Edgar Filing: PROASSURANCE CORP

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2011

¨	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 x 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 x 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):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

As of October 26, 2011, there were 30,535,667 shares of the registrant’s common stock outstanding.

TABLE OF CONTENTS


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			33
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			58
ITEM 4. CONTROLS AND PROCEDURES			60
PART II. OTHER INFORMATION			61
ITEM 1. LEGAL PROCEEDINGS			61
ITEM 1A. RISK FACTORS			61
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			61
ITEM 6. EXHIBITS			62
SIGNATURE			63
EX-31.1
EX-31.2
EX-32.1
EX-32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

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”, “may”, “optimistic”, “preliminary”, “potential”, “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 liquidity and capital requirements, investment valuation and performance, return on equity, financial ratios, net income, premiums, losses and loss reserves, premium rates and retention of current business, competition and market conditions, the expansion of product lines, the development or acquisition of business in new geographical areas, the availability of acceptable reinsurance, actions by regulators and rating agencies, court actions, legislative actions, payment or performance of obligations under indebtedness, payment of dividends, and other matters.

These forward-looking statements are subject to significant risks, assumptions and uncertainties, including, among other things, the following factors that could affect the actual outcome of future events:

•

general economic conditions, either nationally or in our market areas, that are different than anticipated;

•

regulatory, legislative and judicial actions or decisions that could affect our business plans or operations;

•

the enactment or repeal of tort reforms;

•

formation or dissolution of state-sponsored medical professional liability insurance entities that could remove or add sizable groups of physicians from the private insurance market;

•

the impact of deflation or inflation;

•

changes in the interest rate environment;

•

changes in U.S. laws or government regulations regarding financial markets or market activity that may affect the U.S. economy and our business;

•

changes in the ability of the U.S. government to meet its obligations that may affect the U.S. economy and our business;

•

performance of financial markets affecting the fair value of our investments or making it difficult to determine the value of our investments;

•

changes in accounting policies and practices that may be adopted by our regulatory agencies and the Financial Accounting Standards Board, the Securities and Exchange Commission, or the Public Company Accounting Oversight Board;

•

changes in laws or government regulations affecting medical professional liability insurance or the financial community;

•

the effects of changes in the health care delivery system, including but not limited to the Patient Protection and Affordable Care Act;

•

uncertainties inherent in the estimate of loss and loss adjustment expense reserves and reinsurance, and changes in the availability, cost, quality, or collectability of insurance/reinsurance;

•

the results of litigation, including pre- or post-trial motions, trials and/or appeals we undertake;

•

allegation of bad faith which may arise from our handling of any particular claim, including failure to settle;

•

loss of independent agents;

•

changes in our organization, compensation and benefit plans;

•

our ability to retain and recruit senior management;

•

our ability to purchase reinsurance and collect recoveries from our reinsurers;

•

assessments from guaranty funds;

•

our ability to achieve continued growth through expansion into other states or through acquisitions or business combinations;

•

changes to the ratings assigned by rating agencies to our insurance subsidiaries, individually or as a group;

•

insurance market conditions may alter the effectiveness of our current business strategy and impact our revenues;

•

the expected benefits from completed and proposed acquisitions may not be achieved or may be delayed longer than expected due to business disruption, loss of customers, employees and key agents, increased operating costs or inability to achieve cost savings, and assumption of greater than expected liabilities, among other reasons.

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 Securities and Exchange Commission, such as our current reports on Form 8-K, and our regular reports on Form 10-Q.

We caution readers not to place undue reliance on any such forward-looking statements, which speak 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.

ProAssurance Corporation and Subsidiaries

Condensed Consolidated Balance Sheets (Unaudited)

(In thousands, except share data)


	September 30 2011			December 31 2010

Assets
Investments
Fixed maturities available for sale, at fair value	$	3,674,572		$	3,603,754
Equity securities, available for sale, at fair value		22			3,637
Equity securities, trading, at fair value		73,939			37,286
Short-term investments		96,824			168,438
Business owned life insurance		52,174			50,484
Investment in unconsolidated subsidiaries		114,520			88,754
Other investments		34,460			38,078

Total Investments		4,046,511			3,990,431

Cash and cash equivalents		125,707			50,851
Premiums receivable		138,011			120,950
Receivable from reinsurers on paid losses and loss adjustment expenses		2,760			4,582
Receivable from reinsurers on unpaid losses and loss adjustment expenses		283,419			277,436
Prepaid reinsurance premiums		14,373			11,023
Deferred policy acquisition costs		27,998			27,281
Deferred taxes		20,359			56,862
Real estate, net		40,767			43,951
Intangible assets		54,834			60,031
Goodwill		159,625			161,453
Other assets		74,445			70,205

Total Assets	$	4,988,809		$	4,875,056


Liabilities and Shareholders’ Equity
Liabilities
Policy liabilities and accruals
Reserve for losses and loss adjustment expenses	$	2,393,092		$	2,414,100
Unearned premiums		277,702			256,050
Reinsurance premiums payable		110,681			111,680

Total Policy Liabilities		2,781,475			2,781,830
Other liabilities		135,657			186,259
Long-term debt, $35,503 and $35,488, at amortized cost, respectively; $14,411 and $15,616 at fair value, respectively		49,914			51,104

Total Liabilities		2,967,046			3,019,193
Shareholders’ Equity
Common shares, par value $0.01 per share, 100,000,000 shares authorized, 34,534,526 and 34,419,383 shares issued, respectively		345			344
Additional paid-in capital		537,039			532,213
Accumulated other comprehensive income (loss), net of deferred tax expense (benefit) of $65,882 and $42,607, respectively		122,348			79,124
Retained earnings		1,566,888			1,428,026

		2,226,620			2,039,707
Treasury shares, at cost, 4,007,054 shares and 3,666,149 shares, respectively		(204,857	)		(183,844	)

Total Shareholders’ Equity		2,021,763			1,855,863

Total Liabilities and Shareholders’ Equity	$	4,988,809		$	4,875,056

ProAssurance Corporation and Subsidiaries

Condensed Consolidated Statements of Changes in Capital (Unaudited)

(In thousands)


	Total			Accumulated Other Comprehensive Income (Loss)		Retained Earnings			Other Capital Accounts

Balance at December 31, 2010	$	1,855,863		$	79,124	$	1,428,026		$	348,713
Net income		146,494			—		146,494			—
Dividends to shareholders		(7,632	)		—		(7,632	)		—
Change in net unrealized gains (losses) on investments, after tax, net of reclassification adjustments		43,224			43,224		—			—
Common shares reacquired		(21,013	)		—		—			(21,013	)
Common shares issued for compensation and net effect of performance shares issued and stock options exercised		(595	)		—		—			(595	)
Share-based compensation		5,422			—		—			5,422

Balance at September 30, 2011	$	2,021,763		$	122,348	$	1,566,888		$	332,527


	Total			Accumulated Other Comprehensive Income (Loss)		Retained Earnings			Other Capital Accounts

Balance at December 31, 2009	$	1,704,595		$	59,254	$	1,196,428		$	448,913
Net income		129,545			—		129,545			—
Change in net unrealized gains (losses) on investments, after tax, net of reclassification adjustments		73,263			73,263		—			—
Common shares reacquired		(94,426	)		—		—			(94,426	)
Common shares issued for compensation and net effect of performance shares issued and stock options exercised		721			—		—			721
Share-based compensation		4,509			—		—			4,509

Balance at September 30, 2010	$	1,818,207		$	132,517	$	1,325,973		$	359,717

ProAssurance Corporation and Subsidiaries

Condensed Consolidated Statements of Income (Unaudited)

(In thousands, except per share data)


	Three Months Ended September 30						Nine Months Ended September 30

	2011			2010			2011			2010

Revenues
Gross premiums written	$	174,680		$	158,998		$	450,795		$	414,697

Net premiums written	$	164,798		$	149,693		$	421,692		$	383,783

Premiums earned	$	145,844		$	140,802		$	429,627		$	411,006
Premiums ceded		(11,217	)		(10,502	)		(25,861	)		(31,882	)

Net premiums earned		134,627			130,300			403,766			379,124
Net investment income		34,116			35,639			106,573			110,348
Equity in earnings (loss) of unconsolidated subsidiaries		(2,264	)		(1,281	)		(6,044	)		2,544
Net realized investment gains (losses):
Other-than-temporary impairment losses (OTTI)		(1,389	)		(698	)		(4,291	)		(13,077	)
Portion of OTTI losses recognized in (reclassified from) other comprehensive income before taxes		(142	)		113			(823	)		119

Net impairment losses recognized in earnings		(1,531	)		(585	)		(5,114	)		(12,958	)
Other net realized investment gains (losses)		(10,441	)		15,297			(534	)		21,765

Total net realized investment gains (losses)		(11,972	)		14,712			(5,648	)		8,807
Other income		7,471			1,764			11,745			5,769

Total revenues		161,978			181,134			510,392			506,592

Expenses
Losses and loss adjustment expenses		71,777			86,866			218,270			251,944
Reinsurance recoveries		(8,601	)		(7,055	)		(20,319	)		(24,908	)

Net losses and loss adjustment expenses		63,176			79,811			197,951			227,036
Underwriting, policy acquisition and operating expenses		34,954			32,095			103,534			94,940
Interest expense		932			832			2,645			2,472

Total expenses		99,062			112,738			304,130			324,448


Income before income taxes		62,916			68,396			206,262			182,144

Provision for income taxes
Current expense (benefit)		19,220			24,155			46,049			56,080
Deferred expense (benefit)		(9	)		(6,811	)		13,719			(3,481	)

Total income tax expense (benefit)		19,211			17,344			59,768			52,599


Net income	$	43,705		$	51,052		$	146,494		$	129,545

Earnings per share:
Basic	$	1.43		$	1.61		$	4.79		$	4.03

Diluted	$	1.42		$	1.59		$	4.75		$	3.99

Weighted average number of common shares outstanding:
Basic		30,557			31,642			30,577			32,135

Diluted		30,847			32,047			30,844			32,508

Cash dividends declared per common share	$	0.25			—		$	0.25			—

ProAssurance Corporation and Subsidiaries

Condensed Consolidated Statements of Comprehensive Income (Unaudited)

(In thousands)


	Three Months Ended September 30				Nine Months Ended September 30

	2011		2010		2011		2010

Comprehensive income:
Net income	$	43,705	$	51,052	$	146,494	$	129,545
Change in net unrealized gains (losses) on investments, after tax, net of reclassification adjustments		23,291		27,878		43,224		73,263

Comprehensive income	$	66,996	$	78,930	$	189,718	$	202,808

ProAssurance Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows (Unaudited)

(In thousands)


	Nine Months Ended September 30

	2011			2010

Operating Activities
Net income	$	146,494		$	129,545
Depreciation and amortization		27,182			19,571
Net realized investment (gains) losses		5,648			(8,807	)
Share-based compensation		5,422			4,509
Deferred income taxes		13,719			(3,481	)
Other		(328	)		7,232
Other changes in assets and liabilities:
Premiums receivable		(17,061	)		(1,212	)
Other assets		4,090			(9,423	)
Reserve for losses and loss adjustment expenses		(21,008	)		(16,402	)
Unearned premiums		21,652			5,238
Reinsurance related assets and liabilities		(8,510	)		7,158
Other liabilities		(70,882	)		(25,302	)


