10-Q 1 pra-20140331x10q.htm 10-Q PRA-2014.03.31-10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
ý
Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2014 or
¨
Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the transition period from              to                          
Commission file number 0-16533
ProAssurance Corporation
(Exact Name of Registrant as Specified in Its Charter)
 
Delaware
63-1261433
(State or Other Jurisdiction of
Incorporation or Organization)
(IRS Employer Identification No.)
 
 
100 Brookwood Place, Birmingham, AL
35209
(Address of Principal Executive Offices)
(Zip Code)
 
 
(205) 877-4400
 
(Registrant’s Telephone Number,
Including Area Code)
(Former Name, Former Address, and Former
Fiscal Year, if Changed Since Last Report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter), during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
 
ý
 
  
Accelerated filer
 
¨
 
 
 
 
 
 
 
 
Non-accelerated filer
 
¨
(Do not check if a smaller reporting company)
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
As of April 28, 2014, there were 59,372,936 shares of the registrant’s common stock outstanding.




Forward-Looking Statements
Any statements in this Form 10-Q that are not historical facts are specifically identified as forward-looking statements. These statements are based upon our estimates and anticipation of future events and are subject to certain risks and uncertainties that could cause actual results to vary materially from the expected results described in the forward-looking statements. Forward-looking statements are identified by words such as, but not limited to, "anticipate," "believe," "estimate," "expect," "hope," "hopeful," "intend," "likely," "may," "optimistic," "possible," "potential," "preliminary," "project," "should," "will" and other analogous expressions. There are numerous factors that could cause our actual results to differ materially from those in the forward-looking statements. Thus, sentences and phrases that we use to convey our view of future events and trends are expressly designated as forward-looking statements as are sections of this Form 10-Q that are identified as giving our outlook on future business.
Forward-looking statements relating to our business include among other things: statements concerning future liquidity and capital requirements, investment valuation and performance, return on equity, financial ratios, net income, premiums, losses and loss reserves, premium rates and retention of current business, competition and market conditions, the expansion of product lines, the development or acquisition of business in new geographical areas, the availability of acceptable reinsurance, actions by regulators and rating agencies, court actions, legislative actions, payment or performance of obligations under indebtedness, payment of dividends, and other matters.
These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following factors that could affect the actual outcome of future events:
Ÿ
changes in general economic conditions, including the impact of inflation or deflation and unemployment;
Ÿ
our ability to maintain our dividend payments;
Ÿ
regulatory, legislative and judicial actions or decisions that could affect our business plans or operations;
Ÿ
the enactment or repeal of tort reforms;
Ÿ
formation or dissolution of state-sponsored medical professional liability insurance entities that could remove or add sizable groups of physicians from or to the private insurance market;
Ÿ
changes in the interest rate environment;
Ÿ
changes in U.S. laws or government regulations regarding financial markets or market activity that may affect the U.S. economy and our business;
Ÿ
changes in the ability of the U.S. government to meet its obligations that may affect the U.S. economy and our business;
Ÿ
performance of financial markets affecting the fair value of our investments or making it difficult to determine the value of our investments;
Ÿ
changes in requirements or accounting policies and practices that may be adopted by our regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission (SEC), the Public Company Accounting Oversight Board, or the New York Stock Exchange (NYSE) and that may affect our business;
Ÿ
changes in laws or government regulations affecting the financial services industry, the property and casualty insurance industry or particular insurance lines underwritten by our subsidiaries;
Ÿ
the effects of changes in the healthcare delivery system, including but not limited to the Patient Protection and Affordable Care Act (the Healthcare Reform Act);
Ÿ
consolidation of healthcare providers resulting in entities that are more likely to self insure a substantial portion of their healthcare professional liability risk;
Ÿ
uncertainties inherent in the estimate of loss and loss adjustment expense reserves and reinsurance;
Ÿ
changes in the availability, cost, quality or collectability of insurance/reinsurance;
Ÿ
the results of litigation, including pre- or post-trial motions, trials and/or appeals we undertake;
Ÿ
allegation of bad faith which may arise from our handling of any particular claim, including failure to settle;
Ÿ
loss or consolidation of independent agents, agencies, brokers or brokerage firms;
Ÿ
changes in our organization, compensation and benefit plans;
Ÿ
changes in the business or competitive environment may limit the effectiveness of our business strategy and impact our revenues;
Ÿ
our ability to retain and recruit senior management;
Ÿ
the availability, integrity and security of our technology infrastructure;
Ÿ
the impact of a catastrophic event, as it relates to both our operations and our insured risks;

2


Ÿ
the impact of acts of terrorism and acts of war;
Ÿ
the effects of terrorism related insurance legislation and law;
Ÿ
assessments from guaranty funds;
Ÿ
our ability to achieve continued growth through expansion into other states or through acquisitions or business combinations;
Ÿ
changes to the ratings assigned by rating agencies to our insurance subsidiaries, individually or as a group;
Ÿ
provisions in our charter documents, Delaware law and state insurance laws may impede attempts to replace or remove management or may impede a takeover;
Ÿ
state insurance restrictions may prohibit assets held by our insurance subsidiaries, including cash and investment securities, from being used for general corporate purposes;
Ÿ
taxing authorities can take exception to our tax positions and cause us to incur significant amounts of legal and accounting costs and, if our defense is not successful, additional tax costs, including interest and penalties; and
Ÿ
expected benefits from completed and proposed acquisitions may not be achieved or may be delayed longer than expected due to business disruption; loss of customers, employees and key agents; increased operating costs or inability to achieve cost savings; and assumption of greater than expected liabilities, among other reasons.
Additional risks that could adversely affect the integration of Eastern Insurance Holdings, Inc. (Eastern) into ProAssurance, include, but are not limited to, the following:
Ÿ
the operations of ProAssurance and Eastern may not be integrated successfully, or such integration may take longer to accomplish than expected; and
Ÿ
operating costs, customer loss and business disruption following the transaction, including adverse effects on relationships with employees, may be greater than expected.
Additional risks that could arise from our membership in the Lloyd's of London market (Lloyd's) and our participation in Lloyd's Syndicate 1729 (Syndicate 1729) include, but are not limited to, the following:
Ÿ
members of Lloyd's are subject to levies by the Council of Lloyd's based on a percentage of the member's underwriting capacity, currently a maximum of 3%, but can be increased Lloyd's;
Ÿ
Syndicate operating results can be affected by decisions made by the Council of Lloyd's over which the management of Syndicate 1729 has little ability to control, such as a decision to not approve the business plan of the Syndicate, or a decision to increase the capital required to continued operations, and by our obligation to pay levies to Lloyd's;
Ÿ
Lloyd's insurance and reinsurance relationships and distribution channels could be disrupted or Lloyd's trading licenses could be revoked making it more difficult for Syndicate 1729 to distribute and market its products; and
Ÿ
rating agencies could downgrade their ratings of Lloyd's as a whole.
Our results may differ materially from those we expect and discuss in any forward-looking statements. The principal risk factors that may cause these differences are described in "Item 1A, Risk Factor" in our Form 10-K and other documents we file with the Securities and Exchange Commission, such as our current reports on Form 8-K, and our regular reports on Form 10-Q.
We caution readers not to place undue reliance on any such forward-looking statements, which are based upon conditions existing only as of the date made, and advise readers that these factors could affect our financial performance and could cause actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. Except as required by law or regulations, we do not undertake and specifically decline any obligation to publicly release the result of any revisions that may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

