).............. (5,396)
Class A common stock dividends
declared ($.36 per share)..... (2,505)
Conversion of common stock into
Class A common stock.......... --
Unrealized gain on investments
available for sale (net of tax
effect of $(36,063)).......... 66,976
Repayment of notes............. 478
Purchase of treasury shares,
net........................... 4,050 (63) 150,442 (2,355) (2,418)
Effect of other treasury stock
transactions.................. (277,532) 3,541 3,541
------- ------- -------- ------- ---------
Balance--December 31, 1995...... 392,564 (4,769) 73,408 (1,075) 609,668
Net loss....................... (135,334)
Common stock dividends declared
($.32 per share).............. (5,138)
Class A common stock dividends
declared ($.36 per share)..... (2,788)
Conversion of common into Class
A common stock................ --
Unrealized loss on investments
available for sale (net of tax
effect of $22,823)............ (42,385)
Repayment of notes............. 2,734
Purchase of treasury shares,
net........................... 32,800 (639) 1,373 (290) (929)
------- ------- -------- ------- ---------
Balance--December 31, 1996...... 425,364 (5,408) 74,781 (1,365) 425,828
Net income..................... 15,019
Common stock dividends declared
($.32 per share).............. (4,842)
Class A common stock dividends
declared ($.36 per share)..... (3,147)
Conversion of common stock into
Class A common stock.......... --
Class A common stock issued
under stock option plans and
other issuances of Class A
common stock.................. 837
Unrealized gain on investments
available for sale (net of tax
effect of $(23,520)).......... 43,680
Repayment of notes............. 964
(Purchase) reissuance of
treasury shares, net.......... 10,110 (164) (35,834) 755 8
------- ------- -------- ------- ---------
435,474 $(5,572) 38,947 $ (610) $ 478,347
======= ======= ======== ======= =========
</TABLE>
See accompanying notes to the consolidated financial statements.
F-15
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)...................... $ 15,019 $ (135,334) $ 24,130
Adjustments to reconcile net income
(loss) to net cash flows (used)
provided by operating activities:
Depreciation........................... 8,672 12,511 7,652
Amortization........................... 4,054 7,243 35
Provision (benefit) for deferred income
taxes................................. 9,906 (11,488) 15,353
Extraordinary loss from early
extinguishment of debt................ (4,734) -- --
Net realized investment gains.......... (8,598) (2,984) (31,923)
Change in uncollected premiums and
unearned premiums, net................ 39,030 17,983 22,381
Change in dividends to policyholders... (2,324) (632) 910
Change in unpaid losses and loss
adjustment expenses................... (87,885) 21,086 (33,728)
Change in investment income due and
accrued............................... 6,577 5,188 4,961
Change in deferred acquisition costs... (1,282) (6,105) (5,665)
Other, net............................. (85,795) (23,413) 11,807
----------- ----------- -----------
Net cash flows (used) provided by
operating activities................... (107,360) (115,945) 15,913
----------- ----------- -----------
Cash flows from investing activities:
Fixed maturity investments held to
maturity:
Maturities or calls.................... -- -- 3,809
Fixed maturity investments available
for sale:
Purchases.............................. (1,963,492) (1,227,173) (2,147,600)
Maturities or calls.................... 168,304 52,280 75,861
Sales.................................. 2,072,842 1,210,114 2,085,864
Equity securities:
Purchases.............................. -- (5,196) (18,104)
Sales.................................. 254 16,984 28,793
Net (purchases) sales of short-term
investments........................... (130,391) 78,935 (35,445)
Sale of corporate properties........... 7,145 -- --
Net purchases of property and
equipment............................. (3,577) (6,723) (6,017)
Purchase of Caliber One Indemnity
Company............................... (15,990) -- --
Cash acquired in purchase of Caliber
One Indemnity Company................. 4,509 -- --
----------- ----------- -----------
Net cash flows provided (used) by
investing activities................... 139,604 119,221 (12,839)
----------- ----------- -----------
Cash flows from financing activities:
Proceeds from long-term debt........... 210,000 26,000 125,000
Repayments of long-term debt........... (211,699) (25,149) (125,127)
Dividends paid to shareholders......... (7,965) (7,926) (7,885)
Proceeds from exercised stock options
and issuance of Class A common stock.. 837 -- --
Treasury stock transactions, net....... 591 (929) 480
Repayments of notes receivable from
officers.............................. 964 2,734 478
----------- ----------- -----------
Net cash flows used by financing
activities............................. (7,272) (5,270) (7,054)
----------- ----------- -----------
Net increase (decrease) in cash......... 24,972 (1,994) (3,980)
Cash January 1.......................... 7,176 9,170 13,150
----------- ----------- -----------
Cash December 31........................ $ 32,148 $ 7,176 $ 9,170
=========== =========== ===========
Supplementary cash flow information:
Amounts (received) paid for income
taxes................................. $ (19,112) $ 5,525 $ (951)
Amounts paid for interest.............. $ 19,776 $ 16,622 $ 15,062
Fair value of securities transferred
from held to maturity classification
to available for sale classification.. $ -- $ -- $ 1,238,077
</TABLE>
See accompanying notes to the consolidated financial statements.
F-16
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accompanying consolidated financial statements include the accounts of
Pennsylvania Manufacturers Corporation (PMC) and its wholly and majority owned
subsidiaries (the Company). PMC is an insurance holding company that sells
property and casualty reinsurance and insurance through its insurance
subsidiaries. PMC's insurance subsidiaries are domiciled in Pennsylvania,
except for its newly established excess and surplus lines writer, discussed
below, which is domiciled in Delaware, and certain foreign subsidiaries.
Reinsurance--PMC's reinsurance subsidiary, PMA Reinsurance Corporation (PMA
Re), emphasizes risk-exposed, excess of loss reinsurance and operates in the
brokered market. PMA Re's business is predominantly in casualty lines of
reinsurance.
Workers' Compensation and Primary Standard Insurance--PMC's property and
casualty insurance subsidiaries (the Property and Casualty Group) write
workers' compensation and other standard lines of commercial insurance
primarily in the Mid-Atlantic and Southern regions of the U.S.
Specialty Property and Casualty--During 1997, the Company established a
separate specialty insurance operation focusing on excess and surplus lines,
Caliber One Management Company (Caliber One). In December 1997, PMA Re
acquired 100% of the outstanding common stock of Caliber One Indemnity Company
(formerly known as Lincoln Insurance Company) for approximately $16,000 and
made a capital contribution of approximately $11,300 to Caliber One Indemnity
Company. All of Caliber One Indemnity Company's acquired loss reserves were
reinsured by an insurance affiliate of Caliber One Indemnity Company's former
parent immediately prior to and in conjunction with the purchase (the "Reserve
Guarantee"). The Reserve Guarantee covers adverse development and
uncollectible reinsurance in an amount equal to the stated amount of the
reserves acquired, plus an additional $68,500. Upon the purchase of Caliber
One Indemnity Company, management valued the amount of the Reserve Guarantee
at approximately $5,000 in excess of the stated acquired reserves. Management
believes that the Reserve Guarantee will be adequate to cover any future
adverse reserve development or uncollectible reinsurance on the acquired
reserves. At December 31, 1997, $36,807 was recoverable under the Reserve
Guarantee, which is included in reinsurance receivables. Management is
accounting for the Reserve Guarantee in conformity with EITF Topic D-54,
"Accounting by the Purchaser for a Seller's Guarantee of the Adequacy of
Liabilities for Losses and Loss Adjustment Expenses of an Insurance Enterprise
Acquired in a Purchase Business Combination", and, accordingly, any future
revisions to the estimates of the amount of underlying loss reserves and the
amount recoverable under the Reserve Guarantee will be recognized in losses
and loss adjustment expenses in the period in which the estimates are changed.
Management believes that the reinsurance obtained as part of the purchase will
be adequate to cover any future adverse reserve development or uncollectible
insurance on the acquired reserves. PMA Re intends to maintain Caliber One
Indemnity Company's surplus at not less than $25,000, the minimum capital and
surplus required for many states in order to be an eligible excess and surplus
lines carrier. Management anticipates that Caliber One will primarily write
multi-line business consisting of primary and excess commercial general
liability, professional liability, excess automobile and certain property
exposures. Because Caliber One's results were not significant in 1997, Caliber
One's financial information has been included within the Corporate and Other
segment, including pre-opening costs of approximately $900, which have been
expensed as incurred.
F-17
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company's significant accounting policies and practices are as follows:
A. Basis of Presentation--The consolidated financial statements have been
prepared in accordance with generally accepted accounting principles (GAAP).
All significant intercompany accounts and transactions have been eliminated in
consolidation. The preparation of consolidated financial statements in
conformity with GAAP requires management to make certain estimates and
assumptions that affect the amounts reported in its consolidated financial
statements and accompanying notes. Actual results may differ from those
estimates. These consolidated financial statements vary in certain respects
from statutory accounting practices prescribed or permitted by the
Pennsylvania Insurance Department and the Delaware Insurance Department,
(collectively SAP). Prescribed SAP includes state laws, regulations and
general administrative rules, as well as a variety of NAIC publications.
Permitted SAP encompasses all accounting practices that are not prescribed.
The NAIC has a project to codify SAP, the result of which is expected to
constitute the only source of prescribed SAP. The project, when completed,
will change the definitions of what comprises prescribed versus permitted SAP
and may result in changes to the accounting policies that insurance companies
use to prepare SAP financial statements. See Note 18 for additional SAP
information and a reconciliation of SAP net income and surplus to GAAP net
income and shareholders' equity.
B. Investments--Fixed maturity investments include U.S. Treasury securities
and obligations of U.S. Government agencies, obligations of states and
political subdivisions, where applicable, corporate debt securities and
mortgage-backed securities. Under SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," fixed maturities which the Company
may hold for an indefinite period of time are classified as available-for-sale
and, accordingly, are carried at fair value with changes in fair value, net of
income tax effects, reflected in shareholders' equity. Fixed maturities which
the Company has the positive intent and ability to hold to maturity are
carried at amortized cost. In 1995, the Company re-evaluated the
classifications of its fixed maturity investments. As a result, effective June
30, 1995, the Company reclassified its entire held-to-maturity portfolio,
which had an amortized cost of $1,241,774, to the available-for-sale
designation in order to match more closely the Company's investment strategy.
This reclassification resulted in a $1,238,077 increase in available-for-sale
securities and a $2,403 unrealized loss (net of deferred taxes), with no
impact on net income. As of December 31, 1997, the Company's entire fixed
income portfolio remains designated as available for sale.
Equity securities for all periods are stated at fair value with changes in
fair value, net of income tax effects, reflected in shareholders' equity.
Realized gains and losses, determined by specific identification, are
reflected in income in the period in which the sale transaction occurs.
C. Premiums--Premiums, including estimates of additional premiums resulting
from audits of insureds' records, are earned principally on a pro rata basis
over the terms of the policies. Premiums applicable to the unexpired terms of
policies in-force are reported as unearned premiums. Estimated premiums
receivable on retrospectively rated policies are reported as a component of
uncollected premiums (See Note 1-P).
The Company follows Emerging Issues Task Force Consensus Position No. 93-6,
"Accounting for Multiple Year Retrospectively Rated Contracts by Ceding and
Assuming Enterprises" (EITF 93-6).
F-18
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
EITF 93-6 requires that the Company reflect adjustments to future premiums, as
the result of past experience under multiple year reinsurance contracts, in
earnings currently. The impact of EITF 93-6 has been immaterial.
D. Unpaid Losses And Loss Adjustment Expenses--Unpaid losses and loss
adjustment expenses are stated net of estimated salvage and subrogation and
are determined using claims adjusters' evaluations, estimates of losses and
loss adjustment expenses on known claims, and estimates of losses and loss
adjustment expenses incurred but not reported (IBNR). IBNR reserves are
calculated utilizing various actuarial methods. Unpaid losses on certain
workers' compensation claims are discounted to present value using the
Company's payment experience and SAP mortality and interest assumptions (See
Note 3). The methods of making such estimates and establishing the resulting
reserves are continually reviewed and updated and any adjustments resulting
therefrom are reflected in earnings currently.
E. Deferred acquisition costs--The costs of acquiring new and renewal
business are deferred and amortized over the period during which the related
premiums are earned. Such costs include direct acquisition costs, including
commissions, brokerage, and premium taxes as well as other policy issuance
costs and underwriting expenses that directly relate to and vary with the
production of business. The Company determines whether deferred acquisition
costs are recoverable considering future losses and loss adjustment expenses,
maintenance costs, and anticipated investment income. To the extent that
deferred acquisition costs are not recoverable, the deficiency is charged to
income currently.
F. Dividends to Policyholders--The Property and Casualty Group issues
certain workers' compensation insurance policies with dividend payment
features. These policyholders share in the operating results in the form of
dividends declared at the discretion of the Company's board of directors.
Dividends to policyholders are accrued during the period in which the related
premiums are earned and are determined based on the terms of the individual
policies.
G. Income Taxes--The Company accounts for income taxes under SFAS No. 109,
"Accounting for Income Taxes." SFAS No. 109 is an asset and liability
approach, whereby deferred tax assets and liabilities are recorded to the
extent of the tax effect of differences between the financial statement
carrying values and tax bases of assets and liabilities. A valuation allowance
is recorded for deferred tax assets where it appears more likely than not that
the Company will not be able to recover the deferred tax asset. In addition,
PMC and a majority of its subsidiaries have a written tax-sharing agreement
which allocates to each entity subject to the agreement its Federal income
taxes on a separate return basis. The benefit of any net operating losses is
retained by PMC.
H. Property and equipment--Property and equipment are stated at cost, less
accumulated depreciation. Depreciation is calculated on the straight-line
method utilizing useful lives ranging from 3 to 40 years. During 1996, the
Property and Casualty Group changed the depreciable lives for its mainframe
computer equipment from five years to three years. The effect of this
adjustment was to increase 1996 depreciation expense by approximately $4,800.
I. Per Share Information--In February 1997, the Financial Accounting
Standards Board issued SFAS No. 128, "Earnings Per Share", which supersedes
Accounting Principles Board Opinion No. 15, "Earnings Per Share," and Related
Interpretations, and which the Company adopted during 1997. In
F-19
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
accordance with SFAS No. 128, all prior period data presented has been
restated to conform with the provisions of this statement. SFAS No. 128
replaces the presentation of primary earnings per share with a presentation of
basic earnings per share and requires the presentation of both basic and
diluted earnings per share on the face of the income statement. SFAS No. 128
also requires a reconciliation of the numerators and denominators used in the
basic earnings per share calculation to the numerators and denominators used
in the diluted earnings per share calculation. Such reconciliation is provided
in Note 16.
Basic earnings per share: For years 1997, 1996 and 1995, basic earnings per
share was based upon the weighted average number of common and Class A common
shares outstanding for the period.
Diluted earnings per share: For years 1997 and 1995, diluted earnings per
share was based upon the weighted average number of common and Class A common
shares outstanding during the year and the assumed exercise price of dilutive
stock options, less the number of treasury shares assumed to be purchased from
the proceeds using the average market price of the Company's Class A common
stock. In 1996, diluted earnings per share was based upon the weighted average
common and Class A common shares outstanding during the year; the assumed
exercise price of stock options using the average market price of the
Company's Class A common stock was not taken into consideration as these stock
options would have had an anti-dilutive effect on the net loss per share (See
Note 16).
J. Stock-Based Compensation--The Company has chosen to continue to account
for stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," and related Interpretations. Accordingly, compensation cost for
stock options is measured as the excess, if any, of the quoted market price of
the Company's Class A common stock at the date of the grants over the amount
an employee must pay to acquire the Class A common stock.
K. Computer Software Costs Related to the Year 2000--In 1996, the Company
adopted Emerging Issues Task Force Consensus Position No. 96-14, "Accounting
for the Costs Associated with Modifying Computer Software for the Year 2000"
(EITF 96-14). EITF 96-14 states that external and internal costs specifically
associated with modifying internal-use software for the Year 2000 should be
charged to expense as incurred. In accordance with EITF 96-14, the Company
charged approximately $2,000 and $1,800 to operating expenses during the years
ended December 31, 1997 and 1996, respectively, for costs associated with
modifying internal-use software.
L. Service Revenues--Service revenues are earned over the term of the
related contracts in proportion to the actual services rendered.
M. Reclassifications--Certain prior year amounts have been reclassified to
conform to the current year presentation. Additionally, in 1995, the Company
elected to change its method of reporting cash flows from the direct method to
the indirect method.
N. Recently Issued Accounting Standards--In June 1996, the Financial
Accounting Standards Board issued SFAS No. 125, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities." SFAS No.
125, which is effective for transfers and extinguishments occurring after
December 31, 1996, provides consistent standards for distinguishing transfers
of
F-20
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
financial assets that are sales from transfers that are secured borrowings.
The Property and Casualty Group's domestic insurance subsidiaries participated
in a transfer arrangement of certain accounts receivable. This arrangement has
been terminated as a result of SFAS No. 125. The termination did not have a
material impact on the Company's financial condition or results of operations.
During 1997, the FASB issued SFAS No. 130, "Comprehensive Income," which
establishes standards for the reporting and disclosure of comprehensive income
and its components (revenues, expenses, gains and losses). SFAS No. 130
requires that all items that are required to be recognized under accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. In addition, the FASB issued SFAS No. 131, "Disclosures About
Segments of an Enterprise and Related Information," which establishes
standards for the way that public business enterprises report information
about operating segments in annual financial statements and interim financial
reports issued to shareholders. SFAS No. 131 also establishes standards for
related disclosures about products and services, geographic areas and major
customers. The Company will adopt the provisions of these pronouncements in
1998. The adoption of these pronouncements will not have an impact on the
Company's financial position and results of operations, but may change the
presentation of certain of the Company's financial statements and related
notes and data thereto.
O. Long-Lived Assets--It is management's policy to review long-lived assets,
such as the Company's properties, for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Such changes in circumstances include such things as significant
decline in market value or change in use of the asset. Periodically,
management reviews appraisals and/or cash flow projections from properties and
other long- lived assets and compares such amounts to the carrying values to
determine whether or not there has been an impairment. If such an impairment
exists, it is management's policy to write down the carrying value of the
asset to fair value less costs to carry and dispose of the asset, where
applicable.
P. Accrued Retrospective Premiums--Accrued retrospective premiums, which are
a component of uncollected premiums, are based upon actuarial estimates of
expected ultimate losses and resulting estimated premium adjustments relating
to retrospectively rated policies. The change in accrued retrospective
premiums is a component of net premiums earned. The estimated ultimate premium
adjustments under retrospectively rated policies are recorded in the initial
accident year based upon estimated loss experience on the underlying policies
and adjusted in subsequent periods in conjunction with revisions of the
estimated underlying losses on such policies. In addition, accrued
retrospective premiums are increased (decreased) based upon retrospective
policy adjustments paid (billed); such adjustments actually billed or paid do
not impact premium revenues as the Company records an offsetting amount
through net premiums written.
F-21
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following sets forth the components of the change in accrued
retrospective premiums for each of the past three years:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Estimated retrospective policy
adjustments related to current accident
year................................... $ (12,460) $ (18,767) $ (12,941)
Revision of estimate of retrospective
policy adjustments related to prior
accident years......................... (44,719) (9,888) (4,845)
Retrospective policy adjustments paid... 20,179 23,155 13,786
Uncollectible write-off................. -- (5,000) --
---------- ---------- ----------
Total................................. $ (37,000) $ (10,500) $ (4,000)
========== ========== ==========
</TABLE>
In 1997, 1996 and 1995, the Property and Casualty Group reduced accrued
retrospective premiums by $37,000, $10,500 and $4,000, respectively. The
primary reason for the additional reduction in 1997 relative to 1996 was a
$44,719 revision of estimate of accrued retrospective premiums, primarily due
to the favorable development of claims liabilities for more recent accident
years ($35,719) and the commutation of claims for accident years 1991 and
prior in 1997 ($9,000). The reduction for policy years 1991 and prior
primarily relates to the commutation program for such years initiated in late
1996. In July 1997, the Property and Casualty Group completed a formal program
where it commuted a large number of claims associated with workers'
compensation claims from accident years 1991 and prior, including loss
reserves associated with retrospective policies (See Note 3). The commutation
program resulted in current payments to claimants which were less than the
carried reserves. As a result of the differences between the current
commutation payments to claimants and carried reserves on such claims,
management reduced its estimate of amounts recoverable under retrospectively
rated policies and also recognized a reduction in losses and LAE associated
with such policies. The reduction related to 1992 through 1996 policy years
was primarily related to a corresponding amount of favorable development on
underlying loss reserves for such years (See Note 3). The effects of the
commutations on these prior loss reserves, as well as the intent of the
Property and Casualty Group to continue utilizing early intervention
techniques such as commutations on claims from more recent accident years,
have led to a re-estimation of policy liabilities for these more recent
accident years, and a re-estimation of amounts due under retrospectively rated
policies for these more recent accident years.
