10-Q 1 pra-20170930x10q.htm 10-Q 9.30.17 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, 2017 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, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth 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
 
¨
 
 
 
 
 
 
 
 
Emerging growth company
 
¨

 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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, 2017, there were 53,415,236 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
FHLMC
Federal Home Loan Mortgage Corporation
FNMA
Federal National Mortgage Association
GAAP
Generally accepted accounting principles in the United States of America
GNMA
Government National Mortgage Association
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
NRSRO
Nationally recognized statistical rating organization
NYSE
New York Stock Exchange
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


Caution Regarding 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 significant risks, assumptions 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 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 and tax rate environment;
Ÿ
resolution of uncertain tax matters and changes in tax laws;
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 and/or changes in the U.S. political climate that may affect healthcare policy or our business;
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;

3


Ÿ
our ability to retain and recruit senior management;
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
guaranty funds and other state assessments;
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, assumptions and uncertainties 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 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,
2017
 
December 31,
2016
Assets
 
 
 
Investments
 
 
 
Fixed maturities, available for sale, at fair value; amortized cost, $2,429,092 and $2,586,821, respectively
$
2,468,350

 
$
2,613,406

Equity securities, trading, at fair value; cost, $376,074 and $353,744, respectively
411,796

 
387,274

Short-term investments
294,379

 
442,084

Business owned life insurance
61,652

 
60,134

Investment in unconsolidated subsidiaries
331,897

 
340,906

Other investments, $51,789 and $31,501 at fair value, respectively, otherwise at cost or amortized cost
103,764

 
81,892

Total Investments
3,671,838

 
3,925,696

Cash and cash equivalents
119,005

 
117,347

Premiums receivable
262,686

 
223,480

Receivable from reinsurers on paid losses and loss adjustment expenses
7,408

 
5,446

Receivable from reinsurers on unpaid losses and loss adjustment expenses
313,876

 
273,475

Prepaid reinsurance premiums
47,529

 
39,723

Deferred policy acquisition costs
51,691

 
46,809

Deferred tax asset, net
13,957

 
10,256

Real estate, net
32,305

 
31,814

Intangible assets
84,496

 
84,406

Goodwill
210,725

 
210,725

Other assets
109,638

 
96,004

Total Assets
$
4,925,154

 
$
5,065,181

Liabilities and Shareholders’ Equity
 
 
 
Liabilities
 
 
 
Policy liabilities and accruals
 
 
 
Reserve for losses and loss adjustment expenses
$
2,040,698

 
$
1,993,428

Unearned premiums
422,009

 
372,563

Reinsurance premiums payable
34,769

 
30,001

Total Policy Liabilities
2,497,476

 
2,395,992

Other liabilities
176,328

 
422,285

Debt less debt issuance costs
400,460

 
448,202

Total Liabilities
3,074,264

 
3,266,479

Shareholders’ Equity
 
 
 
Common shares, par value $0.01 per share, 100,000,000 shares authorized, 62,822,376 and 62,660,234 shares issued, respectively
628

 
627

Additional paid-in capital
380,595

 
376,518

Accumulated other comprehensive income (loss), net of deferred tax expense (benefit) of $13,985 and $9,894, respectively
25,459

 
17,399

Retained earnings
1,864,136

 
1,824,088

Treasury shares, at cost, 9,408,925 shares and 9,408,977 shares, respectively
(419,928
)
 
(419,930
)
Total Shareholders’ Equity
1,850,890

 
1,798,702

Total Liabilities and Shareholders’ Equity
$
4,925,154

 
$
5,065,181

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, 2016
$
627

 
$
376,518

 
$
17,399

 
$
1,824,088

 
$
(419,930
)
 
$
1,798,702

Cumulative-effect adjustment-
ASU 2016-09 adoption*

 
425

 

 
(276
)
 

 
149

Common shares reacquired

 

 

 

 

 

Common shares issued for compensation and effect of shares reissued to stock purchase plan