3


 
 
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

4


ProAssurance Corporation and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except share data)
 
March 31,
2014
 
December 31,
2013
Assets
 
 
 
Investments
 
 
 
Fixed maturities, available for sale, at fair value; amortized cost, $3,147,859 and $3,026,256, respectively
$
3,256,180

 
$
3,118,049

Equity securities, trading, at fair value; cost, $241,221 and $203,308, respectively
278,514

 
253,541

Short-term investments
161,507

 
248,605

Business owned life insurance
54,820

 
54,374

Investment in unconsolidated subsidiaries
235,220

 
214,236

Other investments
88,722

 
52,240

Total Investments
4,074,963

 
3,941,045

Cash and cash equivalents
296,243

 
129,383

Restricted Cash

 
78,000

Premiums receivable
204,090

 
115,403

Receivable from reinsurers on paid losses and loss adjustment expenses
8,942

 
3,231

Receivable from reinsurers on unpaid losses and loss adjustment expenses
265,995

 
247,518

Prepaid reinsurance premiums
27,098

 
21,449

Deferred policy acquisition costs
41,171

 
28,207

Deferred tax asset

 
1,757

Real estate, net
40,651

 
41,010

Intangible assets
108,402

 
52,002

Goodwill
210,725

 
161,115

Other assets
127,224

 
329,979

Total Assets
$
5,405,504

 
$
5,150,099

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Policy liabilities and accruals
 
 
 
Reserve for losses and loss adjustment expenses
$
2,204,347

 
$
2,072,822

Unearned premiums
366,170

 
255,463

Reinsurance premiums payable
42,113

 
34,321

Total Policy Liabilities
2,612,630

 
2,362,606

Deferred tax liability
24,231

 

Other liabilities
166,661

 
143,079

Long-term debt, at amortized cost
250,000

 
250,000

Total Liabilities
3,053,522

 
2,755,685

Shareholders’ Equity
 
 
 
Common shares, par value $0.01 per share, 100,000,000 shares authorized, 62,269,362 and 62,096,787 shares issued, respectively
623

 
621

Additional paid-in capital
351,548

 
349,894

Accumulated other comprehensive income (loss), net of deferred tax expense (benefit) of $37,676 and $32,127, respectively
70,406

 
59,661

Retained earnings
2,044,428

 
2,015,603

 
2,467,005

 
2,425,779

Treasury shares, at cost, 2,738,289 shares and 900,281 shares, respectively
(115,023
)
 
(31,365
)
Total Shareholders’ Equity
2,351,982

 
2,394,414

Total Liabilities and Shareholders’ Equity
$
5,405,504

 
$
5,150,099

See accompanying notes.

5


ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Changes in Capital (Unaudited)
(In thousands)
 
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Treasury Stock
 
Total
Balance at December 31, 2013
$
621

 
$
349,894

 
$
59,661

 
$
2,015,603

 
$
(31,365
)
 
$
2,394,414

Common shares reacquired

 

 

 

 
(83,658
)
 
(83,658
)
Common shares issued for compensation

 
1,416

 

 

 

 
1,416

Share-based compensation

 
3,240

 

 

 

 
3,240

Net effect of restricted and performance shares issued and stock options exercised
2

 
(3,002
)
 

 

 

 
(3,000
)
Dividends to shareholders

 

 

 
(17,906
)
 

 
(17,906
)
Other comprehensive income (loss)

 

 
10,745

 

 

 
10,745

Net income

 

 

 
46,731

 

 
46,731

Balance at March 31, 2014
$
623

 
$
351,548

 
$
70,406

 
$
2,044,428

 
$
(115,023
)
 
$
2,351,982

 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Treasury Stock
 
Total
Balance at December 31, 2012
$
619

 
$
341,780

 
$
145,380

 
$
1,782,857

 
$
(56
)
 
$
2,270,580

Common shares issued for compensation

 
1,939

 

 

 

 
1,939

Share-based compensation

 
2,282

 

 

 

 
2,282

Net effect of restricted and performance shares issued and stock options exercised
2

 
(3,411
)
 

 

 

 
(3,409
)
Dividends to shareholders

 

 

 
(15,445
)
 

 
(15,445
)
Other comprehensive income (loss)

 

 
(7,754
)
 

 

 
(7,754
)
Net income

 

 

 
112,850

 

 
112,850

Balance at March 31, 2013
$
621

 
$
342,590

 
$
137,626

 
$
1,880,262

 
$
(56
)
 
$
2,361,043

See accompanying notes.

6


ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Income and Comprehensive Income (Unaudited)
(In thousands, except per share data)
 
Three Months Ended March 31
 
2014
 
2013
Revenues
 
 
 
Net premiums earned
$
171,730

 
$
134,578

Net investment income
29,732

 
32,126

Equity in earnings (loss) of unconsolidated subsidiaries
1,751

 
(223
)
Net realized investment gains (losses):
 
 
 
Other-than-temporary impairment (OTTI) losses
(50
)
 

Portion of OTTI losses recognized in (reclassified from) other comprehensive income before taxes

 

Net impairment losses recognized in earnings
(50
)
 

Other net realized investment gains (losses)
2,794

 
26,680

Total net realized investment gains (losses)
2,744

 
26,680

Other income
2,094

 
1,813

Total revenues
208,051

 
194,974

Expenses
 
 
 
Losses and loss adjustment expenses
96,052

 
60,887

Reinsurance recoveries
(6,544
)
 
(3,261
)
Net losses and loss adjustment expenses
89,508

 
57,626

Underwriting, policy acquisition and operating expenses
52,515

 
37,285

Segregated portfolio cells dividend expense
1,049

 

Interest expense
3,570

 
371

Total expenses
146,642

 
95,282

Gain on acquisition

 
35,492

Income before income taxes
61,409

 
135,184

Provision for income taxes
 
 
 
Current expense (benefit)
7,905

 
7,775

Deferred expense (benefit)
6,773

 
14,559

Total income tax expense (benefit)
14,678

 
22,334

Net income
$
46,731

 
$
112,850

Other comprehensive income (loss), after tax, net of reclassification adjustments
10,745

 
(7,754
)
Comprehensive income
$
57,476

 
$
105,096

Earnings per share:
 
 
 
Basic
$
0.76

 
$
1.83

Diluted
$
0.76

 
$
1.82

Weighted average number of common shares outstanding:
 
 
 
Basic
61,251

 
61,708

Diluted
61,497

 
61,963

Cash dividends declared per common share
$
0.30

 
$
0.25

See accompanying notes.