Net cash provided by operating activities		106,418			108,626

Investing Activities
Purchases of:
Fixed maturities available for sale		(597,762	)		(663,341	)
Equity securities trading		(87,787	)		(13,450	)
Other investments		(429	)		(5,383	)
(Investments in) distributions from unconsolidated subsidiaries, net:
Tax credit limited partnerships		(21,542	)		(8,783	)
Other partnership investments		—			24,601
Proceeds from sale or maturities of:
Fixed maturities available for sale		586,455			777,596
Equity securities available for sale		3,836			271
Equity securities trading		40,648			26,887
Other investments		596			1,242
Net sales or maturities (purchases) of short-term investments		71,614			(150,942	)
Unsettled security transactions, net		4,897			9,344
Cash received (paid) for other assets		(9,581	)		(2,752	)


Net cash provided (used) by investing activities		(9,055	)		(4,710	)

Financing Activities
Repurchase of treasury shares		(21,013	)		(94,426	)
Other		(1,494	)		(1,868	)


Net cash provided (used) by financing activities		(22,507	)		(96,294	)


Increase (decrease) in cash and cash equivalents		74,856			7,622
Cash and cash equivalents at beginning of period		50,851			40,642


Cash and cash equivalents at end of period	$	125,707		$	48,264

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

1. Basis of Presentation

The accompanying unaudited Condensed Consolidated Financial Statements include the accounts of ProAssurance Corporation and its consolidated subsidiaries (ProAssurance or PRA). The financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation, consisting of normal recurring adjustments, have been included. ProAssurance’s results for the three-month and nine-month periods ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. The accompanying Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and Notes contained in ProAssurance’s December 31, 2010 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, 2011 for recognition or disclosure in its financial statements and notes to financial statements.

Reclassifications

As of September 30, 2011, ProAssurance has reported intangible assets as a separate line item on the Balance Sheet. Prior period balances in this report have been reclassified to conform to the 2011 presentation. The reclassification had no effect on income from continuing operations, net income or total assets.

Accounting Changes Not Yet Adopted

Intangibles, Goodwill and Other

Effective for interim and annual reporting periods beginning after December 15, 2011, the FASB revised guidance related to goodwill impairment testing. The new guidance permits the assessment of qualitative factors to determine whether events or circumstances lead to the conclusion that it is necessary to perform the two-step goodwill impairment test. Entities are not required to calculate the fair value of a reporting unit unless they conclude that it is more likely than not that the unit’s carrying value is greater than its fair value based on an assessment of events and circumstances. ProAssurance plans to adopt the guidance during the fourth quarter of 2011. Adoption of this guidance is not expected to have a material effect on ProAssurance’s results of operations or financial position.

Presentation of Comprehensive Income

Effective for interim and annual reporting periods beginning after December 15, 2011, the FASB revised guidance related to the presentation of comprehensive income. The new guidance establishes two acceptable options for the presentation of comprehensive income: 1) separate consecutive statements of net income and comprehensive income or 2) a single continuous statement of comprehensive income that includes both the computation of net income and the computation of other comprehensive income. Regardless of the option chosen, reclassification adjustments between other comprehensive income and net income must be presented on the face of the financial statements; total comprehensive income must also be presented. The guidance is applicable to all periods presented. ProAssurance plans to adopt the guidance on January 1, 2012. Adoption of this guidance will have no effect on ProAssurance’s results of operations or financial position.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

Fair Value Measurements

Effective for interim and annual reporting periods beginning after December 15, 2011, the FASB revised guidance related to fair value measurements and disclosures, all of which are to be applied prospectively. The new guidance increases disclosure requirements regarding valuation methods used to determine fair value measurements categorized as Level 3, as well as the sensitivity to change of those measurements, and requires additional disclosures regarding the consideration given to highest and best use in fair value measurements of nonfinancial assets. The guidance also requires that when fair value measurements of items not carried at fair value are disclosed, the fair value measurements are to be categorized by level of the fair value hierarchy. Additionally, the guidance also clarifies or revises certain fair value measurement principles related to the valuation of financial instruments managed within a portfolio, the valuation of instruments classified as a part of shareholders’ equity, the appropriate application of the highest and best use valuation premise, and the consideration of premium and discounts in a fair value measurement. ProAssurance plans to adopt the guidance beginning January 1, 2012. Adoption of this guidance is not expected to have a material effect on ProAssurance’s results of operations or financial position.

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

Effective for fiscal years beginning after December 15, 2011, the FASB revised guidance regarding the interpretation of which costs relating to the acquisition of new or renewal insurance contracts qualify for deferral. The guidance permits deferral of qualifying costs associated only with successful contract acquisitions. Internal selling agent and underwriter salary and benefit costs allocated to unsuccessful contracts, as well as advertising costs, are excluded. The guidance must be applied prospectively, but may be applied retrospectively for all prior periods. ProAssurance plans to adopt the guidance beginning January 1, 2012. Adoption of this guidance is not expected to have a material effect on ProAssurance’s results of operations or financial position.

Accounting Changes

Intangibles, Goodwill and Other

Effective for interim and annual reporting periods beginning after December 15, 2010, the FASB revised guidance related to goodwill impairment testing. The revised guidance clarifies that when evaluating goodwill associated with a reporting unit that has a zero or negative carrying value, an initial determination should be made as to whether it is more likely than not that the goodwill is impaired. When impairment is more likely than not, the goodwill is required to be tested for impairment. ProAssurance adopted the guidance on January 1, 2011. Adoption had no material effect on ProAssurance’s results of operations or financial position.

Fair Value Measurements

Effective for interim and annual reporting periods beginning after December 15, 2010, the FASB revised guidance to require additional disclosure about purchases, sales, issuances, and settlements in the roll forward activity in Level 3 fair value measurements. ProAssurance adopted the guidance on January 1, 2011. Adoption had no effect on ProAssurance’s results of operations or financial position.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

2. Acquisitions

All entities acquired have been accounted for in accordance with GAAP relating to business combinations and are considered to be a part of ProAssurance’s sole reporting segment, the professional liability segment.

On November 30, 2010 ProAssurance acquired 100% of the outstanding shares of American Physicians Service Group, Inc. (APS) as a means of expanding its professional liability business. Total purchase consideration transferred had a fair value of $237 million on the acquisition date and included cash of $233 million and deferred compensation commitments of $4 million.

In the third quarter of 2011, Goodwill related to the purchase of APS was reduced by $1.8 million related to the completion of the valuation of pre-acquisition tax liabilities.

ProAssurance 2011 operating results include revenue and earnings attributable to the operations acquired from APS as follows:


*(In thousands)*	Three Months Ended September 30, 2011		Nine Months Ended September 30, 2011

Revenue	$	15,309	$	46,899
Earnings	$	3,035	$	12,815

The following table provides ProAssurance Pro Forma Consolidated Results as if ProAssurance had acquired APS on January 1, 2010. Pro Forma results reflect ProAssurance Consolidated results, adjusted, net of related tax effects, as follows: 1) in 2010, to include the operating results of APS, 2) to reflect APS related workforce reductions as if the transaction had occurred on January 1, 2010, 3) to exclude the direct costs of completing the APS transaction, 4) to include amortization of APS policy acquisition costs written off upon acquisition, and 5) to reflect amortization of certain purchase adjustments (valuation of investment assets at fair value; intangibles recorded as a part of the purchase price allocation) beginning January 1, 2010. ProAssurance Actual Consolidated Results are also presented for comparative purposes. The ProAssurance Actual Consolidated results for the three and nine months ended September 30, 2010 do not include the operating results of APS because the APS acquisition did not occur until November 30, 2010.

Three Months Ended
September 30, 2011

Nine Months Ended
September 30, 2011

(In thousands)

ProAssurance
Pro Forma
Consolidated
Results

ProAssurance
Actual
Consolidated
Results

ProAssurance
Pro Forma
Consolidated
Results

ProAssurance
Actual
Consolidated
Results

Revenue

161,978

510,392

Earnings

44,555

43,705

147,923

146,494

Three Months Ended
September 30, 2010

Nine Months Ended
September 30, 2010

(In thousands)

ProAssurance
Pro Forma
Consolidated
Results

ProAssurance
Actual
Consolidated
Results

ProAssurance
Pro Forma
Consolidated
Results

ProAssurance
Actual
Consolidated
Results

Revenue

199,306

181,134

565,199

506,592

Earnings

55,413

51,052

143,786

129,545

For additional information regarding the acquisition, see Note 2 of the Notes to the Consolidated Financial Statements in ProAssurance’s 2010 Form 10-K.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

3. Fair Value Measurement

Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three level hierarchy has been established for valuing assets and liabilities based on how transparent (observable) the inputs are that are used to determine fair value, with the inputs considered most observable categorized as Level 1 and those that are the least observable categorized as Level 3. Hierarchy levels are defined as follows:


Level 1:		quoted (unadjusted) market prices in active markets for identical assets and liabilities. For ProAssurance, Level 1 inputs are generally quotes for debt or equity securities actively traded in exchange or over-the-counter markets.

Level 2:		market data obtained from sources independent of the reporting entity (observable inputs). For ProAssurance, Level 2 inputs generally include quoted prices in markets that are not active, quoted prices for similar assets/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.

The following tables present information about ProAssurance’s assets and liabilities that are measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010 and indicate the fair value hierarchy of the valuation techniques utilized to determine such value. 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. ProAssurance’s assessment of the significance of a particular input to the fair value measurement requires judgment and considers factors specific to the assets being valued.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

Assets and liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010, including financial instruments for which ProAssurance has elected fair value accounting, are as follows:

September 30, 2011

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

—

310,547

—

310,547

U.S. Agency obligations

—

87,079

—

87,079

State and municipal bonds

—

1,165,798

7,250

1,173,048

Corporate debt, multiple observable inputs

—

1,361,150

—

1,361,150

Corporate debt, limited observable inputs:

Private placement senior notes

—

617

Other corporate debt, NRSRO ratings available

—

8,227

Other corporate debt, NRSRO ratings not available

—

1,252

Residential mortgage-backed securities

—

563,568

—

563,568

Commercial mortgage-backed securities

—

81,729

—

81,729

Other asset-backed securities

—

87,355

—

87,355

Equity securities, available for sale

Financial

—

Equity securities, trading

Financial

14,503

—

14,503

Energy

10,811

—

10,811

Consumer cyclical

7,114

—

7,114

Consumer non-cyclical

15,494

—

15,494

Technology

4,926

—

4,926

Industrial

7,511

—

7,511

Communications

4,802

—

4,802

Index funds

3,549

—

3,549

All other

5,229

—

5,229

Short-term investments

84,299

12,525

—

96,824

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

Investment in unconsolidated subsidiaries

—

24,830

Other investments

—

16,191

Total assets

158,260

3,669,751

58,367

3,886,378

Liabilities:

2019 Note Payable

—

14,411

Interest rate swap agreement

—

4,749

Total liabilities

—

19,160

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011


	December 31, 2010

	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	$	—	$	225,908	$	—	$	225,908
U.S. Agency obligations		—		68,878		—		68,878
State and municipal bonds		—		1,236,374		7,550		1,243,924
Corporate debt, multiple observable inputs		—		1,312,035		—		1,312,035
Corporate debt, limited observable inputs:
Private placement senior notes		—		—		9,356		9,356
Other corporate debt, NRSRO ratings available		—		—		10,414		10,414
Other corporate debt, NRSRO ratings not available		—		—		1,459		1,459
Residential mortgage-backed securities		—		567,640		2,198		569,838
Commercial mortgage-backed securities		—		99,386		—		99,386
Other asset-backed securities		—		62,534		22		62,556
Equity securities, available for sale
Financial		392		—		—		392
Energy		257		—		—		257
Consumer cyclical		521		—		—		521
Consumer non-cyclical		656		—		—		656
Technology		768		—		—		768
Industrial		737		—		—		737
All Other		306		—		—		306
Equity securities, trading
Financial		4,317		—		—		4,317
Energy		7,149		—		—		7,149
Consumer cyclical		1,599		—		—		1,599
Consumer non-cyclical		4,534		—		—		4,534
Technology		3,400		—		—		3,400
Industrial		2,403		—		—		2,403
Communications		2,623		—		—		2,623
Index funds		3,568		—		—		3,568
All other		7,693		—		—		7,693
Short-term investments		150,344		18,094		—		168,438
Financial instruments carried at fair value, classified as a part of Investment in unconsolidated subsidiaries		—		—		25,112		25,112

Total assets	$	191,267	$	3,590,849	$	56,111	$	3,838,227

Liabilities:
2019 Note Payable		—		—		15,616		15,616
Interest rate swap agreement		—		—		3,658		3,658

Total liabilities	$	—	$	—	$	19,274	$	19,274

The fair values for securities included in the Level 2 category, with the few exceptions described below, have been developed by third party, nationally recognized pricing services. These services use complex methodologies to determine values for securities and subject the values they develop to quality control reviews. The services collect and utilize multiple inputs, although not all inputs are used for every security type or given the same priority in every evaluation. Inputs used include: benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, and offers. The services also consider credit ratings, where appropriate, including ratings updates and information available in appropriate market research publications. Management reviews service-provided values for reasonableness by comparing market yields indicated by the supplied value to yields observed in the market place. If a value does not appear reasonable, the valuation is discussed with the service that provided the value and would be adjusted, if necessary. No such adjustments have been necessary in 2011 or 2010.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

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 are 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. Agency obligations are 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 are included in the valuation process when necessary to reflect recent events, such as regulatory, government or corporate actions or significant economic, industry or geographic events that would affect the security’s fair value.

State and municipal bonds are valued using a series of matrices that consider credit ratings, the structure of the security, the sector in which the security falls, yields, and contractual cash flows. Valuations are further adjusted, when necessary, to reflect recent events such as significant economic or geographic events or ratings changes that would affect the security’s fair value.

Corporate debt with multiple observable inputs, consists primarily of corporate bonds, but also includes a small number of bank loans. The methodology used to value Level 2 corporate bonds is the same as the methodology previously described for U.S. agency obligations. Bank loans are valued by an outside vendor based upon a widely distributed, loan-specific listing of average bid and ask prices published daily by an investment industry group. The publisher of the listing derives the averages from data received from multiple market-makers for bank loans.

Residential and commercial mortgage backed securities. Agency pass through securities are valued by a matrix, considering the issuer type, coupon rate and longest cash flows outstanding. The matrix is developed daily based on available market information. Agency and non-agency collateralized mortgage obligations are 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. Evaluations of Alt-A and subprime mortgages include a review of collateral performance data, which is generally updated monthly.

Other asset-backed securities are 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.

Short term investments, included in the Level 2 category, are commercial paper and certificates of deposit maturing within one year, carried at cost which approximates the fair value of the security due to the short term to maturity.

Below is a summary description of the valuation methodologies used to value securities in the Level 3 category by security type.

State and municipal bonds consists of auction rate municipal bonds valued internally using a model based on discounted cash flows 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. All are rated A or better.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

Corporate debt with limited observable inputs, exclusive of private placement senior notes, consist of corporate bonds valued internally using dealer quotes for similar securities or discounted cash flow models using yields currently available for similar securities. Similar securities are defined as securities having like terms and payment features that are of comparable credit quality. Assessments of credit quality are based on NRSRO ratings, if available, or are subjectively determined by management if not available. At September 30, 2011, the average NRSRO rating of rated securities is BBB+. Private placement senior notes are valued by an outside vendor rather than a third-party pricing service. The valuation is prepared based on a widely available matrix that is produced daily by a leading seller of secondary private placements. The matrix considers the market sector, issuer credit ratings and the remaining loan term and is developed from market data such as interest rate yield curves, credit spreads, quoted market prices for comparable securities and other applicable market data. At both September 30, 2011 and December 31, 2010 Level 3 corporate debt includes private placement senior notes which are unconditionally guaranteed by large regional banks; other corporate debt securities in the Level 3 category are not guaranteed or fully collateralized.

Other asset-backed securities are valued using multiple inputs including multiple broker dealer quotes.

Investments in unconsolidated subsidiaries and Other investments, included in the Level 3 category, are comprised of limited partnership (LP) and limited liability company (LLC) interests that are valued using net asset values provided by the LP/LLC, which approximates the fair value of the interest. The following table provides additional information regarding these interests:


	Fair Value				Unfunded Commitments

(In thousands)	September 30, 2011		December 31, 2010		September 30, 2011

Investment in unconsolidated subsidiaries:
LP primarily invested in long/short equities (1)	$	17,836	$	18,801	None
LP primarily invested in non-public equities (2)		6,994		6,311	None

		24,830	$	25,112

Other investments:
LLC primarily invested in non-public investment companies (3)		16,191			None

	$	41,021

(1)

The LP holds both long and short U.S. and North American equities, and targets absolute returns using a strategy designed to take advantage of event-driven market opportunities. Redemptions are allowed with a notice requirement of up to 45 days and are paid within 30 days of the redemption date, unless the redemption request is for 90% or more of the requestor’s capital balance. Redemptions at the 90% and above level will be paid at 90%, with the remainder paid after the LP’s annual audit.

(2)

The LP is structured to provide capital appreciation through diversified investments in private equity, including investments in buyout, venture capital, mezzanine debt, distressed debt and other private equity-oriented LPs. Redemptions are not allowed, except by special permission of the LP. Income and capital are to be periodically distributed at the discretion of the LP over an anticipated time frame that spans 3 to 5 years.

(3)

The LLC is structured to provide income through diversified investments in private equity, including mezzanine debt, distressed debt, syndicated bank loans and other private equity-oriented investments. Income and capital are required to be distributed back to equity holders at the discretion of the fund manager over a ten year period ending July, 2016. Redemptions are not permitted. The LLC has obtained approval from equity holders to convert into a publicly traded investment fund; but the conversion has not yet occurred.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

The following tables (the Level 3 Tables) present summary information regarding changes in the fair value of assets and liabilities measured at fair value using Level 3 inputs, including financial instruments for which ProAssurance has elected fair value accounting.


	September 30, 2011
	Level 3 Fair Value Measurements – Assets
*(In thousands)*	State and Municipal Bonds			Corporate Debt			Asset- backed Securities			Investment in Unconsolidated Subsidiaries			Other Investments		Total

Balance June 30, 2011	$	7,325		$	7,830		$	1,684		$	25,127		$	—	$	41,966
Total gains (losses) realized and unrealized, included in earnings, as a part of:
Equity in earnings of unconsolidated subsidiaries		—			—			—			(297	)		—		(297	)
Net realized investment gains (losses)		—			—			—			—			—		—
Included in other comprehensive income		—			(638	)		—			—			—		(638	)
Purchases		—			—			—			—			—		—
Sales		(75	)		—			—			—			—		(75	)
Transfers in		—			2,904			—			—			16,191		19,095
Transfers out		—			—			(1,684	)		—			—		(1,684	)

Balance September 30, 2011	$	7,250		$	10,096		$	—		$	24,830		$	16,191	$	58,367


Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end	$	—		$	—		$	—		$	(297	)	$	—	$	(297	)


	September 30, 2011
	Level 3 Fair Value Measurements – Assets
*(In thousands)*	State and Municipal Bonds			Corporate Debt			Asset- backed Securities			Investment in Unconsolidated Subsidiaries			Other Investments		Total

Balance December 31, 2010	$	7,550		$	21,229		$	2,220		$	25,112		$	—	$	56,111
Total gains (losses) realized and unrealized, included in earnings, as a part of:
Equity in earnings of unconsolidated subsidiaries		—			—			—			(282	)		—		(282	)
Net realized investment gains (losses)		—			—			314			—			—		314
Included in other comprehensive income		—			(1,352	)		(15	)		—			—		(1,367	)
Purchases		—			—			1,684			—			—		1,684
Sales		(300	)		(8,504	)		(1,921	)		—			—		(10,725	)
Transfers in		—			6,350			—			—			16,191		22,541
Transfers out		—			(7,627	)		(2,282	)		—			—		(9,909	)

Balance September 30, 2011	$	7,250		$	10,096		$	—		$	24,830		$	16,191	$	58,367


Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end	$	—		$	—		$	—		$	(282	)	$	—	$	(282	)

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011


	September 30, 2010
	Level 3 Fair Value Measurements - Assets
(In thousands)	State and Municipal Bonds			Corporate Debt			Asset- backed Securities		Investment in Unconsolidated Subsidiaries			Other Investments			Total

Balance June 30, 2010	$	9,401		$	25,660		$	—	$	57,488		$	930		$	93,479
Total gains (losses) realized and unrealized, included in earnings, as a part of:
Equity in earnings of unconsolidated subsidiaries		—			—			—		633			—			633
Net realized investment gains (losses)		—			59			—		—			—			59
Included in other comprehensive income		(1,131	)		(130	)		—		—			74			(1,187	)
Purchases		—			3,959			—		—			—			3,959
Sales		(50	)		(4,755	)		—		(33,042	)		—			(37,847	)
Transfers in		—			—			1,004		—			—			1,004
Transfers out		—			(491	)		—		—			(1,004	)		(1,495	)

Balance September 30, 2010	$	8,220		$	24,302		$	1,004	$	25,079		$	—		$	58,605


Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end	$	—		$	59		$	—	$	633		$	—		$	692


	September 30, 2010
	Level 3 Fair Value Measurements – Assets
(In thousands)	State and Municipal Bonds			Corporate Debt			Asset- backed Securities			Investment in Unconsolidated Subsidiaries			Other Investments			Total

Balance December 31, 2009	$	9,495		$	24,335		$	940		$	48,502		$	10,932		$	94,204
Total gains (losses) realized and unrealized, included in earnings, as a part of:
Equity in earnings of unconsolidated subsidiaries		—			—			—			4,618			—			4,618
Net realized investment gains (losses)		—			59			—			—			(10,698	)		(10,639	)
Included in other comprehensive income		(1,049	)		(106	)		60			—			11,953			10,858
Purchases		—			5,510			—			5,000			731			11,241
Sales		(226	)		(4,995	)		—			(33,041	)		(1,242	)		(39,504	)
Transfers in		—			151			1,004			—			—			1,155
Transfers out		—			(652	)		(1,000	)		—			(11,676	)		(13,328	)

Balance September 30, 2010	$	8,220		$	24,302		$	1,004		$	25,079		$	—		$	58,605


Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end	$	—		$	59		$	—		$	4,618		$	(10,698	)	$	(6,021	)

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

Transfers

There were no transfers between Level 1 and Level 2 for the three and nine months ended September 30, 2011, or for the three and nine months ended September 30, 2010.