 
1,873

 

 

 
2

 
1,875

Share-based compensation

 
7,110

 

 

 

 
7,110

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

 
(5,331
)
 

 

 

 
(5,330
)
Dividends to shareholders

 

 

 
(49,598
)
 

 
(49,598
)
Other comprehensive income (loss)

 

 
8,060

 

 

 
8,060

Net income

 

 

 
89,922

 

 
89,922

Balance at September 30, 2017
$
628

 
$
380,595

 
$
25,459

 
$
1,864,136

 
$
(419,928
)
 
$
1,850,890

 
 
 
 
 
 
 
 
 
 
 
 
 
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

 
 
 
 
 
 
 
 
 
 
 
 
* See Note 1 of the Notes to Condensed Consolidated Financial Statements for discussion of accounting guidance adopted during the period.
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
 
2017
 
2016
 
2017
 
2016
Revenues
 
 
 
 
 
 
 
Net premiums earned
$
192,303

 
$
185,275

 
$
555,559

 
$
539,587

Net investment income
23,729

 
25,261

 
69,592

 
75,284

Equity in earnings (loss) of unconsolidated subsidiaries
4,164

 
(3,349
)
 
8,489

 
(6,607
)
Net realized investment gains (losses):
 
 
 
 
 
 
 
OTTI losses

 
(100
)
 
(419
)
 
(10,834
)
Portion of OTTI losses recognized in other comprehensive income before taxes

 

 
248

 
1,068

Net impairment losses recognized in earnings

 
(100
)
 
(171
)
 
(9,766
)
Other net realized investment gains (losses)
7,749

 
15,837

 
18,981

 
28,080

Total net realized investment gains (losses)
7,749

 
15,737

 
18,810

 
18,314

Other income
510

 
1,428

 
4,581

 
5,963

Total revenues
228,455

 
224,352

 
657,031

 
632,541

Expenses
 
 
 
 
 
 
 
Net losses and loss adjustment expenses
129,356

 
118,082

 
364,058

 
335,936

Underwriting, policy acquisition and operating expenses
 
 
 
 
 
 
 
Operating expense
32,606

 
34,060

 
102,062

 
101,862

DPAC amortization
24,505

 
21,752

 
70,044

 
64,873

Segregated portfolio cells dividend expense (income)
2,891

 
3,196

 
14,076

 
5,895

Interest expense
4,124

 
3,748

 
12,402

 
11,285

Total expenses
193,482

 
180,838

 
562,642

 
519,851

Income before income taxes
34,973

 
43,514

 
94,389

 
112,690

Provision for income taxes
 
 
 
 
 
 
 
Current expense (benefit)
13,690

 
13,736

 
12,111

 
16,407

Deferred expense (benefit)
(7,666
)
 
(4,056
)
 
(7,644
)
 
50

Total income tax expense (benefit)
6,024

 
9,680

 
4,467

 
16,457

Net income
28,949

 
33,834

 
89,922

 
96,233

Other comprehensive income (loss), after tax, net of reclassification adjustments
(605
)
 
(4,974
)
 
8,060

 
32,460

Comprehensive income
$
28,344

 
$
28,860

 
$
97,982

 
$
128,693

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.54

 
$
0.64

 
$
1.68

 
$
1.81

Diluted
$
0.54

 
$
0.63

 
$
1.68

 
$
1.80

Weighted average number of common shares outstanding:
 
 
 
 
 
 
 
Basic
53,413

 
53,222

 
53,377

 
53,199

Diluted
53,614

 
53,456

 
53,586

 
53,419

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
 
2017
 
2016
Operating Activities
 
 
 
Net income
$
89,922

 
$
96,233

Adjustments to reconcile income to net cash provided by operating activities:
 
 
 
Depreciation and amortization, net of accretion
21,024

 
25,509

(Increase) decrease in cash surrender value of BOLI
(1,518
)
 
(1,537
)
Net realized investment (gains) losses
(18,810
)
 
