10-Q 1 pra-2016930x10q.htm 10-Q Document

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, 2016 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, 2016, there were 53,246,010 shares of the registrant’s common stock outstanding.



Glossary of Terms and Acronyms

When the following terms and acronyms appear in the text of this report, they have the meanings indicated below.
Term
Meaning
AOCI
Accumulated other comprehensive income (loss)
Board
Board of Directors of ProAssurance Corporation
BOLI
Business owned life insurance
Council of Lloyd's
The governing body for Lloyd's of London
DPAC
Deferred policy acquisition costs
Eastern Re
Eastern Re, LTD, S.P.C.
EBUB
Earned, but unbilled premium
FAL
Funds at Lloyd's
FASB
Financial Accounting Standards Board
FHLB
Federal Home Loan Bank
GAAP
Generally accepted accounting principles in the United States of America
HCPL
Healthcare professional liability
IRS
Internal Revenue Service
LLC
Limited liability company
Lloyd's
Lloyd's of London market
LP
Limited partnership
Medical Technology Liability
Medical technology and life sciences products liability
NAV
Net asset value
NYSE
New York Stock Exchange
NRSRO
Nationally recognized statistical rating organization
OCI
Other comprehensive income (loss)
OTTI
Other-than-temporary impairment
PCAOB
Public Company Accounting Oversight Board
Revolving Credit Agreement
ProAssurance's $250 million revolving credit agreement
ROE
Return on equity
SEC
Securities and Exchange Commission
SPC
Segregated portfolio cell
Specialty P&C
Specialty Property and Casualty
Syndicate 1729
Lloyd's of London Syndicate 1729
Syndicate Credit Agreement
Unconditional revolving credit agreement with the Premium Trust Fund of Syndicate 1729
U.K.
United Kingdom of Great Britain and Northern Ireland
ULAE
Unallocated loss adjustment expense
VIE
Variable interest entity

2


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, 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 insurance entities providing coverages now offered by ProAssurance which could remove or add sizable numbers of insureds 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 FASB, the SEC, the PCAOB, or the NYSE 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 effect on our insureds, particularly the insurance needs of our insureds, and our loss costs, of changes in the healthcare delivery system, including changes attributable to the Patient Protection and Affordable Care Act;
Ÿ
consolidation of our insureds into or under larger entities which may be insured by competitors, or may not have a risk profile that meets our underwriting criteria or which may not use external providers for insuring or otherwise managing substantial portions of their 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
effects on our claims costs from mass tort litigation that are different from that anticipated by us;
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;

3


Ÿ
the availability, integrity and security of our technology infrastructure or that of our third-party providers of technology infrastructure, including any susceptibility to cyber-attacks which might result in a loss of information or operating capability;
Ÿ
the impact of a catastrophic event, as it relates to both our operations and our insured risks;
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 new markets 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 or 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 arise from our membership in the Lloyd's of London market and our participation in 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 Syndicate 1729, 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;
Ÿ
rating agencies could downgrade their ratings of Lloyd's as a whole; and
Ÿ
Syndicate 1729 operations are dependent on a small, specialized management team and the loss of their services could adversely affect the Syndicate’s business. The inability to identify, hire and retain other highly qualified personnel in the future, could adversely affect the quality and profitability of Syndicate 1729’s business.
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.

4


 
 
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

5


ProAssurance Corporation and Subsidiaries
Condensed Consolidated Balance Sheets (Unaudited)
(In thousands, except share data)
 
September 30,
2016
 
December 31,
2015
Assets
 
 
 
Investments
 
 
 
Fixed maturities, available for sale, at fair value; amortized cost, $2,662,428 and $2,722,063, respectively
$
2,750,601

 
$
2,760,287

Equity securities, trading, at fair value; cost, $344,836 and $319,320, respectively
365,490

 
322,353

Short-term investments
254,970

 
119,236

Business owned life insurance
59,664

 
57,213

Investment in unconsolidated subsidiaries
337,472

 
311,908

Other investments, $31,727 and $30,611 at fair value, respectively, otherwise at cost or amortized cost
81,759

 
79,133

Total Investments
3,849,956

 
3,650,130

Cash and cash equivalents
128,903

 
241,100

Premiums receivable
240,907

 
217,034

Receivable from reinsurers on paid losses and loss adjustment expenses
13,122

 
9,249

Receivable from reinsurers on unpaid losses and loss adjustment expenses
254,777

 
249,350

Prepaid reinsurance premiums
45,195

 
34,050

Deferred policy acquisition costs
49,609

 
44,388

Deferred tax asset, net

 
15,097

Real estate, net
38,134

 
38,470

Intangible assets
86,402

 
92,462

Goodwill
210,725

 
210,725

Other assets
98,045

 
103,966

Total Assets
$
5,015,775

 
$
4,906,021

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Policy liabilities and accruals
 
 
 