7


ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
 
Three Months Ended March 31
 
2014
 
2013
Operating Activities
 
 
 
Net income
$
46,731

 
$
112,850

Adjustments to reconcile income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
11,587

 
12,318

Gain on acquisition

 
(35,492
)
Net realized investment gains
(2,744
)
 
(26,680
)
Share-based compensation
3,240

 
2,282

Deferred income taxes
6,773

 
14,559

Policy acquisition costs, net amortization (net deferral)
(2,370
)
 
(3,163
)
Other
2,057

 
(6,304
)
Other changes in assets and liabilities, excluding effect of business combinations:
 
 
 
Premiums receivable
(16,698
)
 
(13,098
)
Reinsurance related assets and liabilities
(12,609
)
 
9,099

Other assets
(1,803
)
 
(26,119
)
Reserve for losses and loss adjustment expenses
(20,230
)
 
(37,064
)
Unearned premiums
30,439

 
20,025

Other liabilities
(13,938
)
 
(36,320
)
Net cash provided (used) by operating activities
30,435

 
(13,107
)
Investing Activities
 
 
 
Purchases of:
 
 
 
Fixed maturities, available for sale
(130,311
)
 
(100,826
)
Equity securities, trading
(20,976
)
 
(26,983
)
Other investments
(5,246
)
 
(3,616
)
Funding of tax credit limited partnerships
(1,811
)
 
(30,167
)
Investment in unconsolidated subsidiaries
(8,995
)
 
(6,614
)
Proceeds from sales or maturities of:
 
 
 
Fixed maturities, available for sale
110,647

 
173,007

Equity securities, trading
62,786

 
26,509

Other investments
397

 
1,364

Net sales or maturities (purchases) of short-term investments
110,843

 
(76,697
)
Cash received from acquisitions
35,013

 
22,780

Unsettled security transactions, net
4,024

 
18,478

(Increase) decrease in restricted cash
78,000

 

Other
4,968

 
(1,047
)
Net cash provided (used) by investing activities
239,339

 
(3,812
)
Continued on following page.
 
 
 

8


 
Three Months Ended March 31
 
2014
 
2013
Financing Activities
 
 
 
Repurchase of common stock
(78,976
)
 

Dividends to shareholders
(18,358
)
 

Other
(5,580
)
 
(6,802
)
Net cash provided (used) by financing activities
(102,914
)
 
(6,802
)
Increase (decrease) in cash and cash equivalents
166,860

 
(23,721
)
Cash and cash equivalents at beginning of period
129,383

 
118,551

Cash and cash equivalents at end of period
$
296,243

 
$
94,830

 
 
 
 
Significant non-cash transactions
 
 
 
Deposit transferred as consideration for acquisition
$
205,244

 
$
153,700

See accompanying notes.

9

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014


1. Basis of Presentation
The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of ProAssurance Corporation and its consolidated subsidiaries (ProAssurance, PRA or the Company). The financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation, consisting of normal recurring adjustments, have been included. ProAssurance’s results for the three-month period ended March 31, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. The accompanying Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes contained in ProAssurance’s December 31, 2013 report on Form 10-K. In connection with its preparation of the Condensed Consolidated Financial Statements, ProAssurance evaluated events that occurred subsequent to March 31, 2014 for recognition or disclosure in its financial statements and notes to financial statements.
ProAssurance operates in four reportable segments as follows: Specialty Property and Casualty (Specialty P&C), Workers' Compensation, Lloyd's Syndicate, and Corporate. For more information on the nature of products and services provided and for financial information by segment, refer to Note 13 of the Notes to Condensed Consolidated Financial Statements.
Reclassifications
As of March 31, 2014, unearned ceding commissions are reported as an offset to Deferred policy acquisition costs on the Condensed Consolidated Balance Sheet, and the December 31, 2013 Condensed Consolidated Balance Sheet has been conformed to the current presentation. Previously, unearned ceding commissions ($0.8 million at December 31, 2013) were reported in Unearned premiums. Also, ceding commission income earned for the three months ended March 31, 2014 and 2013 has been reported as an offset to DPAC amortization (see Note 6) which lowered DPAC amortization as previously reported for the three months ended March 31, 2013 by $1.2 million. Total underwriting, policy acquisition and operating expense for the 2014 and 2013 three month periods was not affected by the change in presentation.
Intangible Assets
Intangible assets with definite lives are amortized over the estimated useful life of the asset. Amortizable intangible assets primarily consist of agency and policyholder relationships, renewal rights and trade names and had a carrying value of $82.6 million at March 31, 2014 and $35.2 million at December 31, 2013. Intangible assets with an indefinite life, primarily state licenses, are not amortized and had carrying values of $25.8 million at March 31, 2014 and $16.8 million at December 31, 2013. Increases in both amortizable and non-amortizable intangible assets during 2014 were attributable to intangible assets purchased in the Eastern acquisition. Intangible assets are evaluated for impairment on an annual basis.
Amortization expense for intangible assets for the three months ended March 31, 2014 and 2013 was $2.6 million and $1.3 million, respectively. Aggregate amortization expense for intangible assets over the next five years is estimated to be $7.7 million for the remainder of 2014, $8.3 million for 2015, $8.0 million for 2016, $5.7 million for 2017 and $5.3 million for 2018.
Other Assets and Other Liabilities
At December 31, 2013, Other assets was principally comprised of a deposit with an intermediate third-party of $205 million, related to the completion of the Eastern Insurance Holdings, Inc. (Eastern) acquisition which closed on January 1, 2014. See Note 2.
At March 31, 2014, Other liabilities included $16.9 million in segregated portfolio cell (SPC) dividends payable related to our recently acquired Workers' Compensation segment. The SPC dividend payable represents the cumulative undistributed earnings of segregated portfolio cells that are contractually payable to external preferred shareholders of the cells.

10

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

Accounting Policies Acquired
The significant accounting policies adopted as a result of the acquisition of Eastern on January 1, 2014 and followed by ProAssurance in making estimates that materially affect financial reporting are summarized in these Notes to the Condensed Consolidated Financial Statements.
Recognition of Revenues
Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the policyholders’ records is conducted after policy expiration to make a final determination of applicable premiums. Audit premium due from or due to a policyholder as a result of an audit is reflected in net premiums earned when billed. In addition, ProAssurance estimates earned but unbilled ("EBUB") premiums by tracking by policy, how much additional premium is billed in final audit invoices as a percentage of payroll exposure to estimate the probable additional amount that it has earned, but not yet billed, as of the balance sheet date. The EBUB premium estimate is included in net premiums earned. As of March 31, 2014, ProAssurance carried earned but unbilled premiums of $3.0 million as a part of Premiums receivable.
Convertible Bond Securities
Investments in convertible bond securities are considered hybrid financial instruments and are carried at estimated fair value, with changes in estimated fair value reported as a realized gain or loss in the Condensed Consolidated Statements of Income and Comprehensive Income.
Accounting Changes Not Yet Adopted
Presentation of Financial Statements and Property, Plant and Equipment-Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity
Effective for fiscal years beginning after December 15, 2014, the Financial Accounting Standards Board (FASB) issued guidance which changes the requirements for reporting discontinued operations. Under the new guidance, reporting entities are required to report disposals of business components only if the disposal represents a strategic shift in the entity’s operations that will have a major effect on the entity’s operations and financial results. The new guidance expands disclosure requirements for reported discontinued operations and requires disclosure of pre-tax profit or loss attributable to significant disposals that are not reported as discontinued operations. ProAssurance plans to adopt the guidance beginning January 1, 2015. Adoption of the guidance is expected to have no effect on ProAssurance’s results of operations or financial position.
Investments-Equity Method and Joint Ventures-Accounting for Investments in Qualified Affordable Housing Projects
Effective for fiscal years beginning after December 15, 2014, the FASB issued guidance which permits but does not require qualified reporting entities to use a new accounting method, the proportional amortization method, for investments in qualified affordable housing projects. Under the new method the initial cost of an investment is amortized in proportion to the tax benefits received, and investment performance is recognized as a component of income tax expense (benefit) rather than as a component of investment income. ProAssurance is in the process of evaluating whether it meets the qualification requirements for using the new method and the effect that the use of the new method would have on its results of operations and financial position. If ProAssurance elects to adopt the guidance, the adoption will occur beginning January 1, 2015.