(18,314
)
Share-based compensation
7,110

 
7,458

Deferred income taxes
(7,644
)
 
50

Policy acquisition costs, net of amortization (net deferral)
(4,882
)
 
(5,221
)
Equity in (earnings) loss of unconsolidated subsidiaries
(8,489
)
 
6,607

Other
(548
)
 
(689
)
Other changes in assets and liabilities:
 
 
 
Premiums receivable
(39,206
)
 
(23,873
)
Reinsurance related assets and liabilities
(45,401
)
 
(19,049
)
Other assets
1,188

 
16,411

Reserve for losses and loss adjustment expenses
47,270

 
(7,307
)
Unearned premiums
49,446

 
44,418

Other liabilities
8,569

 
8,296

Net cash provided (used) by operating activities
98,031

 
128,992

Investing Activities
 
 
 
Purchases of:
 
 
 
Fixed maturities, available for sale
(449,717
)
 
(540,370
)
Equity securities, trading
(127,916
)
 
(76,838
)
Other investments
(35,445
)
 
(15,832
)
Funding of qualified affordable housing tax credit limited partnerships
(394
)
 
(963
)
Investment in unconsolidated subsidiaries
(30,530
)
 
(39,051
)
Proceeds from sales or maturities of:
 
 
 
Fixed maturities, available for sale
599,374

 
582,379

Equity securities, trading
116,833

 
56,670

Other investments
16,479

 
10,952

Distributions from unconsolidated subsidiaries
47,364

 
7,720

Net sales or maturities (purchases) of short-term investments
141,538

 
(135,743
)
Unsettled security transactions, net change
(10,935
)
 
16,665

Purchases of capital assets
(8,620
)
 
(7,797
)
Purchases of intangible assets
(2,984
)
 

Other
(2,745
)
 
(1,520
)
Net cash provided (used) by investing activities
252,302

 
(143,728
)
Continued on following page.
 
 
 

9


 
Nine Months Ended September 30
 
2017
 
2016
Financing Activities
 
 
 
Repayments under revolving credit agreement
(48,000
)
 

Repurchase of common stock

 
(2,106
)
Dividends to shareholders
(298,704
)
 
(102,354
)
External capital contribution received for segregated portfolio cells
2,989

 
9,703

Other
(4,960
)
 
(2,704
)
Net cash provided (used) by financing activities
(348,675
)
 
(97,461
)
Increase (decrease) in Cash and cash equivalents
1,658

 
(112,197
)
Cash and cash equivalents at beginning of period
117,347

 
241,100

Cash and cash equivalents at end of period
$
119,005

 
$
128,903

Significant non-cash transactions
 
 
 
Dividends declared and not yet paid
$
16,558

 
$
16,462

See accompanying notes.

10

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 


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, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. The accompanying Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes contained in ProAssurance’s December 31, 2016 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, 2017 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 11 of the Notes to Condensed Consolidated Financial Statements.
Reclassifications
In the second quarter of 2017, ProAssurance began presenting separately the components of Underwriting, policy acquisition and operating expense as Operating expense and DPAC amortization on the Condensed Consolidated Statements of Income and Comprehensive Income in order to provide additional details for investors. The Condensed Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2016 have been reclassified to conform to the current period presentation. Total Underwriting, policy acquisition and operating expense as well as Net income for all periods presented was not affected by the change in presentation.
Other Liabilities
Other liabilities consisted of the following:
(In thousands)
 