Reserve for losses and loss adjustment expenses
$
1,998,019

 
$
2,005,326

Unearned premiums
406,484

 
362,066

Reinsurance premiums payable
31,510

 
30,114

Total Policy Liabilities
2,436,013

 
2,397,506

Deferred tax liability, net
2,011

 

Other liabilities
187,468

 
202,303

Debt less debt issuance costs
348,116

 
347,858

Total Liabilities
2,973,608

 
2,947,667

Shareholders’ Equity
 
 
 
Common shares, par value $0.01 per share, 100,000,000 shares authorized, 62,653,647 and 62,503,255 shares issued, respectively
627

 
625

Additional paid-in capital
371,993

 
365,399

Accumulated other comprehensive income (loss), net of deferred tax expense (benefit) of $30,086, and $12,972, respectively
56,315

 
23,855

Retained earnings
2,034,898

 
1,988,035

Treasury shares, at cost, 9,447,155 shares and 9,402,697 shares, respectively
(421,666
)
 
(419,560
)
Total Shareholders’ Equity
2,042,167

 
1,958,354

Total Liabilities and Shareholders’ Equity
$
5,015,775

 
$
4,906,021

See accompanying notes.

6


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, 2015
$
625

 
$
365,399

 
$
23,855

 
$
1,988,035

 
$
(419,560
)
 
$
1,958,354

Common shares reacquired

 

 

 

 
(2,106
)
 
(2,106
)
Common shares issued for compensation and effect of shares reissued to stock purchase plan
1

 
2,147

 

 

 

 
2,148

Share-based compensation

 
7,458

 

 

 

 
7,458

Net effect of restricted and performance shares issued and stock options exercised
1

 
(3,011
)
 

 

 

 
(3,010
)
Dividends to shareholders

 

 

 
(49,370
)
 

 
(49,370
)
Other comprehensive income (loss)

 

 
32,460

 

 

 
32,460

Net income

 

 

 
96,233

 

 
96,233

Balance at September 30, 2016
$
627

 
$
371,993

 
$
56,315

 
$
2,034,898

 
$
(421,666
)
 
$
2,042,167

 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income (Loss)
 
Retained Earnings
 
Treasury Stock
 
Total
Balance at December 31, 2014
$
623

 
$
359,577

 
$
58,204

 
$
1,991,704

 
$
(252,164
)
 
$
2,157,944

Common shares reacquired

 

 

 

 
(165,178
)
 
(165,178
)
Common shares issued for compensation and effect of shares reissued to stock purchase plan

 
2,071

 

 

 

 
2,071

Share-based compensation

 
7,638

 

 

 

 
7,638

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

 
(4,409
)
 

 

 

 
(4,407
)
Dividends to shareholders

 

 

 
(50,418
)
 

 
(50,418
)
Other comprehensive income (loss)

 

 
(22,108
)
 

 

 
(22,108
)
Net income

 

 

 
81,248

 

 
81,248

Balance at September 30, 2015
$
625

 
$
364,877

 
$
36,096

 
$
2,022,534

 
$
(417,342
)
 
$
2,006,790

See accompanying notes.

7


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
 
2016
 
2015
 
2016
 
2015
Revenues
 
 
 
 
 
 
 
Net premiums earned
$
185,275

 
$
182,085

 
$
539,587

 
$
529,277

Net investment income
25,261

 
26,942

 
75,284

 
82,201

Equity in earnings (loss) of unconsolidated subsidiaries
(3,349
)
 
(221
)
 
(6,607
)
 
3,821

Net realized investment gains (losses):
 
 
 
 
 
 
 
OTTI losses
(100
)
 
(3,795
)
 
(10,834
)
 
(8,275
)
Portion of OTTI losses recognized in other comprehensive income before taxes

 
385

 
1,068

 
2,174

Net impairment losses recognized in earnings
(100
)
 
(3,410
)
 
(9,766
)
 
(6,101
)
Other net realized investment gains (losses)
15,837

 
(33,222
)
 
28,080

 
(29,519
)
Total net realized investment gains (losses)
15,737

 
(36,632
)
 
18,314

 
(35,620
)
Other income
1,428

 
2,759

 
5,963

 
6,504

Total revenues
224,352

 
174,933

 
632,541

 
586,183

Expenses
 
 
 
 
 
 
 
Losses and loss adjustment expenses
129,722

 
119,824

 
378,750

 
350,739

Reinsurance recoveries
(11,640
)
 
(11,018
)
 
(42,814
)
 
(32,855
)
Net losses and loss adjustment expenses
118,082

 
108,806

 
335,936

 
317,884

Underwriting, policy acquisition and operating expenses
55,812

 
53,025

 
166,735

 
157,908

Segregated portfolio cells dividend expense (income)
3,196

 
(1,933
)
 
5,895

 
1,481

Interest expense
3,748

 
3,637

 
11,285

 
10,978

Total expenses
180,838

 
163,535

 
519,851

 
488,251

Income before income taxes
43,514

 
11,398

 
112,690

 
97,932

Provision for income taxes
 
 
 