Management believes that it has made a reasonable estimate of the Company's
accrued retrospective premiums. While the eventual ultimate receivable may
differ from the current estimates, management does not believe that the
difference will have a material effect, either adversely or favorably, on the
Company's financial position or results of operations.
2. INVESTMENTS
The Company's investment portfolio is well diversified and contains no
significant concentrations in any specific industry, business segment, or
individual issuer. The Company principally invests in U.S. Treasury securities
and obligations of U.S. Government agencies, high-quality obligations of
states and political subdivisions and corporations, and mortgage backed
securities. Equity securities consist entirely of common stocks of financial
institutions, public utilities, and industrial and service entities.
F-22
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The amortized cost and fair value of the Company's investment portfolio are
as follows:
<TABLE>
<CAPTION>
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
December 31, 1997
Fixed maturities available for
sale:
U.S. Treasury securities and
obligations of U.S. Government
agencies........................ $1,105,689 $17,267 $ 3,390 $1,119,566
Corporate debt securities........ 675,218 12,845 392 687,671
Mortgage backed securities....... 119,687 2,657 63 122,281
---------- ------- ------- ----------
Total fixed maturities available
for sale.......................... 1,900,594 32,769 3,845 1,929,518
Equity securities.................. 5 8 -- 13
Short-term investments............. 265,207 -- -- 265,207
---------- ------- ------- ----------
Total investments.............. $2,165,806 $32,777 $ 3,845 $2,194,738
========== ======= ======= ==========
December 31, 1996
Fixed maturities available for
sale:
U.S. Treasury securities and
obligations of U.S. Government
agencies........................ $1,640,881 $ 4,045 $42,182 $1,602,744
Obligations of states and
political subdivisions.......... 77,562 194 1,229 76,527
Corporate debt securities........ 372,620 3,203 2,977 372,846
Mortgage backed securities....... 73,328 728 53 74,003
---------- ------- ------- ----------
Total fixed maturities available
for sale.......................... 2,164,391 8,170 46,441 2,126,120
Equity securities.................. 259 3 -- 262
Short-term investments............. 134,971 -- -- 134,971
---------- ------- ------- ----------
Total investments.............. $2,299,621 $ 8,173 $46,441 $2,261,353
========== ======= ======= ==========
</TABLE>
The amortized cost and estimated fair value of fixed maturities at December
31, 1997, by contractual maturity, are shown below. Expected maturities will
differ from contractual maturities because the issuers may have the right to
call or prepay obligations with or without call or prepayment penalties.
<TABLE>
<CAPTION>
AMORTIZED FAIR
COST VALUE
---------- ----------
<S> <C> <C>
1998................................................ $ 129,047 $ 128,919
1999-2002........................................... 634,888 633,643
2003-2007........................................... 394,704 396,459
2008 and thereafter................................. 622,268 648,216
Mortgage backed securities.......................... 119,687 122,281
---------- ----------
$1,900,594 $1,929,518
========== ==========
</TABLE>
F-23
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Net investment income consists of the following:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Fixed maturities........................... $ 128,400 $ 131,530 $ 129,883
Equity securities.......................... -- 148 503
Short-term investments..................... 7,282 7,711 11,764
Other...................................... 4,422 3,251 4,303
---------- ---------- ----------
Total investment income.................. 140,104 142,640 146,453
Investment expenses........................ 3,406 8,704 7,098
---------- ---------- ----------
Net investment income.................... $ 136,698 $ 133,936 $ 139,355
========== ========== ==========
</TABLE>
Net realized investment gains consist of the following:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Realized gains:
Fixed maturities......................... $ 20,899 $ 12,762 $ 37,900
Equity securities........................ -- 4,351 3,117
Other.................................... -- 4 --
---------- ---------- ----------
20,899 17,117 41,017
---------- ---------- ----------
Realized losses:
Fixed maturities......................... 12,203 12,861 5,956
Equity securities........................ -- 436 2,200
Other.................................... 98 836 938
---------- ---------- ----------
12,301 14,133 9,094
---------- ---------- ----------
Total net realized investment gains.... $ 8,598 $ 2,984 $ 31,923
========== ========== ==========
</TABLE>
On December 31, 1997, the Company had securities with a total amortized cost
and fair value of $30,925 and $31,105, respectively, on deposit with various
governmental authorities, as required by law. In addition, at December 31,
1997, securities with a total amortized cost and fair value of $11,603 and
$11,547, respectively, were pledged as collateral for letters of credit issued
on behalf of the Company.
Change in unrealized appreciation (depreciation) of investments consists of
the following:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
---------- ----------- -----------
<S> <C> <C> <C>
Fixed maturities available for sale.... $ 67,195 $ (62,457) $ 99,874
Equity securities...................... 5 (2,751) 3,165
---------- ----------- -----------
Change in unrealized appreciation
(depreciation) of investments......... $ 67,200 $ (65,208) $ 103,039
========== =========== ===========
</TABLE>
F-24
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
During 1997, the Company established a securities lending program through
which securities are loaned from the Company's portfolio to qualifying third
parties, subject to certain limits, via a lending agent for short periods of
time. Borrowers of these securities must provide collateral equal to a minimum
of 102% of the market value and accrued interest of the loaned securities.
Acceptable collateral may be in the form of either cash or securities. Cash
received as collateral is invested in short-term investments, and all
securities received as collateral are of similar quality to those securities
lent by the Company. Additionally, the Company limits securities lending to
40% of statutory admitted assets of its insurance subsidiaries, with a 2%
limit on statutory admitted assets to any individual borrower. The Company
receives either a fee from the borrower or retains a portion of the income
earned on the collateral. Under the terms of the securities lending program,
the Company is indemnified against borrower default, with the lending agent
responsible to the Company for any deficiency between the cost of replacing a
security that was not returned and the amount of collateral held by the
Company. In 1997, the Company recognized income from securities lending
transactions of $524, net of lending fees, which was included in investment
income. The Company had approximately $175,000 of securities on loan as of
December 31, 1997.
3. UNPAID LOSSES AND LOSS ADJUSTMENT EXPENSES
Activity in the liability for unpaid losses and loss adjustment expenses
(LAE) is summarized as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Balance at January 1.................... $2,091,072 $2,069,986 $2,103,714
Less: reinsurance recoverable on unpaid
losses and LAE......................... 256,576 261,492 247,856
---------- ---------- ----------
Net balance at January 1................ 1,834,496 1,808,494 1,855,858
---------- ---------- ----------
Losses and LAE incurred, net:
Current year.......................... 341,880 323,069 357,787
Prior years........................... (86,006) 156,074 51,491
Accretion of discount (includes
($35,000) effect of the change in the
discount rate for the Property and
Casualty Group's workers'
compensation unpaid losses from 4% to
5% in 1995).......................... 51,407 57,480 13,300
---------- ---------- ----------
Total losses and LAE incurred, net...... 307,281 536,623 422,578
---------- ---------- ----------
Losses and LAE paid, net:
Current year.......................... (72,399) (72,194) (71,126)
Prior years........................... (398,475) (438,427) (398,816)
---------- ---------- ----------
Total losses and LAE paid, net.......... (470,874) (510,621) (469,942)
---------- ---------- ----------
Net balance at December 31.............. 1,670,903 1,834,496 1,808,494
Reinsurance recoverable on unpaid losses
and LAE................................ 332,284 256,576 261,492
---------- ---------- ----------
Balance at December 31.................. $2,003,187 $2,091,072 $2,069,986
========== ========== ==========
</TABLE>
F-25
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company's results of operations included a decrease in estimated
incurred losses and LAE related to prior accident years of $86,006 in 1997,
and an increase of $156,074 and $51,491 in 1996 and 1995, respectively.
During 1997, PMA Re recorded favorable reserve development on prior accident
years of approximately $32,100. PMA Re has consistently recorded favorable
reserve development on prior accident years for the past several years. The
remaining decrease in estimated losses and LAE on prior accident years during
calendar year 1997 can be attributed primarily to the following: the cession
of prior year reserves by PMA Life Insurance Company to a third party
reinsurer of approximately $14,800 (See Note 5); favorable reserve development
at the Property and Casualty Group in conjunction with the formal commutation
program, discussed below, of approximately $9,000 pertaining to
retrospectively rated policies for accident years 1991 and prior; favorable
reserve development at the Property and Casualty Group of approximately
$28,000 related to retrospectively rated policies pertaining to accident years
1992 through 1996; and favorable development on pre-1992 workers' compensation
reserves of $7,100, partially offset by reserve strengthening in commercial
multi-peril business for accident year 1996 of $5,000.
The increase in estimated incurred losses and LAE during 1996 is primarily
due to a loss reserve strengthening charge of $191,400. This loss reserve
strengthening was associated with the following lines of business:
<TABLE>
<CAPTION>
1996
--------
<S> <C>
Workers' compensation............................................ $110,000
Asbestos and environmental....................................... 60,400
Other lines of business.......................................... 21,000
--------
$191,400
========
</TABLE>
The 1996 aggregate workers' compensation adverse development was allocated
$102,000 to Pennsylvania and $8,000 to all other states in the Company's
marketing territory. Of the $102,000, the allocation by accident year is as
follows: prior to 1987: $16,000; 1987 to 1991: $101,000; and 1992 and
subsequent years: $(15,000). In 1995, substantially all of the workers'
compensation adverse development related to accident years 1987 to 1991 in
Pennsylvania. For accident years prior to 1992, the traditional paid loss
development schedules for workers' compensation had begun to exhibit an
increasing trend in loss development factors by 1993. This trend was initially
attributed to an increase in commutation activity. In 1995, management began
to question whether loss data was developing in a manner that was consistent
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
F-26
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
that these rehabilitation efforts were not impacting the closure rates as
expected. Another factor negatively impacting claims closure rates related to
the economic conditions in Pennsylvania in the early 1990's. During the period
from 1990 to 1994, economic conditions in Pennsylvania were considered to be
depressed in the Company's major industry niches for workers' compensation
insurance (construction, heavy manufacturing). Payrolls in these industries
were stagnant, and in many cases, employment was flat or declining. The
Company believes that in periods of declining employment opportunities, there
is a tendency for indemnity periods to increase, which occurred for workers
who suffered injuries in these industries.
The above factors, when considered with the fact that the benefits period in
Pennsylvania was unlimited, caused the Company to believe that a substantial
portion of claimants from the pre-1992 period, who had already been out of
work five to nine years, would not return to work in any capacity. In late
1995 and during 1996, management undertook an effort to quantify the impact of
the declining closure rates versus the increase in commutation activity.
During the fourth quarter of 1995, management strengthened the Property and
Casualty Group's workers' compensation reserves by $54,700; however, the
quantification of the effect of the claims closure rate was an extremely
complex process, and as such, the data was not fully understood at that time.
As the data under analysis was more mature and refined in 1996, management
determined that the workers' compensation loss reserves for Pennsylvania in
the pre-1992 accident years needed to be increased substantially; therefore,
the Property and Casualty Group increased its workers' compensation reserves
by $110,000 in 1996.
Workers' compensation reform legislation enacted in Pennsylvania in 1993 and
1996 introduced various controls and limitations on medical and disability
benefits. Management believes that these reforms have had and will continue to
have a favorable impact on workers' compensation loss ratios for accident
years 1993 and subsequent. In addition, management took several steps to
reduce the outstanding claims associated with the Pennsylvania workers'
compensation business written through 1991. A formal commutation program was
initiated in the fourth quarter 1996 and continued into late 1997.
Commutations are agreements with claimants whereby the claimants, in exchange
for a lump sum payment, will forego their rights to future indemnity payments
from the Property and Casualty Group. Under Pennsylvania workers' compensation
laws, all such commutation arrangements must be approved by the claimant and
the Pennsylvania Workers' Compensation Board. The Property and Casualty Group
paid approximately $101,100 and $17,800 in 1997 and the fourth quarter of
1996, respectively, to commute workers' compensation indemnity claims. Savings
associated with these claims were consistent with management's expectations.
The number of open claims for accident years 1991 and prior was substantially
reduced as a result of the commutation program. This reduction in open claims
is expected to reduce the possibility of any further adverse development on
such reserves, although there can be no assurances that the level of
commutations will have a significant impact on the future development of such
reserves.
Estimating reserves for workers' compensation claims can be more difficult
than many other lines of property and casualty insurance for several reasons,
including (i) the long payment "tail' associated with the business; (ii) the
impact of social, political and regulatory trends on benefit levels; (iii) the
impact of economic trends; and (iv) the impact of changes in the mix of
business. At various times, one or a combination of such factors can make the
interpretation of actuarial data associated with workers' compensation loss
development more difficult, and it can take additional time to recognize
changes in loss development patterns. Under such circumstances, adjustments
will be made to such
F-27
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
reserves as loss patterns develop and new information becomes available and
such adjustments may be material.
The adverse development in reserves associated with asbestos and
environmental claims during 1996 was due to the completion of a detailed
analysis of loss and LAE reserves associated with asbestos and environmental
liability claims in 1996. The reserving for asbestos and environmental claims
has undergone change at both the Company and in the insurance industry in
general. For environmental and asbestos liability claims, reserving
methodology has been evolving into accepted industry practice in the recent
past; the Company's actuaries were able to apply these methods to its loss
reserves in 1997 and 1996. To reserve for environmental claims, the Company
currently utilizes a calendar year development technique known as aggregate
loss development. This technique focuses on the aggregate losses paid as of a
particular date and aggregate payment patterns associated with such claims.
Several elements including remediation studies, remediation, defense,
declaratory judgment, and third party bodily injury claims were considered in
estimating the costs and payment patterns of the environmental and toxic tort
losses. Prior to the development of these techniques, there was a substantial
range in the nature of reserving for environmental and toxic tort liabilities.
The methods employed by the Company prior to the review performed in 1996
included a review of aggregate loss and loss adjustment paid and case incurred
data along with resulting "survival ratios" to establish IBNR for
environmental and toxic tort claims. For asbestos claims, the Company had
previously reserved costs to defend, and any indemnification payments
anticipated on, claims for which it had received notice that it was a
responsible party, plus a bulk factor applied to the estimated case reserves
to provide for potential development of indemnification and defense costs
related to such claims. In 1996, the Company performed a ground up analysis of
asbestos loss reserves using an actuarially accepted modeling technique. Using
historical information as a base and information obtained from a review of
open claims files, assumptions were made about future claims activity in order
to estimate ultimate losses. For each individual major account, projections
were made regarding new plaintiffs per year, the number of years new claims
will be reported, the average loss severity per plaintiff, and the ratio of
loss adjustment expense to loss. In many cases involving larger asbestos
claims, the Company reserved up to the policy limits for the applicable loss
coverage parts for the affected accounts. Policy terms and reinsurance
treaties were applied in the modeling of future losses. Estimation of
obligations for asbestos and environmental exposures continues to be more
difficult than other loss reserves because of several factors, including: (i)
evolving methodologies for the estimation of the liabilities; (ii) lack of
reliable historical claim data; (iii) uncertainties with respect to insurance
and reinsurance coverage related to these obligations; (iv) changing judicial
interpretations; and (v) changing government standards.
F-28
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The Company's asbestos-related losses were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves.................. $ 80,055 $ 27,611 $ 13,969
Incurred losses and LAE............. 2,435 62,854 22,482
Calendar year payments for losses
and LAE............................ (5,764) (10,410) (8,840)
---------- ----------- ----------
Ending reserves..................... $ 76,726 $ 80,055 $ 27,611
========== =========== ==========
Net of reinsurance:
Beginning reserves.................. $ 53,300 $ 23,443 $ 8,168
Incurred losses and LAE............. (36) 39,427 21,826
Calendar year payments for losses
and LAE............................ (4,686) (9,570) (6,551)
---------- ----------- ----------
Ending reserves..................... $ 48,578 $ 53,300 $ 23,443
========== =========== ==========
</TABLE>
The Company's environmental-related losses were as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Gross of reinsurance:
Beginning reserves................... $ 35,626 $ 20,134 $ 20,952
Incurred losses and LAE.............. 1,130 22,143 3,516
Reserves acquired through purchase of
Caliber One Indemnity Company(1).... 13,060 -- --
Calendar year payments for losses and
LAE................................. (4,708) (6,651) (4,334)
---------- ---------- ----------
Ending reserves...................... $ 45,108 $ 35,626 $ 20,134
========== ========== ==========
Net of reinsurance:
Beginning reserves................... $ 34,592 $ 20,134 $ 20,952
Incurred losses and LAE.............. 1,068 21,109 3,516
Calendar year payments for losses and
LAE................................. (3,965) (6,651) (4,334)
---------- ---------- ----------
Ending reserves...................... $ 31,695 $ 34,592 $ 20,134
========== ========== ==========
</TABLE>
- --------
(1) Such acquired reserves have been reinsured by an affiliate of the former
parent (See Note 1).
Of the total net asbestos reserves, approximately $6,700, $6,800, and $6,700
related to established claims reserves at December 31, 1997, 1996, and 1995,
respectively, and $41,900, $46,500, and $16,700 related to incurred but not
reported losses at December 31, 1997, 1996, and 1995, respectively. Of the
total net environmental reserves, approximately $11,200, $12,500, and $10,300
related to established claims reserves at December 31, 1997, 1996, and 1995,
respectively, and $20,500, $22,100, and $9,800 related to incurred but not
reported losses at December 31, 1997, 1996, and 1995, respectively. All
incurred asbestos and environmental losses were for accident years 1986 and
prior.
Management believes that its reserves for asbestos and environmental claims
are appropriately established based upon known facts, existing case law, and
generally accepted actuarial
F-29
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
methodologies. However, due to changing interpretations by courts involving
coverage issues, the potential for changes in federal and state standards for
clean-up and liability and other factors, the ultimate exposure to the Company
for these claims may vary significantly from the amounts currently recorded,
resulting in a potential adjustment in the claims reserves recorded.
Additionally, issues involving policy provisions, allocation of liability
among participating insurers, proof of coverage, and other factors make
quantification of liabilities exceptionally difficult and subject to
adjustment based upon newly available data.
In 1996, other commercial lines for the Property and Casualty Group
experienced reserve strengthening of $21,000, as compared to a reserve release
of $11,600 in 1995. The reserve strengthening was principally due to a re-
estimation of loss adjustment costs associated with general liability claims.
Through 1991, the Property and Casualty Group's mix of general liability
insurance policies were weighted towards the manufacturing classes of
business. Subsequent to 1991, the Property and Casualty Group's mix of
business became more heavily weighted towards the construction and contracting
classes of business. These particular classes of business have experienced
losses due to construction defects and similar matters, that have taken longer
to emerge than the classes of business previously written by the Property and
Casualty Group. Defense costs associated with these claims have also exceeded
the original estimate of the Property and Casualty Group's management, which
was based on the patterns of indemnification payments associated with the
earlier classes of business written. When this issue was discovered, the
Property and Casualty Group factored the increased defense costs and the
emergence pattern in determining a more appropriate reserve amount for loss
handling costs. The release of reserves in 1995 was primarily due to favorable
loss experience in commercial automobile business.
Unpaid losses on workers' compensation claims for the Company include
approximately $816,000 and $1,012,000, net of discount of $460,230 and
$514,248, at December 31, 1997 and 1996, respectively. The approximate
discount rate used was 5% at December 31, 1997 and 1996. In 1995, the Property
and Casualty Group changed its discount rate with respect to its workers'
compensation unpaid losses from approximately 4% to 5% for SAP and GAAP
purposes. This change was approved and is permitted by the Pennsylvania
Insurance Department. The effect on net income (net of tax effect of $12,250)
in 1995 was $22,750 ($0.96 per basic share and $0.92 per diluted share).