September 30, 2017
 
December 31, 2016
SPC dividends payable
 
$
46,353

 
$
34,289

Unpaid dividends
 
16,558

 
265,659

All other
 
113,417

 
122,337

Total other liabilities
 
$
176,328

 
$
422,285

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, 2016 reflect a special dividend declared in late 2016 that was paid in January 2017.
Accounting Changes Adopted
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. The threshold for equity classification has also been revised to permit withholdings up to the maximum statutory tax rates in the applicable jurisdictions. The update also provides an accounting policy election to account for forfeitures as they occur. ProAssurance adopted the guidance as of January 1, 2017. The primary effects of the adoption on the current period are the following: (1) using a prospective application, ProAssurance recorded unrecognized excess tax benefits of $2.6 million as current tax expense for the nine months ended September 30, 2017 (unrecognized excess tax benefits were nominal for the 2017 three-month period), (2) using a modified retrospective application, ProAssurance elected to recognize forfeitures as they occur and recorded a $0.4 million increase to Additional paid-in capital, and a respective $0.3 million

11

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

reduction to Retained earnings and a $0.1 million increase to deferred taxes to reflect the incremental share-based compensation expense, net of related tax impacts, that would have been recognized in prior years under the modified guidance and (3) excess tax benefits from share-based compensation of $2.2 million was reclassified from financing activities to operating activities in the Condensed Consolidated Statements of Cash Flows.
Interests Held Through Related Parties that are Under Common Control
Effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years, the FASB issued additional guidance regarding consolidation of legal entities such as LPs/LLCs and securitization structures (collateralized debt obligations, collateralized loan obligations, and mortgage-backed security transactions). The new guidance modifies the criteria used by a reporting entity when determining if it is a primary beneficiary of a VIE when there are entities under common control and the reporting entity has indirect interests in the VIE through related party relationships. ProAssurance adopted the guidance as of January 1, 2017. Adoption of the guidance had no material effect on ProAssurance’s results of operations or financial position.
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 AOCI is to be recognized through earnings at the date the investment becomes qualified for use of the equity method. ProAssurance adopted the guidance as of January 1, 2017. Adoption of the guidance had no material effect on ProAssurance’s results of operations or financial position.
Clarifying the Definition of a Business
Effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, the FASB issued guidance which provides clarification of the definition of a business, affecting areas such as acquisitions, disposals, goodwill and consolidation. The new guidance intends to assist entities with determining whether a transaction should be accounted for as an acquisition or disposal of assets or a business. The guidance will be applied prospectively to any transaction occurring within the period of adoption. ProAssurance early adopted the guidance during the third quarter of 2017 and adoption of the guidance had no material effect on ProAssurance’s results of operations or financial position.
Accounting Changes Not Yet Adopted
Restricted Cash
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 restricted cash presented in the statement of cash flows with the objective of reducing diversity in practice. Under the new guidance, entities are required to include restricted cash and restricted cash equivalents with cash and cash equivalents when reconciling beginning-of-period and end-of-period total amounts as presented on the statement of cash flows. 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, financial position or cash flows.
Intra-Entity Transfers of Assets Other than Inventory
Effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, the FASB issued guidance which reduces the complexity in accounting standards related to the income tax consequences of intra-entity transfers of assets other than inventory. Under the new guidance, entities are required to recognize income tax consequences of an intra-entity transfer of assets other than inventory when the transfer occurs instead of delaying recognition until the asset has been sold to an outside party. 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, 2018. 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, financial position or cash flows.

12

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

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 under the modified retrospective method. As the majority of ProAssurance's revenues come from insurance contracts which fall under the scope of other FASB standards, only an insignificant amount of the Company's revenue is subject to the updated guidance. Therefore, adoption of the guidance is not expected to have a material 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, with the cumulative effect of the adoption made to retained earnings. The majority of ProAssurance's equity investments are either measured at fair value or accounted for under the equity method of accounting. As of September 30, 2017, approximately 1% of the Company's total investments would be impacted by the guidance and therefore, adoption of the guidance is not expected to have a material effect on ProAssurance’s results of operations or financial position.
Modification Accounting for Employee Share-Based Payment Awards
Effective for fiscal years beginning after December 15, 2017 and interim periods within those fiscal years, the FASB issued guidance which reduces the complexity in accounting standards when there is a change in the terms or conditions of a share-based payment award. The new guidance clarifies that an entity should apply the modification accounting guidance if the value, vesting conditions or classification of the award changes. 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.
Premium Amortization on Purchased Callable Debt Securities
Effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, the FASB issued guidance that will require the premium for certain callable debt securities to be amortized over a shorter period than is currently required. Currently amortization is permitted over the contractual life of the instrument and the guidance shortens the amortization to the earliest call date. The purpose of the guidance is to more closely align the amortization period of premiums to expectations incorporated in market pricing on the underlying securities. 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.
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 leases it believes to be material.