 
 
 
 
Current expense (benefit)
13,736

 
17,277

 
16,407

 
31,406

Deferred expense (benefit)
(4,056
)
 
(16,155
)
 
50

 
(14,722
)
Total income tax expense (benefit)
9,680

 
1,122

 
16,457

 
16,684

Net income
33,834

 
10,276

 
96,233

 
81,248

Other comprehensive income (loss), after tax, net of reclassification adjustments
(4,974
)
 
(4,953
)
 
32,460

 
(22,108
)
Comprehensive income
$
28,860

 
$
5,323

 
$
128,693

 
$
59,140

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.64

 
$
0.19

 
$
1.81

 
$
1.47

Diluted
$
0.63

 
$
0.19

 
$
1.80

 
$
1.46

Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
53,222

 
54,007

 
53,199

 
55,339

Diluted
53,456

 
54,232

 
53,419

 
55,554

Cash dividends declared per common share
$
0.31

 
$
0.31

 
$
0.93

 
$
0.93

See accompanying notes.

8


ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)
 
Nine Months Ended September 30
 
2016
 
2015
Operating Activities
 
 
 
Net income
$
96,233

 
$
81,248

Adjustments to reconcile income to net cash provided by operating activities:
 
 
 
Depreciation and amortization, net of accretion
25,509

 
27,194

Net realized investment (gains) losses
(18,314
)
 
35,620

Share-based compensation
7,458

 
7,638

Deferred income taxes
50

 
(14,722
)
Policy acquisition costs, net amortization (net deferral)
(5,221
)
 
(8,872
)
Equity in earnings (loss) of unconsolidated subsidiaries
6,607

 
(3,821
)
Other
(2,226
)
 
(608
)
Other changes in assets and liabilities, excluding effect of business combinations:
 
 
 
Premiums receivable
(23,873
)
 
(37,379
)
Reinsurance related assets and liabilities
(19,049
)
 
(1,029
)
Other assets
16,411

 
5,191

Reserve for losses and loss adjustment expenses
(7,307
)
 
(36,005
)
Unearned premiums
44,418

 
56,168

Other liabilities
8,296

 
(5,100
)
Net cash provided (used) by operating activities
128,992

 
105,523

Investing Activities
 
 
 
Purchases of:
 
 
 
Fixed maturities, available for sale
(540,370
)
 
(466,248
)
Equity securities, trading
(76,838
)
 
(211,437
)
Other investments
(15,832
)
 
(25,360
)
Funding of qualified affordable housing tax credit limited partnerships
(963
)
 
(903
)
Investment in unconsolidated subsidiaries
(39,051
)
 
(43,142
)
Proceeds from sales or maturities of:
 
 
 
Fixed maturities, available for sale
582,379

 
738,377

Equity securities, trading
56,670

 
172,502

Other investments
10,952

 
18,369

Distributions from unconsolidated subsidiaries
7,720

 
23,390

Net sales or maturities (purchases) of short-term investments
(135,743
)
 
(26,861
)
Unsettled security transactions, net change
16,665

 
(473
)
Purchases of capital assets
(7,797
)
 
(6,382
)
Other
(1,520
)
 
(1,514
)
Net cash provided (used) by investing activities
(143,728
)
 
170,318

Continued on following page.
 
 
 

9


 
Nine Months Ended September 30
 
2016
 
2015
Financing Activities
 
 
 
Borrowing under revolving credit agreement

 
100,000

Repurchase of common stock
(2,106
)
 
(165,178
)
Dividends to shareholders
(102,354
)
 
(201,158
)
External capital contribution received for segregated portfolio cells
9,703

 

Other
(2,704
)
 
(5,203
)
Net cash provided (used) by financing activities
(97,461
)
 
(271,539
)
Increase (decrease) in cash and cash equivalents
(112,197
)
 
4,302

Cash and cash equivalents at beginning of period
241,100

 
197,040

Cash and cash equivalents at end of period
$
128,903

 
$
201,342

Significant non-cash transactions
 
 
 
Dividends declared and not yet paid
$
16,462

 
$
16,454

See accompanying notes.