11

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

Accounting Changes Adopted
Liabilities-Obligations Resulting from Joint and Several Liability Arrangements
Effective for fiscal years beginning after December 15, 2013, the FASB revised guidance related to obligations resulting from joint and several liability arrangements. The new guidance requires an entity to recognize, measure and disclose obligations resulting from joint and several liability arrangements for which the total amount of the obligation is fixed at the reporting date, except for obligations already addressed within existing GAAP guidance, with retrospective application required for such arrangements existing at the beginning of the fiscal year of adoption. ProAssurance adopted the guidance on January 1, 2014. Adoption of this guidance had no effect on ProAssurance's results of operations or financial position.
Income Taxes-Presentation of Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists
Effective for fiscal years beginning after December 15, 2013, the FASB issued guidance related to the financial statement presentation of unrecognized tax benefits. The new guidance requires an entity to present unrecognized tax benefits as a reduction to a deferred tax asset resulting from a net operating loss carryforward, a similar tax loss, or tax credit carryforward except in circumstances where the relevant taxing authority does not permit offset or does not require offset and the entity does not intend to use the deferred tax asset for offset. The guidance requires prospective application for all unrecognized tax benefits that exist as of the effective date, but may be applied retrospectively. ProAssurance adopted the guidance prospectively on January 1, 2014. Adoption of this guidance had no material effect on ProAssurance's results of operations or financial position.

12

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

2. Business Combinations
All entities acquired in 2014 were accounted for in accordance with GAAP relating to business combinations.
On January 1, 2014, ProAssurance completed the acquisition of Eastern (NASDAQ: EIHI) by purchasing 100% of its outstanding common shares for cash of $205 million. Eastern is based in Lancaster, Pennsylvania and specializes in workers' compensation insurance and reinsurance products and services, including alternative market solutions. ProAssurance incurred expenses related to the purchase of approximately $1.5 million during the first three months of 2014 and approximately $0.9 million during the year ended December 31, 2013. These expenses were included as a part of operating expenses in the periods incurred.
The purchase consideration for Eastern was allocated to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. Goodwill of $49.6 million was recognized equal to the excess of the purchase price over the net fair value of identifiable assets acquired and liabilities assumed. Factors contributing to the recognition of goodwill include strategic and synergistic benefits that are expected to be realized as a result of the acquisition. These benefits include insurance market diversification, expanded access to alternative markets, and opportunities to reach additional insureds in the healthcare market by being a single source provider of a suite of insurance products. None of the goodwill is expected to be tax deductible. The allocation of purchase consideration is shown in the table below.
(In thousands)
 
 
Fixed maturities, available for sale
 
$
111,222

Equity securities, trading
 
66,267

Cash and short-term investments
 
54,869

Other investments
 
41,795

Premiums receivable
 
71,989

Receivable from reinsurers on paid and unpaid losses and LAE
 
18,942

Intangible assets
 
59,000

Deferred policy acquisition costs (see discussion below)
 
10,593

Other assets
 
19,225

Reserve for losses and loss adjustment expenses
 
(151,755
)
Unearned premiums
 
(80,268
)
Ceded balances payable
 
(9,507
)
Segregated portfolio cells dividends payable
 
(15,866
)
Deferred tax liabilities
 
(12,835
)
Other liabilities
 
(28,038
)
Fair value of net assets acquired
 
$
155,633

Goodwill
 
49,610

Total purchase consideration
 
$
205,243

Intangible assets acquired included the following:
(In millions)
Estimated Fair Value on Acquisition Date
 
Estimated Useful Life
Agency relationships
$27.0
 
15
Policyholder relationships
$8.0
 
15
Trade names
$8.0
 
15
Non-compete agreements
$7.0
 
3
Total intangibles subject to amortization
$50.0
 
13
*
Insurance license agreements
$9.0
 
Indefinite
* Reflects the weighted average estimated useful life of all intangible assets subject to
amortization.
ProAssurance's fair value estimate of the value of business acquired (VOBA), calculated as the present value of future earnings expected from the insurance contracts acquired, approximated the carrying value of Eastern's asset for deferred policy

13

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

acquisition costs as of the acquisition date. Consequently, Eastern's asset for deferred policy acquisition costs was recognized in the purchase price allocation, as listed above, in lieu of recognizing an intangible asset for VOBA.
ProAssurance believes that all contractual cash flows related to acquired receivables will be collected. The fair value of reserves for losses and loss adjustment expenses and related reinsurance recoverables were based on the following three components: an actuarial estimate of the expected future net cash flows, a reduction of those cash flows for the time value of money determined utilizing the U.S. Treasury Yield Curve, and a risk adjustment to reflect the net present value of profit that an investor would demand in return for the assumption of the development risk associated with the reserves. The fair value of the reserves, reflecting the risk margin, exceeded the undiscounted loss reserve previously established by Eastern by $9.3 million; this fair value adjustment will be amortized over the average expected life of the reserves of 6 years as a reduction to loss expenses.
The following table provides Pro Forma Consolidated Results for the three months ended March 31, 2014 and 2013 as if the Eastern transaction had occurred on January 1, 2013. ProAssurance Actual Consolidated Results have been adjusted by the following, net of related tax effects, to reflect the Pro Forma Consolidated Results below.
For the three months ended March 31, 2013, the ProAssurance 2013 Actual Consolidated Results, which did not include Eastern, have been adjusted to include Eastern's 2013 operating results. ProAssurance Actual Consolidated Results for the three months ended March 31, 2014 included Eastern's operating results (Revenue of $48.3 million and Net income of $3.0 million).
Certain costs included in ProAssurance actual results for the three months ended March 31, 2014 have been reported in the Pro Forma Consolidated Results as if the costs had been incurred for the three months ended March 31, 2013. Such costs include direct transaction costs and certain compensation costs directly related to the integration of Eastern operations.
Actual Consolidated Results for the three months ended March 31, 2013, were reduced to reflect amortization of intangible assets and debt security premiums and discounts recorded as a part of the Eastern purchase price allocation.
 
Three Months Ended March 31, 2014
(In thousands)
ProAssurance
Pro Forma
Consolidated
Results
 
ProAssurance
Actual
Consolidated Results
Revenue
$208,051
 
$208,051
Net income
$47,695
 
$46,731
 
 
 
 
 
Three Months Ended March 31, 2013
(In thousands)
ProAssurance
Pro Forma
Consolidated
Results
 
ProAssurance
Actual
Consolidated Results
Revenue
$239,139
 
$194,974
Net income
$114,260
 
$112,850

14

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

3. Fair Value Measurement
Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three level hierarchy has been established for valuing assets and liabilities based on how transparent (observable) the inputs are that are used to determine fair value, with the inputs considered most observable categorized as Level 1 and those that are the least observable categorized as Level 3. Hierarchy levels are defined as follows:
 
Level 1:
quoted (unadjusted) market prices in active markets for identical assets and liabilities. For ProAssurance, Level 1 inputs are generally quotes for debt or equity securities actively traded in exchange or over-the-counter markets.
 
Level 2:
market data obtained from sources independent of the reporting entity (observable inputs). For ProAssurance, Level 2 inputs generally include quoted prices in markets that are not active, quoted prices for similar assets or liabilities, and results from pricing models that use observable inputs such as interest rates and yield curves that are generally available at commonly quoted intervals.
 