13

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

Simplifying the Test for Goodwill Impairment
Effective for the fiscal years beginning after December 15, 2019 and interim periods within those fiscal years, the FASB issued guidance that simplifies the requirements to test goodwill for impairment for business entities that have goodwill reported in their financial statements. The guidance eliminates the second step of the impairment test which measures a goodwill impairment loss by comparing the implied fair value of a reporting unit's goodwill with the carrying amount. In addition, the guidance also eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment. ProAssurance plans to adopt the guidance beginning January 1, 2020. Adoption is not expected to have a material effect on ProAssurance’s results of operations or financial position.
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.

14

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

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, 2017 and December 31, 2016 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, 2017
 

 
September 30, 2017
 
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
$

 
$
148,372

 
$

 
$
148,372

U.S. Government-sponsored enterprise obligations

 
18,772

 

 
18,772

State and municipal bonds

 
693,398

 

 
693,398

Corporate debt, multiple observable inputs
2,406

 
1,255,413

 

 
1,257,819

Corporate debt, limited observable inputs

 

 
14,963

 
14,963

Residential mortgage-backed securities

 
201,691

 

 
201,691

Agency commercial mortgage-backed securities

 
11,835

 

 
11,835

Other commercial mortgage-backed securities

 
16,190

 

 
16,190

Other asset-backed securities

 
101,770

 
3,540

 
105,310

Equity securities
 
 
 
 
 
 

Financial
75,274

 

 

 
75,274

Utilities/Energy
53,553

 

 

 
53,553

Consumer oriented
53,569

 

 

 
53,569

Industrial
51,002

 

 

 
51,002

Bond funds
119,155

 

 

 
119,155

All other
59,243

 

 

 
59,243

Short-term investments
288,796

 
5,583

 

 
294,379

Other investments
747

 
30,614

 
428

 
31,789

Total assets categorized within the fair value hierarchy
$
703,745

 
$
2,483,638

 
$
18,931

 
3,206,314

LP/LLC and investment fund interests carried at NAV which approximates fair value. These interests, reported as a part of Investment in unconsolidated subsidiaries and Other investments, respectively, are not categorized within the fair value hierarchy.
 
 
 
 
 
 
222,541

Total assets at fair value
 
 
 
 
 
 
$
3,428,855


16

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

 
December 31, 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
$

 
$
146,539

 
$

 
$
146,539

U.S. Government-sponsored enterprise obligations

 
30,235

 

 
30,235

State and municipal bonds

 
800,463

 

 
800,463

Corporate debt, multiple observable inputs
2,339

 
1,261,842

 

 
1,264,181

Corporate debt, limited observable inputs

 

 
14,810

 
14,810

Residential mortgage-backed securities

 
217,906

 

 
217,906

Agency commercial mortgage-backed securities

 
12,783

 

 
12,783

Other commercial mortgage-backed securities

 
19,611

 

 
19,611

Other asset-backed securities

 
103,871

 
3,007

 
106,878

Equity securities
 
 
 
 
 
 

Financial
81,749

 

 

 
81,749

Utilities/Energy
52,869

 

 

 
52,869

Consumer oriented
61,284

 

 

 
61,284

Industrial
54,265

 

 

 
54,265

Bond funds
79,843

 
10,159

 

 
90,002

All other
27,181

 
19,924

 

 
47,105

Short-term investments
437,580

 
4,504

 

 
442,084

Other investments
1,956

 
29,542

 
3

 
31,501

Total assets categorized within the fair value hierarchy
$
799,066


$
2,657,379


$
17,820


3,474,265

LP/LLC and investment fund interests carried at NAV which approximates fair value. These interests, reported as a part of Investment in unconsolidated subsidiaries and Other investments, respectively, are not categorized within the fair value hierarchy.
 