Transfers shown in the preceding Level 3 Tables are as of the end of period and were to or from Level 2, unless otherwise noted.

Transfers summarized in the Level 3 Tables include:

•

For the three- and nine-month periods ended September 30, 2011, an interest in an LLC (classified as a part of Other Investments) began to be included in the Level 3 Tables. The interest is accounted for using the cost method, but due to the recognition of OTTIs, is carried at fair value, $16.2 million at September 30, 2011. The fund is expected to convert to a public fund in the near term. After conversion, the investment is expected to be classified as an available-for-sale security, valued at fair value.

•

For the three-month period ended September 30, 2010, asset-backed securities valued at $1 million that were previously held in a private investment fund became directly held and were reclassified from Other Investments to Asset-backed Securities.

•

For the nine-month period ended September 30, 2010, beneficially owned asset-backed securities held in a private investment fund (classified as a part of Other Investments) having a fair value of $10.7 million were transferred from Level 3 to Level 2 because the fund manager provided additional information regarding the valuation methodologies followed. Previously, the investments were 100% categorized as Level 3 because valuations were determined by the fund manager using various methodologies, not all of which were based on multiple observable inputs.

•

All remaining transfers relate to securities held for which there is little market activity for identical or nearly identical securities in a given quarter. Such securities are valued using multiple observable inputs when those inputs are available; otherwise the securities are valued using limited observable inputs.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011


	September 30, 2011
	Level 3 Fair Value Measurements - Liabilities
*(In thousands)*	2019 Note Payable			Interest rate swap agreement		Total

Balance June 30, 2011	$	15,863		$	3,852	$	19,715
Total (gains) losses realized and unrealized:
Included in earnings as a part of net realized investment (gains) losses		(1,370	)		897		(473	)
Settlements		(82	)		—		(82	)

Balance September 30, 2011	$	14,411		$	4,749	$	19,160

Change in unrealized (gains) losses included in earnings for the above period for Level 3 liabilities outstanding at period-end	$	(1,370	)	$	897	$	(473	)


	September 30, 2011
	Level 3 Fair Value Measurements - Liabilities
*(In thousands)*	2019 Note Payable			Interest rate swap agreement		Total

Balance December 31, 2010	$	15,616		$	3,658	$	19,274
Total (gains) losses realized and unrealized:
Included in earnings as a part of net realized investment (gains) losses		(962	)		1,091		129
Settlements		(243	)		—		(243	)

Balance September 30, 2011	$	14,411		$	4,749	$	19,160

Change in unrealized (gains) losses included in earnings for the above period for Level 3 liabilities outstanding at period-end	$	(962	)	$	1,091	$	129

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011


	September 30, 2010
	Level 3 Fair Value Measurements - Liabilities
(In thousands)	2019 Note Payable			Interest rate swap agreement		Total

Balance June 30, 2010	$	15,107		$	4,284	$	19,391
Total (gains) losses realized and unrealized:
Included in earnings as a part of net realized investment (gains) losses		710			548		1,258
Settlements		(76	)		—		(76	)

Balance September 30, 2010	$	15,741		$	4,832	$	20,573

Change in unrealized (gains) losses included in earnings for the above period for Level 3 liabilities outstanding at period-end	$	710		$	548	$	1,258


	September 30, 2010
	Level 3 Fair Value Measurements - Liabilities
(In thousands)	2019 Note Payable			Interest rate swap agreement		Total

Balance December 31, 2009	$	14,740		$	2,937	$	17,677
Total (gains) losses realized and unrealized:
Included in earnings as a part of net realized investment (gains) losses		1,229			1,895		3,124
Settlements		(228	)		—		(228	)

Balance September 30, 2010	$	15,741		$	4,832	$	20,573

Change in unrealized (gains) losses included in earnings for the above period for Level 3 liabilities outstanding at period-end	$	1,229		$	1,895	$	3,124

Fair Value Option Elections

The 2019 Note Payable and a related interest rate swap agreement (the Swap) are measured at fair value on a recurring basis, with changes in the fair value of each liability recorded in net realized gains (losses). ProAssurance assumed both liabilities as part of a previous acquisition. The fair value option was elected for the 2019 Note Payable and the Swap because valuation at fair value better reflects the economics of the related liabilities and eliminates the inconsistency that would otherwise result from carrying the 2019 Note Payable on an amortized cost basis and the Swap at fair value.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

Financial Instruments Not Measured At Fair Value

Financial assets and liabilities which are not measured at fair value on a recurring basis are as follows:


	September 30, 2011				December 31, 2010

(In thousands)	Carrying Value		Estimated Fair Value		Carrying Value		Estimated Fair Value

Financial assets:
Other investments	$	18,269	$	23,793	$	38,078	$	44,387
Investment in unconsolidated subsidiaries		89,690		99,947		63,642		66,862
BOLI		52,174		52,174		50,484		50,484
Other assets		8,992		8,992		7,743		7,743

Financial liabilities:
Trust Preferred Securities	$	22,992	$	22,992	$	22,992	$	22,992
Surplus Notes due May 2034		12,000		12,000		12,000		12,000
Note Payable due February 2012		511		518		496		521
Other liabilities		18,486		18,459		22,367		21,837

Other Investments listed in the table above include interests in certain investment fund LP/LLCs accounted for using the cost method, investments in Federal Home Loan Bank (FHLB) common stock carried at cost, and an annuity investment carried at amortized cost. The estimated fair value of the LP/LLC interests is based on NAVs provided by the LP/LLC managers. The fair value of the FHLB common stock is estimated as the carrying value of the investment as it is the amount we would receive if we cancel our membership; the investment has been determined not to have suffered an OTTI and the membership cannot be sold. The fair value of the annuity is the present value of the expected future cash flows discounted using a rate available in active markets for similarly structured instruments.

Investment in Unconsolidated Subsidiaries consists primarily of investments in tax credit partnerships, and an interest in a non-controlling limited liability company. Fair values of investments in tax credit partnerships are based on the present value of the cash flows expected to be generated by the partnerships discounted at rates for investments with similar risk structures and repayment periods. The fair value of the interest in the LLC is estimated at our initial capital contribution which occurred less than one year ago and represented an arm’s length transaction between market participants.

The fair value of the BOLI is the cash surrender value associated with the policies on the valuation date.

Other Assets and Other Liabilities primarily consist of related investment assets and liabilities associated with funded deferred compensation agreements. Included in Other Liabilities are also certain contractual liabilities associated with business combinations completed in 2009 and 2010. Fair values of the funded deferred compensation assets/liabilities are based on the net asset value of the underlying securities. The fair values of the business combination liabilities are based on the present value of the expected cash flows, discounted at ProAssurance’s assumed incremental borrowing rate on the valuation date for unsecured liabilities with similar repayment structures.

The fair value of the long-term debt is the present value of expected underlying cash flows of the debt, discounted at rates available on the valuation date for similar debt issued by entities with a similar credit standing to ProAssurance or, if issued by an insurance subsidiary, the subsidiary issuing the debt.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

4. Investments

The amortized cost and estimated fair value of available-for-sale fixed maturities and equity securities are as follows:

September 30, 2011

(In thousands)

Amortized

Cost

Gross

Unrealized

Gains

Gross

Unrealized

Losses

Estimated

Fair

Value

Fixed maturities

U.S. Treasury obligations

293,301

17,255

)

310,547

U.S. Agency obligations

81,337

5,758

(16

)

87,079

State and municipal bonds

1,100,718

72,500

(170

)

1,173,048

Corporate debt

1,313,579

66,405

(8,738

)

1,371,246

Residential mortgage-backed securities

533,195

32,418

(2,045

563,568

Commercial mortgage-backed securities

77,958

3,849

(78

)

81,729

Other asset-backed securities

86,267

1,113

(25

)

87,355

3,486,355

199,298

(11,081

)

3,674,572

Equity securities

—

3,486,361

199,314

(11,081

)

3,674,594


	December 31, 2010

(In thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value

Fixed maturities
U.S. Treasury obligations	$	219,631	$	7,519	$	(1,242	)	$	225,908
U.S. Agency obligations		64,804		4,113		(39	)		68,878
State and municipal bonds		1,204,327		44,047		(4,450	)		1,243,924
Corporate debt		1,287,842		52,757		(7,335	)		1,333,264
Residential mortgage-backed securities		549,543		25,409		(5,114	)*		569,838
Commercial mortgage-backed securities		95,758		3,663		(35	)		99,386
Other asset-backed securities		61,314		1,373		(131	)		62,556

		3,483,219		138,881		(18,346	)		3,603,754
Equity securities		2,438		1,212		(13	)		3,637

	$	3,485,657	$	140,093	$	(18,359	)	$	3,607,391

*	Includes other-than-temporary impairments recognized in accumulated other comprehensive income of $3.3 million at September 30, 2011 and $4.1 million at December 31, 2010.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

The recorded cost basis and estimated fair value of available-for-sale fixed maturities at September 30, 2011, 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. ProAssurance uses the call date as the contractual maturity for pre-refunded state and municipal bonds which are 100% backed by U.S. Treasury obligations.

(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

293,301

25,105

182,916

98,257

4,269

310,547

U.S. Agency obligations

81,337

2,036

59,311

25,455

277

87,079

State and municipal bonds

1,100,718

34,708

349,435

549,262

239,643

1,173,048

Corporate debt

1,313,579

136,940

695,009

513,274

26,023

1,371,246

Residential mortgage-backed securities

533,195

563,568

Commercial mortgage-backed securities

77,958

81,729

Other asset-backed securities

86,267

87,355

3,486,355

3,674,572

Excluding investments in bonds and notes of the U.S. Government, a U.S. Government agency, or pre-refunded state and municipal bonds which are 100% backed by U.S. Treasury obligations, no investment in any entity or its affiliates exceeds 10% of shareholders’ equity at September 30, 2011.

At September 30, 2011, ProAssurance has available-for-sale securities with a fair value of $28.6 million on deposit with various state insurance departments to meet regulatory requirements. ProAssurance also has available-for-sale securities with a fair value of $28.3 million that are pledged as collateral security for the 2019 Note Payable (see Note 9).

Business Owned Life Insurance (BOLI)

ProAssurance holds BOLI policies on management employees that are carried at the current cash surrender value of the policies (original cost $35 million). The primary purpose of the program is to offset future employee benefit expenses through earnings on the cash value of the policies. ProAssurance is the owner and principal beneficiary of these policies.