The Company's loss reserves were stated net of salvage and subrogation of
approximately $59,900 and $75,000 at December 31, 1997 and 1996, respectively.
The following table presents the salvage and subrogation by segment and
product line:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1997 1996
------- -------
<S> <C> <C>
Property and Casualty Group:
Workers' compensation................................... $46,000 $61,900
Other Commercial Lines.................................. 4,800 3,900
------- -------
Total Property and Casualty Group......................... 50,800 65,800
PMA Re.................................................... 9,100 9,200
------- -------
Total salvage and subrogation............................. $59,900 $75,000
======= =======
</TABLE>
The Company's policy with respect to estimating the amounts and
realizability of salvage and subrogation is to develop historical accident
year schedules of paid salvage and subrogation by line of
F-30
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
business, which are then projected to an ultimate basis using actuarial
projection techniques. The anticipated salvage and subrogation is the
estimated ultimate salvage and subrogation less any amounts received by the
Company. The realizability of anticipated salvage and subrogation is reflected
in the historical data that is used to complete the projection, as historical
paid data implicitly considers realization and collectibility.
4. DEFERRED ACQUISITION COSTS
The following represents the components of deferred acquisition costs and
the amounts that were charged to expense:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Balance at January 1................... $ 44,006 $ 37,901 $ 32,236
Deferral of acquisition costs.......... 94,783 96,397 92,872
Amortization of deferred acquisition
costs................................. (93,501) (90,292) (87,207)
---------- ---------- ----------
Balance at December 31................. $ 45,288 $ 44,006 $ 37,901
========== ========== ==========
</TABLE>
5. REINSURANCE
In the ordinary course of business, PMC's reinsurance and insurance
subsidiaries assume and cede reinsurance with other insurance companies and
are members of various pools and associations. The reinsurance and insurance
subsidiaries cede business, primarily on an excess of loss basis, in order to
limit the maximum net loss from large risks and limit the accumulation of many
smaller losses from a catastrophic event. The reinsurance and insurance
subsidiaries remain primarily liable to their clients in the event their
reinsurers are unable to meet their financial obligations.
Amounts receivable from reinsurers related to paid and unpaid losses are
displayed separately on the consolidated balance sheets, net of an allowance
for uncollectible accounts.
The components of net premiums earned and losses and LAE incurred are as
follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
----------- ---------- ----------
<S> <C> <C> <C>
Earned Premiums:
Direct................................ $ 277,871 $ 299,386 $ 370,590
Assumed............................... 216,357 209,688 149,838
Ceded................................. (118,277) (88,499) (35,476)
----------- ---------- ----------
Net..................................... $ 375,951 $ 420,575 $ 484,952
=========== ========== ==========
Losses and LAE Incurred:
Direct................................ $ 244,429 $ 420,157 $ 317,552
Assumed............................... 166,202 163,799 127,910
Ceded................................. (103,350) (47,333) (22,884)
----------- ---------- ----------
Net..................................... $ 307,281 $ 536,623 $ 422,578
=========== ========== ==========
</TABLE>
The Company performs extensive credit reviews on its reinsurers, focusing
on, among other things, financial capacity, stability, trends, and commitment
to the reinsurance business. Prospective
F-31
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
and existing reinsurers failing to meet the Company's standards are excluded
from the Company's reinsurance programs. In addition, the Company requires
letters of credit to support balances due from reinsurers not authorized to
transact business in the applicable jurisdictions.
At December 31, 1997, the Company had reinsurance recoverables due from the
following unaffiliated single reinsurers in excess of 3% of shareholders'
equity:
<TABLE>
<CAPTION>
GROSS AMOUNT DUE
REINSURER TO THE COMPANY A.M. BEST RATING
--------- ---------------- ----------------
<S> <C> <C>
United States Fidelity and Guaranty
Company............................... $74,041 A
Essex Insurance Company................ 36,807 A
American Re-Insurance Corporation...... 35,411 A+
Kemper Reinsurance Corporation......... 21,853 A
London Life International Reinsurance
Corporation........................... 16,212 A+
Continental Casualty Company........... 15,209 A
</TABLE>
The Company maintained funds held to collateralize the above balances in the
amount of $66,891 at December 31, 1997. The Company believes that it would
have the right to offset the funds withheld from a reinsurer against the
balances due from such reinsurer in the event of insolvency.
During 1997, PMA Life Insurance Company reinsured the majority of its in
force annuity business with a third party reinsurer via a quota-share
reinsurance agreement for approximately $15,400. The transaction effectively
makes PMA Life Insurance Company a dormant company.
All of Caliber One Indemnity Company's acquired loss reserves were reinsured
with an affiliate of its former parent in conjunction with its purchase by PMA
Re, as discussed in Note 1. Management believes that such reinsurance is
adequate to cover any future reserve development or uncollectible reinsurance
on the acquired reserves.
6. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1997 1996
-------- --------
<S> <C> <C>
Senior notes 9.53%, due 1997.............................. $ -- $ 7,143
Senior notes 9.60%, due 2001.............................. -- 46,428
Senior notes 7.62%, due 2001, Series A.................... -- 71,000
Senior notes 7.62%, due 2000, Series B.................... -- 36,000
Revolving credit agreement, expiring in 1998.............. -- 44,000
Revolving credit facility, expiring in 2002(1)............ 203,000 --
Mortgage notes............................................ -- 128
-------- --------
Long-term debt............................................ $203,000 $204,699
======== ========
</TABLE>
- --------
(1) Maturing in an installment of $15,500 in 1999 and annual installments of
$62,500 commencing in 2000 through 2002.
F-32
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
On March 14, 1997, the Company refinanced substantially all of its existing
credit agreements not already maturing in 1997 through the completion of a new
$235,000 revolving credit facility (New Credit Facility). Utilizing the New
Credit Facility, the Company refinanced the following obligations:
<TABLE>
<S> <C>
Senior notes 9.60%, due 2001..................................... $ 46,428
Senior notes 7.62%, due 2001, Series A........................... 71,000
Senior notes 7.62%, due 2000, Series B........................... 36,000
Revolving credit agreement, expiring in 1998(1).................. 36,000
--------
Total............................................................ $189,428
========
</TABLE>
- --------
(1) The Company repaid $8,000 of the revolving credit agreement prior to March
14, 1997.
The early extinguishment of the senior note agreements resulted in an
extraordinary loss of $4,734 ($7,283 pre-tax). The New Credit Facility bears
interest at LIBOR plus 0.70% on the utilized portion and carries a 0.275%
facility fee on the unutilized portion. The spread over LIBOR and the facility
fee are adjustable downward based upon the Company's debt to capitalization
ratios in the future. As of December 31, 1997, the interest rate on the
utilized portion of the New Credit Facility was 6.61%.
In November of 1996, the Company entered into a letter of credit agreement
with a group of banks, which currently extends through November of 1998. The
original agreement allowed the issuing bank to issue letters of credit having
an aggregate outstanding face amount up to $75,000. Effective March 14, 1997,
this facility was reduced to an aggregate outstanding face amount not to
exceed $50,000. The agreement requires the Company to pay a commitment fee
during the existence of the agreement equal to 0.1875% per annum on the
average daily available amount. At December 31, 1997 and 1996, the aggregate
outstanding face amount of letters of credit issued was $46,881 and $47,461,
respectively. This agreement primarily secures reinsurance liabilities of the
insurance subsidiaries of the Company.
The debt covenants supporting the revolving credit facility and the letter
of credit agreement contain provisions which, among other matters, limit the
Company's ability to incur additional indebtedness, merge, consolidate and
acquire or sell assets. The debt covenants also require the Company to satisfy
certain ratios related to net worth, debt-to-capitalization, and interest
coverage. Additionally, the debt covenants place restrictions on dividends to
shareholders (See Note 15).
The Company has entered into an interest rate swap agreement in its
management of its existing interest rate exposures. This transaction
effectively changed the Company's interest rate exposure on a portion of the
New Credit Facility, which has a floating rate, to a fixed obligation as
follows:
<TABLE>
<CAPTION>
NOTIONAL PRINCIPAL
BALANCE AT
DEBT AGREEMENT DECEMBER 31, 1997 FIXED RATE FLOATING RATE
-------------- ------------------ ---------- -------------
<S> <C> <C> <C>
Revolving Credit Facility,
2002......................... $150,000 7.24% 6.61%
</TABLE>
The variable rate resets every three months. This agreement involves the
exchange of interest payment obligation without the exchange of underlying
principal. The differential to be paid or received is recognized as an
adjustment of interest expense. In the event that a counterparty fails to meet
the
F-33
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
terms of the agreement, the Company's exposure is limited to the interest rate
differential on the notional principal amount ($150,000). Management believes
such credit risk is minimal and any loss would not be significant.
7. STOCK OPTIONS
The Company currently has six stock option plans in place for options
granted to officers and other key employees for the purchase of the Company's
Class A common stock, under which 3,864,903 Class A common shares are reserved
for issuance. The stock options are granted under terms and conditions
determined by a committee appointed by the Company's board of directors.
Granted stock options have a maximum term of ten years, vest over periods
ranging between zero and five years, and are typically granted with an
exercise price equal to the fair market value of the stock. Information
regarding these option plans for 1997, 1996, and 1995 are as follows:
<TABLE>
<CAPTION>
1997 1996 1995
------------------- ------------------- -------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
SHARES PRICE SHARES PRICE SHARES PRICE
--------- -------- --------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding,
beginning of year...... 3,242,160 $ 12.43 3,087,260 $ 11.80 2,926,000 $ 10.41
Options granted......... 324,500 17.00 325,000 17.00 775,000 15.59
Options exercised....... (162,248) (8.78) (99,150) (8.33) (205,199) (8.66)
Options canceled........ (286,800) (11.53) (70,950) (11.55) (408,541) (10.65)
--------- ------- --------- ------- --------- -------
Options outstanding, end
of year................ 3,117,612 $ 13.18 3,242,160 $ 12.43 3,087,260 $ 11.80
========= ======= ========= ======= ========= =======
Option price range at
end of year............ $8.00 to $17.00 $8.00 to $17.00 $6.60 to $16.00
Option price range for
exercised shares....... $8.00 to $15.00 $6.60 to $10.00 $6.60 to $11.50
Options available for
grant at end of year... 747,291 921,566 425,616
</TABLE>
Stock options outstanding at December 31, 1997 and related exercise price
and weighted average remaining life information is as follows:
<TABLE>
<CAPTION>
WEIGHTED
OPTIONS OPTIONS AVERAGE
OUTSTANDING AT EXERCISABLE AT REMAINING LIFE
EXERCISE PRICES DECEMBER 31, 1997 DECEMBER 31, 1997 (IN YEARS)
--------------- ----------------- ----------------- --------------
<S> <C> <C> <C>
$ 8.00................... 254,357 246,857 3.49
10.00................... 438,690 438,690 4.46
11.50................... 799,000 799,000 5.65
12.75................... 271,500 271,500 6.17
15.00................... 296,580 287,580 7.45
16.00................... 411,485 283,735 7.43
17.00................... 646,000 228,725 9.15
--------- ---------
3,117,612 2,556,087
========= =========
</TABLE>
F-34
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The fair value of options at date of grant was estimated using a binomial
model with the following weighted average assumptions:
<TABLE>
<CAPTION>
1997(1) 1996(2) 1995(3) 1995(4)
------- ------- ------- -------
<S> <C> <C> <C> <C>
Expected life (years)..................... 10 10 10 10
Interest rate............................. 6.3% 6.3% 6.1% 6.2%
Volatility................................ 18% 18% 18% 18%
Dividend yield............................ 2.3% 2.3% 2.3% 2.3%
</TABLE>
- --------
(1) Options granted on September 3, 1997
(2) Options granted on July 23, 1996
(3) Options granted on June 5, 1995
(4) Options granted on September 1, 1995
The Company has adopted the disclosure-only provision of SFAS No. 123,
"Accounting for Stock-Based Compensation". Accordingly, no compensation cost
has been recognized for the stock option plans. Had compensation costs for the
Company's stock option plans been determined based on the fair value at the
grant date for awards granted during the year, pretax income would have been
reduced by $1,878 ($1,221 after tax, or $0.05 per basic share), $2,079 ($1,352
after tax, or $0.06 per basic share), and $4,308 ($2,800 after tax, or $0.12
per basic share) in 1997, 1996, and 1995, respectively.
8. INCOME TAXES
The components of income tax provision (benefit) from continuing operations
are:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
Current:
Federal........................... $ (4,506) $ (44,572) $ (4,570)
---------- ----------- ----------
(4,506) (44,572) (4,570)
---------- ----------- ----------
Deferred:
Federal........................... 9,906 (11,488) 15,353
---------- ----------- ----------
9,906 (11,488) 15,353
---------- ----------- ----------
Income tax provision (benefit) from
continuing operations.............. $ 5,400 $ (56,060) $ 10,783
========== =========== ==========
</TABLE>
F-35
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The components of income tax benefit from extraordinary item are:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
----------------------
1997 1996 1995
-------- ------------
<S> <C> <C> <C>
Current:
Federal........................................... $ (374) $ -- $ --
-------- ----- -----
(374) -- --
-------- ----- -----
Deferred:
Federal........................................... (2,175) -- --
-------- ----- -----
(2,175) -- --
-------- ----- -----
Income tax benefit from extraordinary item.......... $ (2,549) $ -- $ --
======== ===== =====
</TABLE>
A reconciliation between the total provision (benefit) for income taxes and
the amounts computed at the Statutory Federal income tax rate of 35% for the
years 1997, 1996 and 1995 is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
Computed at the Statutory tax rate..... $ 8,804 $ (66,988) $ 12,220
(Decrease) increase in taxes resulting
from:
Excludable dividends................. -- (36) (107)
Tax-exempt interest.................. (61) (4,547) (12,917)
Losses of foreign reinsurance affili-
ate................................. -- 16,060 8,469
Reversal of income tax accruals...... (3,703) -- --
Other................................ 360 (549) 3,118
--------- ----------- ----------
Provision (benefit) for income taxes... $ 5,400 $ (56,060) $ 10,783
========= =========== ==========
</TABLE>
F-36
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The tax effects of significant temporary differences between the financial
statement carrying amounts and tax bases of assets and liabilities that
represent the net deferred tax asset are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1997 1996
-------- --------
<S> <C> <C>
Allowance for uncollectible accounts................... $ 6,839 $ 9,037
Unearned premiums...................................... 13,756 13,386
Discounting of unpaid losses and LAE................... 63,743 51,086
Unrealized depreciation of investments................. -- 13,394
Depreciation........................................... -- 5,646
Postretirement benefit obligation...................... 5,139 5,111
Tax carryforwards...................................... 46,088 67,014
Other.................................................. 18,919 9,458
-------- --------
Gross deferred tax asset............................... 154,484 174,132
-------- --------
Deferred acquisition costs............................. (15,723) (15,352)
Pension asset.......................................... (371) (1,348)
Depreciation........................................... (574) --
Unrealized appreciation of investments................. (10,126) --
Losses of foreign reinsurance affiliate................ (55,087) (55,790)
Other.................................................. (2,212) --
-------- --------
Gross deferred tax liability........................... (84,093) (72,490)
-------- --------
Net deferred tax asset................................. $ 70,391 $101,642
======== ========
</TABLE>
At December 31, 1997, the Company had approximately $109,622 of net
operating loss carryforwards (expiring in 2011), approximately $7,532 of
alternative minimum tax credit carryforwards (which do not expire) and
approximately $188 of general business credit carryforwards (expiring in 2010
and 2011).
Under SFAS 109, a valuation allowance should be provided to offset the
effects of a deferred tax asset if management believes that it is more likely
than not that the benefit of a deferred tax item will not be realized.
Management believes that the benefit of its deferred tax asset will be fully
realized, and therefore has not provided for a valuation allowance.
U.S. Federal tax return examinations have been completed for the years 1992
and 1993. The examinations for years 1994 and 1995 are currently in progress.
In management's opinion, the ultimate resolution of these matters will not
have an adverse impact on the Company's financial position or results of
operations.
9. EMPLOYEE RETIREMENT, POSTRETIREMENT, AND POSTEMPLOYMENT BENEFITS
During 1996, the Property and Casualty Group initiated a Voluntary Early
Retirement Program ("VERIP"). Eligibility to participate in the VERIP was
contingent upon an employee's age and years of service with the Company. Of
the approximately 85 employees eligible to participate in the VERIP,
approximately 50 employees opted to participate. At December 31, 1996, the
Company accrued $7,635 in connection with the VERIP. The components of this
accrual are as follows:
F-37
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<S> <C>
Pension costs....................................................... $4,300
Postemployment costs................................................ 2,360
Postretirement costs................................................ 975
------
$7,635
======
</TABLE>
The Company did not offer a VERIP in 1997, and as such, did not incur any
VERIP expenses. The Company did, however, incur certain restructuring and
other charges during 1997 (See Note 20).
A. Pension and Retirement Plans--The Company sponsors a qualified non-
contributory defined benefit pension plan (Qualified Pension Plan) covering
substantially all employees. After meeting certain qualifications, an employee
acquires a vested right to future benefits. The benefits payable under the
plan are generally determined on the basis of an employee's length of
employment and career average salary. The Company's policy is to fund pension
cost accrued in accordance with the Employee Retirement Income Security Act of
1974. The Company also maintains a non-qualified unfunded supplemental defined
benefit pension plan (Non-qualified Pension Plan) for the benefit of certain
key employees.
The following tables set forth the amounts recognized in the Company's
financial statements with respect to the Qualified and Non-qualified pension
plans:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED FOR THE YEAR ENDED FOR THE YEAR ENDED
DECEMBER 31, 1997 DECEMBER 31, 1996 DECEMBER 31, 1995
--------------------------- --------------------------- ---------------------------
NON- NON- NON-
QUALIFIED QUALIFIED QUALIFIED QUALIFIED QUALIFIED QUALIFIED
PLAN PLAN TOTAL PLAN PLAN TOTAL PLAN PLAN TOTAL
--------- --------- ------- --------- --------- ------- --------- --------- -------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Service cost-benefits
earned during the
period................. $ 1,375 $ 93 $ 1,468 $ 1,665 $ 98 $ 1,763 $ 1,132 $108 $ 1,240
Interest cost on
projected benefit
obligation............. 3,034 166 3,200 2,948 150 3,098 2,770 158 2,928
Actual return on plan
assets................. (2,490) -- (2,490) (2,830) -- (2,830) (8,712) -- (8,712)
Net amortization and
deferral............... (884) 93 (791) (842) 94 (748) 5,803 94 5,897
VERIP................... -- -- -- 4,300 -- 4,300 -- -- --
------- ---- ------- ------- ---- ------- ------- ---- -------
Net pension cost........ $ 1,035 $352 $ 1,387 $ 5,241 $342 $ 5,583 $ 993 $360 $ 1,353
======= ==== ======= ======= ==== ======= ======= ==== =======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
--------------------------- ---------------------------
NON- NON-
QUALIFIED QUALIFIED QUALIFIED QUALIFIED
PLAN PLAN TOTAL PLAN PLAN TOTAL
--------- --------- ------- --------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
Actuarial present value
of:
Vested benefit
obligation............ $36,405 $ 1,238 $37,643 $41,932 $ 1,069 $43,001
Non-vested benefit
obligation............ 3,919 79 3,998 3,487 68 3,555
------- ------- ------- ------- ------- -------
Accumulated benefit
obligation............. $40,324 $ 1,317 $41,641 $45,419 $ 1,137 $46,556
======= ======= ======= ======= ======= =======
Projected benefit
obligation............. $44,653 $ 2,472 $47,125 $49,331 $ 2,133 $51,464
Fair value of Pension
Plan assets............ 40,600 -- 40,600 46,739 -- 46,739
------- ------- ------- ------- ------- -------
Excess of projected
benefit obligation over
Pension Plan assets.... (4,053) (2,472) (6,525) (2,592) (2,133) (4,725)
Unrecognized net loss
(gain)................. 4,830 29 4,859 588 (63) 525
Unrecognized transition
asset.................. (810) 1,123 313 (1,081) 1,216 135
Unrecognized prior
service benefit........ (1,101) -- (1,101) (1,199) -- (1,199)
------- ------- ------- ------- ------- -------
Pension liability....... $(1,134) $(1,320) $(2,454) $(4,284) $ (980) $(5,264)
======= ======= ======= ======= ======= =======
</TABLE>
F-38
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Qualified Pension Plan assets consist of equity securities, fixed maturity
securities, fixed income contracts, and the Company's common stock.