Level 3:
the reporting entity’s own assumptions about market participant assumptions based on the best information available in the circumstances (non-observable inputs). For ProAssurance, Level 3 inputs are used in situations where little or no Level 1 or 2 inputs are available or are inappropriate given the particular circumstances. Level 3 inputs include results from pricing models for which some or all of the inputs are not observable, discounted cash flow methodologies, single non-binding broker quotes and adjustments to externally quoted prices that are based on management judgment or estimation.
Fair values of assets measured at fair value on a recurring basis as of March 31, 2014 and December 31, 2013, including financial instruments for which ProAssurance has elected fair value, are shown in the following tables. The tables also indicate the fair value hierarchy of the valuation techniques utilized to determine those fair values. For some assets, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When this is the case, the asset is categorized based on the level of the most significant input to the fair value measurement. Assessments of the significance of a particular input to the fair value measurement require judgment and consideration of factors specific to the assets being valued.

15

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

 
March 31, 2014
 
Fair Value Measurements Using
 
Total
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Fair Value
Assets:
 
 
 
 
 
 
 
Fixed maturities, available for sale
 
 
 
 
 
 
 
U.S. Treasury obligations
$

 
$
184,447

 
$

 
$
184,447

U.S. Government-sponsored enterprise obligations

 
37,977

 
999

 
38,976

State and municipal bonds

 
1,163,727

 
7,490

 
1,171,217

Corporate debt, multiple observable inputs

 
1,398,607

 

 
1,398,607

Corporate debt, limited observable inputs:
 
 
 
 
 
 

Other corporate debt, NRSRO ratings available

 

 
11,708

 
11,708

Other corporate debt, NRSRO ratings not available

 

 
673

 
673

Residential mortgage-backed securities

 
287,697

 

 
287,697

Agency commercial mortgage-backed securities

 
22,631

 

 
22,631

Other commercial mortgage-backed securities

 
62,951

 

 
62,951

Other asset-backed securities

 
70,047

 
7,226

 
77,273

Equity securities
 
 
 
 
 
 

Financial
71,109

 

 

 
71,109

Utilities/Energy
25,179

 

 

 
25,179

Consumer oriented
57,173

 

 

 
57,173

Industrial
48,042

 

 

 
48,042

Fixed maturity investment funds
42,683

 

 

 
42,683

All other
34,328

 

 

 
34,328

Short-term investments
157,283

 
4,224

 

 
161,507

Financial instruments carried at fair value, classified as a part of:
 
 
 
 
 
 
 
Investment in unconsolidated subsidiaries

 

 
91,907

 
91,907

Other investments
6,016

 
25,602

 

 
31,618

Total assets
$
441,813

 
$
3,257,910

 
$
120,003

 
$
3,819,726


16

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

 
December 31, 2013
 
Fair Value Measurements Using
 
Total
(In thousands)
Level 1
 
Level 2
 
Level 3
 
Fair Value
Assets:
 
 
 
 
 
 
 
Fixed maturities, available for sale
 
 
 
 
 
 
 
U.S. Treasury obligations
$

 
$
170,714

 
$

 
$
170,714

U.S. Government-sponsored enterprise obligations

 
32,768

 

 
32,768

State and municipal bonds

 
1,147,328

 
7,338

 
1,154,666

Corporate debt, multiple observable inputs

 
1,346,977

 

 
1,346,977

Corporate debt, limited observable inputs:
 
 
 
 
 
 

Other corporate debt, NRSRO ratings available

 

 
11,449

 
11,449

Other corporate debt, NRSRO ratings not available

 

 
2,727

 
2,727

Residential mortgage-backed securities

 
235,614

 

 
235,614

Agency commercial mortgage-backed securities

 
27,475

 

 
27,475

Other commercial mortgage-backed securities

 
61,390

 

 
61,390

Other asset-backed securities

 
67,455

 
6,814

 
74,269

Equity securities
 
 
 
 
 
 

Financial
81,536

 

 

 
81,536

Utilities/Energy
32,350

 

 

 
32,350

Consumer oriented
66,461

 

 

 
66,461

Industrial
57,262

 

 

 
57,262

All other
15,932

 

 

 
15,932

Short-term investments
248,605

 


 


 
248,605

Financial instruments carried at fair value, classified as a part of:
 
 
 
 
 
 

Investment in unconsolidated subsidiaries

 

 
72,062

 
72,062

Total assets
$
502,146

 
$
3,089,721

 
$
100,390

 
$
3,692,257

The fair values for securities included in the Level 2 category, with the few exceptions described below, were developed by one of several third party, nationally recognized pricing services, including services that price only certain types of securities. Each service uses complex methodologies to determine values for securities and subject the values they develop to quality control reviews. Management selected a primary source for each type of security in the portfolio, and reviewed the values provided for reasonableness by comparing data to alternate pricing services and to available market and trade data. Values that appeared inconsistent were further reviewed for appropriateness. If a value did not appear reasonable, the valuation was discussed with the service that provided the value and would have been adjusted, if necessary. No such adjustments were necessary in 2014 or 2013.
Level 2 Valuations
Below is a summary description of the valuation methodologies primarily used by the pricing services for securities in the Level 2 category, by security type:
U.S. Treasury obligations were valued based on quoted prices for identical assets, or, in markets that are not active, quotes for similar assets, taking into consideration adjustments for variations in contractual cash flows and yields to maturity.
U.S. Government-sponsored enterprise obligations were valued using pricing models that consider current and historical market data, normal trading conventions, credit ratings, and the particular structure and characteristics of the security being valued, such as yield to maturity, redemption options, and contractual cash flows. Adjustments to model inputs or model results were included in the valuation process when necessary to reflect recent regulatory, government or corporate actions or significant economic, industry or geographic events affecting the security’s fair value.
State and municipal bonds were valued using a series of matrices that considered credit ratings, the structure of the security, the sector in which the security falls, yields, and contractual cash flows. Valuations were further adjusted, when necessary, to reflect recent significant economic or geographic events or ratings changes affecting the security’s fair value.

17

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

Corporate debt with multiple observable inputs consisted primarily of corporate bonds, but also included a small number of bank loans. The methodology used to value Level 2 corporate bonds was the same as the methodology previously described for U.S. Government-sponsored enterprise obligations. Bank loans were valued by an outside vendor based upon a widely distributed, loan-specific listing of average bid and ask prices published daily by an investment industry group. The publisher of the listing derived the averages from data received from multiple market-makers for bank loans.
Residential and commercial mortgage backed securities. Agency pass-through securities were valued using a matrix, considering the issuer type, coupon rate and longest cash flows outstanding. The matrix was developed daily based on available market information. Agency and non-agency collateralized mortgage obligations were both valued using models that consider the structure of the security, current and historical information regarding prepayment speeds, ratings and ratings updates, and current and historical interest rate and interest rate spread data. Valuations of Alt-A mortgages included a review of collateral performance data, which is generally updated monthly.
Other asset-backed securities were valued using models that consider the structure of the security, monthly payment information, current and historical information regarding prepayment speeds, ratings and ratings updates, and current and historical interest rate and interest rate spread data. Spreads and prepayment speeds considered collateral type. Valuations of subprime home equity loans used the same valuation methodology as previously described for Alt-A mortgages.
Short-term investments are securities maturing within one year, carried at cost which approximated the fair value of the security due to the short term to maturity.
Other investments consisted primarily of convertible bond securities. Convertible bonds were valued using a pricing model that incorporated selected dealer quotes as well as real-time market data including equity prices and risk free rates. If dealer quotes were unavailable for the security being valued, quotes for securities with similar terms and credit status were used in the pricing model. Dealer quotes selected for use were those considered most accurate based on parameters such as underwriter status and historical reliability.
 Level 3 Valuations
Below is a summary description of the valuation processes and methodologies used as well as quantitative information regarding securities in the Level 3 category.
Level 3 Valuation Processes
Level 3 securities are priced by the Chief Investment Officer.
Level 3 valuations are computed quarterly. Prices are evaluated quarterly against prior period prices and the expected change in price.
Exclusive of Investments in unconsolidated subsidiaries, which are valued at net asset value (NAV), the securities noted in the disclosure are primarily NRSRO rated debt instruments for which comparable market inputs are commonly available for evaluating the securities in question. Valuation of these debt instruments is not overly sensitive to changes in the unobservable inputs used.

