10-Q 1 pra-20140930x10q.htm 10-Q PRA-2014.09.30-10Q
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 September 30, 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 October 31, 2014, there were 57,183,941 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 reserve, 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 our loss and loss adjustment expense reserve and reinsurance recoverable;
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
allegations 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 laws;
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 by 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 continue 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 Factors" in our Form 10-K and other documents we file with the SEC, 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)
 
September 30,
2014
 
December 31,
2013
Assets
 
 
 
Investments
 
 
 
Fixed maturities, available for sale, at fair value; amortized cost, $3,143,726 and $3,026,256, respectively
$
3,246,820

 
$
3,118,049

Equity securities, trading, at fair value; cost, $274,324 and $203,308, respectively
306,631

 
253,541

Short-term investments
94,973

 
248,605

Business owned life insurance
55,918

 
54,374

Investment in unconsolidated subsidiaries
254,962

 
214,236

Other investments, $30,058 at fair value at September 30, 2014, otherwise at cost or amortized cost
92,010

 
52,240

Total Investments
4,051,314

 
3,941,045

Cash and cash equivalents
248,005

 
129,383

Restricted cash

 
78,000

Premiums receivable
229,798

 
115,403

Receivable from reinsurers on paid losses and loss adjustment expenses
9,918

 
3,231

Receivable from reinsurers on unpaid losses and loss adjustment expenses
251,605

 
247,518

Prepaid reinsurance premiums
36,286

 
21,449

Deferred policy acquisition costs
44,049

 
28,207

Deferred tax asset

 
1,757

Real estate, net
40,116

 
41,010

Intangible assets
103,224

 
52,002

Goodwill
210,725

 
161,115

Other assets
100,957

 
329,979

Total Assets
$
5,325,997

 
$
5,150,099

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Policy liabilities and accruals
 
 
 
Reserve for losses and loss adjustment expenses
$
2,146,018

 
$
2,072,822

Unearned premiums
391,296

 
255,463

Reinsurance premiums payable
32,314

 
34,321

Total Policy Liabilities
2,569,628

 
2,362,606

Deferred tax liability
21,062

 

Other liabilities
164,095

 
143,079

Long-term debt
250,000

 
250,000

Total Liabilities
3,004,785

 
2,755,685

Shareholders’ Equity
 
 
 
Common shares, par value $0.01 per share, 100,000,000 shares authorized, 62,283,426 and 62,096,787 shares issued, respectively
623

 
621

Additional paid-in capital
357,779

 
349,894

Accumulated other comprehensive income (loss), net of deferred tax expense (benefit) of $35,591 and $32,127, respectively
67,007

 
59,661

Retained earnings
2,094,181

 
2,015,603

Treasury shares, at cost, 4,596,000 shares and 900,281 shares, respectively
(198,378
)
 
(31,365
)
Total Shareholders’ Equity
2,321,212

 
2,394,414

Total Liabilities and Shareholders’ Equity
$
5,325,997

 
$
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

 

 

 

 
(167,242
)
 
(167,242
)
Common shares issued for compensation

 
2,679

 

 

 
229

 
2,908

Share-based compensation

 
8,022

 

 

 

 
8,022

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

 
(2,816
)
 

 

 

 
(2,814
)
Dividends to shareholders

 

 

 
(52,873
)
 

 
(52,873
)
Other comprehensive income (loss)

 

 
7,346

 

 

 
7,346

Net income

 

 

 
131,451

 

 
131,451

Balance at September 30, 2014
$
623

 
$
357,779

 
$
67,007

 
$
2,094,181

 
$
(198,378
)
 
$
2,321,212

 
 
 
 
 
 
 
 
 
 
 
 
 
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 reacquired

 

 

 

 
(7,964
)
 
(7,964
)
Common shares issued for compensation

 
2,807

 

 

 

 
2,807

Share-based compensation

 
6,930

 

 

 

 
6,930

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

 
(3,970
)
 

 

 

 
(3,968
)
Dividends to shareholders

 

 

 
(46,375
)
 

 
(46,375
)
Other comprehensive income (loss)

 

 
(75,307
)
 

 

 
(75,307
)
Net income

 

 

 
226,658

 

 
226,658

Balance at September 30, 2013
$
621

 
$
347,547

 
$
70,073

 
$
1,963,140

 
$
(8,020
)
 