Actuarial assumptions utilized by the Qualified and Non-qualified Pension
Plan are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
--------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Discount rate........................................ 7.0% 7.5% 7.0%
Rate of compensation increase........................ 4.5% 5.0% 5.0%
Expected long-term rate of return on plan assets..... 8.0% 8.0% 8.0%
</TABLE>
The Company also maintains a voluntary defined contribution savings plan
covering all employees who work a minimum of 20 hours per week. The Company
matches employee contributions up to 5% of compensation. Contributions under
such plans charged to income were $1,735, $2,153 and $1,726 in 1997, 1996 and
1995, respectively.
B. Postretirement Benefits--In addition to providing pension benefits, the
Company provides certain health care benefits for retired employees.
Substantially all of the Company's employees may become eligible for those
benefits if they have worked fifteen or more years with the Company and have
attained the age of fifty while in the service of the Company. For employees
who retire on or subsequent to January 1, 1993, the Company will pay a fixed
portion of medical insurance premiums. Retirees will absorb future increases
in medical premiums.
The funded status of this liability is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1997 1996
------- -------
<S> <C> <C>
Accumulated postretirement benefit obligation:
Retirees and dependents................................... $ 6,076 $ 6,931
Fully eligible active employees........................... 1,214 952
Active employees not fully eligible....................... 2,383 1,871
------- -------
Total..................................................... 9,673 9,754
Unrecognized prior service cost........................... 1,317 1,436
Unrecognized net gain..................................... 3,455 4,031
------- -------
Accrued postretirement benefit liability.................. $14,445 $15,221
======= =======
</TABLE>
The components of postretirement benefit cost include the following:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-----------------------
1997 1996 1995
------ ------- ------
<S> <C> <C> <C>
Service cost...................................... $ 237 $ 248 $ 330
Interest cost..................................... 655 561 658
Amortization...................................... (242) (251) (209)
VERIP............................................. -- 975 --
------ ------- ------
Postretirement benefit cost....................... $ 650 $ 1,533 $ 779
====== ======= ======
</TABLE>
F-39
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Assumptions used in the computation of the funded status and postretirement
benefit cost are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
--------------------
1997 1996 1995
------ ------ ------
<S> <C> <C> <C>
Discount rate......................................... 7.5% 7.0% 7.0%
Health care inflation rate:
Next year........................................... 7.5% 8.0% 8.5%
Ultimate............................................ 5.5% 5.5% 5.5%
</TABLE>
The assumed health care cost trend rate used to measure the expected cost of
benefits covered by the plan has been established at 7.5% for 1998 and is
expected to decline gradually to 5.5% in 2002 and remain at that level
thereafter. The health care cost trend rate assumption has a significant
effect on the amounts reported. A 1% increase in the trend rate for health
care costs would have increased the accumulated postretirement benefit
obligation by $405 and the annual service and interest cost by $27.
C. Postemployment Benefits--SFAS No. 112, "Employers' Accounting for
Postemployment Benefits," establishes the accounting standards for employers
who provide benefits to employees subsequent to their employment, but prior to
retirement. These benefits include severance, long-term and short-term
disability payments, salary continuation, postemployment health benefits,
supplemental unemployment benefits, and other related payments. SFAS No. 112
requires that benefit obligations attributable to prior service and/or that
relate to benefits that vest or accumulate must be accrued presently if the
payments are probable and reasonably estimable. Postemployment benefits that
do not meet such criteria are accrued when payments are probable and
reasonably estimable. In connection with the VERIP described above, the
Company recorded $2,360 of postemployment costs in 1996. While a VERIP was not
offered in 1997, the Company incurred approximately $7,000 of severance and
other restructuring charges during 1997 (See Note 20).
10. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following table represents the carrying amounts and estimated fair
values of the Company's financial instruments. Estimated fair value is defined
as the amount at which the instrument could be exchanged in a current
transaction between willing parties. Certain financial instruments,
specifically amounts relating to insurance contracts, are excluded from this
disclosure.
<TABLE>
<CAPTION>
DECEMBER 31, 1997 DECEMBER 31, 1996
--------------------- ---------------------
CARRYING ESTIMATED CARRYING ESTIMATED
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Financial assets:
Fixed maturities available for
sale............................ $1,929,518 $1,929,518 $2,126,120 $2,126,120
Equity securities................ 13 13 262 262
Financial liabilities:
Long-term debt................... 203,000 203,000 204,699 218,101
Interest rate swap agreements.... -- 3,388 -- 52
</TABLE>
F-40
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
values:
<TABLE>
<S> <C>
</TABLE>
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>
<S> <C>
</TABLE>
11. DISCLOSURE OF CERTAIN RISKS AND UNCERTAINTIES
A. Business Segments and Concentrations--As stated in Note 1, PMC is an
insurance holding company that sells property and casualty reinsurance and
insurance through its insurance subsidiaries.
The following summarizes the relative importance of the segments and lines
of insurance in terms of net premiums written:
<TABLE>
<CAPTION>
PERCENT OF THE COMPANY'S
NET PREMIUMS WRITTEN
----------------------------
1997 1996 1995
-------- -------- --------
<S> <C> <C> <C>
PMA Re-total............................... 42.5% 37.0% 31.2%
PMA Re-casualty reinsurance lines.......... 28.4 27.5 21.9
The Property and Casualty Group-total...... 57.5 63.0 68.8
The Property and Casualty Group-workers'
compensation.............................. 43.2 45.6 42.8
</TABLE>
PMA Re distributes its products through major reinsurance brokers. PMA Re's
top five such brokers accounted for 90.8% of PMA Re's gross premiums in force
at December 31, 1997.
The Property and Casualty Group's operations are concentrated in six
contiguous states in the Mid-Atlantic and Southern regions of the U.S. As
such, economic trends in individual states may not be independent of one
another. Also, the Property and Casualty Group's products are highly regulated
by each of these states. For many of the Property and Casualty Group's
products, the insurance departments of the states in which it conducts
business must approve rates and policy forms. In addition, workers'
compensation benefits are determined by statutes and regulations in each of
these
F-41
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
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.
The Company actively manages its exposure to catastrophic events. In the
underwriting process, the Company generally avoids the accumulation of
insurable values in catastrophe prone regions. Also, in writing property
reinsurance coverages, PMA Re typically requires per occurrence loss
limitations for contracts that could have catastrophe exposure. Through per
risk reinsurance, the Company also manages its net retention in each exposure.
In addition, PMA Re maintains retrocessional protection of $46,000 excess of
$2,000 per occurrence, and the Property and Casualty Group maintains
catastrophe reinsurance protection of $27,700 excess of $850. As a result, the
Company's loss ratios have not been significantly impacted by catastrophes,
and management believes that the Company has adequate reinsurance to protect
against the estimated probable maximum gross loss from a catastrophic event;
however, though management believes it is unlikely, an especially severe
catastrophic event could exceed the Company's reinsurance and/or
retrocessional protection, and adversely impact the Company's financial
position, perhaps materially.
B. Use of Estimates in the Preparation of the Financial Statements--The
preparation of financial statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities, disclosure of contingent assets and liabilities at
the date of the financial statements, and the reported amounts of revenues and
expenses during the period. Actual results could differ from those estimates.
Unpaid Losses and Loss Adjustment Expenses--At December 31, 1997, the
Company carried $2,003,187 of unpaid losses and loss adjustment expenses.
Unpaid losses and loss adjustment expenses reflect management's best estimate
of future amounts needed to pay claims and related settlement costs with
respect to insured events which have occurred, including events that have not
been reported to the Company. In many cases, significant periods of time,
ranging up to several years or more, may elapse between the occurrence of an
insured loss, the reporting of the loss to the Company and the Company's
payment of that loss. In general, liabilities for reinsurers become known more
slowly than for primary insurers and are subject to more unforeseen
development. As part of the process in determining these amounts, historical
data is reviewed and consideration is given to the impact of various factors,
such as legal developments, changes in social attitudes, and economic
conditions. In addition, estimating reserves for workers' compensation claims
can be more difficult than many other lines of property and casualty insurance
for several reasons, including (i) the long payment "tail' associated with the
business; (ii) the impact of social, political and regulatory trends on
benefit levels for both medical and indemnity payments; (iii) the impact of
economic trends; and (iv) the impact of changes in the mix of business. At
various times, one or a combination of such factors can make the
interpretation of actuarial data associated with workers' compensation loss
development more difficult, and it can take additional time to recognize
changes in loss development patterns. Under such circumstances, adjustments
will be made to such reserves as loss patterns develop and new information
becomes available and such adjustments may be material.
Management believes that its unpaid losses and loss adjustment expenses are
fairly stated at December 31, 1997, in accordance with GAAP. However,
estimating the ultimate claims liability is necessarily a complex and
judgmental process inasmuch as the amounts are based on management's informed
estimates and judgments using data currently available. As additional
experience and data
F-42
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
become available regarding claims payment and reporting patterns, legislative
developments, and economic conditions, the estimates are revised accordingly.
If the Company's ultimate net losses prove to be substantially greater than
the amounts recorded at December 31, 1997, the related adjustments could have
a material adverse impact on the Company's financial condition and results of
operations (See also Note 3).
C. Year 2000 Issue--The unprecedented advances in computer technology over
the past several decades have resulted in dramatic changes in the way
companies do business. Most of these developments have been tremendously
beneficial, but some have proven costly, as businesses have struggled to adapt
to various features of the new technological landscape. One such well-
publicized problem has arisen out of the worldwide use of the so-called "Year
2000" programming convention, in which two digit numbers were generally used
instead of four digit numbers to identify the years used in dates. As a
consequence, most computers require relatively costly reprogramming to enable
them to correctly perform date operations involving years 2000 or later, a
problem anticipated to have substantial repercussions on the business world,
since computer operations involving date calculations are pervasive.
With the assistance of outside consulting groups, the Company began
evaluating and reprogramming its own computer systems to address the Year 2000
problem in late 1995. Management anticipates that by no later than year end
1998, it will have completed substantially all necessary programming work so
that Year 2000 issues are not likely to result in any material adverse
disruption in the Company's computer systems or its internal business
operations. The cost of this work through year-end 1997 has been approximately
$3,800. The Company estimates that the total remaining cost will be
approximately $1,300, and will be expensed in 1998.
Many experts now believe that Year 2000 problem may have a material adverse
impact on the national and global economy generally. In addition, it seems
likely that if businesses are materially damaged as a result of Year 2000
problems, at least some such businesses may attempt to recoup their losses by
claiming coverage under various types of insurance policies. And, although
management has concluded that under a fair reading of the various policies of
insurance issued by it no coverage for Year 2000 problems should be considered
to exist, it is not possible to predict whether or to what extent any such
coverage could ultimately be found to exist by courts in the various
jurisdictions. Accordingly, important factors which could cause actual results
to differ materially from those expressed in the forward looking statements
include but are not limited to the inability of the Company to accurately
estimate the impact of the Year 2000 problem on the insurance, or other
business operations, of the Company.
12. TRANSACTIONS WITH RELATED PARTIES
The Company's largest shareholder is PMA Foundation (the "Foundation"),
formerly known as Pennsylvania Manufacturers' Association, which is a not-for-
profit corporation qualified under Section 501(c)(6) of the Internal Revenue
Code, whose purposes include the promotion of the common business interests of
its members and the economic prosperity of the Commonwealth of Pennsylvania.
As of December 31, 1997, the Foundation owned 4,561,225 shares of common stock
(30.7% of the class) and 912,225 shares of Class A common stock (10.0% of the
class), which constitutes 29.5% of the total number of votes available to be
cast in matters brought before the Company's shareholders. All of the members
of the Company's Board of Directors currently serve as members of the
F-43
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Foundation's Board of Trustees. Also, Frederick W. Anton III, Chairman of the
Company, serves as President and Chief Executive Officer of the Foundation.
The Company and certain of its subsidiaries provide certain administrative
services to the Foundation for which the Company and its subsidiaries receive
reimbursement. Total reimbursements amounted to $34, $82, and $269 for the
years ended December 31, 1997, 1996, and 1995, respectively. The Foundation
also leases its Harrisburg, Pennsylvania headquarters facility from a
subsidiary of the Company under a monthly operating lease presently requiring
rent payments of $20 per month and reimburses a subsidiary of the Company for
its use of office space in the Blue Bell, Pennsylvania facility. Rent and
related reimbursements paid to the Company's affiliates by the Foundation
amounted to $250, $247, and $294, for the years ended December 31, 1997, 1996,
and 1995, respectively.
In addition, the Company has arranged an executive loan program with a
financial institution whereby such institution will provide prime rate
personal loans to officers of the Company and its subsidiaries collateralized
by common stock and Class A common stock at a maximum 50% loan to value ratio.
The Company has agreed to purchase any loan made under this program from the
financial institution in the event that the borrower defaults on such loan.
The amount of loans outstanding at December 31, 1997 under this program was
$4,642.
The Company incurred legal and consulting fees aggregating approximately
$6,506, $7,917, and $6,279 in 1997, 1996 and 1995, respectively, from firms in
which directors of the Company are partners or principals.
The Company has notes receivable from officers which are accounted for as a
reduction of shareholders' equity in the accompanying balance sheets. Such
notes receivable had balances of $198 and $1,162 as of December 31, 1997 and
December 31, 1996, respectively. The interest rate on the notes range between
6.0% and 8.0%.
13. COMMITMENTS AND CONTINGENCIES
For the years ended December 31, 1997, 1996 and 1995, total rent expense was
$5,745, $6,114 and $4,536 respectively. At December 31, 1997, the Company was
obligated under noncancelable operating leases for office space with aggregate
minimum annual rentals as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED
DECEMBER 31,
-------------------
<S> <C>
1998................................................... $ 3,972
1999................................................... 2,940
2000................................................... 1,811
2001................................................... 1,820
2002................................................... 1,566
Thereafter............................................. 2,133
-------
Total................................................ $14,242
=======
</TABLE>
In the event a property and casualty insurer, operating in a jurisdiction
where the Company's insurance subsidiaries also operate becomes or is declared
insolvent state insurance regulations provide for the assessment of other
insurers to fund any capital deficiency of the insolvent insurer. Generally,
this assessment is based upon the ratio of an insurer's voluntary premiums
written to the
F-44
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
total premiums written for all insurers in that particular jurisdiction. The
Company is not aware of any material potential assessments at December 31,
1997.
The Company has provided guarantees of approximately $11,048 related to
loans on properties in which the Company has an interest.
The Company is named in various legal proceedings arising in the normal
course of business. In the opinion of management, the resolution of these
matters will not have a material adverse effect on the Company's financial
condition, results of operations, or cash flows.
14. SALE OF UNCOLLECTED PREMIUMS
Insurance subsidiaries of PMC, from time to time, engage in the practice of
selling uncollected premiums to a third-party financial institution. No such
sales were transacted during 1997. The proceeds received from such sales were
$10,628 and $19,509 in 1996 and 1995, respectively. These receivables were
excluded from uncollected premiums in the accompanying balance sheets.
However, the Company had recorded an allowance for doubtful accounts related
to the estimated uncollectible accounts since the Company had retained risk
under the recourse provisions. At December 31, 1997, the Company had no
contingent obligations outstanding related to the sale of uncollected
premiums.
15. SHAREHOLDERS' EQUITY
The Company has two classes of common stock, Class A common stock and common
stock. The Company's common stock and Class A common stock generally vote
without regard to class on matters submitted to shareholders, with the common
stock having ten votes per share and the Class A common stock having one vote
per share.
With respect to dividend rights, the Class A common stock is entitled to
cash dividends at least 10% higher than those declared and paid on the common
stock. The Company's bylaws limit the classes of persons who may own the
common stock. Holders of common stock may elect to convert any or all such
shares into Class A common stock on a share-for-share basis.
Under the insurance laws and regulations of Pennsylvania, PMC's insurance
subsidiaries may not pay dividends to PMC without prior regulatory approval,
over a twelve-month period in excess of the greater of (a) 10% of the
preceding year-end's policyholders surplus or (b) the preceding year's SAP net
income, but in no event to exceed unassigned funds. At December 31, 1997, the
maximum amount available to be paid as dividends from the Company's insurance
subsidiaries to PMC, without the prior consent of the Pennsylvania Insurance
Department, was $51,220.
PMC's dividends to shareholders are restricted by its debt agreements. On
March 14, 1997, the Company refinanced certain debt agreements through the
completion of the New Credit Facility (See Note 6). Under the terms of the New
Credit Facility under the most restrictive debt covenant, the Company could
pay dividends of approximately $14,500 in 1998.
PMA Re intends to maintain Caliber One Indemnity Company's surplus at not
less than $25,000, the minimum capital and surplus required for many states in
order to be an eligible surplus lines carrier (See Note 1).
F-45
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
16. EARNINGS PER SHARE
In accordance with SFAS No. 128 discussed in Note 1-I, the Company is
required to present a reconciliation of the numerators and denominators used
in the basic earnings per share calculation to the numerators and denominators
used in the diluted earnings per share calculation. The computation of diluted
earnings per share is similar to the computation of basic earnings per share
except that the denominator is increased to include the number of additional
common shares that would have been outstanding if all dilutive potential
common shares, such as outstanding stock options with exercise prices below
the average market price, had been issued. For all years presented, there were
no differences in the numerator for the basic and diluted earnings per share
calculation. For entities that report an extraordinary item, as the Company
did in 1997, SFAS No. 128 requires that income before extraordinary item be
used as the control number in determining whether or not potential common
shares are dilutive. The Company's income (loss) before extraordinary item,
which was equal to net income in 1996 and 1995, and a reconciliation of the
denominator of the basic and diluted earnings per share computations are
presented below.
<TABLE>
<CAPTION>
1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Numerator:
Control number--income (loss) before
extraordinary item................. $ 19,753 $ (135,334) $ 24,130
Denominator:
Basic shares--weighted average
common and Class A common shares
outstanding........................ 23,855,031 23,800,791 23,816,088
Dilutive stock options.............. 712,347 -- 965,861
----------- ----------- -----------
Total diluted shares.............. 24,567,378 23,800,791 24,781,949
=========== =========== ===========
</TABLE>
Options to purchase 646,000 shares of Class A common stock at $17.00 per
share were outstanding at December 31, 1997, but were not included in the
computation of diluted earnings per share because the options' exercise price
was greater than the average market price of the Class A common shares.
Options to purchase 3,242,160 shares of Class A common stock at prices ranging
between $8.00 and $17.00 were outstanding during at December 31, 1996, but
were excluded from the computation of diluted earnings per share as they would
have been anti-dilutive.
F-46
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
17. BUSINESS SEGMENTS
Operating revenues, income (loss) before income taxes, and identifiable
assets of the Company's business segments were as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDING DECEMBER 31,
--------------------------------
1997 1996 1995
---------- ---------- ----------
<S> <C> <C> <C>
Operating Revenues(1)
PMA Re
Net premiums earned..................... $ 163,603 $ 151,974 $ 139,345
Net investment income................... 52,270 48,676 45,166
---------- ---------- ----------
215,873 200,650 184,511
---------- ---------- ----------
The Property and Casualty Group
Net premiums earned--workers'
compensation......................... 152,773 176,380 243,175
Net premiums earned--commercial
lines................................ 59,575 92,221 102,432
---------- ---------- ----------
Net premiums earned--total............ 212,348 268,601 345,607
Net investment income................... 82,098 82,455 92,275
Service revenues........................ 10,311 9,189 5,106
---------- ---------- ----------
304,757 360,245 442,988
---------- ---------- ----------
Corporate, Other and Consolidating Elimi-
nations
Net investment income................... 2,330 2,805 1,914
---------- ---------- ----------
2,330 2,805 1,914
---------- ---------- ----------
Total operating revenues............ $ 522,960 $ 563,700 $ 629,413
========== ========== ==========
</TABLE>
- --------
(1) Operating revenues exclude net realized investment gains.