 
 
 
 
 
204,719

Total assets at fair value
 
 
 
 
 
 
$
3,678,984

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 adjusted, if necessary. There were no material changes to the values supplied by the pricing services during the three and nine months ended September 30, 2017 and 2016.
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, 2017
 

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, 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 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's 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, 2017
 

Level 3 Valuation Methodologies
Corporate debt, 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, 2017, 73% of the securities were rated and the average rating was BBB+. At December 31, 2016, 84% of the securities were rated and the average rating was BBB+.
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.
Other investments consisted of convertible securities for which limited observable inputs were available at September 30, 2017 and at December 31, 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.
Quantitative Information Regarding Level 3 Valuations
 
 
Fair Value at
 
 
 
 
 
 
(In thousands)
 
September 30, 2017
 
December 31, 2016
 
Valuation Technique
 
Unobservable Input
 
Range
(Weighted Average)
Assets:
 
 
 
 
 
 
 
 
 
 
Corporate debt, limited observable inputs
 
$14,963
 
$14,810
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
Other asset-backed securities
 
$3,540
 
$3,007
 
Market Comparable
Securities
 
Comparability Adjustment
 
0% - 5% (2.5%)
 
 
 
 
 
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 5% (2.5%)
Other investments
 
$428
 
$3
 
Discounted Cash Flows
 
Comparability Adjustment
 
0% - 10% (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, 2017
 

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, 2017
 
Level 3 Fair Value Measurements – Assets
(In thousands)
Corporate Debt
 
Asset-backed Securities
 
All other investments
 
Total
Balance June 30, 2017
$
17,849

 
$
3,005

 
$
5

 
$
20,859

Total gains (losses) realized and unrealized:
 
 
 
 
 
 
 
Included in earnings, as a part of:
 
 
 
 
 
 
 
Net investment income
(52
)
 

 

 
(52
)
Included in other comprehensive income
(18
)
 
(45
)
 

 
(63
)
Purchases
1

 
580

 

 
581

Sales
(858
)
 

 

 
(858
)
Transfers in
989

 

 
423

 
1,412

Transfers out
(2,948
)
 

 

 
(2,948
)
Balance September 30, 2017
$
14,963

 
$
3,540

 
$
428

 
$
18,931

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

 
$

 
$

 
$

 
September 30, 2017
 
Level 3 Fair Value Measurements – Assets
(In thousands)
Corporate Debt
 
Asset-backed Securities
 
All other investments
 
Total
Balance December 31, 2016
$
14,810

 
$
3,007

 
$
3

 
$
17,820

Total gains (losses) realized and unrealized:
 
 
 
 
 
 
 
Included in earnings, as a part of:
 
 
 
 
 
 
 
Net investment income
(125
)
 

 

 
(125
)
Net realized investment gains (losses)
13

 

 
(124
)
 
(111
)
Included in other comprehensive income
(296
)
 
(47
)
 
140

 
(203
)
Purchases
11,890

 
580

 

 
12,470

Sales
(4,418
)
 

 
(912
)
 
(5,330
)
Transfers in
999

 

 
1,321

 
2,320

Transfers out
(7,910
)
 

 

 
(7,910
)
Balance September 30, 2017
$
14,963

 
$
3,540


$
428

 
$
18,931

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, 2017
 

 
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
)
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
)
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
$