$
2,373,361

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 September 30
 
Nine Months Ended September 30
 
2014
 
2013
 
2014
 
2013
Revenues
 
 
 
 
 
 
 
Net premiums earned
$
177,028

 
$
133,598

 
$
525,061

 
$
398,528

Net investment income
32,830

 
33,889

 
92,788

 
99,282

Equity in earnings (loss) of unconsolidated subsidiaries
298

 
(305
)
 
2,767

 
(3,500
)
Net realized investment gains (losses):
 
 
 
 
 
 
 
Other-than-temporary impairment (OTTI) losses
(1,425
)
 

 
(1,475
)
 
(71
)
Portion of OTTI losses recognized in (reclassified from) other comprehensive income before taxes
268

 

 
268

 

Net impairment losses recognized in earnings
(1,157
)
 

 
(1,207
)
 
(71
)
Other net realized investment gains (losses)
(6,974
)
 
12,500

 
8,866

 
47,721

Total net realized investment gains (losses)
(8,131
)
 
12,500

 
7,659

 
47,650

Other income
1,808

 
1,804

 
6,055

 
5,305

Total revenues
203,833

 
181,486

 
634,330

 
547,265

Expenses
 
 
 
 
 
 
 
Losses and loss adjustment expenses
106,486

 
65,619

 
306,591

 
203,885

Reinsurance recoveries
(7,264
)
 
(3,982
)
 
(18,948
)
 
(14,013
)
Net losses and loss adjustment expenses
99,222

 
61,637

 
287,643

 
189,872

Underwriting, policy acquisition and operating expenses
54,185

 
33,348

 
158,856

 
105,592

Segregated portfolio cells dividend expense
(483
)
 

 
2,355

 

Interest expense
3,606

 
322

 
10,697

 
1,085

Total expenses
156,530

 
95,307

 
459,551

 
296,549

Gain on acquisition

 
494

 

 
35,986

Income before income taxes
47,303

 
86,673

 
174,779

 
286,702

Provision for income taxes
 
 
 
 
 
 
 
Current expense (benefit)
15,591

 
12,687

 
37,884

 
36,902

Deferred expense (benefit)
(3,066
)
 
10,629

 
5,444

 
23,142

Total income tax expense (benefit)
12,525

 
23,316

 
43,328

 
60,044

Net income
34,778

 
63,357

 
131,451

 
226,658

Other comprehensive income (loss), after tax, net of reclassification adjustments
(14,646
)
 
(4,989
)
 
7,346

 
(75,307
)
Comprehensive income
$
20,132

 
$
58,368

 
$
138,797

 
$
151,351

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.59

 
$
1.02

 
$
2.20

 
$
3.67

Diluted
$
0.59

 
$
1.02

 
$
2.19

 
$
3.65

Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
58,676

 
61,844

 
59,807

 
61,793

Diluted
58,931

 
62,108

 
60,047

 
62,040

Cash dividends declared per common share
$
0.30

 
$
0.25

 
$
0.90

 
$
0.75

See accompanying notes.

7


ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
 
Nine Months Ended September 30
 
2014
 
2013
Operating Activities
 
 
 
Net income
$
131,451

 
$
226,658

Adjustments to reconcile income to net cash provided by operating activities:
 
 
 
Depreciation and amortization, net of accretion
36,286

 
34,364

Gain on acquisition

 
(35,986
)
Net realized investment gains
(7,659
)
 
(47,650
)
Share-based compensation
8,022

 
6,930

Deferred income taxes
5,444

 
23,142

Policy acquisition costs, net amortization (net deferral)
(5,249
)
 
(7,066
)
Other
(5,980
)
 
(8,367
)
Other changes in assets and liabilities, excluding effect of business combinations:
 
 
 
Premiums receivable
(42,406
)
 
(21,881
)
Reinsurance related assets and liabilities
(19,829
)
 
(1,510
)
Other assets
33,823

 
(34,016
)
Reserve for losses and loss adjustment expenses
(78,558
)
 
(104,387
)
Unearned premiums
55,565

 
23,574

Other liabilities
(9,827
)
 
(29,844
)
Net cash provided (used) by operating activities
101,083

 
23,961

Investing Activities
 
 
 
Purchases of:
 
 
 