<TABLE>
<CAPTION>
FOR THE YEAR ENDING DECEMBER 31,
-----------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
Income (Loss) Before Income Taxes
PMA Re................................ $ 44,802 $ 42,783 $ 39,443
The Property and Casualty Group....... (9,038) (219,619) (4,305)
Corporate, Other and Consolidating
Eliminations......................... (3,441) (490) (13,414)
---------- ----------- ----------
Pre-tax operating income (loss) before
interest expense..................... 32,323 (177,326) 21,724
Net realized investment gains......... 8,598 2,984 31,923
Interest expense...................... (15,768) (17,052) (18,734)
---------- ----------- ----------
Total income (loss) before income
taxes.............................. $ 25,153 $ (191,394) $ 34,913
========== =========== ==========
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1997 1996
---------- ----------
<S> <C> <C>
Identifiable Assets
PMA Re................................................ $1,126,176 $1,031,149
The Property and Casualty Group....................... 1,863,975 2,050,648
Corporate, Other and Consolidating Eliminations....... 67,107 35,719
---------- ----------
Total identifiable assets........................... $3,057,258 $3,117,516
========== ==========
</TABLE>
F-47
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
18. SAP INFORMATION
SAP net income (loss) and capital and surplus for PMC's domestic insurance
subsidiaries as reported to the Insurance Departments of Pennsylvania and
Delaware are as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
SAP Net Income (Loss)
PMA Re................................... $ 25,752 $ 26,338 $ 36,854
The Property and Casualty Group.......... 10,785 (191,640) 30,925
---------- ----------- ----------
Total(1)............................... $ 36,537 $ (165,302) $ 67,779
========== =========== ==========
- --------
(1) Caliber One Indemnity Company had no SAP net income or loss during 1997.
<CAPTION>
DECEMBER 31,
----------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
SAP Capital and Surplus
PMA Re(1)................................ $ 271,154 $ 260,853 $ 254,088
The Property and Casualty Group.......... 281,071 279,764 402,968
---------- ----------- ----------
Total.................................. $ 552,225 $ 540,617 $ 657,056
========== =========== ==========
</TABLE>
- --------
(1) The SAP capital and surplus of PMA Re includes PMA Re's investment in
Caliber One Indemnity Company, equal to Caliber One Indemnity Company's
SAP capital and surplus of $25,039 at December 31, 1997.
A reconciliation of PMC's domestic insurance subsidiaries' SAP net income
(loss) and capital and surplus to the Company's GAAP net income (loss) and
shareholders' equity is as follows:
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-----------------------------------
1997 1996 1995
---------- ----------- ----------
<S> <C> <C> <C>
Net Income (Loss)
SAP net income (loss):
Domestic insurance subsidiaries..... $ 36,537 $ (165,302) $ 67,779
GAAP adjustments:
Change in deferred acquisition
costs.............................. 1,282 6,105 5,665
Benefit (provision) for deferred
income taxes....................... 4,725 11,488 (15,353)
Allowance for doubtful accounts..... 307 (5,317) 4,105
Retirement accruals................. 275 (76) (3,613)
Other............................... 549 (938) (306)
---------- ----------- ----------
GAAP net income (loss)--domestic
insurance subsidiaries............... 43,675 (154,040) 58,277
Other entities and eliminations....... (23,922) 18,706 (34,147)
Extraordinary loss.................... (4,734) -- --
---------- ----------- ----------
GAAP net income (loss)................ $ 15,019 $ (135,334) $ 24,130
========== =========== ==========
</TABLE>
F-48
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------
1997 1996 1995
--------- --------- ---------
<S> <C> <C> <C>
Shareholders' Equity
SAP capital and surplus:
Domestic insurance subsidiaries......... $ 552,225 $ 540,617 $ 657,056
GAAP adjustments:
Deferred acquisition costs.............. 45,288 44,006 37,901
Deferred income taxes................... 52,571 101,642 67,331
Allowance for doubtful accounts......... (19,700) (26,214) (20,897)
Retirement accruals..................... (10,653) (14,571) (14,495)
Reversal of non-admitted assets......... 21,330 25,599 32,841
Unrealized gain (loss) on fixed maturity
investments available for sale......... 19,380 (38,271) 24,186
Other................................... 3,254 (338) 958
--------- --------- ---------
GAAP shareholders' equity--domestic
insurance subsidiaries................... 663,695 632,470 784,881
Other entities and eliminations........... (185,348) (206,642) (175,213)
--------- --------- ---------
GAAP shareholders' equity................. $ 478,347 $ 425,828 $ 609,668
========= ========= =========
</TABLE>
19. SUBSEQUENT EVENTS
In February of 1998, the Company's Board of Directors authorized a plan to
repurchase, over the next two years, up to a maximum of 1,500,000 shares of
common stock and Class A common stock, in an amount not to exceed $25,000.
Repurchases may be made, from time to time, at the discretion of the Company
in the open market or directly from shareholders at prevailing market prices.
The 1.5 million share limit equated to approximately 6.25% of the total common
and Class A common stock outstanding at December 31, 1997.
Effective February 5, 1998, the Company's Class A common stock began trading
on the Nasdaq National Market under the ticker symbol, "PMFRA". Previously,
the Company's Class A common stock traded on the OTC Bulletin Board under the
same ticker symbol.
20. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
As noted in Note 19, the Company's Class A common stock began trading on the
Nasdaq National Market during 1998. As of December 31, 1997 and 1996, neither
class of common equity was traded on an established exchange. Transactions in
the common stock were conducted privately among persons qualified to own the
common stock. No price information was available for such transactions.
Throughout 1997 and 1996, Class A common stock traded under the symbol,
"PMFRA", on the OTC Bulletin Board through approximately ten broker/dealers
who voluntarily made a market in the Class A common stock. The stock price
data presented below for 1997 and 1996 for the Class A common stock are based
upon over-the-counter market bid quotations, which reflect interdealer prices,
without retail mark-up, mark-down or commission, and may not represent actual
transactions. As of February 28, 1998, the Company had 186 and 404 record
holders of common stock and Class A common stock, respectively.
F-49
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
Over the past two years, the Company's operating results have been impacted
by restructuring charges and other related items.
During 1997, the Company incurred restructuring and other charges of
approximately $775, $3,500, $2,660 and $5,165 for the first, second, third and
fourth quarters, respectively. The components of the charges for 1997, which
were included in operating expenses, were as follows: $7,000, for costs
associated with nonvoluntary terminations of approximately 60 employees in
various operational and management positions; $2,000, for converting internal
computer programs to address the Year 2000 problem, as further discussed in
Note 11 to the Consolidated Financial Statements: $2,200, for operating costs
associated with certain corporate properties which were disposed of during
1997; and $900, for costs to establish the new specialty insurance operation
in 1997. As of December 31, 1997, approximately $3.5 million of such charges
remained in Other Liabilities on the balance sheet.
During 1996, the Company incurred approximately $31,700 of restructuring and
other charges, excluding loss reserve strengthening, during the fourth
quarter. The components of the charges for 1996, which were included in
operating expenses, were as follows: $7,600, for costs associated with the
VERIP which is discussed further in Note 9 to the Consolidated Financial
Statements; $2,000, for converting internal computer programs to address the
Year 2000 problem, as further discussed in Note 11 to the Consolidated
Financial Statements; $17,500, for a valuation adjustment related to premium
balances; and $4,800, associated with a change in depreciable lives of
computer equipment. Excluding the Year 2000 issue, these initiatives were
completed in 1996 with no material difference from original estimates. The
Company recorded $10,000 and $181,400 of loss reserve strengthening in the
third and fourth quarters of 1996, respectively (See Note 3).
F-50
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
The following tables provide a summary of quarterly financial information:
<TABLE>
<CAPTION>
1997
-------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Income Statement Data:
Net premiums written..................... $149,882 $ 98,389 $104,487 $ 65,524
======== ======== ======== ========
Net premiums earned...................... $107,950 $114,451 $ 62,970 $ 90,580
Net investment income.................... 35,847 32,612 34,353 33,886
Net realized investment (losses) gains... (1,251) (680) 5,531 4,998
Service revenues......................... 2,548 2,490 2,674 2,599
-------- -------- -------- --------
Total revenues......................... 145,094 148,873 105,528 132,063
-------- -------- -------- --------
Losses and loss adjustment expenses...... 94,904 98,230 47,785 66,362
Operating expenses....................... 35,281 48,093 38,858 46,408
Dividends to policyholders............... 3,257 3,360 3,566 4,533
Interest expense......................... 4,334 3,888 3,803 3,743
-------- -------- -------- --------
Total losses and expenses.............. 137,776 153,571 94,012 121,046
-------- -------- -------- --------
Income before income taxes and
extraordinary item....................... 7,318 (4,698) 11,516 11,017
Provision (benefit) for income tax....... 2,561 (5,218) 4,172 3,885
-------- -------- -------- --------
Income before extraordinary item......... 4,757 520 7,344 7,132
Extraordinary item, net of tax........... (4,734) -- -- --
-------- -------- -------- --------
Net income............................. $ 23 $ 520 $ 7,344 $ 7,132
======== ======== ======== ========
Per Share Data:
Basic:
Income before extraordinary item..... $ 0.20 $ 0.02 $ 0.31 $ 0.30
Extraordinary item................... (0.20) -- -- --
-------- -------- -------- --------
Net income............................. $ -- $ 0.02 $ 0.31 $ 0.30
======== ======== ======== ========
Diluted:
Income before extraordinary item..... $ 0.19 $ 0.02 $ 0.30 $ 0.29
Extraordinary item................... (0.19) -- -- --
-------- -------- -------- --------
Net income............................. $ -- $ 0.02 $ 0.30 $ 0.29
======== ======== ======== ========
Class A Common Stock Prices:
High................................... $ 16.125 $ 16.000 $ 16.750 $ 18.000
Low.................................... $ 15.625 $ 14.000 $ 15.000 $ 16.000
Close.................................. $ 16.000 $ 15.000 $ 16.750 $ 16.000
</TABLE>
F-51
<PAGE>
PENNSYLVANIA MANUFACTURERS CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
<TABLE>
<CAPTION>
1996
--------------------------------------
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
-------- -------- -------- ---------
<S> <C> <C> <C> <C>
Income Statement Data:
Net premiums written.................. $147,444 $ 96,336 $116,745 $ 82,950
======== ======== ======== =========
Net premiums earned................... $117,937 $102,226 $106,034 $ 94,378
Net investment income................. 33,420 32,511 32,732 35,273
Net realized investment gains (loss-
es).................................. 943 (1,412) 5,972 (2,519)
Service revenues...................... 1,748 2,264 2,642 2,535
-------- -------- -------- ---------
Total revenues...................... 154,048 135,589 147,380 129,667
-------- -------- -------- ---------
Losses and loss adjustment expenses... 99,943 85,512 97,013 254,155
Operating expenses.................... 38,310 42,012 40,748 67,078
Dividends to policyholders............ 3,122 2,730 3,566 6,837
Interest expense...................... 4,472 4,358 4,331 3,891
-------- -------- -------- ---------
Total losses and expenses........... 145,847 134,612 145,658 331,961
-------- -------- -------- ---------
Income before income taxes and
extraordinary item.................... 8,201 977 1,722 (202,294)
Provision (benefit) for income tax.... 2,572 (139) (734) (57,759)
-------- -------- -------- ---------
Net income (loss)................... $ 5,629 $ 1,116 $ 2,456 $(144,535)
======== ======== ======== =========
Per Share Data:
Basic:
Net income (loss)................. $ 0.23 $ 0.05 $ 0.11 $ (6.07)
======== ======== ======== =========
Diluted:
Net income (loss)................. $ 0.22 $ 0.05 $ 0.10 $ (6.07)
======== ======== ======== =========
Class A Common Stock Prices:
High................................ $ 20.500 $ 18.500 $ 17.500 $ 17.500
Low................................. $ 18.250 $ 16.500 $ 17.000 $ 15.625
Close............................... $ 18.875 $ 17.000 $ 17.500 $ 15.750
</TABLE>
F-52
<PAGE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRE-
SENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR
MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING
BEEN AUTHORIZED. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR THE
SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OTHER THAN THE SECURITIES TO
WHICH IT RELATES OR AN OFFER TO SELL OR THE SOLICITATION OF AN OFFER TO BUY
SUCH SECURITIES IN ANY CIRCUMSTANCES IN WHICH SUCH OFFER OR SOLICITATION IS
UNLAWFUL. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF PMA CAPITAL SINCE THE DATE HEREOF OR THAT THE INFOR-
MATION CONTAINED HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO ITS DATE.
-----------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information.................................................... 4
Prospectus Summary....................................................... 6
Risk Factors............................................................. 16
The Company.............................................................. 29
The Issuer............................................................... 30
Ratio of Earnings to Fixed Charges....................................... 31
Capitalization........................................................... 32
Use of Proceeds.......................................................... 33
Accounting Treatment..................................................... 33
Selected Consolidated Financial and Operating Data....................... 34
Management's Discussion and Analysis of Financial Condition and Results
of Operations........................................................... 37
Business................................................................. 79
Supervision and Regulation............................................... 108
Management............................................................... 113
Description of the Capital Securities.................................... 115
Description of the Guarantee............................................. 130
Description of the Junior Subordinated Debentures........................ 133
Relationship Among the Capital Securities, the Junior Subordinated
Debentures and the Guarantee............................................ 144
United States Federal Income Taxation.................................... 145
Certain ERISA Considerations............................................. 150
Validity of Securities................................................... 151
Underwriting............................................................. 152
Experts.................................................................. 153
Incorporation of Certain Documents by Reference.......................... 154
Glossary of Certain Insurance and Other Defined Terms.................... 155
Index to Consolidated Financial Statements............................... F-1
</TABLE>
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
$100,000,000
PMC CAPITAL I
% CAPITAL SECURITIES, SERIES A
FULLY AND UNCONDITIONALLY
GUARANTEED, AS DESCRIBED HEREIN, BY
PMA CAPITAL CORPORATION
-----------
PROSPECTUS
-----------
GOLDMAN, SACHS & CO.
MERRILL LYNCH & CO.
FIRST UNION CAPITAL MARKETS
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
<PAGE>
PART II
INFORMATION NOT REQUIRED IN THE PROSPECTUS
Item 14. Other Expenses of Issuance and Distribution.
- ------- -------------------------------------------
The following table sets forth an itemized statement of all estimated
expenses to be paid by PMA Capital Corporation (the "Company") in connection
with the issuance and distribution of the Capital Securities being registered
other than underwriting discounts and commissions:
Securities and Exchange Commission registration fee......... $ 29,500
NASD filing fee............................................. 10,500
Trustees' fees and expenses................................. 8,000
Legal fees and expenses..................................... 160,000
Accountants fees and expenses............................... 60,000
Printing and engraving expenses............................. 130,000
Rating agencies' fees....................................... *
Blue sky fees and expenses.................................. *
Miscellaneous............................................... *
____________
Total............. $500,000
===========
* TO BE FILED BY AMENDMENT
Except for the Securities and Exchange Commission registration fee, all
fees and expenses are estimated and subject to future contingencies.
II-1
<PAGE>
Item 16. Exhibits.
- ------- --------
Exhibit No. Description of Exhibit
----------- --------------------------------------------------------
* 1.1 Form of Underwriting Agreement among the Issuer, the
Company and Goldman, Sachs & Co., Merrill Lynch, Pierce,
Fenner & Smith Incorporated and First Union Capital
Markets as representatives of the Underwriters
3.1 Amended and Restated Articles of Incorporation of the
Company (filed herewith)
*** 3.2 Amended and Restated By-laws of the Company
*** 3.3 Certificate of Trust of the Issuer
*** 3.4 Trust Agreement
***** 3.5 Form of Amended and Restated Trust Agreement
***** 4.1 Form of Indenture between the Company and The Bank of
New York as Indenture Trustee
***** 4.2 Form of Capital Security (included in Exhibit 3.5)
***** 4.3 Form of Junior Subordinated Debenture (included in
Exhibit 3.5)
***** 4.4 Form of Guarantee Agreement between the Company and
Bank of New York
* 5.1 Opinion of Duane, Morris & Heckscher LLP re legality of
securities offered hereby
* 5.2 Opinion of Duane, Morris & Heckscher LLP re certain
matters of Delaware and Pennsylvania Law
8.1 Form of Opinion of Duane, Morris & Heckscher LLP re
certain tax matters
** 10.1 Employment Agreement dated April 1, 1995 between the
Company and Frederick W. Anton III
II-2
<PAGE>
** 10.2 Employment Agreement dated May 1, 1995 between the
Company and John W. Smithson
** 10.3 The PMC EDC Plan Trust Agreement dated as of 1994
** 10.4 The PMC Supplemental Executive Retirement Plan (SERP)
dated July 1995
** 10.5 The Company's Amended and Restated 1987 Incentive Stock
Option Plan
** 10.6 The Company's Amended and Restated 1991 Equity Incentive
Plan
** 10.7 The Company's Amended and Restated 1993 Equity Incentive
Plan
** 10.8 The Company's Amended and Restated 1994 Equity Incentive
Plan
** 10.9 The Company's 1995 Equity Incentive Plan
** 10.10 The Company's 1996 Equity Incentive Plan
** 10.11 Federal Tax Allocation Agreement
** 10.12 Office lease between Nine Penn Center Associates, L.P.,
as Landlord, and Lorjo Corp., as Tenant, covering
premises located at Mellon Bank Center, 1735 Market
Street, Philadelphia, Pennsylvania, dated May 26, 1994
** 10.13 Credit Agreement dated as of March 14, 1997 by and among
the Company, The Bank of New York, First Union National
Bank of North Carolina, Fleet National Bank, PNC Bank,
National Association, Mellon Bank, N.A., CoreStates
Bank, N.A. and Dresdener Bank AG, New York Branch and
Grand Cayman Branch
** 10.14 Master Agreement dated as of February 7, 1997 between
the Company and First Union National Bank of North
Carolina
** 10.15 First Amended and Restated Letter of Credit Agreement by
and among the Company, the Bank of New York, Mellon
Bank, N.A., Fleet Bank, National Association, PNC Bank,
National Association and First Union Bank of North
Carolina
**** 10.16 Amendment No. 1 to Tax Allocation Agreement dated
January 7, 1998
II-3
<PAGE>
**** 10.17 Caliber One Indemnity Company Purchase Agreement dated
December 15, 1997
**** 11.1 Statement regarding computation of per share earnings
12.1 Statement regarding computation of earnings to fixed
charges
**** 21.1 Subsidiaries of the Company
23.1 Consent of PricewaterhouseCoopers LLP (filed herewith)
* 23.2 Consent of Duane, Morris & Heckscher LLP (included in
Exhibits 5.1, 5.2 and 8.1)
*** 24.1 Powers of Attorney (included as part of signature pages
to initial filing of this Registration Statement on
September 16, 1998)
***** 25.1 Statement of Eligibility of The Bank of New York as to
the Guarantee (Form T-1)
***** 25.2 Statement of Eligibility of The Bank of New York as to
the Capital Securities (Form T-1)
***** 25.3 Statement of Eligibility of The Bank of New York as to
the Junior Subordinated Debentures (Form T-1)
**** 27 Financial Data Schedule
______________
* to be filed by Amendment.
** incorporated by reference to like-numbered exhibit in the Company's
Form 10 Registration Statement as filed with the Commission on June 26,
1997.
*** previously filed as part of this registration statement on
September 16, 1998.
**** incorporated by reference to like-numbered exhibit in the Company's
Annual Report on Form 10-K for the year ended December 31, 1997 and/or
the Company's Report on Form 10-Q for the quarter ended September 30,
1998.
***** previously filed as part of Amendment No. 1 to this registration
statement on November 5, 1998.