10

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 


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 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 nine months ended September 30, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. The accompanying Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes contained in ProAssurance’s December 31, 2015 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, 2016 for recognition or disclosure in its financial statements and notes to financial statements.
ProAssurance operates in four reportable segments as follows: 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 12 of the Notes to Condensed Consolidated Financial Statements.
Reclassifications
On January 1, 2016 in accordance with adopted guidance, ProAssurance began presenting debt issuance costs as a direct deduction from the carrying amount of debt on the Condensed Consolidated Balance Sheet, and the December 31, 2015 Condensed Consolidated Balance Sheet has been conformed to the current presentation. Previously, debt issuance costs ($2.1 million at December 31, 2015) were reported in Other assets.
Other Liabilities
Other liabilities consisted of the following:
(In millions)
 
September 30, 2016
 
December 31, 2015
SPC dividends payable
 
$
33.1

 
$
16.7

Unpaid dividends
 
16.5

 
69.4

All other
 
137.9

 
116.2

Total other liabilities
 
$
187.5

 
$
202.3

SPC dividends payable are the cumulative undistributed earnings contractually payable to the external preferred shareholders of SPCs operated by ProAssurance's Cayman Islands subsidiary, Eastern Re.
Unpaid dividends represent common stock dividends declared by ProAssurance's Board of Directors that had not yet been paid. Unpaid dividends at December 31, 2015 reflect a special dividend declared in late 2015 that was paid in January 2016.

11

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 

Accounting Changes Adopted
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 is to be recognized in the period in which it becomes probable that the performance target will be achieved and is to represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. ProAssurance adopted the guidance as of January 1, 2016. Adoption of the guidance had 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.
Simplifying the Presentation of Debt Issuance Costs
Effective for fiscal years beginning after December 15, 2015, the FASB issued guidance related to the presentation of debt issuance costs. The new guidance requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Related guidance issued by the SEC permits issuance costs associated with line-of-credit arrangements to be presented as an asset and subsequently amortized proportionally over the term of the arrangement. ProAssurance adopted the guidance as of January 1, 2016. Adoption of the guidance had no material effect on ProAssurance’s results of operations or financial position as it affected disclosure only.
Amendments to the Consolidation Analysis
Effective for fiscal years beginning after December 15, 2015, the FASB issued additional guidance regarding the consolidation of legal entities such as limited partnerships, limited liability corporations, and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). The new standard modifies the evaluation of whether or not entities are VIEs and the consolidation analysis to be performed by entities involved with VIEs, particularly VIE's for which there are fee arrangements and related party relationships. ProAssurance retrospectively adopted the guidance as of January 1, 2016. Adoption of the guidance had no material effect on ProAssurance’s results of operations or financial position as it affected disclosure only.
Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement
Effective for fiscal years beginning after December 15, 2015, the FASB issued additional guidance regarding accounting for cloud computing arrangements. Under the new guidance, the software license elements of cloud computing arrangements are to be accounted for in a manner that is consistent with the acquisition of other software licenses. Cloud computing arrangements that do not include a software license are to be accounted for as a service contract, following existing guidance for service contracts. ProAssurance adopted the guidance on a prospective basis as of January 1, 2016. Adoption of the guidance had no material effect on ProAssurance’s results of operations or financial position.
Disclosures about Short-Duration Contracts
Effective for fiscal years beginning after December 15, 2015 and interim periods within fiscal years beginning after December 15, 2016, the FASB issued guidance that requires insurance entities that issue short-duration contracts to provide detailed disclosures relative to the reserve for losses and loss adjustment expenses in annual reporting periods and a roll-forward of the reserve for losses and loss adjustment expenses in interim reporting periods. The guidance also requires disclosures regarding significant changes in the methodologies and assumptions used to calculate the reserve for losses and loss adjustment expenses, including reasons for and the effects of such changes. ProAssurance adopted the guidance as of January 1, 2016. Adoption of the guidance affects disclosures for the fiscal year 2016 and interim periods thereafter and is not expected to have a 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, 2016
 

Simplifying the Accounting for Measurement-Period Adjustments
Effective for fiscal years beginning after December 15, 2015 and interim periods within those fiscal years, the FASB issued guidance that requires an acquirer to recognize adjustments to estimated amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. An acquirer must also record, in the same period’s financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the estimated amounts, calculated as if the accounting had been completed at the acquisition date. The amendments also require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the estimated amounts had been recognized as of the acquisition date. ProAssurance adopted the guidance as of January 1, 2016. Adoption of the guidance had no material effect on ProAssurance’s results of operations or financial position.
Accounting Changes Not Yet Adopted
Revenue from Contracts with Customers
Effective for fiscal years beginning after December 15, 2017, the FASB issued guidance related to revenue from contracts with customers. The core principle of the new guidance is that revenue is 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, 2018. 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 on its effective date. Adoption is expected to have no effect on ProAssurance’s results of operations or financial position.
Recognition and Measurement of Financial Assets and Financial Liabilities
Effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, the FASB issued guidance that requires equity investments (except those accounted for under the equity method of accounting, or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. The new guidance also specifies that an entity use the exit price notion when measuring the fair value of financial instruments for disclosure purposes and present financial assets and liabilities by measurement category and form of financial asset. Other provisions of the new guidance include: revised disclosure requirements related to the presentation in comprehensive income of changes in the fair value of liabilities; elimination, for public companies, of disclosure requirements relative to the method(s) and significant assumptions underlying fair values disclosed for financial instruments measured at amortized cost; and simplified impairment assessments for equity investments without readily determinable fair values. ProAssurance plans to adopt the guidance beginning January 1, 2018. Adoption of the guidance is not expected to have a material effect on ProAssurance’s results of operations or financial position.
Leases
Effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, the FASB issued guidance that requires a lessee to recognize for all leases (with the exception of short-term leases) a lease liability, which is a lessee's obligation to make lease payments arising from a lease, measured on a discounted basis, and a right-of-use asset, which is an asset that represents the lessee's right to use, or control the use of, a specified asset for the lease term. ProAssurance plans to adopt the guidance beginning January 1, 2019. Adoption of the guidance is not expected to have a material effect on ProAssurance’s results of operations or financial position as ProAssurance does not have any material leases.