Fixed maturities, available for sale
(511,894
)
 
(406,152
)
Equity securities, trading
(85,986
)
 
(73,292
)
Other investments
(25,109
)
 
(7,926
)
Funding of tax credit limited partnerships
(8,439
)
 
(58,801
)
Investment in unconsolidated subsidiaries
(30,394
)
 
(15,637
)
Proceeds from sales or maturities of:
 
 
 
Fixed maturities, available for sale
486,702

 
782,612

Equity securities, trading
102,765

 
95,658

Other investments
15,074

 
2,352

Distributions from unconsolidated subsidiaries
3,850

 
14,564

Net sales or maturities (purchases) of short-term investments
177,013

 
(43,434
)
Cash received in acquisitions
35,013

 
22,780

Unsettled security transactions, net
(127
)
 
(2,744
)
(Increase) decrease in restricted cash
78,000

 

Other
3,467

 
(8,253
)
Net cash provided (used) by investing activities
239,935

 
301,727

Continued on following page.
 
 
 

8


 
Nine Months Ended September 30
 
2014
 
2013
Financing Activities
 
 
 
Repayment of long-term debt

 
(125,000
)
Repurchase of common stock
(163,146
)
 
(1,990
)
Dividends to shareholders
(53,820
)
 
(30,842
)
Other
(5,430
)
 
(7,356
)
Net cash provided (used) by financing activities
(222,396
)
 
(165,188
)
Increase (decrease) in cash and cash equivalents
118,622

 
160,500

Cash and cash equivalents at beginning of period
129,383

 
118,551

Cash and cash equivalents at end of period
$
248,005

 
$
279,051

 
 
 
 
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)
September 30, 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- and nine-month periods ended September 30, 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 September 30, 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
On January 1, 2014, ProAssurance began reporting unearned ceding commissions as an offset to deferred policy acquisition costs (DPAC) 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 and nine months ended September 30, 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 and nine months ended September 30, 2013 by $1.5 million and $4.2 million, respectively. Total underwriting, policy acquisition and operating expense for the 2013 three- and nine-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 $77.5 million at September 30, 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 September 30, 2014 and $16.8 million at December 31, 2013. Both amortizable and non-amortizable intangible assets increased during 2014 due to intangible assets purchased in the Eastern acquisition, see Note 2. Intangible assets are evaluated for impairment on an annual basis.
Amortization expense for intangible assets for the three and nine months ended September 30, 2014 was $2.6 million and $7.7 million, respectively, and was $1.3 million and $4.0 million for the three and nine months ended September 30, 2013, respectively. Aggregate amortization expense for intangible assets over the next five years is estimated to be $2.6 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 September 30, 2014, Other liabilities included $16.5 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)
September 30, 2014

Accounting Policy Additions
The significant accounting policies adopted as a result of the acquisition of Eastern and commencement of our Lloyd's Syndicate operations effective January 1, 2014 and followed by ProAssurance in making estimates that materially affect financial reporting are as follows:
Earned But Unbilled Premiums (EBUB)
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. ProAssurance tracks, by policy, the amount of additional premium billed in final audit invoices as a percentage of payroll exposure and uses this information to estimate the probable additional amount that it has earned, but not yet billed, as of the balance sheet date. Changes to the EBUB estimate are included in Net premiums earned in the period recognized. As of September 30, 2014, ProAssurance carried earned but unbilled premiums of $3.4 million as a part of Premiums receivable.
Convertible Bond Securities
Investments in convertible bond securities are carried at fair value as permitted by the accounting guidance for hybrid financial instruments, with changes in fair value recognized in income as a component of Net realized investment gains (losses) during the period of change. Interest on convertible bond securities is recorded on an accrual basis based on contractual interest rates and is included in Net investment income.
Foreign Currency
The functional currency of all ProAssurance foreign subsidiaries is the U.S. Dollar.
Accounting Changes Not Yet Adopted
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.
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, also referred to as low income 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 new method, the adoption will occur beginning January 1, 2015.