 
$

 
$

 
$

 
$


21

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

Transfers
There were no transfers between the Level 1 and Level 2 categories during the three months ended September 30, 2017. During the nine months ended September 30, 2017, equity securities of approximately $35.4 million were transferred from Level 2 to Level 1. During the three and nine months ended September 30, 2016, equity securities of approximately $10.2 million were transferred from Level 2 to Level 1.
Transfers shown in the preceding Level 3 tables were as of the end of the quarter in which the transfer occurred. All transfers were to or from Level 2.
All transfers during the three and nine months ended September 30, 2017 and 2016 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, 2017 and December 31, 2016 included interests in investment fund LPs/LLCs and Other investments at September 30, 2017 included interests in certain investment funds 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,
2017
 
September 30,
2017
 
December 31,
2016
Investments in LPs/LLCs:
 
 
 
 
 
Private debt funds (1)
$12,006
 
$
42,650

 
$
55,637

Long equity fund (2)
None
 
7,396

 
6,268

Long/short equity funds (3)
None
 
30,904

 
28,926

Non-public equity funds (4)
$86,985
 
92,887

 
89,691

Multi-strategy fund of funds (5)
None
 
8,966

 
8,448

Structured credit fund (6)
None
 
6,394

 
4,273

Long/short commodities fund (7)
None
 
12,648

 
11,476

Strategy focused fund (8)
$4,304
 
696

 

Other investments:
 
 
 
 
 
Mortgage fund (9)
None
 
20,000

 

 
 
 
$
222,541

 
$
204,719

(1) 
The investment is 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 three to eight 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) 
The investment is 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.

22

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

(4) 
The investment is 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, debt including senior, second lien and mezzanine, 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 nine 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.
(8) 
This fund is a LLC focused exclusively on investing in consumer product companies. The fund will invest exclusively in North American companies, comprised of equity and equity-related securities, as well as debt instruments. Redemptions are not permitted.
(9) 
This investment fund is focused on the structured mortgage market. The fund will primarily invest in U.S. Agency mortgage-backed securities. Redemptions are allowed at the end of any calendar quarter with a prior notice requirement of 65 days and are paid within 45 days at the end of the redemption dealing day.
ProAssurance may not sell, transfer or assign its interest in any of the above LPs/LLCs without special consent from the LPs/LLCs.
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, 2017
 
December 31, 2016
(In thousands)
Carrying
Value
 
Fair
Value
 
Carrying
Value
 
Fair
Value
Financial assets:
 
 
 
 
 
 
 
BOLI
$
61,652

 
$
61,652

 
$
60,134

 
$
60,134

Other investments
$
51,975

 
$
60,713

 
$
50,391

 
$
58,757

Other assets
$
34,412

 
$
34,311

 
$
29,111

 
$
28,960

Financial liabilities:
 
 
 
 
 
 
 
Senior notes due 2023*
$
250,000

 
$
273,923

 
$
250,000

 
$
270,898

Revolving Credit Agreement*
$
152,000

 
$
152,000

 
$
200,000

 
$
200,000

Other liabilities
$
19,858

 
$
19,858

 
$
17,033

 
$
17,011

* Carrying value excludes debt issuance costs.
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.

23

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

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 unsecured note receivable under two separate line of credit agreements. Fair value of these notes receivable was based on the present value of expected cash flows from the notes receivable, discounted at market rates on the valuation date for receivables with similar credit standings and similar payment 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.

24

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

3. Investments
Available-for-sale securities at September 30, 2017 and December 31, 2016 included the following:
 
September 30, 2017
(In thousands)
Amortized
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Fixed maturities
 
 
 
 
 
 
 
U.S. Treasury obligations
$
148,194

 
$
954

 
$
776

 
$
148,372

U.S. Government-sponsored enterprise obligations
18,756

 
119

 
103

 
18,772

State and municipal bonds
675,012

 
20,086

 
1,700

 
693,398

Corporate debt
1,254,878

 
22,427

 
4,523

 
1,272,782

Residential mortgage-backed securities
199,110

 
3,401

 
820

 
201,691

Agency commercial mortgage-backed securities
11,841

 
63

 
69

 
11,835

Other commercial mortgage-backed securities
16,135

 
126

 
71

 
16,190

Other asset-backed securities
105,166

 
303

 
159

 
105,310

 
$
2,429,092

 
$
47,479

 
$
8,221

 
$
2,468,350

 
 