The following financial statement schedules are included:
<TABLE>
<CAPTION>
<S> <C>
Consolidated Financial Statement Schedules:
Report of Independent Accountants S-1
Schedule I- Summary of Investments Other Than Investments in Related Parties S-2
Schedule II- Condensed Financial Information of Registrant as of December 31,
1997 and 1996 and for the years ended December 31, 1997, 1996, and 1995 S-3
Schedule III- Supplementary Insurance Information for the years ended December
31, 1997, 1996, and 1995 S-6
Schedule IV- Reinsurance for the years ended December 31, 1997, 1996, and 1995 S-7
Schedule V- Valuation and Qualifying Accounts for the years ended December
31, 1997, 1996, and 1995 S-8
Schedule VI- Supplementary Information Concerning Property & Casualty
Insurance Operations for the years ended December 31, 1997, 1996, and 1995 S-9
</TABLE>
II-4
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
Our report on the consolidated financial statements of PMA Capital Corporation
(formerly Pennsylvania Manufacturers Corporation) and subsidiaries has been
included in this Registration Statement on page F-11. In connection with our
audit of such financial statements, we have also audited the financial statement
schedules listed in the index in Item 16 of this Registration Statement.
In our opinion, these financial statement schedules referred to above, when
considered in relation to the basic financial statements taken as whole, present
fairly, in all material respects, the information required to be included
therein.
/s/ PricewaterhouseCoopers LLP
One South Market Square
Harrisburg, Pennsylvania
February 6, 1998
S-1
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule I
Summary of Investments-Other Than Investments in Related Parties
December 31, 1997
<TABLE>
<CAPTION>
Amount at
which shown in
Type of investment Cost Value the balance sheet
- ---------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
(Dollar amounts in thousands)
Fixed maturities:
Bonds:
U.S. Treasury Securities and obligations of U.S.
Government agencies $ 1,105,689 $ 1,119,566 $ 1,119,566
Corporate debt securities 675,218 687,671 687,671
Mortgage-backed securities 119,687 122,281 122,281
----------- ----------- -----------
Total fixed maturities 1,900,594 1,929,518 1,929,518
----------- ----------- -----------
Equity securities:
Common Stocks:
Industrial, miscellaneous and all other 5 13 13
----------- ----------- -----------
Total equity securities 5 13 13
----------- ----------- -----------
Short-term investments 265,207 265,207 265,207
----------- ----------- -----------
Total investments $ 2,165,806 $ 2,194,738 $ 2,194,738
=========== =========== ===========
</TABLE>
S-2
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule II
Balance Sheets
(Parent Company Only)
<TABLE>
<CAPTION>
as of December 31 (in thousands, except share data) 1997 1996
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
ASSETS
Cash $ 253 $ -
Investments in subsidiaries 632,680 584,608
Deferred tax asset, net 29,163 36,602
Related party receivables 7,074 727
Other assets 22,545 21,096
----------------------
Total assets $ 691,715 $ 643,033
======================
LIABILITIES
Long term debt $ 203,000 $ 204,571
Related party payables - 1,605
Dividends payable to shareholders 2,008 1,983
Other liabilities 8,360 9,046
----------------------
Total liabilities 213,368 217,205
----------------------
SHAREHOLDERS' EQUITY
Common stock, $5 par value (40,000,000 shares authorized;
15,286,263 shares issued and 14,850,789 outstanding - 1997
16,095,416 shares issued and 15,670,052 outstanding - 1996) 76,431 80,477
Class A common stock, $5 par value (40,000,000 shares authorized;
9,156,682 shares issued and 9,117,735 outstanding - 1997
8,247,804 shares issued and 8,173,023 outstanding - 1996) 45,783 41,239
Additional paid-in capital - Class A common stock 339 -
Retained earnings 343,368 336,921
Unrealized gain (loss) on investments of subsidiaries (net of
deferred income taxes: 1997 - $(10,126); 1996 - $13,394) 18,806 (24,874)
Notes receivable from officers (198) (1,162)
Treasury stock, at cost:
Common stock (1997 - 435,474 shares; 1996 - 425,364 shares (5,572) (5,408)
Class A common stock (1997 - 38,947 shares; 1996 - 74,781
shares) (610) (1,365)
----------------------
Total shareholders' equity 478,347 425,828
----------------------
Total liabilities and shareholders' equity $ 691,715 $ 643,033
======================
</TABLE>
These financial statements should be read in conjunction with the Consolidated
Financial Statements and the notes thereto.
S-3
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule II
Statements of Operations
(Parent Company Only)
<TABLE>
<CAPTION>
for the years ended December 31, (in thousands) 1997 1996 1995
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Revenues:
Net investment income $ 263 $ 354 $ 217
Net realized investment gains - 35 4
Management fees 8,977 5,974 350
Other related party income - 263 1,642
-----------------------------------
Total revenues 9,240 6,626 2,213
-----------------------------------
Expenses:
General expenses 9,375 7,082 6,982
Interest expense 15,764 17,039 18,712
-----------------------------------
Total expenses 25,139 24,121 25,694
-----------------------------------
Loss before income taxes and equity in earnings (losses) of subsidiaries (15,899) (17,495) (23,481)
Benefit for income taxes (14,271) (60,345) (13,210)
-----------------------------------
(Loss) income before equity in earnings (losses) of subsidiaries and
extraordinary item (1,628) 42,850 (10,271)
Equity in earnings (losses) of subsidiaries 21,381 (178,184) 34,401
-----------------------------------
Income (loss) before extraordinary item 19,753 (135,334) 24,130
Extraordinary loss from early extinguishment of debt
(net of income tax benefit of $2,549) (4,734) - -
-----------------------------------
Net income (loss) $ 15,019 $ (135,334) $ 24,130
===================================
</TABLE>
These financial statements should be read in conjunction with the
Consolidated Financial Statements and the notes thereto.
S-4
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule II
Statements of Cash Flows
(Parent Company Only)
<TABLE>
<CAPTION>
for the years ended December 31, (in thousands) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Cash Flows From Operating Activities:
Net income (loss) $ 15,019 $(135,334) $ 24,130
Adjustments to reconcile net income to net cash flows provided
by operating activities:
Equity in (earnings) losses of subsidiaries (21,381) 178,184 (34,401)
Net realized investment gains - (35) (4)
Provision (benefit) for deferred income taxes 9,614 (19,822) 7,000
Extraordinary loss from early extingusihment of debt (4,734) - -
Dividends received from subsidiaries 22,500 53,634 103,213
Other, net 5,331 (33,283) (20,384)
-----------------------------------
Net cash flows provided by operating activities 26,349 43,344 79,554
-----------------------------------
Cash Flows From Investing Activities:
Cash contributions to subsidiaries (11,000) (50,000) (61,000)
Sales of fixed maturity investments, net - 45 2,122
Sales (purchases) of equity investments, net - 70 (16)
-----------------------------------
Net cash flows used by investing activities (11,000) (49,885) (58,894)
-----------------------------------
Cash Flows From Financing Activities:
Change in related party receivables and payables (7,952) 10,863 (12,939)
Proceeds from issuance of long-term debt 210,000 26,000 125,000
Repayments of long-term debt (211,571) (25,000) (125,000)
Dividends paid to shareholders (7,965) (7,926) (7,885)
Proceeds from exercised stock options and issuance of Class A
common stock 837 - -
Treasury stock transactions, net 591 (929) 480
Repayments of notes receivable from officers 964 2,734 478
-----------------------------------
Net cash flows (used) provided by financing activities (15,096) 5,742 (19,866)
-----------------------------------
Net increase (decrease) in cash 253 (799) 794
Cash January 1 - 799 5
-----------------------------------
Cash December 31 $ 253 $ - $ 799
===================================
</TABLE>
These financial statements should be read in conjunction with the Consolidated
Financial Statements and the notes thereto.
S-5
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule III
Supplementary Insurance Information
<TABLE>
<CAPTION>
Future policy
benefits, losses, Net
Deferred policy claims, and loss Unearned Premium investment
(in thousands) acquisition costs expenses premiums revenue income(1)
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997:
The Property and Casualty Group $20,010 $1,353,917 $115,998 $212,348 $ 82,098
PMA Re 25,278 622,484 95,457 163,603 52,270
Corporate and Other - 26,786 - - 2,330
- -----------------------------------------------------------------------------------------------------------------------------------
Total $45,288 $2,003,187 $211,455 $375,951 $136,698
===================================================================================================================================
Year ended December 31, 1996:
The Property and Casualty Group $23,488 $1,501,897 $127,986 $268,601 $ 82,455
PMA Re 20,518 589,175 77,996 151,974 48,676
Corporate and Other - - - - 2,805
- -----------------------------------------------------------------------------------------------------------------------------------
Total $44,006 $2,091,072 $205,982 $420,575 $133,936
===================================================================================================================================
Year ended December 31, 1995:
The Property and Casualty Group $20,747 $1,518,163 $124,988 $345,607 $ 92,275
PMA Re 17,154 551,823 67,734 139,345 45,166
Corporate and Other - - - - 1,914
- -----------------------------------------------------------------------------------------------------------------------------------
Total $37,901 $2,069,986 $192,722 $484,952 $139,355
===================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
Benefits, claims, Amortization of Other
losses and settlement deferred policy operating Net premiums
(in thousands) expenses acquisition costs expenses(2) written
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Year ended December 31, 1997:
The Property and Casualty Group $ 193,530 $48,343 $57,206 $240,348
PMA Re 113,931 45,158 11,982 177,934
Corporate and Other (180) - 5,951 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 307,281 $93,501 $75,139 $418,282
==================================================================================================================================
Year ended December 31, 1996:
The Property and Casualty Group $ 424,900 $52,706 $86,003 $279,422
PMA Re 111,937 37,586 8,344 164,053
Corporate and Other (214) - 3,509 -
- -----------------------------------------------------------------------------------------------------------------------------------
Total $ 536,623 $90,292 $97,856 $443,475
===================================================================================================================================
Year ended December 31, 1995:
The Property and Casualty Group $ 319,644 $53,420 $57,486 $337,116
PMA Re 103,947 33,787 7,334 152,760
Corporate and Other (1,013) - 16,341 -
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 422,578 $87,207 $81,161 $489,876
==================================================================================================================================
</TABLE>
(1) Net investment income is based on each segment's invested assets.
(2) Other operating expenses are allocated primarily on the specific
identification basis. When indirect expenses cannot be directly related to
a segment, these expenses are allocated depending on the nature of the
expense.
S-6
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule IV
Reinsurance
<TABLE>
<CAPTION>
Ceded to Percentage of
Direct other Assumed from amount assumed to
(dollar amounts in thousands) Amount companies other companies Net amount net
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Year Ended December 31, 1997:
Premiums:
Property and liability insurance $ 277,871 $ 118,277 $ 216,357 $ 375,951 58%
========= ========= ========= ========= =========
Year Ended December 31, 1996:
Premiums:
Property and liability insurance $ 299,386 $ 88,499 $ 209,688 $ 420,575 50%
========= ========= ========= ========= =========
Year Ended December 31, 1995:
Premiums:
Property and liability insurance $ 370,590 $ 35,476 $ 149,838 $ 484,952 31%
========= ========= ========= ========= =========
</TABLE>
S-7
<PAGE>
<TABLE>
<CAPTION>
Pennsylvania Manufacturers Corporation
Schedule V
Valuation and Qualifying Accounts
Description Balance at beginning of Charged to cost and Deductions - write-offs
period expenses uncollectible accounts
<S> <C> <C> <C>
Year ended December 31, 1997:
Allowance for uncollectible accounts:
Uncollected premiums $18,877 - 471
Year ended December 31, 1996:
Allowance for uncollectible accounts:
Uncollected premiums $16,330 19,532 16,985
Year ended December 31, 1995:
Allowance for uncollectible accounts:
Uncollected premiums $22,402 - 6,072
</TABLE>
<TABLE>
<CAPTION>
Description Balance at end of period
<S> <C>
Year ended December 31, 1997:
Allowance for uncollectible accounts:
Uncollected premiums $18,406
Year ended December 31, 1996:
Allowance for uncollectible accounts:
Uncollected premiums $18,877
Year ended December 31, 1995:
Allowance for uncollectible accounts:
Uncollected premiums $16,330
</TABLE>
S-8
<PAGE>
Pennsylvania Manufacturers Corporation
Schedule VI
Supplemental Information Concerning Property and Casualty Insurance Operations
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Discount on
Reserves for
Reserves for Unpaid Unpaid Claims and
Deferred policy Claims and Claim Claim Adjustment
Affiliation with Registrant acquisition costs Adjustment Expenses Expenses(1) Unearned Premiums Earned Premiums
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Consolidated property-casualty
subsidiaries:
Year Ended December 31, 1997 $45,288 $2,003,187 $ 460,230 $ 211,455 $375,951
Year Ended December 31, 1996 $44,006 $2,091,072 $ 514,248 $ 205,982 $420,575
Year Ended December 31, 1995 $37,901 $2,069,986 $ 587,025 $ 192,722 $484,952
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------------------------------------------------------
Claims and claim adjustment
expenses incurred related to
---------------------------- Amortization of
Net Investment Prior deferred policy Paid claims and Net Premiums
Affiliation with Registrant Income Current Year Years(2) acquisition costs adjustment expenses Written
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Consolidated property-casualty
subsidiaries:
Year Ended December 31, 1997 $134,368 $ 341,880 $(86,006) $93,501 $470,874 $ 418,282
Year Ended December 31, 1996 $131,133 $ 323,069 $156,074 $90,292 $510,621 $ 443,475
Year Ended December 31, 1995 $137,441 $ 357,787 $ 51,491 $87,207 $469,942 $ 489,876
- ----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) - Workers' compensation reserves discounted at approximately 5%.
(2) - Excludes accretion of loss reserve discount of $51,407, $57,480 and
$13,300 in 1997, 1996 and 1995, respectively.
S-9
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, PMA Capital
Corporation certifies that it has reasonable grounds to believe that it meets
all of the requirements for filing on Form S-3 and that it has duly caused this
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the city of Philadelphia, Pennsylvania on January 20, 1999.
PMA CAPITAL CORPORATION
By:/s/ John W. Smithson
--------------------------------------
John W. Smithson, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed below by the following persons in the
capacities and on the dates indicated.
Signature Title Date
- -------------------------- ---------------------------- ------------------
* Chairman of the Board and January 20, 1999
- --------------------------- a Director
Frederick W. Anton, III
/s/ John W. Smithson President, Chief Executive January 20, 1999
- --------------------------- Officer and a Director
John W. Smithson (principal executive officer)
* Senior Vice President, Chief January 20, 1999
- --------------------------- Financial Officer and
Francis W. McDonnell Treasurer (principal financial
and accounting officer)
II-5
<PAGE>
* Director January 20, 1999
- --------------------------
Paul I. Detwiler, Jr.
* Director January 20, 1999
- --------------------------
Joseph H. Foster
* Director January 20, 1999
- --------------------------
Anne S. Genter
* Director January 20, 1999
- --------------------------
James F. Malone, III
* Director January 20, 1999
- --------------------------
A. John May
* Director January 20, 1999
- --------------------------
Louis N. McCarter, III
* Director January 20, 1999
- --------------------------
John W. Miller, Jr.
* Director January 20, 1999
- --------------------------
Edward H. Owlett
* Director January 20, 1999
- --------------------------
Louis I. Pollock
* Director January 20, 1999
- --------------------------
Roderic H. Ross
* Director January 20, 1999
- --------------------------
L.J. Rowell, Jr.
*By: Francis W. McDonnell
---------------------
Attorney-in-Fact
II-6
<PAGE>
Pursuant to the requirements of the Securities Act of 1933, PMC Capital I
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and that it has duly caused this
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the city of Philadelphia, Pennsylvania on January 20, 1999.
PMC CAPITAL I
By PMA Capital Corporation,
as Depositor
By: /s/ Francis W. McDonnell
---------------------------------------
Francis W. McDonnell,
Senior Vice President,
Chief Financial Officer and Treasurer
II-7
<PAGE>
EXHIBIT INDEX
-------------
Exhibit No. Description of Exhibit
----------- --------------------------------------------------------
* 1.1 Form of Underwriting Agreement among the Issuer, the
Company and Goldman, Sachs & Co., Merrill Lynch, Pierce,
Fenner & Smith Incorporated and First Union Capital
Markets as representatives of the Underwriters
3.1 Amended and Restated Articles of Incorporation of the
Company (filed herewith)
*** 3.2 Amended and Restated By-laws of the Company
*** 3.3 Certificate of Trust of the Issuer
*** 3.4 Trust Agreement
***** 3.5 Form of Amended and Restated Trust Agreement
***** 4.1 Form of Indenture between the Company and Bank of New
York as Indenture Trustee
***** 4.2 Form of Capital Security (included in Exhibit 3.5)
***** 4.3 Form of Junior Subordinated Debenture (included in
Exhibit 3.5)
***** 4.4 Form of Guarantee Agreement between the Company and
Bank of New York
* 5.1 Opinion of Duane, Morris & Heckscher LLP re legality of
securities offered hereby
* 5.2 Opinion of Duane, Morris & Heckscher LLP re certain
matters of Delaware and Pennsylvania Law
8.1 Form of Opinion of Duane, Morris & Heckscher LLP re
certain tax matters
** 10.1 Employment Agreement dated April 1, 1995 between the
Company and Frederick W. Anton III
** 10.2 Employment Agreement dated May 1, 1995 between the
Company and John W. Smithson
** 10.3 The PMC EDC Plan Trust Agreement dated as of 1994
** 10.4 The PMC Supplemental Executive Retirement Plan (SERP)
dated July 1995
** 10.5 The Company's Amended and Restated 1987 Incentive Stock
Option Plan
** 10.6 The Company's Amended and Restated 1991 Equity Incentive
Plan
** 10.7 The Company's Amended and Restated 1993 Equity Incentive
Plan
** 10.8 The Company's Amended and Restated 1994 Equity Incentive
Plan
** 10.9 The Company's 1995 Equity Incentive Plan
** 10.10 The Company's 1996 Equity Incentive Plan
** 10.11 Federal Tax Allocation Agreement
** 10.12 Office lease between Nine Penn Center Associates, L.P.,
as Landlord, and Lorjo Corp., as Tenant, covering
premises located at Mellon Bank Center, 1735 Market
Street, Philadelphia, Pennsylvania, dated May 26, 1994
** 10.13 Credit Agreement dated as of March 14, 1997 by and among
the Company, The Bank of New York, First Union National
Bank of North Carolina, Fleet National Bank, PNC Bank,
National Association, Mellon Bank, N.A., CoreStates
Bank, N.A. and Dresdener Bank AG, New York Branch and
Grand Cayman Branch
** 10.14 Master Agreement dated as of February 7, 1997 between
the Company and First Union National Bank of North
Carolina
** 10.15 First Amended and Restated Letter of Credit Agreement by
and among the Company, the Bank of New York, Mellon
Bank, N.A., Fleet Bank, National Association, PNC Bank,
National Association and First Union Bank of North
Carolina
**** 10.16 Amendment No. 1 to Tax Allocation Agreement dated
January 7, 1998
**** 10.17 Caliber One Indemnity Company Purchase Agreement dated
December 15, 1997
**** 11.1 Statement regarding computation of per share earnings
12.1 Statement regarding computation of earnings to fixed
charges (filed herewith)
**** 21.1 Subsidiaries of the Company
23.1 Consent of PricewaterhouseCoopers LLP (filed herewith)
* 23.2 Consent of Duane, Morris & Heckscher LLP (included in
Exhibits 5.1, 5.2 and 8.1)
*** 24.1 Powers of Attorney (included as part of signature pages
to initial filing of this Registration Statement on
September 16, 1998)
***** 25.1 Statement of Eligibility of Bank of New York as to the
Guarantee (Form T-1) (Filed herewith)
***** 25.2 Statement of Eligibility of Bank of New York as to the
Capital Securities (Form T-1) (Filed herewith)
***** 25.3 Statement of Eligibility of Bank of New York as to the
Junior Subordinated Debentures (Form T-1) (Filed
herewith)
**** 27 Financial Data Schedule
______________
* to be filed by Amendment.
** incorporated by reference to like-numbered exhibit in the Company's
Form 10 Registration Statement as filed with the Commission on June 26,
1997.