11

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2014

Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period
Effective for fiscal years beginning after December 15, 2015, the FASB issued guidance for share-based payments in which the terms of the award provide that a performance target can be achieved after completion of the requisite service period. The new guidance provides that compensation cost for such awards should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. ProAssurance plans to adopt the guidance beginning January 1, 2016. Adoption of the guidance is expected to have no effect on ProAssurance’s results of operations or financial position as ProAssurance has no awards with performance targets extending beyond the requisite service period.
Revenue from Contracts with Customers
Effective for fiscal years beginning after December 15, 2016, the FASB issued guidance related to revenue from contracts with customers. The core principle of the new guidance is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. ProAssurance plans to adopt the guidance beginning January 1, 2017. As the majority of ProAssurance's revenues come from insurance contracts which fall under the scope of other FASB standards, adoption of the guidance is expected to have no material effect on ProAssurance’s results of operations or financial position.
Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern
Effective for fiscal years ending after December 15, 2016 and interim periods beginning after December 15, 2016, the FASB issued guidance that establishes principles and definitions related to management's evaluation of whether there is substantial doubt about the organization's ability to continue as a going concern. For each interim and annual reporting period, the new guidance requires management to evaluate the organization's ability to meet its obligations as they are due within one year of the date the financial statements are issued and requires disclosure when there is substantial doubt regarding the organization's ability to continue as a going concern. ProAssurance plans to adopt the guidance beginning December 15, 2016. Adoption is expected to have no effect on ProAssurance’s results of operations or financial position.
Accounting Changes Adopted
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.
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)
September 30, 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 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 $2.1 million during the first nine 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
 
$
107,131

Equity securities, trading
 
65,945

Cash and short-term investments
 
58,944

Other investments
 
42,133

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
 
(153,191
)
Unearned premiums
 
(80,268
)
Ceded balances payable
 
(9,507
)
Segregated portfolio cells dividends payable
 
(14,430
)
Deferred tax liabilities, net
 
(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 acquired intangible assets that are 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 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.

13

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2014

ProAssurance believes that all contractual cash flows related to acquired receivables will be collected. The fair value of the reserve for losses and loss adjustment expenses and related reinsurance recoverables was based on three components: an actuarial estimate of the expected future net cash flows, a reduction to those cash flows for the time value of money determined utilizing the U.S. Treasury Yield Curve, and a risk margin 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 reserve. The fair value of the reserve, including the risk margin adjustment, exceeded the undiscounted loss reserve previously established by Eastern by $9.3 million; this fair value adjustment is being amortized over the average expected life of the reserve of 6 years as a reduction to loss expenses.
The following table provides Pro Forma Consolidated Results for the three and nine months ended September 30, 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 and nine months ended September 30, 2013, 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 and nine months ended September 30, 2014 included Eastern's operating results (Revenue of $49.6 million and $149.9 million, respectively, and Net income of $1.7 million and $7.1 million, respectively).
Certain costs included in ProAssurance actual results for the three and nine months ended September 30, 2014 have been reported in the Pro Forma Consolidated Results as if the costs had been incurred for the three and nine months ended September 30, 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 and nine months ended September 30, 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 September 30, 2014
 
Nine Months Ended September 30, 2014
(In thousands)
ProAssurance
Pro Forma
Consolidated
Results
 
ProAssurance
Actual
Consolidated Results
 
ProAssurance
Pro Forma
Consolidated
Results
 
ProAssurance
Actual
Consolidated Results
Revenue
$203,833
 
$203,833
 
$634,330
 
$634,330
Net income
$34,759
 
$34,778
 
$132,451
 
$131,451
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2013
 
Nine Months Ended September 30, 2013
(In thousands)
ProAssurance
Pro Forma
Consolidated
Results
 
ProAssurance
Actual
Consolidated Results
 
ProAssurance
Pro Forma
Consolidated
Results
 
ProAssurance
Actual
Consolidated Results
Revenue
$229,608
 
$181,486
 
$686,391
 
$547,265
Net income
$66,868
 
$63,357
 
$233,666
 
$226,658

14

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 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 September 30, 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)
September 30, 2014

 
September 30, 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
$

 
$
176,813

 
$

 
$
176,813

U.S. Government-sponsored enterprise obligations

 
43,966

 

 
43,966

State and municipal bonds

 
1,082,040

 
5,594

 
1,087,634

Corporate debt, multiple observable inputs

 
1,459,550

 

 
1,459,550

Corporate debt, limited observable inputs:
 
 
 
 
 
 

Other corporate debt, NRSRO ratings available

 