 
 
 
 
 
 
 
December 31, 2016
(In thousands)
Amortized
Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Estimated Fair Value
Fixed maturities
 
 
 
 
 
 
 
U.S. Treasury obligations
$
146,186

 
$
1,264

 
$
911

 
$
146,539

U.S. Government-sponsored enterprise obligations
30,038

 
388

 
191

 
30,235

State and municipal bonds
790,154

 
17,261

 
6,952

 
800,463

Corporate debt
1,264,812

 
22,659

 
8,480

 
1,278,991

Residential mortgage-backed securities
216,285

 
3,667

 
2,046

 
217,906

Agency commercial mortgage-backed securities
12,837

 
89

 
143

 
12,783

Other commercial mortgage-backed securities
19,571

 
177

 
137

 
19,611

Other asset-backed securities
106,938

 
207

 
267

 
106,878

 
$
2,586,821

 
$
45,712

 
$
19,127

 
$
2,613,406


25

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

The recorded cost basis and estimated fair value of available-for-sale fixed maturities at September 30, 2017, 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
$
148,194

 
$
30,655

 
$
93,222

 
$
21,495

 
$
3,000

 
$
148,372

U.S. Government-sponsored enterprise obligations
18,756

 
249

 
8,362

 
10,020

 
141

 
18,772

State and municipal bonds
675,012

 
57,500

 
233,506

 
295,098

 
107,294

 
693,398

Corporate debt
1,254,878

 
124,057

 
737,639

 
390,103

 
20,983

 
1,272,782

Residential mortgage-backed securities
199,110

 

 

 

 

 
201,691

Agency commercial mortgage-backed securities
11,841

 

 

 

 

 
11,835

Other commercial mortgage-backed securities
16,135

 

 

 

 

 
16,190

Other asset-backed securities
105,166

 

 

 

 

 
105,310

 
$
2,429,092

 
 
 
 
 
 
 
 
 
$
2,468,350

Excluding obligations of the U.S. Government, U.S. Government-sponsored enterprises and a U.S. Government obligations money market fund, no investment in any entity or its affiliates exceeded 10% of Shareholders’ equity at September 30, 2017.
Cash and securities with a carrying value of $46.6 million at September 30, 2017 were on deposit with various state insurance departments to meet regulatory requirements. ProAssurance also held securities with a carrying value of $189.5 million at September 30, 2017 that are pledged as collateral security for advances under the Revolving Credit Agreement (see Note 7 of the Notes to Condensed Consolidated Financial Statements for additional detail on the Revolving Credit Agreement).
As a member of Lloyd's and a capital provider to Syndicate 1729, ProAssurance is required to maintain capital at Lloyd's, referred to as FAL. ProAssurance investments at September 30, 2017 included fixed maturities with a fair value of $98.7 million and short-term investments with a fair value of approximately $0.5 million on deposit with Lloyd's in order to satisfy these FAL requirements.
BOLI
ProAssurance holds BOLI policies that are carried at the current cash surrender value of the policies (original cost $33 million). All insured individuals were members of ProAssurance management at the time the policies were acquired. The primary purpose of the program is to offset future employee benefit expenses through earnings on the cash value of the policies. ProAssurance is the owner and beneficiary of these policies.


26

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2017
 

Investment in Unconsolidated Subsidiaries
ProAssurance holds investments in unconsolidated subsidiaries, accounted for under the equity method. The investments include the following:
 
Carrying Value
(In thousands)
September 30,
2017
 
December 31,
2016
Investment in LPs/LLCs:
 
 
 
Qualified affordable housing tax credit partnerships
$
91,598

 
$
102,313

Other tax credit partnerships
8,355

 
11,459

All other LPs/LLCs
231,944

 
227,134

 
$
331,897

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