18

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

Level 3 Valuation Methodologies
U.S. Government-sponsored enterprise obligations consisted of a bond valued internally using published quotes for similar securities. At March 31, 2014, the bond was rated AA+.
State and municipal bonds consisted of auction rate municipal bonds valued internally using either published quotes for similar securities or values produced by discounted cash flow models using yields currently available on fixed rate securities with a similar term and collateral, adjusted to consider the effect of a floating rate and a premium for illiquidity. At March 31, 2014, all of the securities were rated; the average rating was A+.
Corporate debt with limited observable inputs consisted of corporate bonds valued using dealer quotes for similar securities or discounted cash flow models using yields currently available for similar securities. Similar securities are defined as securities having like terms and payment features that are of comparable credit quality. Assessments of credit quality were based on NRSRO ratings, if available, or were subjectively determined by management if not available. At March 31, 2014, the average rating of rated securities was A-.
Other asset-backed securities consisted of securitizations of receivables valued using dealer quotes for similar securities or discounted cash flow models using yields currently available for similar securities.
Investment in unconsolidated subsidiaries consisted of limited partnership (LP) and limited liability company (LLC) interests valued using the NAV provided by the LP/LLC, which approximated the fair value of the interest.
Such interests include the following:
 
Unfunded
Commitments
 
Fair Value
(In thousands)
March 31,
2014
 
March 31,
2014
 
December 31,
2013
Investments in LPs/LLCs:
 
 
 
 
 
Secured debt fund (1)
$24,200
 
$
15,938

 
$
13,233

Long equity fund (2)
None
 
6,780

 
6,574

Long/Short equity funds (3)
None
 
29,103

 
28,385

Non-public equity funds (4)
$82,605
 
28,419

 
23,870

Multi-strategy fund of funds (5)
None
 
8,097

 

Structured credit fund (6)
None
 
3,570

 

 
 
 
$
91,907

 
$
72,062

(1)
The LP is structured to provide income and capital appreciation primarily through investments in senior secured debt. Redemptions are not allowed. Income and capital are to be periodically distributed at the discretion of the LP over an anticipated time frame that spans from 7 to 9 years.
(2)
The LP holds long equities of public international companies. Redemptions are allowed at the end of any calendar month with a prior notice requirement of 15 days and are paid within 10 days of the end of the calendar month of the redemption request.
(3)
Comprised of interests in multiple unrelated LP funds. The funds hold primarily long and short U.S. and North American equities, and target absolute returns using strategies designed to take advantage of event-driven market opportunities. Fund redemptions above the 90%-95% level are permitted but are not payable until after the fund’s fiscal year-end, and for some funds, after completion of an audit of the fund. Otherwise, the funds generally permit quarterly or semi-annual redemptions of the investors’ existing capital balance with notice requirements of from 30 to 90 days. Redemptions are then payable within 30 days following the end of the period of the request
(4)
Comprised of interests in three unrelated LP funds, each structured to provide capital appreciation through diversified investments in private equity, which can include investments in buyout, venture capital, mezzanine debt, distressed debt and other private equity-oriented LPs. One LP allows redemption by special consent; the others do not permit redemption. Income and capital are to be periodically distributed at the discretion of the LP over time frames that are anticipated to span from 4 to 12 years.
(5)
The LLC is structured to build and manage low volatility, multi-manager portfolios that have little or no correlation to the broader fixed income and equity security markets. Redemptions are not permitted but the LLC Board is permitted discretion to periodically extend offers to repurchase units of the LLC.

19

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

(6)
The LP seeks to obtain superior risk-adjusted absolute returns by acquiring and actively managing a diversified portfolio of debt securities, including bonds, loans and other asset-backed instruments. Redemptions are allowed at any quarter-end with a prior notice requirement of 90 days.
Quantitative Information Regarding Level 3 Valuations
Quantitative Information about Level 3 Fair Value Measurements
 
 
Fair Value at
 
 
 
 
 
 
(In millions)
 
March 31, 2014
 
December 31, 2013
 
Valuation Technique
 
Unobservable Input
 
Range
(Weighted Average)
Assets:
 
 
 
 
 
 
 
 
 
 
U.S. Government-sponsored enterprise obligations
 
$1.0
 
$—
 
Market Comparable Securities
 
Comparability Adjustment
 
0% - 2% (1%)
State and municipal bonds
 
$7.5
 
$7.3
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 10% (5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 10% (5%)
Corporate debt with limited observable inputs
 
$12.4
 
$14.2
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
Other asset-backed securities
 
$7.2
 
$6.8
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
The significant unobservable inputs used in the fair value measurement of the above listed securities were the valuations of comparable securities with similar issuer, credit quality and maturity. Changes in the availability of comparable securities could result in changes in the fair value measurements.

20

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

Fair Value Measurements - Level 3 Assets
The following tables (the Level 3 Tables) present summary information regarding changes in the fair value of assets measured at fair value using Level 3 inputs.
 
March 31, 2014
 
Level 3 Fair Value Measurements – Assets
(In thousands)
U.S. Government-sponsored Enterprise Obligations
 
State and Municipal Bonds
 
Corporate Debt
 
Asset-backed Securities
 
Investment in Unconsolidated Subsidiaries
 
Total
Balance December 31, 2013
$

 
$
7,338

 
$
14,176

 
$
6,814

 
$
72,062

 
$
100,390

Total gains (losses) realized and unrealized:
 
 
 
 
 
 
 
 
 
 
 
Included in earnings, as a part of:
 
 
 
 
 
 
 
 
 
 
 
Net investment income

 
(2
)
 
16

 

 

 
14

Equity in earnings of unconsolidated subsidiaries

 

 

 

 
2,865

 
2,865

Net realized investment gains (losses)

 
(95
)
 
3

 

 

 
(92
)
Included in other comprehensive income
(1
)
 
68

 
669

 
44

 

 
780

Purchases
1,000

 
1,861

 

 
2,165

 
18,436

 
23,462

Sales

 
(257
)
 
(458
)
 

 
(1,456
)
 
(2,171
)
Transfers in

 
570

 

 
305

 

 
875

Transfers out

 
(1,993
)
 
(2,025
)
 
(2,102
)
 