 
10,793

 
10,793

Other corporate debt, NRSRO ratings not available

 

 
2,642

 
2,642

Residential mortgage-backed securities

 
290,314

 

 
290,314

Agency commercial mortgage-backed securities

 
16,893

 

 
16,893

Other commercial mortgage-backed securities

 
57,323

 

 
57,323

Other asset-backed securities

 
96,119

 
4,773

 
100,892

Equity securities
 
 
 
 
 
 

Financial
75,141

 

 

 
75,141

Utilities/Energy
26,551

 

 

 
26,551

Consumer oriented
64,912

 

 

 
64,912

Industrial
54,912

 

 

 
54,912

Bond funds
53,178

 

 

 
53,178

All other
31,937

 

 

 
31,937

Short-term investments
94,323

 
650

 

 
94,973

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

 

 
110,793

 
110,793

Other investments
4,830

 
25,228

 

 
30,058

Total assets
$
405,784

 
$
3,248,896

 
$
134,595

 
$
3,789,275


16

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 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)
September 30, 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.
Level 3 Valuation Methodologies
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 September 30, 2014, 100% 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 September 30, 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.

18

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2014

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)
September 30,
2014
 
September 30,
2014
 
December 31,
2013
Investments in LPs/LLCs:
 
 
 
 
 
Secured debt fund (1)
$16,200
 
$
23,896

 
$
13,233

Long equity fund (2)
None
 
7,034

 
6,574

Long/Short equity funds (3)
None
 
25,016

 
28,385

Non-public equity funds (4)
$71,518
 
42,818

 
23,870

Multi-strategy fund of funds (5)
None
 
8,263

 

Structured credit fund (6)
None
 
3,766

 

 
 
 
$
110,793

 
$
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 North American equities, and target absolute returns using strategies designed to take advantage of event-driven market opportunities. The funds generally permit quarterly or semi-annual redemptions of the investors’ existing capital balance with notice requirements of 30 to 90 days. For some funds, redemptions above specified thresholds (lowest threshold is 90%) may be only partially payable until after a fund audit is completed and are then payable within 30 days.
(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.
(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.
ProAssurance may not sell, transfer or assign its interest in any of the above LPs/LLCs without special consent from the LPs/LLCs.

19

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2014

Quantitative Information Regarding Level 3 Valuations
Quantitative Information about Level 3 Fair Value Measurements
 
 
Fair Value at
 
 
 
 
 
 
(In millions)
 
September 30, 2014
 
December 31, 2013
 
Valuation Technique
 
Unobservable Input
 
Range
(Weighted Average)
Assets:
 
 
 
 
 
 
 
 
 
 
State and municipal bonds
 
$5.6
 
$7.3
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 10% (5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 10% (5%)
Corporate debt with limited observable inputs
 
$13.4
 
$14.2
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
Other asset-backed securities
 
$4.8
 
$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 issuers, credit quality and maturity. Changes in the availability of comparable securities could result in changes in the fair value measurements.
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.
 
September 30, 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 June 30, 2014
$

 
$
7,148

 
$
14,544

 
$
5,960

 
$
101,342

 
$
128,994

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

 
(4
)
 
16

 

 

 
12

Equity in earnings of unconsolidated subsidiaries

 

 

 

 
(683
)
 
(683
)
Net realized investment gains (losses)

 

 

 

 

 

Included in other comprehensive income

 
(76
)
 
35

 
(6
)
 

 
(47
)
Purchases

 

 
(499
)
 

 
12,055

 
11,556

Sales

 
(1,474
)
 
(661
)
 

 
(1,921
)
 
(4,056
)
Transfers in

 

 

 

 

 

Transfers out

 

 

 
(1,181
)
 

 
(1,181
)
Balance September 30, 2014
$

 
$
5,594

 
$
13,435

 
$
4,773

 
$
110,793

 
$
134,595

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

 
$

 
$

 
$

 
$
(683
)
 
$
(683
)

20

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2014

 
September 30, 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

 
(10
)
 
48

 

 

 
38

Equity in earnings of unconsolidated subsidiaries

 

 

 

 
5,413

 
5,413

Net realized investment gains (losses)

 
(95
)
 
3

 

 

 
(92
)
Included in other comprehensive income
1

 
(34
)
 
702

 
63

 