13

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 

Simplifying the Transition to the Equity Method of Accounting
Effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years, the FASB issued guidance that eliminates the requirement for retroactive restatement when an investment qualifies for use of the equity method as a result of an increase in the level of ownership interest or degree of influence. The new guidance provides that the cost of acquiring an additional interest in an investee is to be added to the current basis of an investor’s previously held interest and the equity method of accounting adopted as of the date the investment becomes qualified for equity method accounting with no retroactive adjustment of the investment. If an available-for-sale equity security qualifies for the equity method of accounting the unrealized holding gain or loss in accumulated other comprehensive income is to be recognized through earnings at the date the investment becomes qualified for use of the equity method. ProAssurance plans to adopt the guidance beginning January 1, 2017. Adoption of the guidance is not expected to have a material effect on ProAssurance’s results of operations or financial position.
Improvements to Employee Share-Based Payment Accounting
Effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years, the FASB issued guidance that simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of cash flows, and the classification of awards as either equity or liabilities. Under the new guidance, the difference between the deduction for tax purposes and the compensation cost recognized for financial reporting purposes is to be recognized as income tax expense in the current period and included with other income tax cash flows as an operating activity. Also the threshold for equity classification has been revised to permit withholdings up to the maximum statutory tax rates in the applicable jurisdictions. ProAssurance is in the process of evaluating the effect the new guidance would have on its results of operations and financial position and plans to adopt the guidance beginning January 1, 2017.
Improvements to Financial Instruments - Credit Losses
Effective for fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, the FASB issued guidance that replaces the incurred loss impairment methodology, which delays recognition of credit losses until a probable loss has been incurred, with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. Under the new guidance, credit losses are required to be recorded through an allowance for credit losses account and the income statement reflects the measurement for newly recognized financial assets, as well as increases or decreases of expected credit losses that have taken place during the period. ProAssurance is in the process of evaluating the effect the new guidance would have on its results of operations and financial position and plans to adopt the guidance beginning January 1, 2020. Adoption of the guidance is not expected to have a material effect on ProAssurance’s results of operations or financial position.
Classification of Certain Cash Receipts and Cash Payments
Effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, the FASB issued guidance related to the classification of certain cash receipts and cash payments presented in the statement of cash flows with the objective of reducing diversity in practice. ProAssurance plans to adopt the guidance beginning January 1, 2018. Adoption is not expected to have a material effect on ProAssurance’s results of operations or financial position as it affects disclosure only.


14

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 

2. 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, 2016 and December 31, 2015 are shown in the following tables. Where applicable, 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, 2016
 

 
September 30, 2016
 
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
$

 
$
142,314

 
$

 
$
142,314

U.S. Government-sponsored enterprise obligations

 
30,716

 

 
30,716

State and municipal bonds

 
883,638

 
900

 
884,538

Corporate debt, multiple observable inputs
2,458

 
1,321,014

 

 
1,323,472

Corporate debt, limited observable inputs

 

 
12,287

 
12,287

Residential mortgage-backed securities

 
217,575

 

 
217,575

Agency commercial mortgage-backed securities

 
13,227

 

 
13,227

Other commercial mortgage-backed securities

 
19,635

 
1,000

 
20,635

Other asset-backed securities

 
105,084

 
753

 
105,837

Equity securities
 
 
 
 
 
 

Financial
76,489

 

 

 
76,489

Utilities/Energy
50,820

 

 
201

 
51,021

Consumer oriented
62,555

 

 

 
62,555

Industrial
52,908

 

 

 
52,908

Bond funds
87,365

 

 

 
87,365

All other
16,867

 
18,285

 

 
35,152

Short-term investments
248,617

 
4,800

 
1,553

 
254,970

Other investments
2,071

 
28,737

 
919

 
31,727

Total assets categorized within the fair value hierarchy
$
600,150

 
$
2,785,025

 
$
17,613

 
3,402,788

LP/LLC interests carried at NAV which approximates fair value. These interests, reported as a part of Investment in unconsolidated subsidiaries, are not categorized within the fair value hierarchy.
 