*** previously filed as part of this registration statement on
September 16, 1998.
**** incorporated by reference to like-numbered exhibit in the Company's
Annual Report on Form 10-K for the year ended December 31, 1997 and/or
the Company's Report on Form 10-Q for the quarter ended September 30,
1998.
***** previously filed as part of Amendment No. 1 to this registration
statement on November 5, 1998.
<PAGE>
Commonwealth of Pennsylvania
Department of State
To All to Whom These Presents Shall Come, Greeting:
Whereas, In and by Article VIII of the Business Corporation Law, approved
the fifth day of May, Anno Domini one thousand nine hundred and thirty-three,
P.L. 364, as amended, the Department of State is authorized and required to
issue a
CERTIFICATE OF AMENDMENT
evidencing the amendment and restatement of the Articles of Incorporation in
their entirety of a business corporation organized under or subject to the
provisions of that Law; and
Whereas, The stipulations and conditions of that Law pertaining to the
amendment of Articles of Incorporation have been fully complied with by
PENNSYLVANIA MANUFACTURERS CORPORATION
Henceforth The "Articles," as defined in Article I of the Business
Corporation Law, shall not include any prior documents;
Therefore, Know Ye, That subject to the Constitution of this Commonwealth
and under authority of the Business Corporation Law, I do by these presents,
which I have caused to be Sealed with the Great Seal of the Commonwealth, extend
the rights and powers of the corporation named above, in accordance with the
terms and provisions of the Articles of Amendment presented by it to the
Department of State, with full power and authority to use and enjoy such rights
and powers, subject to all the provisions and restrictions of the Business
Corporation Law and all other applicable laws of this Commonwealth.
Given under my Hand and the Great Seal of the Commonwealth, at the City of
Harrisburg, this 7th day of May in the year of our Lord one thousand nine
hundred and eighty seven and of the Commonwealth the two hundred eleventh,
/s/ James J. Hagerty
- -----------------------------
Secretary of the Commonwealth
<PAGE>
COMMONWEALTH OF PENNSYLVANIA
DEPARTMENT OF STATE
CORPORATION BUREAU
APPLICANT'S ACCT. NO. Filed this day of May 07 1987
DSCB: BCL-806 (REV. 8-72) Commonwealth of Pennsylvania
Department of State
/s/ James J. Hagerty
Secretary of the Commonwealth
(Box for Certification)
Articles of
Amendment--
Domestic Business Corporation
In compliance with the requirements of section 806 of the Business Corporation
Law, act of May 5, 1933 (P.L.364) (15 P.S. SS.1806), the undersigned
corporation, desiring to amend its Articles, does hereby certify that:
1. The name of the corporation is:
Pennsylvania Manufacturers Corporation
2. The location of its registered office in this Commonwealth is (the Department
of State is hereby authorized to correct the following statement to conform to
the records of the Department):
1021 West Eighth Avenue
-----------------------
(NUMBER) (STREET)
King of Prussia Pennsylvania 19406
--------------------------------------------------------------------
(CITY) (ZIP CODE)
3. The statute by or under which it was incorporated is:
Act of May 5, 1933, P.L. 364, as amended
4. The date of its incorporation is: February 23, 1982
5. (Check, and if appropriate, complete one of the following):
/X/ The meeting of the shareholders of the corporation at which the amendment
was adopted was held at the time and place and pursuant to the kind and period
of notice herein stated.
Time: The 27th day of April, 1987
Place: 925 Chestnut Street, Philadelphia, PA
Kind and period of notice Written notice (Proxy Statement); 30 days
/ / The amendment was adopted by a consent in writing, setting forth the action
so taken, signed by all of the shareholders entitled to vote thereon and filed
with the Secretary of the corporation.
6. At the time of the action of shareholders:
(a) The total number of shares outstanding was:
797,476 shares
(b) The number of shares entitled to vote was:
797,476 shares
<PAGE>
7. In the action taken by the shareholders:
(a) The number of shares voted in favor of the amendment was:
699,557 shares
(b) The number of shares voted against the amendment was:
-0 against; 10,000 abstained
8. The amendment adopted by the shareholders, set forth in full, is as follows:
See Exhibit A attached and incorporated by reference herein for the text of the
Amended and Restated Articles of Incorporation of the Corporation.
IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles of
Amendment to be signed by a duly authorized officer and its corporate seal, duly
attested by another such officer, to be hereunto affixed this 27th day of April,
1987.
PENNSYLVANIA MANUFACTURERS CORPORATION
--------------------------------------
(NAME OF CORPORATION)
Attest:
By: /s/ David L. Johnson By: /s/ Frederick W. Anton
------------------------------- ---------------------------------
(SIGNATURE) (SIGNATURE)
David L. Johnson, Secretary Frederick W. Anton, III, President
- ----------------------------------- ----------------------------------
(TITLE; SECRETARY, (TITLE; PRESIDENT,
ASSISTANT SECRETARY, ETC.) VICE PRESIDENT, ETC.)
(CORPORATE SEAL)
INSTRUCTIONS FOR COMPLETION OF FORM
A. Any necessary copies of Form DSCB:17.2 (Consent to Appropriation of Name) or
Form DSCB: 17.3 (Consent to Use of Similar Name) shall accompany Articles of
Amendment effecting a change of name.
B. Any necessary governmental approvals shall accompany this form.
C. Where action is taken by partial written consent pursuant to the Articles,
the second alternate of Paragraph 5 should be modified accordingly.
D. If the shares of any class were entitled to vote as a class, the number of
shares of each class so entitled and the number of shares of all other
classes entitled to vote should be set forth in Paragraph 6(b).
E. If the shares of any class were entitled to vote as a class, the number of
shares of such class and the number of shares of all other classes voted for
and against such amendment respectively should be set forth in Paragraphs
7(a) and 7(b).
F. BCL Section 807 (15 P.S. Section 1807) requires that the corporation shall
advertise its intention to file or the filing of Articles of Amendment.
Proof of publication of such advertising should not be delivered to the
Department, but should be filed with the minutes of the corporation.
<PAGE>
EXHIBIT A
RESOLVED that, the Articles of Incorporation of Pennsylvania Manufacturers
Corporation shall be amended and restated in their entirety as follows:
AMENDED AND RESTATED ARTICLES OF INCORPORATION
1. The name of the Corporation is Pennsylvania Manufacturers Corporation.
2. The location and post office address of the registered office of the
Corporation in this Commonwealth is 1021 West Eighth Avenue, King of Prussia,
Pennsylvania 19406.
3. The Corporation is incorporated under the Business Corporation Law of
the Commonwealth of Pennsylvania for the following purpose or purposes: The
Corporation shall have unlimited power to engage in and to do any or all lawful
business for which corporations may be incorporated under the Act of Assembly
approved May 5, 1933, P.S. 364, as amended, under which Act the Corporation is
incorporated, including, without limitation of the foregoing, the power to
manufacture, buy, sell, trade and generally deal in products, merchandise, goods
and articles of any kind and description whatsoever.
4. The term for which the Corporation is to exist is perpetual.
5. The aggregate number of shares which the Corporation shall have the
authority to issue is: Two Million (2,000,000) shares of Common Stock, $5.00 par
value per share (the "Common Stock"), and Two Million (2,000,000) shares of
Class A Common Stock, $5.00 par value per share (the "Class A Common Stock").
A. Voting Rights and Powers. Except as otherwise required by the
Pennsylvania Business Corporation Law or as otherwise provided in these Articles
of Incorporation or the By-laws of the Corporation, with respect to all matters
upon which shareholders are entitled to vote or to which shareholders are
entitled to give consent, the holders of the outstanding shares of the Common
Stock and the holders of any outstanding shares of the Class A Common Stock
shall vote together without regard to class, and every holder of the outstanding
shares of the Common Stock shall be entitled to cast thereon ten (10) votes in
person or by proxy for each share of the Common Stock standing in his name, and
every holder of any outstanding shares of the Class A Common Stock shall be
entitled to cast thereon one (1) vote in person or by proxy for each share of
the Class A Common Stock standing in his name. In all elections for directors,
each shareholder is entitled to cumulate his votes. With respect to any proposed
amendment to these Articles of Incorporation which would increase or decrease
the number of authorized shares of either the Common Stock or the Class A Common
Stock, increase or decrease the par value of the shares of the Common Stock or
the Class A Common Stock, or alter or change the powers, preferences, relative
voting power or special rights of the shares of the Common Stock or the Class A
Common Stock so as to affect it 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 the
Common Stock and the Class A Common Stock voting together without regard to
class as hereinbefore provided.
<PAGE>
B. Dividends and Distributions.
(a) Cash Dividends. At any time shares of the Class A Common Stock are
outstanding, as and when cash dividends may be declared by the Board of
Directors, the cash dividend payable on shares of the Class A Common Stock shall
in all cases be at least ten percent (10%) higher on a per share basis than the
cash dividend payable on shares of the Common Stock.
(b) Other Dividends and Distributions. Each share of the Common Stock and
each share of the Class A Common Stock shall be equal in respect of rights to
dividends (other than cash) and distributions, when and as declared, in the form
of stock or other property of the Corporation, except that in the case of
dividends or other distributions payable in stock of the Corporation, including
distributions pursuant to stock split-ups or divisions, which occur after the
date shares of the Class A Common Stock are first issued by the Corporation,
only shares of the Common Stock shall be distributed with respect to the Common
Stock and only shares of Class A Common Stock shall be distributed with respect
to Class A Common Stock.
C. Other Rights. Except as otherwise required by the Pennsylvania Business
Corporation Law or as otherwise provided in these Articles of Incorporation,
each share of the Common Stock and each share of Class A Common Stock shall have
identical powers, preferences and rights, including rights in liquidation.
D. Conversion of the Common Stock. 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 shall 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 Corporation 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 Corporation) by instruments
of transfer, in form satisfactory to the transfer agent and to the Corporation,
duly executed by such holder of 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 shall 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 shall pay to the transfer agent or to the Corporation the
amount of any tax which may be payable in respect of any such transfer, or shall
establish to the satisfaction of the transfer agent or of the Corporation 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 Corporation 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 shall be irrevocable and shall 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 Corporation 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
A-2
<PAGE>
such holder arising from ownership of such shares of Common Stock shall 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 shall
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 shall have and may exercise
all the rights and powers appertaining thereto. No adjustments in respect of
past cash dividends shall be made upon the conversion of any share of Common
Stock; provided, however, that if any shares of Common Stock shall be 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
shall be entitled to receive the cash or stock dividend or the distribution
payable to holders of the Common Stock. The Corporation shall at all times
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 Corporation may deliver shares of Class A Common
Stock which are held in the treasury of the Corporation 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 Corporation 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.
6. Except with respect to shares, rights, options and other securities of
the Corporation 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 Corporation's outstanding Common Stock, the
holders of Common Stock of the Corporation shall be 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, or any securities convertible into, exchangeable for or carrying 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, the preemptive right herein granted shall only be an opportunity to
acquire such shares or other securities under such terms and conditions as the
Board of Directors shall fix. The preemptive right herein granted shall not
apply in any respect to the Corporation's Class A Common Stock, and holders of
such Class A Common Stock, as such, shall have no preemptive rights.
A-3
<PAGE>
Commonwealth of Pennsylvania
Department of State
To All to Whom These Presents Shall Come, Greeting:
Whereas, In and by Article VIII of the Business Corporation Law,
approved the fifth day of May, Anno Domini one thousand nine hundred and
thirty-three, P.L. 364, as amended, the Department of State is authorized and
required to issue a
CERTIFICATE OF AMENDMENT
evidencing the amendment of the Articles of Incorporation of a business
corporation organized under or subject to the provisions of that Law; and
Whereas, The stipulations and conditions of that Law pertaining to the
amendment of Articles of Incorporation have been fully complied with by
PENNSYLVANIA MANUFACTURERS CORPORATION
Therefore, Know Ye, That subject to the Constitution of this
Commonwealth and under the authority of the Business Corporation Law, I do by
these presents, which I have caused to be sealed with the Great Seal of the
Commonwealth, extend the rights and powers of the corporation named above, in
accordance with the terms and provisions of the Articles of Amendment presented
by it to the Department of State, with full power and authority to use and enjoy
such rights and powers, subject to all the provisions and restrictions of the
Business Corporation Law and all other applicable laws of this Commonwealth.
Given under my Hand and the Great Seal of the Commonwealth, at the City
of Harrisburg, this 27th day of April in the year of our Lord one thousand nine
hundred and eighty eight and of the Commonwealth the two hundred twelfth.
/s/ James J. Hagerty
- -----------------------------
Secretary of the Commonwealth
pjd
DSCB-21 (7-73)
<PAGE>
COMMONWEALTH OF PENNSYLVANIA
DEPARTMENT OF STATE
CORPORATION BUREAU
Filed this day of April 27 1988
Commonwealth of Pennsylvania
Department of State
/s/ James J. Hagerty
Secretary of the Commonwealth
(Box for Certification)
Articles of
Amendment--
Domestic Business Corporation
In compliance with the requirements of section 806 of the Business Corporation
Law, act of May 5, 1933 (P.L.364) (15 P.S. SS.1806), the undersigned
corporation, desiring to amend its Articles, does hereby certify that:
1. The name of the corporation is:
Pennsylvania Manufacturers Corporation
2. The location of its registered office in this Commonwealth is (the Department
of State is hereby authorized to correct the following statement to conform to
the records of the Department):
1021 West Eighth Avenue
-----------------------
(NUMBER) (STREET)
King of Prussia Pennsylvania 19406
--------------------------------------------------------------------
(CITY) (ZIP CODE)
3. The statute by or under which it was incorporated is:
Act of May 5, 1933, P.L. 364, as amended
4. The date of its incorporation is: February 23, 1982
5. (Check, and if appropriate, complete one of the following):
/X/ The meeting of the shareholders of the corporation at which the amendment
was adopted was held at the time and place and pursuant to the kind and period
of notice herein stated.
Time: The 25th day of April, 1988
Place: 925 Chestnut Street, Philadelphia, PA
Kind and period of notice Written notice (proxy statement); 30 days
/ / The amendment was adopted by a consent in writing, setting forth the
action so taken, signed by all of the shareholders entitled to vote thereon and
filed with the Secretary of the corporation.
6. At the time of the action of shareholders:
(a) The total number of shares outstanding was:
749,605 shares of Common Stock and 206,511 shares of Class A Common
Stock.
(b) The number of shares entitled to vote was:
749,605 shares of Common Stock (entitled to cast ten votes per share) and
206,511 shares of Class A Common Stock (entitled to cast one vote per
share).
<PAGE>
7. In the action taken by the shareholders:
(a) The number of shares voted in favor of the amendment was:
652,403 shares of Common Stock and 184,675 shares of Class A Common
Stock.
(b) The number of shares voted against the amendment was:
11,680 shares of Common Stock and 2,336 shares of Class A Common Stock.
8. The amendment adopted by the shareholders, set forth in full, is as follows:
RESOLVED, that the first full paragraph of Article 5 of the Articles of
Incorporation of Pennsylvania Manufacturers Corporation shall be amended and
restated in its entirety as follows:
5. The aggregate number of shares which the Corporation shall have
authority to issue is: Ten Million (10,000,000) shares of Common Stock, $5.00
par value per share (the "Common Stock"), and Ten Million (10,000,000) shares
of Class A Common Stock, $5.00 par value per share (the "Class A Common
Stock").
IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles of
Amendment to be signed by a duly authorized officer and its corporate seal, duly
attested by another such officer, to be hereunto affixed this 25th day of April,
1988.
PENNSYLVANIA MANUFACTURERS CORPORATION
--------------------------------------
(NAME OF CORPORATION)
Attest:
By: /s/ David L. Johnson By: /s/ Frederick W. Anton
------------------------------- ---------------------------------
(SIGNATURE) (SIGNATURE)
David L. Johnson, Secretary Frederick W. Anton, III, President
- ----------------------------------- --------------------------------
(TITLE; SECRETARY, (TITLE; PRESIDENT,
ASSISTANT SECRETARY, ETC.) VICE PRESIDENT, ETC.)
(CORPORATE SEAL)
INSTRUCTIONS FOR COMPLETION OF FORM
A. Any necessary copies of Form DSCB:17.2 (Consent to Appropriation of Name) or
Form DSCB: 17.3 (Consent to Use of Similar Name) shall accompany Articles of
Amendment effecting a change of name.
B. Any necessary governmental approvals shall accompany this form.
C. Where action is taken by partial written consent pursuant to the Articles,
the second alternate of Paragraph 5 should be modified accordingly.
D. If the shares of any class were entitled to vote as a class, the number of
shares of each class so entitled and the number of shares of all other
classes entitled to vote should be set forth in Paragraph 6(b).
E. If the shares of any class were entitled to vote as a class, the number of
shares of such class and the number of shares of all other classes voted for
and against such amendment respectively should be set forth in Paragraphs
7(a) and 7(b).
F. BCL Section 807 (15 P.S. Section 1807) requires that the corporation shall
advertise its intention to file or the filing of Articles of Amendment.
Proofs of publication of such advertising should not be delivered to the
Department, but should be filed with the minutes of the corporation.
<PAGE>
Commonwealth of Pennsylvania
Department of State
To All to Whom These Presents Shall Come, Greeting:
Whereas, In and by Article VIII of the Business Corporation Law,
approved the fifth day of May, Anno Domini one thousand nine hundred and
thirty-three, P.L. 364, as amended, the Department of State is authorized and
required to issue a
CERTIFICATE OF AMENDMENT
evidencing the amendment of the Articles of Incorporation of a business
corporation organized under or subject to the provisions of that Law; and
Whereas, The stipulations and conditions of that Law pertaining to the
amendment of Articles of Incorporation have been fully complied with by
PENNSYLVANIA MANUFACTURERS CORPORATION
Therefore, Know Ye, That subject to the Constitution of this
Commonwealth and under the authority of the Business Corporation Law, I do by
these presents, which I have caused to be sealed with the Great Seal of the
Commonwealth, extend the rights and powers of the corporation named above, in
accordance with the terms and provisions of the Articles of Amendment presented
by it to the Department of State, with full power and authority to use and enjoy
such rights and powers, subject to all the provisions and restrictions of the
Business Corporation Law and all other applicable laws of this Commonwealth.
Given under my Hand and the Great Seal of the Commonwealth, at the City
of Harrisburg, this 24th day of April in the year of our Lord one thousand nine
hundred and eighty-nine and of the Commonwealth the two hundred thirteenth.
/s/ James J. Hagerty
- -----------------------------
Secretary of the Commonwealth
cas
DSCB-21 (7-73)
<PAGE>
COMMONWEALTH OF PENNSYLVANIA
DEPARTMENT OF STATE
CORPORATION BUREAU
Filed this day of April 24 1989
Commonwealth of Pennsylvania
Department of State
/s/ James J. Hagerty
Secretary of the Commonwealth
(Box for Certification)
Articles of
Amendment--
Domestic Business Corporation
In compliance with the requirements of section 806 of the Business Corporation
Law, act of May 5, 1933 (P.L.364) (15 P.S. SS.1806), the undersigned
corporation, desiring to amend its Articles, does hereby certify that:
1. The name of the corporation is:
Pennsylvania Manufacturers Corporation
2. The location of its registered office in this Commonwealth is (the Department
of State is hereby authorized to correct the following statement to conform to
the records of the Department):
1021 West Eighth Avenue
-----------------------
(NUMBER) (STREET)
King of Prussia Pennsylvania 19406
--------------------------------------------------------------------
(CITY) (ZIP CODE)
3. The statute by or under which it was incorporated is:
Act of May 5, 1933, P.L. 364, as amended
4. The date of its incorporation is: February 23, 1982
5. (Check, and if appropriate, complete one of the following):
/X/ The meeting of the shareholders of the corporation at which the amendment
was adopted was held at the time and place and pursuant to the kind and period
of notice herein stated.
Time: The 17th day of April, 1989
Place: 925 Chestnut Street, Philadelphia, PA
Kind and period of notice Written notice (proxy statement); 31 days
/ / The amendment was adopted by a consent in writing, setting forth the
action so taken, signed by all of the shareholders entitled to vote thereon and
filed with the Secretary of the corporation.