Other Investments

ProAssurance has Other Investments comprised of the following:


*(In millions)*	September 30 2011		December 31 2010

Investments in LP/LLCs, at cost; estimated fair value of $33.7 and $37.5, respectively	$	28.1	$	31.2
FHLB capital stock, at cost		4.6		5.2
Other, principally an annuity, at amortized cost		1.8		1.7

	$	34.5	$	38.1

FHLB capital stock is not marketable, but may be liquidated by terminating membership in the FHLB. The liquidation process can take up to five years.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

Unconsolidated Subsidiaries

ProAssurance holds investments in unconsolidated subsidiaries, accounted for under the equity method. The investments include the following:

Carrying Value

Unfunded
Commitments
September 30,
2011

Percentage
Ownership

September 30,
2011

(In millions)

September 30,
2011

December, 31
2010

Investment LP/LLCs:

Tax Credit Partnerships

88.4

60.3

57.2

<20%

Long-short Equity Fund

17.8

18.8

—

<20%

Non-public Equity Fund

7.0

6.3

—

<20%

Business LLC

1.3

3.4

—

See below

114.5

88.8

57.2

Investments in Tax Credit Partnerships are comprised of multiple separate limited partnership interests designed to generate investment returns by providing tax benefits to fund investors in the form of project operating losses and tax credits. The related properties are principally low income housing projects.

The Long/Short Equity Fund LP targets absolute returns using a strategy designed to take advantage of event-driven market opportunities.

The Non-public Equity Investment LP holds diversified private equities and is structured to provide capital appreciation.

The Business LLC interest is a convertible preferred interest in a service-related business that began business operations in 2011. The preferred interest can be converted into a non-controlling common interest in May 2015, but conversion is not required.

Investments Held in a Loss Position

The following tables provide summarized information with respect to investments held in an unrealized loss position at September 30, 2011 and December 31, 2010, including the length of time the investment has been held in a continuous unrealized loss position.


	September 30, 2011

	Total					Less than 12 months					More than 12 months

*(In thousands)*	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss

Fixed maturities, available for sale
U.S. Treasury obligations	$	633	$	(9	)	$	633	$	(9	)	$	—	$	—
U.S. Agency obligations		4,730		(16	)		4,730		(16	)		—		—
State and municipal bonds		10,034		(170	)		5,112		(26	)		4,922		(144	)
Corporate debt		237,870		(8,738	)		224,735		(7,371	)		13,135		(1,367	)
Residential mortgage-backed securities		41,651		(2,045	)		33,867		(351	)		7,784		(1,694	)
Commercial mortgage-backed securities		9,486		(78	)		6,675		(5	)		2,811		(73	)
Other asset-backed securities		20,001		(25	)		20,001		(25	)		—		—

	$	324,405	$	(11,081	)	$	295,753	$	(7,803	)	$	28,652	$	(3,278	)

Equity securities, available for sale	$	—	$	—		$	—	$	—		$	—	$	—

Other investments
Investments in LP/LLCs carried at cost of $0.9 million	$	729	$	(211	)	$	729	$	(211	)	$	—	$	—

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011


	December 31, 2010

	Total					Less than 12 months					More than 12 months

(In thousands)	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss

Fixed maturities, available for sale
U.S. Treasury obligations	$	61,127	$	(1,242	)	$	61,127	$	(1,242	)	$	—	$	—
U.S. Agency obligations		6,340		(39	)		6,340		(39	)		—		—
State and municipal bonds		199,079		(4,450	)		191,157		(3,893	)		7,922		(557	)
Corporate debt		287,418		(7,335	)		275,808		(5,695	)		11,610		(1,640	)
Residential mortgage-backed securities		121,956		(5,114	)		105,193		(1,927	)		16,763		(3,187	)
Commercial mortgage-backed securities		7,507		(35	)		6,537		(5	)		970		(30	)
Other asset-backed securities		11,692		(131	)		11,246		(103	)		446		(28	)

	$	695,119	$	(18,346	)	$	657,408	$	(12,904	)	$	37,711	$	(5,442	)

Equity securities, available for sale	$	499	$	(13	)	$	335	$	(3	)	$	164	$	(10	)

Other investments
Investments in LP/LLCs carried at cost of $19.7 million	$	19,298	$	(401	)	$	—	$	—		$	19,298	$	(401	)

As of September 30, 2011, there are 263 debt securities (10.2% of all available-for-sale fixed maturity securities held) in an unrealized loss position representing 231 issuers. The single greatest unrealized loss position is approximately $1.0 million; the second greatest unrealized loss position is approximately $0.6 million. The securities were evaluated for impairment as of September 30, 2011.

As of December 31, 2010, there were 510 debt securities (19% of all available-for-sale fixed maturity securities held) in an unrealized loss position representing 309 issuers. The single greatest unrealized loss position approximated $0.8 million; the second greatest unrealized loss position approximated $0.6 million. The securities were evaluated for impairment as of December 31, 2010.

Each quarter, ProAssurance performs a detailed analysis for the purpose of assessing whether any of the securities it holds in an unrealized loss position have suffered an other-than-temporary impairment in value. A detailed discussion of the factors considered in the assessment is included in Note 1 of the Notes to the Consolidated Financial Statements included in ProAssurance’s December 31, 2010 Form 10-K.

At September 30, 2011 fixed maturity securities held in an unrealized loss position, excluding asset-backed securities, have paid all scheduled contractual payments and are expected to continue doing so. Expected future cash flows of asset-backed securities held in an unrealized loss position equaled or exceeded the current amortized cost basis of the security; such future cash flows were estimated using the most recently available six-month historical performance data for the collateral (loans) underlying the security or, if historical data was not available, sector based assumptions.

Net Investment Income

Net investment income by investment category is as follows:


	Three Months Ended September 30						Nine Months Ended September 30

(In thousands)	2011			2010			2011			2010

Fixed maturities	$	33,939		$	35,952		$	106,573		$	110,349
Equities		569			142			985			597
Short-term investments		20			115			93			279
Other invested assets		573			548			2,137			2,153
Business owned life insurance		635			340			1,571			1,161

		35,736			37,097			111,359			114,539
Investment expenses		(1,620	)		(1,458	)		(4,786	)		(4,191	)

Net investment income	$	34,116		$	35,639		$	106,573		$	110,348

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

Net Realized Investment Gains (Losses)

Net realized investment gains (losses) are comprised of the following:


	Three Months Ended September 30						Nine Months Ended September 30

(In thousands)	2011			2010			2011			2010

Total other-than-temporary impairment losses:
Residential mortgage-backed securities	$	(13	)	$	(166	)	$	(782	)	$	(189	)
Other investments		(1,376	)		—			(3,509	)		(3,373	)
High yield asset-backed securities		—			(532	)		—			(9,515	)
Portion recognized in (reclassified from) Other Comprehensive Income:
Residential mortgage-backed securities		(142	)		113			(823	)		119

Net impairment losses recognized in earnings		(1,531	)		(585	)		(5,114	)		(12,958	)
Gross realized gains, available-for-sale securities		1,441			13,213			11,733			23,310
Gross realized (losses), available-for-sale securities		(296	)		(244	)		(1,653	)		(445	)
Net realized gains (losses), short-term		—			200			—			200
Net realized gains (losses), trading securities		(357	)		26			2,558			4,926
Change in unrealized holding gains (losses), trading securities		(11,702	)		3,360			(13,043	)		(3,102	)
Decrease (increase) in the fair value of liabilities carried at fair value		473			(1,258	)		(129	)		(3,124	)

Net realized investment gains (losses)	$	(11,972	)	$	14,712		$	(5,648	)	$	8,807

ProAssurance recognized impairments of $3.5 million in 2011 related to an interest in an LLC, accounted for on a cost basis. The LLC has notified ProAssurance of its intention to be sold publicly in the next few months, and the Company has reduced the carrying value of its interest in the LLC to reflect the expected market value of the assets.

ProAssurance recognized credit-related impairments in earnings of $1.6 million in 2011, related to residential mortgage-backed securities. Expected future cash flows were less than ProAssurance’s carrying value for these securities; therefore, ProAssurance reduced the carrying value of its interest in these securities and recognized the loss in its 2011 net income.

The following table presents a roll forward of cumulative credit losses recorded in earnings related to impaired debt securities for which a portion of the other-than-temporary impairment has been recorded in Other Comprehensive Income.


(In thousands)	Three Months Ended September 30, 2011		Nine Months Ended September 30, 2011

Balance beginning of period	$	5,728	$	4,446
Additional credit losses recognized during the period, related to securities for which:
No OTTI has been previously recognized		—		—
OTTI has been previously recognized		142		1,424
Reductions due to:
Securities sold during the period (realized)		—		—
Securities which will be sold in coming periods		—		—
Securities for which it is more likely than not that the security will be required to be sold prior to anticipated recovery of amortized cost basis		—		—
Accretion recognized during the period related to cash flows that are expected to exceed the amortized cost basis of the security		—		—

Balance September 30, 2011	$	5,870	$	5,870

Proceeds from the sales of available-for-sale securities during the three and nine months ended September 30, 2011 are $60.7 million and $371.6 million, respectively, as compared to $232.2 million and $625.5 million for the same respective periods of 2010. Purchases of available-for-sale securities are $144.9 million and $597.8 million during the three and nine months ended September 30, 2011, respectively, as compared to $215.0 million and $673.3 million for the same respective periods of 2010.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

5. Income Taxes

ProAssurance estimates its annual effective tax rate at the end of each quarterly reporting period which is used to record the provision for income taxes in the interim financial statements. The provision for income taxes is different from that which would be obtained by applying the statutory Federal income tax rate to income before taxes primarily because a portion of ProAssurance’s investment income is tax-exempt.

ProAssurance files income tax returns in the U.S. federal jurisdiction and various states. The Internal Revenue Service has completed an examination of the Company’s 2005 through 2008 returns (the 2005-2008 exam) and has begun an examination of the 2009 return. The 2005-2008 exam principally resulted in delaying the deductibility of certain bonus compensation which increased taxes due for the 2007 and 2008 tax years but decreased taxes due for the 2009 tax year by an offsetting amount, the effect of which had previously been recorded as an uncertain tax position. The 2005-2008 exam resulted in no adjustment to tax expense (exclusive of interest accruals) and no penalties or fines. Upon finalization of the 2005-2008 exam, uncertain tax positions totaling $8.3 million were deemed effectively settled and were reversed (along with approximately $324,000 of related accrued interest) in the first quarter of 2011.

ProAssurance’s liability for unrecognized tax benefits is $0.4 million at September 30, 2011 and $8.3 million at December 31, 2010.

6. Deferred Policy Acquisition Costs

Policy acquisition costs, most significantly commissions, premium taxes, and underwriting salaries, that are primarily and directly related to the production of new and renewal premiums are capitalized as policy acquisition costs and amortized to expense as the related premium revenues are earned.

Amortization of deferred policy acquisition costs is $15.5 million and $44.5 million for the three and nine months ended September 30, 2011, respectively, and $14.8 million and $43.9 million for the three and nine months ended September, 2010, respectively.