 
732

Purchases
1,000

 
1,861

 
2,000

 
3,340

 
37,430

 
45,631

Sales

 
(1,731
)
 
(1,469
)
 
(61
)
 
(4,112
)
 
(7,373
)
Transfers in

 
2,119

 

 
305

 

 
2,424

Transfers out
(1,001
)
 
(3,854
)
 
(2,025
)
 
(5,688
)
 

 
(12,568
)
Balance September 30, 2014
$

 
$
5,594

 
$
13,435

 
$
4,773

 
$
110,793

 
$
134,595

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

 
$

 
$

 
$

 
$
5,413

 
$
5,413

 
September 30, 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 June 30, 2013
$

 
$
5,025

 
$
11,359

 
$
4,679

 
$
44,549

 
$
65,612

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

 

 
(1
)
 

 

 
(1
)
Equity in earnings of unconsolidated subsidiaries

 

 

 

 
1,301

 
1,301

Net realized investment gains (losses)

 

 

 

 

 

Included in other comprehensive income

 

 
(221
)
 
16

 

 
(205
)
Purchases

 

 

 

 
2,354

 
2,354

Sales

 

 
(503
)
 

 
(3,548
)
 
(4,051
)
Transfers in

 

 
100

 

 

 
100

Transfers out

 

 

 

 

 

Balance September 30, 2013
$

 
$
5,025

 
$
10,734

 
$
4,695

 
$
44,656

 
$
65,110

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

 
$

 
$

 
$

 
$
1,301

 
$
1,301


21

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2014

 
September 30, 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

 

 
(103
)
 
(17
)
 

 
(120
)
Equity in earnings of unconsolidated subsidiaries

 

 

 

 
3,582

 
3,582

Net realized investment gains (losses)

 
(44
)
 
(69
)
 

 

 
(113
)
Included in other comprehensive income

 

 
(514
)
 
(81
)
 

 
(595
)
Purchases

 

 
7,470

 
1,356

 
20,975

 
29,801

Sales

 
(2,106
)
 
(1,368
)
 
(18
)
 
(13,640
)
 
(17,132
)
Transfers in

 

 
100

 
1,701

 

 
1,801

Transfers out

 

 
(9,973
)
 
(2,281
)
 

 
(12,254
)
Balance September 30, 2013
$

 
$
5,025

 
$
10,734

 
$
4,695

 
$
44,656

 
$
65,110

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

 
$

 
$

 
$

 
$
3,582

 
$
3,582


Transfers
There were no transfers between the Level 1 and Level 2 categories during the three and nine months ended September 30, 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 and nine months ended September 30, 2014 and September 30, 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)
September 30, 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.
 
September 30, 2014
 
December 31, 2013
(In thousands)
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Financial assets:
 
 
 
 
 
 
 
BOLI
$
55,918

 
$
55,918

 
$
54,374

 
$
54,374

Other investments
61,952

 
63,247

 
52,240

 
51,833

Other assets
21,298

 
21,248

 
17,940

 
17,940

Financial liabilities:
 
 
 
 
 
 
 
Senior notes due 2023
$
250,000

 
$
273,750

 
$
250,000

 
$
262,500

Other liabilities
14,022

 
14,139

 
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.
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)
September 30, 2014

4. Investments
Available-for-sale securities at September 30, 2014 and December 31, 2013 included the following:
 
September 30, 2014
(In thousands)
Amortized
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Fixed maturities
 
 
 
 
 
 
 
U.S. Treasury obligations
$
173,632

 
$
4,396

 
$
1,215

 
$
176,813

U.S. Government-sponsored enterprise obligations
42,480

 
1,709

 
223

 
43,966

State and municipal bonds
1,038,278

 
50,055

 
699

 
1,087,634

Corporate debt
1,433,266

 
48,894

 
9,175

 
1,472,985

Residential mortgage-backed securities
282,717

 
8,817

 
1,220

 
290,314

Agency commercial mortgage-backed securities
16,785

 
172

 
64

 
16,893

Other commercial mortgage-backed securities
55,853

 
1,587

 
117

 
57,323

Other asset-backed securities
100,715

 
346

 
169

 
100,892

 
$
3,143,726

 
$
115,976

 
$
12,882

 
$
3,246,820

 
 
 
 
 
 
 
 
 
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