 
 
 
 
 
195,016

Total assets at fair value
 
 
 
 
 
 
$
3,597,804


16

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 

 
December 31, 2015
 
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
$

 
$
123,892

 
$

 
$
123,892

U.S. Government-sponsored enterprise obligations

 
26,334

 

 
26,334

State and municipal bonds

 
940,635

 

 
940,635

Corporate debt, multiple observable inputs
2,362

 
1,274,824

 

 
1,277,186

Corporate debt, limited observable inputs

 

 
14,500

 
14,500

Residential mortgage-backed securities

 
238,387

 

 
238,387

Agency commercial mortgage-backed securities

 
10,999

 

 
10,999

Other commercial mortgage-backed securities

 
30,134

 

 
30,134

Other asset-backed securities

 
97,463

 
757

 
98,220

Equity securities
 
 
 
 
 
 

Financial
67,764

 

 

 
67,764

Utilities/Energy
41,050

 

 

 
41,050

Consumer oriented
56,470

 

 

 
56,470

Industrial
48,305

 

 

 
48,305

Bond funds
76,316

 

 

 
76,316

All other
18,239

 
14,209

 

 
32,448

Short-term investments
86,271

 
32,965

 

 
119,236

Other investments
3,478

 
27,133

 

 
30,611

Total assets categorized within the fair value hierarchy
$
400,255


$
2,816,975


$
15,257


3,232,487

LP/LLC interests carried at NAV which approximates fair value. These interests, reported as a part of Investment in unconsolidated subsidiaries, are not categorized within the fair value hierarchy.
 
 
 
 
 
 
162,624

Total assets at fair value
 
 
 
 
 
 
$
3,395,111

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. Any value that did not appear reasonable was discussed with the service that provided the value and would have been adjusted, if necessary. No such adjustments were necessary in 2015. One nominal adjustment was made during the third quarter of 2016 and related to an investment in an unrealized loss position that was sold subsequent to period end.
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.

17

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 

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 the expected effect on fair value of recent significant economic or geographic events or ratings changes.
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 based on an average of broker quotes for the loans in question, if available. If quotes were not available, the loans were valued based on quoted prices for comparable loans or, if the loan was newly issued, by comparison to similar seasoned issues. Broker quotes were compared to actual trade prices to permit assessment of the reliability of the quotes; unreliable quotes were not considered in quoted averages.
Residential and commercial mortgage-backed securities. Agency pass-through securities were valued using a pricing matrix which considers the issuer type, coupon rate and longest cash flows outstanding. The matrix used was based on the most recently 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.
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 consider collateral type.
Equity securities were securities not traded on an exchange on the valuation date. The securities were valued using the most recently available quotes for the securities.
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 bonds valued using a pricing model that incorporated selected dealer quotes as well as current market data regarding 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 prices.
ProAssurance Level 3 securities 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)
September 30, 2016
 

Level 3 Valuation Methodologies
State and municipal bonds consisted of a municipal bond valued internally using 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.
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 of comparable credit quality that have like terms and payment features. Assessments of credit quality were based on NRSRO ratings, if available, or were subjectively determined by management if not available. At September 30, 2016, 72% of the securities were rated; the average rating was A-. At December 31, 2015, 83% of the securities were rated; the average rating was A-.
Other commercial mortgage-backed securities consisted of a security primarily backed by telecommunication structures and equipment. At September 30, 2016, this security had an average rating of A and is valued using a dealer quote.
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.
Equity securities and Other investments consisted of common stock and convertible securities for which limited observable inputs were available at September 30, 2016. The securities were valued internally based on expected cash flows, including the expected final recovery, discounted at a yield that considered the lack of liquidity and the financial status of the issuer.
Short-term investments 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 of comparable credit quality that have like terms and payment features.
Quantitative Information Regarding Level 3 Valuations
 
 
 
Fair Value at
 
 
 
 
 
 
(In millions)
 
September 30, 2016
 
December 31, 2015
 
Valuation Technique
 
Unobservable Input
 
Range
(Weighted Average)
Assets:
 
 
 
 
 
 
 
 
 
 
State and municipal bonds
 
$0.9
 
$—
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 10% (5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 10% (5%)
Corporate debt with limited observable inputs
 
$12.3
 
$14.5
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
Other commercial mortgage-backed securities
 
$1.0
 
$—
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
Other asset-backed securities
 
$0.8
 
$0.8
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
Equity securities & Other investments
 
$1.1
 
$—
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 10% (5%)
Short-term investments
 
$1.6
 
$—
 
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.