7. Reserve for Losses and Loss Adjustment Expenses

The reserve for losses is established based on estimates of individual claims and actuarially determined estimates of future losses based on ProAssurance’s past loss experience, available industry data and projections as to future claims frequency, severity, inflationary trends and settlement patterns. Estimating reserves, and particularly liability reserves, is a complex process. Claims may be resolved over an extended period of time, often five years or more, and may be subject to litigation. Estimating losses for liability claims requires ProAssurance to make and revise judgments and assessments regarding multiple uncertainties over an extended period of time. As a result, reserve estimates may vary significantly from the eventual outcome. The assumptions used in establishing ProAssurance’s reserves are regularly reviewed and updated by management as new data becomes available. Changes to estimates of previously established reserves are included in earnings in the period in which the estimate is changed.

ProAssurance recognized favorable net loss development of $52.1 million and $142.3 million related to previously established reserves for the three and nine months ended September 30, 2011, respectively. The favorable net loss development reflects reductions in the Company’s estimates of claims severity, principally for the 2004 through 2009 accident years.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

For the three and nine months ended September 30, 2010, ProAssurance recognized favorable net loss development of $33.4 million and $95.9 million, respectively, to reflect reductions in estimated claim severity principally for accident years 2004 through 2008, offset by a $1.6 million loss on the commutation of a reinsurance agreement.

8. Commitments and Contingencies

ProAssurance is involved in various legal actions related to insurance policies and claims handling including, but not limited to, claims asserted by policyholders. These types of legal actions arise in the Company’s ordinary course of business and, in accordance with GAAP for insurance entities, are considered as a part of the Company’s loss reserving process, which is described in detail under “Accounting Policies - Losses and Loss Adjustment Expenses” in Note 1 of the Notes to the Consolidated Financial Statements in ProAssurance’s 2010 Form 10-K.

As a result of its acquisition of APS, ProAssurance assumed risk of loss related to certain non-claims related legal actions previously asserted against APS subsidiaries. ProAssurance included a liability of $5.6 million related to these actions as a component of the fair value of assets acquired and liabilities assumed in the purchase price allocation. The value of the reserve was based on management’s assessment of the expected outcome of the actions and a reasonable estimate of losses expected to be incurred. The majority of these actions have been resolved during 2011; resolution had no significant effect on operating results. In the best judgment of management, the remaining reserve is adequate to cover the expected ultimate losses of the remaining open litigation.

ProAssurance has commitments to fund approximately $57.2 million in capital contributions to tax credit partnerships as of September 30, 2011. Funding of the commitments is primarily expected to occur in 2011 and 2012; additional information regarding tax credit partnership investments is provided in Note 4. ProAssurance has also entered into agreements with several LP/LLCs, totaling approximately $52.1 million at September 30, 2011, to be funded within the next five years as requested by the partnership.

9. Long-term Debt

ProAssurance’s outstanding long-term debt consists of the following:


	(In thousands)
	September 30 2011		December 31 2010

Trust Preferred Securities due 2034, unsecured. Bears interest at a variable rate of LIBOR plus 3.85%, adjusted quarterly, set as 4.1% at September 30, 2011.	$	22,992	$	22,992
Surplus Notes due May 2034, unsecured. Bears interest at a variable rate of LIBOR plus 3.85%, adjusted quarterly, set as 4.2% at September 30, 2011.		12,000		12,000
Note Payable due February 2019, carried at fair value, principal of $17.2 million at September 30, 2011 and $17.4 million at December 31, 2010. Secured by available-for-sale securities having a fair value at September 30, 2011 of approximately $28.3 million. Bears interest at a variable rate of LIBOR plus 0.7%. See information below regarding the associated interest rate swap.		14,411		15,616
Note Payable due February 2012, unsecured, principal of $517,000 at September 30, 2011 and December 31, 2010. Bears interest at the U.S. prime rate, paid and adjusted quarterly, set as 3.3% at September 30, 2011.		511		496

	$	49,914	$	51,104

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

Interest Rate Swap

ProAssurance, through its PICA subsidiary, is party to an interest rate swap agreement (the Swap) with the issuing bank of the Note Payable due February 2019 (the 2019 Note Payable). The purpose of the Swap is to reduce the market risk from changes in future interest rates relative to the 2019 Note Payable. The Swap, which terminates February 1, 2019, effectively fixes the interest rate related to the 2019 Note Payable at 6.6%. The notional amount of the Swap corresponds directly to the unamortized portion of the debt being hedged each month. Under the Swap agreement, PICA agrees to exchange, at monthly intervals, the difference between the fixed-rate and LIBOR variable rate by reference to the notional principal amount. The liability associated with the Swap is measured at fair value on a recurring basis which approximates $4.7 million at September 30, 2011 and $3.7 million at December 31, 2010. The Swap liability is classified as a part of other liabilities.

Revolving Credit Agreement

On April 15, 2011 ProAssurance entered into a revolving credit agreement (the “Agreement”) with five participating lenders. The Agreement permits ProAssurance to borrow, repay and reborrow from the lenders during the term of the Agreement; aggregate outstanding borrowings are not permitted to exceed $150 million at any time. All borrowings are required to be repaid prior to the expiration date of the Agreement (April 15, 2014). ProAssurance is required to pay a commitment fee during the term of the Agreement, ranging from 20 to 40 basis points , based on the average unused portion of the credit line and ProAssurance’s credit ratings, initially set at 25 basis points. The interest rate applicable to borrowings under the Agreement is set at the time funds are borrowed, and is an adjusted rate based on the Eurocurrency rate, if so selected by ProAssurance, or the higher of the Prime rate, the Eurocurrency rate plus 100 basis points, or the Federal Funds rate plus 50 basis points. The amount of the rate adjustment can vary from 0 to 225 basis points, depending upon ProAssurance’s credit ratings at the time funds are borrowed, and on whether the borrowing is secured or unsecured. The Agreement contains customary representations, covenants and events constituting default, and remedies for default. Additionally, the Agreement carries the following financial covenants:

(1)

ProAssurance is not permitted to have a leverage ratio of Consolidated Funded Indebtedness (principally, obligations for borrowed money, obligations evidenced by instruments such as notes or acceptances, standby and commercial Letters of Credit, and contingent obligations) to Consolidated Total Capitalization (principally, total non-trade liabilities on a consolidated basis plus consolidated shareholders’ equity, exclusive of accumulated other comprehensive income) greater than 0.35 to 1.0, determined at the end of each fiscal quarter.

(2)

ProAssurance is required to maintain a minimum net worth of not less than the sum of 75% of Consolidated Net Worth (consolidated shareholders’ equity, exclusive of accumulated other comprehensive income) at December 31, 2010, plus 50% of consolidated net income earned each fiscal quarter, if positive, beginning with the quarter ending March 31, 2011, plus 100% of net cash proceeds resulting from the issuance of ProAssurance capital stock.

Funds borrowed under the terms of the Revolving Credit Agreement will be used for general corporate purposes, including, but not limited to, use as short-term working capital, funding for share repurchases as authorized by the Board, and for support of other activities ProAssurance enters into in the normal course of business. To date, ProAssurance has not borrowed any funds under the Agreement.

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

Covenant Compliance

ProAssurance is currently in compliance with all covenants.

Additional Information

For additional information regarding the terms of ProAssurance’s outstanding long-term debt, see Note 10 of the Notes to the Consolidated Financial Statements included in ProAssurance’s December 31, 2010 Form 10-K.

10. Shareholders’ Equity

At September 30, 2011 and December 31, 2010, ProAssurance had 100 million shares of authorized common stock and 50 million shares of authorized preferred stock. The Board of Directors of ProAssurance Corporation (the Board) has the authority to determine provisions for the issuance of preferred shares, including the number of shares to be issued, the designations, powers, preferences and rights, and the qualifications, limitations or restrictions of such shares. To date, the Board has not approved the issuance of preferred stock.

On September 7, 2011, the Board adopted a cash dividend policy that anticipates a dividend of $1.00 per common share annually, and declared an initial quarterly dividend of $0.25 per common share, $7.6 million in total, to be paid October 13, 2011 to shareholders of record on September 29, 2011. The liability for unpaid dividends is included in Other Liabilities.

At September 30, 2011 approximately $188.4 million in prior authorizations from the Board for the repurchase of common shares or the retirement of outstanding debt remains available for use. The timing and quantity of purchases depends upon market conditions and changes in ProAssurance’s capital requirements and is subject to limitations that may be imposed on such purchases by applicable securities laws and regulations, and the rules of the New York Stock Exchange.

ProAssurance reacquired approximately 341,000 common shares, having a total cost of $21.0 million, during the nine-month period ended September 30, 2011, including approximately 7,000 forfeited employer match shares (cost basis of $0.4 million) reacquired due to the termination of the ProAssurance Corporation Stock Ownership Plan. Approximately 82,000 shares at a total cost of $5.6 million were reacquired during the three-month period ended September 30, 2011. ProAssurance repurchased approximately 1.6 million common shares, having a total cost of $94.4 million, during the nine months ended September 30, 2010 (including approximately 975,000 shares at a total cost of $55.3 million during the three months ended September 30, 2010).

Share-based compensation expense is $1.7 million and $5.4 million for the three and nine months ended September 30, 2011, respectively, and $1.6 million and $4.5 million for the three and nine months ended September 30, 2010, respectively. Related tax benefits are $0.6 million and $1.9 million for the three and nine months ended September 30, 2011, respectively, and $0.6 million and $1.6 million for the three and nine months ended September 30, 2010, respectively.

ProAssurance granted approximately 20,000 restricted share units to employees in February 2011. The awards 100% vest three years from the grant date, based on a continued service requirement. The fair value of each unit was estimated at $64.08, equal to the market value of a ProAssurance common share on the date of grant.

ProAssurance awarded approximately 93,000 (target) performance share units to employees in February 2011. The awards 100% vest at the end of a three-year period if the service requirements are met and minimum performance goals are achieved. If minimum performance goals are achieved, the payment of awards can vary from 75% to 125% of set targets depending upon the degree to which the

ProAssurance Corporation and Subsidiaries

Notes to Condensed Consolidated Financial Statements (Unaudited)

September 30, 2011

performance goals are achieved. The fair value of each award was estimated at $64.08, equal to the market value of a ProAssurance common share on the date of grant. ProAssurance issued approximately 52,000 common shares to employees in February 2011 related to performance share awards granted in 2008. The awards were issued at the maximum level (125% of target) based on performance levels achieved. Cash was given in lieu of shares sufficient to satisfy required tax withholdings.

ProAssurance issued approximately 20,000 and 40,000 common shares to employees in February 2011 and February 2010, respectively, as bonus compensation, as approved by the Compensation Committee of the Board. The shares issued were valued at fair value (the market price of a ProAssurance common share on the date of award).

In late 2010 ProAssurance terminated the ProAssurance Corporation Stock Ownership Plan and established the ProAssurance Corporation 2011 Stock Ownership Plan (the Plan). Under the Plan, eligible employees and directors of ProAssurance and its subsidiaries are given the opportunity to annually contribute up to $5,000 to be used each October for the purchase of ProAssurance common shares. For each share so purchased, ProAssurance will award a matching restricted stock unit to the participant. The restricted stock units will vest at the end of a three-year period subject to a continuous service requirement and be ratably charged to expense over the vesting period.