 
(6,120
)
Balance March 31, 2014
$
999

 
$
7,490

 
$
12,381

 
$
7,226

 
$
91,907

 
$
120,003

Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end
$

 
$

 
$

 
$

 
$
2,865

 
$
2,865


21

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

 
March 31, 2013
 
Level 3 Fair Value Measurements – Assets
(In thousands)
U.S. Government-sponsored Enterprise Obligations
 
State and Municipal Bonds
 
Corporate Debt
 
Asset-backed Securities
 
Investment in Unconsolidated Subsidiaries
 
Total
Balance December 31, 2012
$

 
$
7,175

 
$
15,191

 
$
4,035

 
$
33,739

 
$
60,140

Total gains (losses) realized and unrealized:
 
 
 
 
 
 
 
 
 
 
 
Included in earnings, as a part of:
 
 
 
 
 
 
 
 
 
 
 
Net investment income

 

 
(102
)
 
(16
)
 

 
(118
)
Equity in earnings of unconsolidated subsidiaries

 

 

 

 
1,848

 
1,848

Net realized investment gains (losses)

 

 
(69
)
 

 

 
(69
)
Included in other comprehensive income

 

 

 

 

 

Purchases

 

 
3,875

 
1,356

 
13,078

 
18,309

Sales

 

 
(616
)
 

 
(1,125
)
 
(1,741
)
Transfers in

 

 

 
1,701

 

 
1,701

Transfers out

 

 
(8,617
)
 

 

 
(8,617
)
Balance March 31, 2013
$

 
$
7,175

 
$
9,662

 
$
7,076

 
$
47,540

 
$
71,453

Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end
$

 
$

 
$

 
$

 
$
1,848

 
$
1,848


Transfers
There were no transfers between the Level 1 and Level 2 categories during the three months ended March 31, 2014 or 2013.
Transfers shown in the preceding Level 3 Tables were as of the end of the period and were to or from Level 2, unless otherwise noted.
All transfers during the three months ended March 31, 2014 and March 31, 2013 related to securities held for which the level of market activity for identical or nearly identical securities varies from period to period. The securities were valued using multiple observable inputs when those inputs were available; otherwise the securities were valued using limited observable inputs.

22

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

Financial Instruments - Methodologies Other Than Fair Value
The following table provides the estimated fair value of our financial instruments that, in accordance with GAAP for the type of investment, are measured using a methodology other than fair value. All fair values provided fall within the Level 3 fair value category.
 
March 31, 2014
 
December 31, 2013
(In thousands)
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Financial assets:
 
 
 
 
 
 
 
BOLI
$
54,820

 
$
54,820

 
$
54,374

 
$
54,374

Investment in unconsolidated subsidiaries
143,313

 
139,362

 
142,174

 
139,548

Other investments
57,104

 
58,504

 
52,240

 
51,833

Other assets
22,452

 
22,390

 
17,940

 
17,940

Financial liabilities:
 
 
 
 
 
 
 
Senior notes due 2023
$
250,000

 
$
265,058

 
$
250,000

 
$
262,500

Other liabilities
13,917

 
13,905

 
13,303

 
13,303

The fair value of the BOLI was equal to the cash surrender value associated with the policies on the valuation date.
Investment in unconsolidated subsidiaries consisted of investments in tax credit partnerships and, at March 31, 2014, included an interest in an investment fund LP accounted for using the equity method of approximately $2.8 million. The carrying value of tax credit partnerships approximated ProAssurance’s initial investment commitment to the partnerships less a pro rata portion of partnership operating losses over the period the investments have been held. The estimated fair value of tax credit partnerships was based on the net present values of the expected cash flows from the partnerships and considered the timing of tax benefits expected to be received, the funding schedule for the partnerships, and current rates for investments with similar risk structures and repayment periods. The fair value of the LP interest was estimated to approximate our initial capital contribution which occurred in 2014 and represented an arm's length transaction between market participants.
Other investments listed in the table above include interests in certain investment fund LPs/LLCs accounted for using the cost method, investments in Federal Home Loan Bank (FHLB) common stock carried at cost, and an annuity investment carried at amortized cost. The estimated fair value of the LP/LLC interests was based on the NAVs provided by the LP/LLC managers. The estimated fair value of the FHLB common stock was based on the amount ProAssurance would receive if its membership were canceled, as the membership cannot be sold. The fair value of the annuity represents the present value of the expected future cash flows discounted using a rate available in active markets for similarly structured instruments.
Other assets and Other liabilities primarily consisted of related investment assets and liabilities associated with funded deferred compensation agreements. Fair values of the funded deferred compensation assets and liabilities were based on the NAVs of the underlying securities. Other assets also included a secured note receivable and an unsecured receivable under a revolving credit agreement. Fair value of these receivables was based on the present value of expected cash flows from the receivables, discounted at market rates on the valuation date for receivables with similar credit standings and similar payment structures. Other liabilities also included certain contractual liabilities related to prior business combinations. The fair values of the business combination liabilities were based on the present value of the expected future cash outflows, discounted at ProAssurance’s assumed incremental borrowing rate on the valuation date for unsecured liabilities with similar repayment structures.
The fair value of the long-term debt was estimated based on the present value of expected future cash outflows, discounted at rates available on the valuation date for similar debt issued by entities with a similar credit standing to ProAssurance.

23

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

4. Investments
Available-for-sale securities at March 31, 2014 and December 31, 2013 included the following:
 
March 31, 2014
(In thousands)
Amortized
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Fixed maturities
 
 
 
 
 
 
 
U.S. Treasury obligations
$
179,323

 
$
6,173

 
$
(1,049
)
 
$
184,447

U.S. Government-sponsored enterprise obligations
37,169

 
2,092

 
(285
)
 
38,976

State and municipal bonds
1,127,323

 
47,530

 
(3,636
)
 
1,171,217

Corporate debt
1,361,960

 
56,429

 
(7,401
)
 
1,410,988

Residential mortgage-backed securities
281,585

 
8,289

 
(2,177
)
 
287,697

Agency commercial mortgage-backed securities
22,482

 
253

 
(104
)
 
22,631

Other commercial mortgage-backed securities
60,943

 
2,137

 
(129
)
 
62,951

Other asset-backed securities
77,074

 
433

 
(234
)
 
77,273

 
$
3,147,859

 
$
123,336

 
$
(15,015
)
 
$
3,256,180

 
 
 
 
 
 
 
 
 
December 31, 2013
(In thousands)
Amortized
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Fixed maturities
 
 
 
 
 
 
 
U.S. Treasury obligations
$
166,115

 
$
6,118

 
$
(1,519
)
 
$
170,714

U.S. Government-sponsored enterprise obligations
30,942

 
2,251

 
(425
)
 
32,768

State and municipal bonds
1,116,060

 
46,533

 
(7,927
)
 
1,154,666

Corporate debt
1,321,838

 
53,059

 
(13,744
)
 
1,361,153

Residential mortgage-backed securities
230,861

 
7,608

 
(2,855
)
 
235,614

Agency commercial mortgage-backed securities
27,268

 
343

 
(136
)
 
27,475

Other commercial mortgage-backed securities
59,066

 
2,491

 
(167
)
 
61,390

Other asset-backed securities
74,106

 
487

 
(324
)
 
74,269

 
$
3,026,256

 
$
118,890

 
$
(27,097
)
 
$
3,118,049


24

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

The recorded cost basis and estimated fair value of available-for-sale fixed maturities at March 31, 2014, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
(In thousands)
Amortized
Cost
 