19

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 

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, 2016
 
Level 3 Fair Value Measurements – Assets
(In thousands)
State and Municipal Bonds
 
Corporate Debt
 
Asset-backed Securities
 
All other investments
 
Total
Balance June 30, 2016
$

 
$
17,810

 
$
755

 
$
1,556

 
$
20,121

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

 
(28
)
 

 
(3
)
 
(31
)
Equity in earnings of unconsolidated subsidiaries

 

 

 

 

Net realized investment gains (losses)

 

 

 

 

Included in other comprehensive income

 
324

 
(2
)
 
8

 
330

Purchases

 

 

 
193

 
193

Sales

 
(709
)
 

 

 
(709
)
Transfers in
900

 

 
1,000

 
919

 
2,819

Transfers out

 
(5,110
)
 

 

 
(5,110
)
Balance September 30, 2016
$
900

 
$
12,287

 
$
1,753

 
$
2,673

 
$
17,613

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

 
$

 
$

 
$

 
$

 
September 30, 2016
 
Level 3 Fair Value Measurements – Assets
(In thousands)
State and Municipal Bonds
 
Corporate Debt
 
Asset-backed Securities
 
All other investments
 
Total
Balance December 31, 2015
$

 
$
14,500

 
$
757

 
$

 
$
15,257

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

 
(64
)
 

 
(7
)
 
(71
)
Equity in earnings of unconsolidated subsidiaries

 

 

 

 

Net realized investment gains (losses)

 
(75
)
 

 

 
(75
)
Included in other comprehensive income

 
453

 
3

 
8

 
464

Purchases

 
5,995

 
3,500

 
1,753

 
11,248

Sales

 
(3,406
)
 
(702
)
 

 
(4,108
)
Transfers in
900

 

 
1,000

 
919

 
2,819

Transfers out

 
(5,116
)
 
(2,805
)
 

 
(7,921
)
Balance September 30, 2016
$
900

 
$
12,287

 
$
1,753


$
2,673

 
$
17,613

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

 
$

 
$

 
$

 
$


20

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 

 
September 30, 2015
 
Level 3 Fair Value Measurements – Assets
(In thousands)
State and Municipal Bonds
 
Corporate Debt
 
Asset-backed Securities
 
All other investments
 
Total
Balance June 30, 2015
$

 
$
8,468

 
$
4,777

 
$
1,036

 
$
14,281

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

 

 

 

 

Net realized investment gains (losses)

 
(311
)
 

 

 
(311
)
Included in other comprehensive income

 
300

 
(9
)
 
(53
)
 
238

Purchases

 

 
1,500

 
584

 
2,084

Sales

 
(648
)
 

 

 
(648
)
Transfers in

 
11

 

 

 
11

Transfers out

 

 

 
(918
)
 
(918
)
Balance September 30, 2015
$

 
$
7,820

 
$
6,268

 
$
540

 
$
14,628

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

 
$

 
$

 
$
(109
)
 
$
(109
)
 
September 30, 2015
 
Level 3 Fair Value Measurements – Assets
(In thousands)
State and Municipal Bonds
 
Corporate Debt
 
Asset-backed Securities
 
All other investments
 
Total
Balance December 31, 2014
$
5,025

 
$
13,081

 
$
4,769

 
$

 
$
22,875

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

 
17

 

 

 
17

Net realized investment gains (losses)

 
(309
)
 

 

 
(309
)
Included in other comprehensive income
(459
)
 
38

 
(1
)
 
(133
)
 
(555
)
Purchases

 
1,515

 
1,500

 
1,700

 
4,715

Sales

 
(1,484
)
 

 

 
(1,484
)
Transfers in

 
11

 

 

 
11

Transfers out
(4,566
)
 
(5,049
)
 

 
(918
)
 
(10,533
)
Balance September 30, 2015
$

 
$
7,820

 
$
6,268


$
540

 
$
14,628

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

 
$

 
$

 
$
(109
)
 
$
(109
)
Transfers
Equity securities of approximately $10.2 million were transferred from Level 2 to Level 1 during the three and nine months ended September 30, 2016. There were no transfers between the Level 1 and Level 2 categories during the three and nine months ended September 30, 2015.
Transfers shown in the preceding Level 3 tables were as of the end of the period in which the transfer occurred. All transfers were to or from Level 2.

21

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 

All transfers during the three and nine months ended September 30, 2016 and 2015 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.
Fair Values Not Categorized
Investments in unconsolidated subsidiaries at both September 30, 2016 and December 31, 2015 included interests in investment fund LPs/LLCs that measure fund assets at fair value on a recurring basis and that provide a NAV for the interest. The carrying value of these interests is based on the NAV provided, and was considered to approximate the fair value of the interests. In accordance with GAAP, the fair value of these investments was not classified within the fair value hierarchy. Additional information regarding these investments is as follows:
 
Unfunded
Commitments
 
Fair Value
(In thousands)
September 30,
2016
 
September 30,
2016
 
December 31,
2015
Investments in LPs/LLCs:
 
 
 
 
 
Private debt funds (1)
$7,936
 
$
55,675

 
$
50,268

Long equity fund (2)
None
 
6,536

 
6,407

Long/short equity funds (3)
None
 
29,099

 
28,030

Non-public equity funds (4)
$50,699
 
80,326

 
65,722

Multi-strategy fund of funds (5)
None
 
8,303

 
8,252

Structured credit fund (6)
None
 
4,128

 
3,945

Long/short commodities fund (7)
None
 
10,949

 