11. Earnings Per Share

Diluted weighted average shares is calculated as basic weighted average shares plus the effect, calculated using the treasury stock method, of assuming that dilutive stock options have been exercised and that performance share awards and restricted stock units have vested.

Stock options are not dilutive when the option exercise price exceeds the average price of a common share during the period or when the result from assuming an option is exercised is a net decrease to outstanding shares. All outstanding options were dilutive for the three- and nine-month periods ended September 30, 2011, and for the three-month period ended September 30, 2010. Approximately 77,500 of ProAssurance’s outstanding options, on average, were not dilutive for the nine-month period ended September 30, 2010.

12. Variable Interest Entities

ProAssurance holds passive interests in a number of LP/LLCs that are considered to be Variable Interest Entities (VIEs) under GAAP guidance. ProAssurance has not consolidated these entities because it has either very limited or no power to control the activities that most significantly affect the economic performance of these entities and is thus not the primary beneficiary of any of the entities. ProAssurance’s involvement with each entity is limited to its direct ownership interest in the entity. ProAssurance has no arrangements or agreements with any of the entities to provide other financial support to or on behalf of the entity. ProAssurance’s maximum loss exposure relative to these investments is limited to the carrying value of ProAssurance’s investment in the entity.

The entities consist of 1) investments in LP/LLCs formed for the purpose of achieving diversified equity and debt returns, 2) investments in limited partnerships formed to provide investment returns through the transfer of tax credits (principally federal or state tax credits related to federal low-income housing) and 3) a limited liability interest in a development stage business operation. In those instances where ProAssurance holds a minor interest in the entity, ProAssurance accounts for its interest on a cost basis. Cost method investments are included in Other Investments and have a carrying value of $28.1 million and $31.2 million at September 30, 2011 and December 31, 2010, respectively. In those instances where ProAssurance holds a greater than minor interest, ProAssurance accounts for its interest using the equity method. Equity method investments are included in Investment in Unconsolidated Subsidiaries and have a carrying value of $114.5 million at September 30, 2011 and $88.8 million at December 31, 2010.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

The following discussion should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and Notes to those statements which accompany this report as well as our 2010 Form 10-K. A glossary of insurance terms and phrases is available on the investor section of our website. Throughout the discussion, references to ProAssurance, “PRA,” “Company,” “we,” “us” and “our” refer to ProAssurance Corporation and its consolidated subsidiaries. The discussion contains certain forward-looking information that involves risks and uncertainties. As discussed under “Forward-Looking Statements,” our actual financial condition and operating results could differ significantly from these forward-looking statements.

Critical Accounting Estimates

Our Condensed Consolidated Financial Statements are prepared in conformity with U.S. generally accepted accounting principles (GAAP). Preparation of these financial statements requires us to make estimates and assumptions that affect the amounts we report on those statements. We evaluate these estimates and assumptions on an ongoing basis based on current and historical developments, market conditions, industry trends and other information that we believe to be reasonable under the circumstances. There can be no assurance that actual results will conform to our estimates and assumptions; reported results of operations may be materially affected by changes in these estimates and assumptions.

Management considers the following accounting estimates to be critical because they involve significant judgment by management and the effect of those judgments could result in a material effect on our financial statements.

Reserve for Losses and Loss Adjustment Expenses (reserve for losses or reserve)

The largest component of our liabilities is our reserve for losses, and the largest component of expense for our operations is incurred losses. Incurred losses reported in any period reflect our estimate of losses incurred related to the premiums earned in that period as well as any changes to our estimates of the reserve established for losses of prior periods.

The estimation of professional liability losses is inherently difficult and is the subject of significant judgment on the part of management. Loss costs, even for claims with similar characteristics, can vary significantly depending upon many factors, including but not limited to: the nature of the claim and the personal situation of the claimant or the claimant’s family, the outcome of jury trials, the legislative and judicial climate where the insured event occurred, general economic conditions and, for medical professional liability, the trend of health care costs. Professional liability claims are typically resolved over an extended period of time, often five years or more. The combination of changing conditions and the extended time required for claim resolution results in a loss cost estimation process that requires actuarial skill and the application of significant judgment, and such estimates require periodic revision. Our reserves are established by management after taking into consideration a variety of factors including premium rates, claims frequency, historical paid and incurred loss development trends, the effect of inflation, general economic trends, the legal and political environment, and the conclusions reached by our internal and consulting actuaries. We update and review the data underlying the estimation of our reserve for losses each reporting period and make adjustments to loss estimation assumptions that we believe best reflect emerging data. Both our internal and consulting actuaries perform an in-depth review of our reserve for losses on at least a semi-annual basis using the loss and exposure data of our insurance subsidiaries. We engage consulting actuaries to review our data and provide us with their observations regarding our data and the adequacy of our established reserve, believing that the consulting actuaries provide an independent view of our loss data as well as a broader perspective on industry loss trends.

In establishing our initial reserves for a given accident year, due to the lack of data for both open and closed claims available for that accident year, we rely significantly on the many loss assumptions that are used in our pricing models, plus an additional 8 to 10 percentage points we believe necessary to bring our pricing models and resulting loss reserves in line with historical loss experience. We believe that this is initially warranted given inherent risks associated with our rate development process and the historic volatility of professional liability losses (the industry has experienced accident year loss ratios as high as 163% and as low as 57% over the past 30 years). Our current pricing model assumes a severity trend (i.e., annual increase in

the average costs of claims settlement) of 4%. If the severity trend were to be higher by one percentage point the impact would be an increase in our expected loss ratio of 3.2 percentage points. An increase in the severity trend of three percentage points would result in a 10.1 percentage point increase in our expected loss ratio. For all these reasons, management believes establishing reserves 8 to 10 percentage points above its pricing targets provides a reasonable best estimate of our reserves to cover actual ultimate unpaid losses. In the current environment this equates to an initial loss ratio of approximately 85% as compared to a 75% loss ratio assumed in our pricing.

Given the long-tailed nature of our business and the historical volatility of loss costs as discussed above, we are cautious in giving full credibility to emerging trends that, when more fully mature, may lead to the recognition of favorable and/or adverse development of our losses. Frequently there may be trends, both positive and negative, reflected in the numerical data both within the Company’s own information and in the broader medical professional liability (MPL) marketplace that mitigate or reverse as time progresses and additional data becomes available. Accordingly, management must evaluate emerging trends and make judgments as to how much consideration should be given to these trends when establishing our reserves. The recognition of favorable or adverse loss development is an outcome of management’s best estimate of reserves and is dependent on, among other things, the resolution of claims and the increasing maturity of each accident year. Until claims for a given accident year are mostly resolved, the estimated ultimate loss costs are subject to change. Based on a weighted average of payments, resolution of 85% of claims for a given accident year requires more than eight years.

As each accident year matures, we analyze reserves in a variety of ways and use multiple actuarial methodologies in performing these analyses, including the Bornhuetter-Ferguson (Paid and Reported) Method, Paid Development Method, Reported Development Method, Average Paid Value Method, Average Reported Value Method and Backward Recursive Method which are all described in our 2010 Form 10K within the Critical Accounting Estimates section. Generally, methods such as the Bornhuetter-Ferguson Method are used on more recent accident years where we have less data on which to base our analysis. As time progresses and we have an increased amount of data for a given accident year, we begin to give more confidence to the development and average methods, as these methods typically rely more heavily on our own historical data. Each of these methods treats our assumptions differently, and thus provides a different perspective of our reserve review.

Any adjustments resulting from our review process are reflected in the then-current operations. Due to the size of our reserve for losses, even a small percentage adjustment to these estimates could have a material effect on our results of operations for the period in which the adjustment is made, as was the case in 2010 and has been thus far in 2011.

Reinsurance

We use insurance and reinsurance (collectively, “reinsurance”) to provide capacity to write larger limits of liability, to provide protection against losses in excess of policy limits, and to stabilize underwriting results in years in which higher losses occur. The purchase of reinsurance does not relieve us from the ultimate risk on our policies, but it does provide reimbursement for certain losses we pay.

We evaluate each of our ceded reinsurance contracts at inception to confirm that there is sufficient risk transfer to allow the contract to be accounted for as reinsurance under current accounting guidance. At September 30, 2011, all ceded contracts are accounted for as risk transferring contracts.

Our receivable from reinsurers on unpaid losses and loss adjustment expenses represents our estimate of the amount of our reserve for losses that will be recoverable under our reinsurance programs. We base our estimate of funds recoverable upon our expectation of ultimate losses and the portion of those losses that we estimate to be allocable to reinsurers based upon the terms of our reinsurance agreements. Our assessment of the collectability of the recorded amounts receivable from reinsurers considers the payment history of the reinsurer, publicly available financial and rating agency data, our interpretation of the underlying contracts and policies, and responses by reinsurers. Appropriate reserves are established for any balances we believe may not be collected.

Given the uncertainty of the ultimate amounts of our losses, our estimates of losses and related amounts recoverable may vary significantly from the eventual outcome. Also, we estimate premiums ceded under reinsurance agreements wherein the premium due to the reinsurer, subject to certain maximums and minimums, is based in part on losses reimbursed or to be reimbursed under the agreement. Any adjustments are reflected in then-current operations. Due to the size of our reinsurance balances, an adjustment to these estimates could have a material effect on our results of operations for the period in which the adjustment is made.

Our risk retention level is dependent upon numerous factors including our risk tolerance and the capital we have to support it, the price and availability of reinsurance, volume of business, level of experience with a particular set of claims and our analysis of the potential underwriting results within each state. We purchase reinsurance from a number of companies to mitigate concentrations of credit risk. We utilize a reinsurance broker to assist us in the analysis of the credit quality of our reinsurers. We base our reinsurance buying decisions on an evaluation of the then-current financial strength, rating and stability of prospective reinsurers. However, the financial strength of our reinsurers, and their corresponding ability to pay us, may change in the future due to forces or events we cannot control or anticipate.

We have not experienced significant collection difficulties due to the financial condition of any reinsurer; however, periodically, reinsurers may dispute our claim for reimbursement from them. We have established appropriate reserves for any balances that we believe may not be ultimately collected. Should future events lead us to believe that any reinsurer will not meet its obligations to us, adjustments to the amounts recoverable would be reflected in the results of current operations. Such an adjustment has the potential to be material to the results of operations in the period in which it is recorded; however, we would not expect such an adjustment to have a material effect on our capital position or our liquidity.

Investment Valuations

We record a substantial portion of our investments at fair value as shown in the table below. The distribution of our investments based on GAAP fair value hierarchies (levels) is as follows:


	Distribution by GAAP Fair Value Hierarchy									September 30, 2011 Total Investments
	Level 1			Level 2			Level 3			September 30, 2011 Total Investments

Fair Value		4	%		91	%		1	%		96	%
Cost or cash surrender value											4	%

Total Investments											100	%

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. All of our fixed maturity and equity security investments are carried at fair value. Our short-term securities are carried at amortized cost, which approximates fair value.