Due in one
year or less
 
Due after
one year
through
five years
 
Due after
five years
through
ten years
 
Due after
ten years
 
Total Fair
Value
Fixed maturities, available for sale
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury obligations
$
179,323

 
$
38,194

 
$
99,086

 
$
43,224

 
$
3,943

 
$
184,447

U.S. Government-sponsored enterprise obligations
37,169

 
6,839

 
23,278

 
8,516

 
343

 
38,976

State and municipal bonds
1,127,323

 
56,745

 
417,304

 
476,080

 
221,088

 
1,171,217

Corporate debt
1,361,960

 
160,689

 
637,450

 
585,807

 
27,042

 
1,410,988

Residential mortgage-backed securities
281,585

 

 

 

 

 
287,697

Agency commercial mortgage-backed securities
22,482

 

 

 

 

 
22,631

Other commercial mortgage-backed securities
60,943

 

 

 

 

 
62,951

Other asset-backed securities
77,074

 

 

 

 

 
77,273

 
$
3,147,859

 
 
 
 
 
 
 
 
 
$
3,256,180

Excluding investments in bonds and notes of the U.S. Government and U.S. Government-sponsored enterprise obligations, no investment in any entity or its affiliates exceeded 10% of shareholders’ equity at March 31, 2014.
Cash and securities with a carrying value of $48.3 million at March 31, 2014 were on deposit with various state insurance departments to meet regulatory requirements.
As a member of Lloyd's and a capital provider to Syndicate 1729, ProAssurance is required to maintain capital at Lloyd's, referred to as Funds at Lloyd's (FAL). ProAssurance investments at March 31, 2014 included fixed maturities with a fair value of $42.2 million and short term investments with a fair value of approximately $34.8 million on deposit with Lloyd's in order to satisfy these FAL requirements.
Business Owned Life Insurance (BOLI)
ProAssurance holds BOLI policies on management employees that are carried at the current cash surrender value of the policies (original cost $33 million). The primary purpose of the program is to offset future employee benefit expenses through earnings on the cash value of the policies. ProAssurance is the owner and principal beneficiary of these policies.
Other Investments
Other investments at March 31, 2014 and December 31, 2013 was comprised as follows:
(In thousands)
March 31,
2014
 
December 31,
2013
Investments in LPs/LLCs, at cost
$
52,106

 
$
47,258

FHLB capital stock, at cost
3,449

 
3,449

Convertible securities
31,618

 

Other, principally an annuity, at amortized cost
1,549

 
1,533

 
$
88,722

 
$
52,240

FHLB capital stock is not marketable, but may be liquidated by terminating membership in the FHLB. The liquidation process can take up to five years.
ProAssurance's investments in convertible securities are hybrid financial instruments and are carried at fair value, with changes in fair value reported as a realized gain or loss in the Condensed Consolidated Statements of Income and Comprehensive Income.

25

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

Unconsolidated Subsidiaries
ProAssurance holds investments in unconsolidated subsidiaries, accounted for under the equity method. The investments include the following:
 
March 31, 2014
 
Carrying Value
(In thousands)
Unfunded
Commitments*
 
Percentage
Ownership
 
March 31,
2014
 
December 31,
2013
Investment in LPs/LLCs:
 
 
 
 
 
 
 
 
Tax credit partnerships
$20,631
 
See below
 
$
140,495

 
$
142,174

Secured debt fund
$24,200
 
<
20%
 
15,938

 
13,233

Long equity fund
None
 
<
20%
 
6,780

 
6,574

Long/Short equity funds
None
 
<
25%
 
29,103

 
28,385

Non-public equity funds
$99,788
 
<
20%
 
31,237

 
23,870

Multi-strategy fund of funds
None
 
<
20%
 
8,097

 

Structured credit fund
None
 
<
20%
 
3,570

 

 
 
 
 
 
 
$
235,220

 
$
214,236

 
 
 
 
 
 
 
 
 
* Unfunded commitments are included in the carrying value of tax credit partnerships only.
Tax credit partnership interests held by ProAssurance generate investment returns by providing tax benefits to fund investors in the form of project operating losses and tax credits. The related properties are principally low income housing projects. ProAssurance's ownership percentage relative to two of the tax credit partnership interests is almost 100%; these interests had a carrying value of $61.3 million at March 31, 2014. ProAssurance's ownership percentage relative to the remaining tax credit partnership interests is less than 20%; these interests had a carrying value of $79.2 million at March 31, 2014. All are accounted for under the equity method as ProAssurance does not have the ability to exert control over the partnerships.
The Secured debt fund is structured to provide interest distributions and capital appreciation primarily through investments in senior secured debt.
The Long equity fund targets long-term total returns through holdings in public international companies.
The Long/Short equity fund targets absolute returns using a strategy designed to take advantage of event-driven market opportunities.
The Non-public equity funds hold diversified private equities and are structured to provide capital appreciation.
The Multi-strategy fund of funds holds portfolios having little or no correlation to the broader fixed income and equity security markets.
The Structured credit fund seeks to obtain superior risk-adjusted absolute returns by acquiring and actively managing a diversified portfolio of debt securities.

26

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2014

Investments Held in a Loss Position
The following tables provide summarized information with respect to investments held in an unrealized loss position at March 31, 2014 and December 31, 2013, including the length of time the investment had been held in a continuous unrealized loss position.
 
March 31, 2014
 
Total
 
Less than 12 months
 
12 months or longer
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
(In thousands)
Value
 
Loss
 
Value
 
Loss
 
Value
 
Loss
Fixed maturities, available for sale
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury obligations
$
36,476

 
$
(1,049
)
 
$
32,770

 
$
(786
)
 
$
3,706

 
$
(263
)
U.S. Government-sponsored enterprise obligations
6,743

 
(285
)
 
5,826

 
(209
)
 
917

 
(76
)
State and municipal bonds
159,656

 
(3,636
)
 
146,584

 
(3,145
)
 
13,072

 
(491
)
Corporate debt
336,077

 
(7,401
)
 
307,864

 
(6,217
)
 
28,213

 
(1,184
)
Residential mortgage-backed securities
118,266

 
(2,177
)
 
111,102

 
(1,902
)
 
7,164

 
(275
)
Agency commercial mortgage-backed securities
11,127

 
(104
)
 
11,127

 
(104
)
 

 

Other commercial mortgage-backed securities
11,431

 
(129
)
 
10,541

 
(124
)
 
890

 
(5
)
Other asset-backed securities
18,502

 
(234
)
 
13,647

 
(45
)
 
4,855

 
(189
)
 
$
698,278

 
$
(15,015
)
 
$
639,461

 
$
(12,532
)
 
$
58,817

 
$
(2,483
)
Other investments
 
 
 
 
 
 
 
 
 
 
 
Investments in LPs/LLCs carried at cost
$
6,506

 
$
(256
)
 
$
4,852

 
$
(256
)
 
$
1,654

 
$


 
December 31, 2013
 
Total
 
Less than 12 months
 
12 months or longer
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
(In thousands)
Value
 
Loss
 
Value
 
Loss
 
Value
 
Loss
Fixed maturities, available for sale
 
 
 
 
 
 
 
 
 
 
 
U.S. Treasury obligations
$
47,668

 
$
(1,519
)
 
$
44,304

 
$
(1,182
)
 
$
3,364

 
$
(337
)
U.S. Government-sponsored enterprise obligations
6,640

 
(425
)
 
5,752

 
(321