6. At the time of the action of shareholders:
(a) The total number of shares outstanding was:
805,275 shares of Common Stock and 220,725 shares of Class A common
Stock.
(b) The number of shares entitled to vote was:
805,275 shares of Common Stock (entitled to cast ten votes per share) and
220,725 shares of Class A Common Stock (entitled to cast one vote per
share).
<PAGE>
7. In the action taken by the shareholders:
(a) The number of shares voted in favor of the amendment was:
720,853 shares of Common Stock and 196,822 shares of Class A Common
Stock.
(b) The number of shares voted against the amendment was:
10,000 shares of Common Stock and 2,000 shares of Class A Common Stock.
8. The amendment adopted by the shareholders, set forth in full, is as follows:
RESOLVED, that the first full paragraph of Article 5 of the Articles of
Incorporation of Pennsylvania Manufacturers Corporation shall be amended and
restated in its entirety as follows:
5. The aggregate number of shares which the Corporation shall have
authority to issue is: Twenty Million (20,000,000) shares of Common Stock,
$5.00 par value per share (the "Common Stock"), and Twenty Million
(20,000,000) shares of Class A Common Stock, $5.00 par value per share
(the "Class A Common Stock").
IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles of
Amendment to be signed by a duly authorized officer and its corporate seal, duly
attested by another such officer, to be hereunto affixed this 17th day of April,
1989.
PENNSYLVANIA MANUFACTURERS CORPORATION
--------------------------------------
(NAME OF CORPORATION)
Attest:
By: /s/ David L. Johnson By: /s/ Frederick W. Anton
------------------------------- ---------------------------------
(SIGNATURE) (SIGNATURE)
David L. Johnson, Secretary Frederick W. Anton, III, President
- ----------------------------------- --------------------------------
(TITLE; SECRETARY, (TITLE; PRESIDENT,
ASSISTANT SECRETARY, ETC.) VICE PRESIDENT, ETC.)
(CORPORATE SEAL)
INSTRUCTIONS FOR COMPLETION OF FORM
A. Any necessary copies of Form DSCB:17.2 (Consent to Appropriation of Name) or
Form DSCB: 17.3 (Consent to Use of Similar Name) shall accompany Articles of
Amendment effecting a change of name.
B. Any necessary governmental approvals shall accompany this form.
C. Where action is taken by partial written consent pursuant to the Articles,
the second alternate of Paragraph 5 should be modified accordingly.
D. If the shares of any class were entitled to vote as a class, the number of
shares of each class so entitled and the number of shares of all other
classes entitled to vote should be set forth in Paragraph 6(b).
E. If the shares of any class were entitled to vote as a class, the number of
shares of such class and the number of shares of all other classes voted for
and against such amendment respectively should be set forth in Paragraphs
7(a) and 7(b).
F. BCL Section 807 (15 P.S. Section 1807) requires that the corporation shall
advertise its intention to file or the filing of Articles of Amendment.
Proofs of publication of such advertising should not be delivered to the
Department, but should be filed with the minutes of the corporation.
<PAGE>
ARTICLES OF AMENDMENT-DOMESTIC BUSINESS CORPORATION
In compliance with the requirements of 15 Pa. C.S. ss. 1915 (relating
to articles of amendment), the undersigned business corporation, desiring to
amend its Articles, hereby states that:
1. The name of the corporation is Pennsylvania Manufacturers Corporation
2. The (a) address of this corporation's current registered office in this
Commonwealth or (b) name of its commercial registered office provider and the
county of venue is (the Department is hereby authorized to correct the following
information to conform to the records of the Department):
<TABLE>
<CAPTION>
<S> <C>
(a) 1021 West Eighth Avenue King of Prussia Pennsylvania 19046 Montgomery
-----------------------------------------------------------------------------
Number and Street City State Zip County
(b) c/o:
----------------------------------------------------------------------------
Name of Commercial Registered Office Provider County
</TABLE>
For a corporation represented by a commercial registered office provider, the
county in (b) shall be deemed the county in which the corporation is located for
venue and official publication purposes.
3. The statute by or under which it was incorporated is: Act of Assembly
approved May 5, 1933, P.S. 364
4. The date of its incorporation is: February 23, 1982
5. (Check, and if appropriate complete, one of the following):
X The amendment shall be effective upon filing these Articles of Amendment
in the Department of State.
__ The amendment shall be effective on _________________ at _______________
Date Hour
6. (Check one of the following):
X The amendment was adopted by the shareholders (or members) pursuant to 15
Pa.C.S. ss. 1914(a) and (b).
__ The amendment was adopted by the board of directors pursuant to 15 Pa.
C.S. ss. 1914(c).
7. (Check, and if appropriate complete, one of the following):
__ The amendment adopted by the corporation, set forth in full, as follows:
X The amendment adopted by the corporation as set forth in full in Exhibit A
attached hereto and made a part hereof.
<PAGE>
8. (Check if the amendment restates the Articles):
__ The restated Articles of Incorporation supersede the original Articles and
all amendments thereto.
IN TESTIMONY WHEREOF, the undersigned corporation has caused these
Articles of Amendment to be signed by a duly authorized officer thereof this
22nd day of April 1991.
PENNSYLVANIA MANUFACTURERS CORPORATION
---------------------------------------
(Name of Corporation)
BY: /s/ Frederick W. Anton, III
-------------------------------
Frederick W. Anton, III
TITLE: President
-----------------
<PAGE>
EXHIBIT A
TO ARTICLES OF AMENDMENT OF
PENNSYLVANIA MANUFACTURERS CORPORATION
The first full paragraph of Article 5 of the Articles of Incorporation
of Pennsylvania Manufacturers Corporation is amended and restated to read in its
entirety as follows:
"5. The aggregate number of shares which the Corporation shall
have authority to issue is: Forty Million (40,000,000) shares of Common
Stock, $5.00 par value per share (the "Common Stock"), and Forty
Million (40,000,000) shares of Class A Common Stock, $5.00 par value
per share (the "Class A Common Stock")."
<PAGE>
STATEMENT OF CHANGE OF REGISTERED OFFICE
Indicate type of entity (check one)
X Domestic Business Corporation (15 PA.C.S. ss. 1507)
- ---
Foreign Business Corporation (15 PA.C.S. ss. 4144)
- ---
Domestic Nonprofit Corporation (15 PA.C.S. ss. 5507)
- ---
Foreign Nonprofit Corporation (15 PA.C.S. ss. 6144)
- ---
Domestic Limited Partnership (15 PA.C.S. ss. 8506)
- ---
In compliance with the requirements of the applicable provisions of 15
Pa.C.S. (relating to corporations and unincorporated associations) the
undersigned corporation or limited partnership, desiring to effect a change of
registered office, hereby states that:
1. The name of the corporation or limited partnership is:
Pennsylvania Manufacturers Corporation
----------------------------------------------------------------------------
2. The (a) address of this corporation's or limited partnership's current
registered office in this Commonwealth or (b) name of its commercial
registered office provider and the county of venue is: (the Department is
hereby authorized to correct the following information to conform to the
records of the Department):
(a) 1021 W. Eighth Avenue, King of Prussia PA 19406 Montgomery
------------------------------------------------------------------------
Number and Street City State Zip County
(b) c/o:
--------------------------------------------------------------------
Name of Commercial Registered Office Provider County
For a corporation or a limited partnership represented by a commercial
registered office provider, the county in (b) shall be deemed the county in
which the corporation or limited partnership is located for venue and
official publication purposes.
3. (Complete part (a) or (b)):
(a) The address to which the registered office of the corporation or limited
partnership in this Commonwealth is to be changed is:
380 Sentry Parkway Blue Bell PA 19422-0754 Montgomery
------------------------------------------------------------------------
Number and Street City State Zip County
(b) The registered office of the corporation or limited partnership shall be
provided by:
c/o:
--------------------------------------------------------------------
Name of Commercial Registered Office Provider County
For a corporation or a limited partnership represented by a commercial
registered office provider, the count in (b) shall be deemed the county in
which the corporation or limited partnership is located for venue and
official publication purposes.
<PAGE>
4. (Strike out if a limited partnership): Such change was authorized by the
Board of Directors of the corporation.
IN TESTIMONY WHEREOF, the undersigned corporation or limited partnership has
caused this statement to be signed by a duly authorized officer thereof this
14 day of September, 1974.
--- --------- --
Pennsylvania Manufacturers Corporation
----------------------------------------
(Name of Corporation/Limited Partnership)
BY: /s/ Robert Gaffney
------------------------------------
(Signature)
TITLE: Secretary
---------------------------------
<PAGE>
ARTICLES OF AMENDMENT-DOMESTIC BUSINESS CORPORATION
In compliance with the requirements of 15 Pa.C.S. (section) 1915 (relating
to articles of amendment), the undersigned business corporation, desiring to
amend its Articles, hereby states that:
1. The name of the corporation is: Pennsylvania Manufacturers Corporation
------------------------------------------
- --------------------------------------------------------------------------------
2. The (a) address of this corporation's current registered office in this
Commonwealth or (b) name of its commercial registered office provider and
the county of venue is (the Department is hereby authorized to correct the
following information to conform to the records of the Department):
(a) The PMA Building, 380 Sentry Parkway Blue Bell PA 19422 Montgomery
-----------------------------------------------------------------------
Number and Street City State Zip County
(b) c/o N/A
-----------------------------------------------------------------------
Name of Commercial Registered Office Provider County
For a corporation represented by a commercial registered office provider,
the county in (b) shall be deemed the county in which the corporation is located
for venue and official publication purposes.
3. The statute by or under which it was incorporated is: Act of May 5, 1934,
P.L. 364, as amended
--------------------
4. The date of its incorporation is: February 23, 1982
---------------------------------------
5. (Check, and if appropriate complete, one of the following):
X The amendment shall be effective upon filing these Articles of
--- Amendment in the Department of State.
--- The amendment shall be effective on: at
-------------- ---------------
Date Hour
6. (Check one of the following):
X The amendment was adopted by the shareholders (or members) pursuant to
--- 15 Pa.C.S. (section) 1914(a) and (b).
--- The amendment was adopted by the board of directors pursuant to
15 Pa.C.S. (section) 1914(c).
7. (Check, and if appropriate, complete one of the following):
X The amendment adopted by the corporation, set forth in full,
--- as follows:
Article 7, the full text of which is set forth in its entirety
below, is hereby added to the Amended and Restated Articles of Incorporation of
the Corporation:
"7. Subchapters E, F, G, H, I and J of Chapter 25 and Sections 2538 and
2539 of Subchapter D of Chapter 25 of the Pennsylvania Business Corporation
Law of 1988, as amended, shall not be applicable to the Corporation."
--- The amendment adopted by the corporation is set forth in full in
Exhibit A attached hereto and made a part hereof.
<PAGE>
8. (Check if the amendment restates the Articles):
The restated articles of Incorporation supercede the original
--- Articles and all amendments thereto.
IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles
of Amendment to be signed by a duly authorized officer thereof this
25th day of June , 1997.
- ------------- ------------ ----
Pennsylvania Manufacturers Corporation
--------------------------------------
(Name of Corporation)
BY: /s/ Francis W. McDonnell
-----------------------------------
(Signature)
Francis W. McDonnell, Senior Vice President,
TITLE: Chief Financial Officer and Treasurer
----------------------------------------------
<PAGE>
ARTICLES OF AMENDMENT-DOMESTIC BUSINESS CORPORATION
DSCB:15-1915 (Rev 91)
In compliance with the requirements of 15 Pa.C.S. (S) 1915 (relating to
articles of amendment), the undersigned business corporation, desiring to amend
its Articles, hereby states that:
1. The name of the corporation is: PENNSYLVANIA MANUFACTURERS CORPORATION
--------------------------------------
2. The (a) address of this corporation's current registered office in this
Commonwealth or (b) name of its commercial registered office provider and the
county of venue is (the Department is hereby authorized to correct the
following information to conform to the records of the Department):
<TABLE>
<S> <C>
(a) The PMA Building, 380 Sentry Parkway, Blue Bell, Pennsylvania 19422-2328 Montgomery
-----------------------------------------------------------------------------------
Number and Street City State Zip County
(b) c/o: N/A
-----------------------------------------------------------------------------------
Name of Commercial Registered Office Provider County
</TABLE>
For a corporation represented by a commercial registered office provider, the
county in (b) shall be deemed the county in which the corporation is located for
venue and official publication purposes.
<TABLE>
<S> <C>
3. The statute by or under which it was incorporated is: Act of May 5, 1933, P.L. 364, as amended
----------------------------------------
</TABLE>
4. The date of its incorporation is: February 23, 1982
-----------------
5. (Check, and if appropriate complete, one of the following):
The amendment shall be effective upon filing these Articles of Amendment in
the Department of State.
X The amendment shall be effective on: December 7, 1998 at 12:01 a.m.
---------------- ---------
Date Hour
6. (Check one of the following):
The amendment was adopted by the shareholders (or members) pursuant to 15
Pa.C.S. (S) 1914(a) and (b).
X The amendment was adopted by the board of directors pursuant to 15 Pa.C.S.
(S) 1914(c).
7. (Check, and if appropriate complete, one of the following):
X The amendment adopted by the corporation, set forth in full, is as follows:
Resolved, that Article I of the Articles of Incorporation of the
Corporation is hereby amended in its entirety, to read as follows:
"I. The name of the Corporation is: PMA Capital Corporation."
The amendment adopted by the corporation is set forth in full in Exhibit A
attached hereto and made a part hereof.
<PAGE>
DSCB:15-1915 (Rev 91)-2
8. (Check if the amendment restates the Articles):
The restated Articles of Incorporation supersede the original Articles and
all amendments thereto.
IN TESTIMONY WHEREOF, the undersigned corporation has caused these Articles
of Amendment to be signed by a duly authorized officer thereof this 1st day
-------
of December, 1998.
- -----------------
Pennsylvania Manufacturers Corporation
--------------------------------------
(Name of Corporation)
BY: /s/ Francis W. McDonnell
----------------------------------
(Signature)
Francis W. McDonnell,
TITLE: Senior Vice President, Chief Financial
Officer and Treasurer
-------------------------------
<PAGE>
EXHIBIT 8.1
[AN OPINION SUBSTANTIALLY IN THE FORM BELOW WILL BE DELIVERED
AT CLOSING OF THE TRANSACTION DESCRIBED HEREIN, ASSUMING NO
MATERIAL CHANGE IN THE FACTS OR LAW UPON WHICH SUCH OPINION IS
BASED]
[Letterhead of Duane, Morris & Heckscher LLP]
[Date]
PMA Capital Corporation
1735 Market Street, Suite 2800
Philadelphia, Pennsylvania 19103-7590
Dear Ladies and Gentlemen:
We have acted as counsel to PMA Capital Corporation, a Pennsylvania
corporation ("PMA Capital"), and PMC Capital I, a Delaware statutory business
trust (the "Trust"), in connection with the proposed offering by the Trust of
its Capital Securities, Series A (the "Capital Securities") as described in the
Registration Statement on Form S-1 (the "Registration Statement"), filed by PMA
Capital and the Trust with the Securities and Exchange Commission pursuant to
the Securities Act of 1933, as amended. The Registration Statement includes the
Preliminary Prospectus (the "Prospectus") of PMA Capital and the Trust.
Capitalized terms not defined herein have the meanings specified in the
Prospectus.
In rendering the opinions expressed below, we have examined the Prospectus
and such other documents as we have deemed relevant and necessary, including,
without limitation, the Form of Amended and Restated Trust Agreement, the Form
of Indenture and the Form of Guarantee Agreement, attached as Exhibits to the
Registration Statement. Such opinions are conditioned, among other things, upon
the accuracy and completeness of the facts, information and representations
contained in the Prospectus as of the date hereof and the continuing accuracy
and completeness thereof as of the date of the issuance of the Capital
Securities. We have assumed that the transactions contemplated by the
Prospectus and such other documents will occur as provided therein and that
there will be no material change to the Prospectus or any of such other
documents between the date hereof and the date of the issuance of the Capital
Securities.
<PAGE>
We have assumed the authenticity of all documents submitted to us as
originals, the genuineness of all signatures, the legal capacity of all natural
persons and the conformity with original documents of all copies submitted to us
for our examination. We have also assumed that all obligations imposed by such
documents on the parties thereto are or will be enforceable, and have been or
will be performed or satisfied in accordance with their terms.
In rendering the opinions expressed below, we have considered the
applicable provisions of the Internal Revenue Code of 1986, as amended (the
"Code"), Regulations promulgated thereunder by the United States Treasury
Department (the "Regulations"), pertinent judicial authorities, rulings of the
Internal Revenue Service and such other authorities as we have considered
relevant. It should be noted that the Code, the Regulations and such judicial
decisions, administrative interpretations and other authorities are subject to
change at any time and, in some circumstances, with retroactive effect; and any
such change could affect the opinions stated herein.
Based upon and subject to the foregoing, we are of the opinion that:
(1) Under current law, the Junior Subordinated Debentures held by the Trust
will be classified for United States federal income tax purposes as indebtedness
of PMA Capital;
(2) Under current law, the Trust will be classified for United States
federal income tax purposes as a grantor trust and not as an association taxable
as a corporation; and
(3) The discussion set forth in the Prospectus under the caption "UNITED
STATES FEDERAL INCOME TAX CONSEQUENCES" is our opinion of the material federal
income tax consequences of the purchase, ownership and disposition of the
Capital Securities, based upon current law and the assumptions stated or
referred to therein.
We assume no obligation to update or supplement this letter to reflect any
facts or circumstance which may hereafter come to our attention with respect to
the opinions expressed above, including any changes in applicable law which may
hereafter occur.
We hereby consent to the filing of this letter as an Exhibit to the
Registration Statement and to all references to our Firm included in or made a
part of the Registration Statement and to all references to our Firm included in
or made a part of the Registration Statement.
Very truly yours,
DUANE, MORRIS & HECKSCHER LLP
<PAGE>
Exhibit 12.1
STATEMENT REGARDING COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES (1)
(dollar amounts in thousands)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30, YEAR ENDED DECEMBER 31,
1998 1997 1997 1996 1995 1994 1993
----------- ----------- ------- ---------- ------- ------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
EARNINGS
Pre-tax income $38,100 $14,136 $25,153 $(191,394) $34,913 $65,380 $ 89,621
Fixed charges 12,642 13,482 17,664 19,070 20,231 14,550 13,356
---------------------------------------------------------------------------
Earnings (a) $50,742 $27,618 $42,817 $(172,324) $55,144 $79,930 $102,977
===========================================================================
FIXED CHARGES
Interest expense and amortization of
debt discount and premium on all
indebtedness $11,231 $12,025 $15,768 $ 17,052 $18,734 $13,051 $ 11,650
Interest portion of rental expense 1,411 1,457 1,896 2,018 1,497 1,499 1,706
---------------------------------------------------------------------------
Fixed charges (c) $12,642 $13,482 $17,664 $ 19,070 $20,231 $14,550 $ 13,356
===========================================================================
Ratio of earnings to fixed charges
including net realized investment
gains (a)/(c) 4.0x 2.0x 2.4x (2) 2.7x 5.5x 7.7x
</TABLE>
(1) For purposes of determining this ratio, earnings (loss) consist of income
(loss) before income taxes and extraordinary loss (1997), plus fixed
charges. Fixed charges consist of interest expense and the portion of
operating leases that management believes is representative of the interest
factor.
(2) Earnings were insufficient to cover fixed charges by $191.4 million in
1996.
<PAGE>
EXHIBIT 23.1
[LETTERHEAD OF PRICEWATERHOUSECOOPERS]
CONSENT OF INDEPENDENT ACCOUNTANTS
----------------------------------
We consent to the inclusion in this Registration Statement on Form S-3 of our
reports dated February 6, 1998, on our audits of the consolidated financial
statements and financial statement schedules of PMA Capital Corporation and
subsidiaries as of December 31, 1997 and 1996, and for each of the three years
in the period ended December 31, 1997. We also consent to the reference to our
firm under the captions "Experts."
/s/ PricewaterhouseCoopers LLP
One South Market Square
Harrisburg, Pennsylvania
January 20, 1999