 
 
 
$
195,016

 
$
162,624

(1)
Comprised of interests in two unrelated LP funds that are structured to provide interest distributions primarily through diversified portfolios of private debt instruments. One LP allows redemption by special consent; the other does not permit redemption. Income and capital are to be periodically distributed at the discretion of the LPs over an anticipated time frame that spans from 3 to 8 years.
(2)
The fund is a LP that 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 market opportunities. The funds generally permit quarterly or semi-annual capital redemptions subject to 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 multiple 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. Two of the LPs allow redemption by terms set forth in the LP agreements; 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 up to 9 years.
(5)
This fund is a LLC 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 offers to repurchase units of the LLC may be extended periodically.
(6)
This fund is a LP seeking 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.
(7)
This fund is a LLC invested across a broad range of commodities and focuses primarily on market neutral, relative value strategies, seeking to generate absolute returns with low correlation to broad commodity, equity and fixed income markets. Following an initial one year lock-up period, redemptions are allowed with a prior notice requirement of 30 days and are payable within 30 days.

22

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 

ProAssurance may not sell, transfer or assign its interest in any of the above LPs/LLCs without special consent from the LP/LLC.
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, 2016
 
December 31, 2015
(In thousands)
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Financial assets:
 
 
 
 
 
 
 
BOLI
$
59,664

 
$
59,664

 
$
57,213

 
$
57,213

Other investments
50,032

 
54,325

 
48,522

 
51,646

Other assets
28,135

 
28,086

 
24,215

 
24,193

Financial liabilities:
 
 
 
 
 
 
 
Senior notes due 2023
$
250,000

 
$
278,913

 
$
250,000

 
$
261,308

Revolving credit agreement
100,000

 
100,000

 
100,000

 
100,000

Other liabilities
16,331

 
16,331

 
14,897

 
14,893

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 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 equity value of the interest provided by the LP/LLC managers for the most recent quarter, which approximates the fair value of the interest. 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 provided by the underlying funds. Other assets also included a secured note receivable and two unsecured receivables under two separate line of credit agreements. 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 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 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, 2016
 

3. Investments
Available-for-sale securities at September 30, 2016 and December 31, 2015 included the following:
 
September 30, 2016
(In thousands)
Amortized
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Fixed maturities
 
 
 
 
 
 
 
U.S. Treasury obligations
$
139,654

 
$
2,719

 
$
59

 
$
142,314

U.S. Government-sponsored enterprise obligations
29,945

 
771

 

 
30,716

State and municipal bonds
849,487

 
35,828

 
777

 
884,538

Corporate debt
1,295,190

 
44,880

 
4,311

 
1,335,759

Residential mortgage-backed securities
209,708

 
7,924

 
57

 
217,575

Agency commercial mortgage-backed securities
12,958

 
285

 
16

 
13,227

Other commercial mortgage-backed securities
20,315

 
329

 
9

 
20,635

Other asset-backed securities
105,171

 
692

 
26

 
105,837

 
$
2,662,428

 
$
93,428

 
$
5,255

 
$
2,750,601

 
 
 
 
 
 
 
 
 
December 31, 2015
(In thousands)
Amortized
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Fixed maturities
 
 
 
 
 
 
 
U.S. Treasury obligations
$
122,855

 
$
1,696

 
$
659

 
$
123,892

U.S. Government-sponsored enterprise obligations
25,456

 
927

 
49

 
26,334

State and municipal bonds
904,719

 
36,739

 
823

 
940,635

Corporate debt
1,296,128

 
24,720

 
29,162

 
1,291,686

Residential mortgage-backed securities
233,659

 
6,039

 
1,311

 
238,387

Agency commercial mortgage-backed securities
10,851

 
174

 
26

 
10,999

Other commercial mortgage-backed securities
29,983

 
354

 
203

 
30,134

Other asset-backed securities
98,412

 
54

 
246

 
98,220

 
$
2,722,063

 
$
70,703

 
$
32,479

 
$
2,760,287


24

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2016
 

The recorded cost basis and estimated fair value of available-for-sale fixed maturities at September 30, 2016, 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
$
139,654

 
$
15,698

 
$
111,393

 
$
11,834

 
$
3,389

 
$
142,314

U.S. Government-sponsored enterprise obligations
29,945

 
12,599

 
5,767

 
10,590

 
1,760

 
30,716

State and municipal bonds
849,487

 
52,084

 
294,177

 
411,429

 
126,848

 
884,538

Corporate debt
1,295,190

 
105,978

 
796,088

 
407,156

 
26,537

 
1,335,759

Residential mortgage-backed securities
209,708

 

 

 

 

 
217,575

Agency commercial mortgage-backed securities
12,958

 

 

 

 

 
13,227

Other commercial mortgage-backed securities
20,315

 

 

 

 

 
20,635

Other asset-backed securities
105,171