Because of the number of securities we own and the complexity and cost of developing accurate fair values internally, we utilize independent pricing services to assist us in establishing fair values. The pricing services provide fair values based on exchange traded prices, if available. If an exchange traded price is not available, the pricing services, if possible, provide a fair value that is based on multiple broker/dealer quotes or that has been developed using pricing models. Pricing models vary by asset class and utilize currently available market data for securities comparable to ours to estimate the fair value for our security. The pricing services scrutinize market data for consistency with other relevant market information before including the data in the pricing models. The pricing services disclose the types of pricing models used and the inputs used for each asset class. Determining fair values using these pricing models requires the use of judgment to identify appropriate comparable securities and to choose valuation methodology that is appropriate for the asset class and available data.

The pricing services provide a single value per instrument quoted. We review the values provided for reasonableness each quarter by comparing market yields generated by the supplied price versus market yields observed in the market place. If a supplied value is deemed unreasonable, we discuss the valuation in question with the pricing service and will make adjustments if deemed necessary. To date, we have not adjusted any values supplied by the pricing services.

The pricing services do not provide a fair value unless an exchange traded price or multiple observable inputs are available. As a result, the pricing services may provide a fair value for a security in some periods but not others, depending upon the level of recent market activity for the security or comparable securities.

Level 1 Investments

As of September 30, 2011, fair values for our equity and a portion of our short-term securities have been determined using an exchange traded price. There is little judgment involved when fair value is determined using an exchange traded price. In accordance with GAAP, for disclosure purposes we classify securities valued using an exchange traded price as Level 1 securities.

Level 2 Investments

With the exception of certain government bonds, most fixed income securities do not trade daily and thus exchange traded prices are generally not available for these securities. However, market information (often referred to as observable inputs or market data; including but not limited to, last reported trade, non-binding broker quotes, bids, benchmark yield curves, issuer spreads, two sided markets, benchmark securities, offers, and recent data regarding assumed prepayment speeds, cash flow and loan performance data) is available for most of our fixed income securities. We determine fair value for a large portion of our fixed income securities using available market information. In accordance with GAAP, for disclosure purposes we classify any securities that have been valued based on multiple market observable inputs as Level 2 securities.

Level 3 Investments

When a pricing service does not provide a value for one of our fixed maturity securities, management estimates fair value using either a single non-binding broker quote or pricing models that utilize market based assumptions which have limited observable inputs. The process involves significant judgment in selecting the appropriate data and modeling techniques to use in the valuation process. For disclosure purposes we classify fixed maturity securities that are valued using limited observable inputs as Level 3 securities.

We also classify as Level 3 securities our LP/LLC interests that are carried at fair value, based on the quarterly NAV provided to us by the LP/LLC managers. At September 30, 2011 such investments total $41.0 million or 1% of total investments. All interests valued in this manner are interests in private investment funds that hold debt and equity securities. Of the total, $24.8 million relates to interests, included in Investments in Unconsolidated Subsidiaries, which are accounted for using the equity method because we are deemed to have an other than minor interest in the LP/LLC. An interest in an LLC, which has a fair value at September 30, 2011 of $16.2 million and is included in Other Investments, is accounted for using the cost method because our interest in the LLC is a minor interest. This LLC has announced its intention to convert to a public fund in the near term, and we recognized an OTTI at September 30, 2010 to reduce the carrying value of our interest to the NAV reported by the LLC manager.

Investments Not Valued at Fair Value

Business Owned Life Insurance:

•

Policies having a carrying value of $52.2 million at September 30, 2011; valued at cash surrender value.

Investment in Unconsolidated Subsidiaries:

•

Interests in tax credit partnerships having a carrying value of approximately $88.4 million at September 30, 2011; valued under the equity method.

•

An interest in a business LLC that has a carrying value of $1.3 million at September 30, 2011; valued under the equity method based on the latest financial statements of the entity.

Other Investments:

•

Interests in LPs having a carrying value of $11.9 million at September 30, 2011; valued at cost as ownership interest is nominal.

•

FHLB capital stock having a carrying value of $4.6 million at September 30, 2011; valued at cost.

•

Other investments having a carrying value at $1.8 million at September 30, 2011; valued at cost.

Investment Impairments

We evaluate our investments on at least a quarterly basis for declines in fair value that represent OTTIs. In all instances we consider an impairment to be an OTTI if we intend to sell the security or if we believe we will be required to sell the security before we fully recover the amortized cost basis of the security. Otherwise, we consider various factors in our evaluation, depending upon the type of security, as discussed below.

For debt securities, we consider whether we expect to fully recover the amortized cost basis of the security, based upon consideration of some or all of the following:

•

third party research and credit rating reports;

•

the current credit standing of the issuer, including credit rating downgrades;

•

extent to which the decline in fair value is attributable to credit risk specifically associated with an investment or its issuer;

•

our internal assessments and those of our external portfolio managers regarding specific circumstances surrounding an investment, which can cause us to believe the investment is more or less likely to recover its value than other investments with a similar structure;

•

for asset-backed securities, the origination date of the underlying loans, the remaining average life, the probability that credit performance of the underlying loans will deteriorate in the future, and our assessment of the quality of the collateral underlying the loan;

•

failure of the issuer of the security to make scheduled interest or principal payments;

•

any changes to the rating of the security by a rating agency;

•

recoveries or additional declines in fair value subsequent to the balance sheet date; and

•

our ability and intent to hold the investment for a period of time sufficient to allow for any anticipated recovery in fair value.

In assessing whether we expect to recover the cost basis of debt securities, particularly asset-backed securities, we must make a number of assumptions regarding matters that will affect the cash flows that we expect to receive from the security in future periods. These judgments are subjective in nature and may subsequently be proved to be inaccurate.

We evaluate our cost method interests in LP/LLCs for OTTI by considering whether there has been a decline in fair value below the recorded value. We receive a report from each of the LP/LLCs at least quarterly which provide us a net asset value (NAV) for our interest in the LP/LLC. The NAV is based on the fair values of securities held by the LP/LLC as determined by the LP/LLC manager. Determining whether there has been a decline in fair value involves assumptions and estimates. We consider the most recent NAV provided, the performance of the LP/LLC relative to the market, the stated objectives of the LP/LLC, the cash flows expected from the LP/LLC and audit results in considering whether an OTTI exists.

Our investments in tax credit partnerships are evaluated for OTTI by comparing cash flow projections of future operating results of the underlying projects generating the tax credits to our recorded basis, and considering our ability to utilize the tax credits from the investments.

We also evaluate our holdings of FHLB securities for impairment. We consider the current capital status of the FHLB, whether the FHLB is in compliance with regulatory minimum capital requirements, and the reported operating results of the current period.

Deferred Policy Acquisition Costs

Policy acquisition costs (primarily commissions, premium taxes and underwriting salaries) which are directly related to the acquisition of new and renewal premiums are capitalized as deferred policy acquisition costs and charged to expense as the related premium revenue is recognized. We evaluate the recoverability of our deferred policy acquisition costs each reporting period, and any amounts estimated to be unrecoverable are charged to expense in the current period.

Deferred Taxes

Deferred federal income taxes arise from the recognition of temporary differences between the basis of assets and liabilities determined for financial reporting purposes and the basis determined for income tax purposes. Our temporary differences principally relate to loss reserves, unearned premiums, deferred policy acquisition costs, unrealized investment gains (losses) and investment impairments. Deferred tax assets and liabilities are measured using the enacted tax rates expected to be in effect when such benefits are realized. We review our deferred tax assets quarterly for impairment. If we determine that it is more likely than not that some or all of a deferred tax asset will not be realized, a valuation allowance is recorded to reduce the carrying value of the asset. In assessing the need for a valuation allowance, management is required to make certain judgments and assumptions about our future operations based on historical experience and information as of the measurement period regarding reversal of existing temporary differences, carryback capacity, future taxable income (including its capital and operating characteristics) and tax planning strategies.

Goodwill

We make at least an annual assessment as to whether the value of our goodwill asset is impaired. Management evaluates the carrying value of goodwill annually during the fourth quarter and before the annual evaluation if events occur or circumstances change that would more likely than not reduce the fair value below the carrying value. We evaluate goodwill as one reporting unit because we operate in a single operating segment and our segment components are economically similar. We estimate the fair value of our reporting unit on the evaluation date based on market capitalization and an expected premium that would be paid to acquire control of our Company (a control premium). We then perform a sensitivity analysis using a range of historical stock prices and control premiums. We concluded as of our last evaluation date, October 1, 2010, that the fair value of our reporting unit exceeded the carrying value and no adjustment to impair goodwill was necessary.

Accounting Changes

We are not aware of any accounting changes that we have not yet adopted as of September 30, 2011 that would have a material impact on ProAssurance’s results of operations or financial position.

Liquidity and Capital Resources and Financial Condition

Overview

ProAssurance Corporation is a holding company and is a legal entity separate and distinct from its subsidiaries. Because it has no other business operations, dividends from its operating subsidiaries represent a significant source of funds for its obligations, including debt service. At September 30, 2011, we held cash and liquid investments of approximately $196.3 million outside of our insurance subsidiaries that are available for use without regulatory approval. Our insurance subsidiaries, in aggregate, are permitted to pay dividends of approximately $248 million over the course of 2011 without prior approval. However, the payment of any dividend requires prior notice to the insurance regulator in the state of domicile and the regulator may prevent the dividend if, in its judgment, payment of the dividend would have an adverse effect on the surplus of the insurance subsidiary. Through the nine months ended September 30, 2011, $109.0 million of the permitted dividends have been paid.

Shareholder Dividends

On September 7, 2011 our Board adopted a cash dividend policy that anticipates a dividend of $1.00 per common share annually, and declared an initial quarterly dividend of $0.25 per common share, $7.6 million in total, which was paid on October 13, 2011 to shareholders of record on September 29, 2011.

Acquisitions

On November 30, 2010, we acquired 100% of the outstanding shares of American Physicians Service Group, Inc. (APS), principally a provider of medical professional liability insurance for physicians largely in the state of Texas, in a transaction valued at $237 million including cash paid of $233 million and liabilities assumed of $4 million. APS reported gross written premium of $61 million for the year ended December 31, 2010, $5 million of which was included in ProAssurance consolidated premium for 2010.

See Note 2 of the Notes to the Consolidated Financial Statements in our 2010 Form 10-K for detailed information regarding our acquisition of APS, including a summarized listing of the assets acquired and liabilities assumed.

Cash Flows

The principal components of our operating cash flows are the excess of premiums collected and net investment income over losses paid and operating costs, including income taxes. Timing delays exist between the collection of premiums and the payment of losses associated with the premiums. Premiums are generally collected within the twelve-month period after the policy is written while our claim payments are generally paid over a more extended period of time. Likewise, timing delays exist between the payment of claims and the collection of any associated reinsurance recoveries.

Our operating activities provided positive cash flows of approximately $106.4 million and $108.6 million for the nine months ended September 30, 2011 and 2010, respectively. Operating cash flows for 2011 and 2010 compare as follows:


(In millions)	Cash Flow Increase (Decrease)
Cash provided by operating activities nine months ended September 30, 2010	$	109
Increase (decrease) in operating cash flows for the nine months ended September 30, 2011:
Decrease in premium receipts (1)		(21	)
Increase in payments to reinsurers (2)		(2	)
Decrease in losses paid (3)		41
Decrease in reinsurance recoveries (4)		(13	)
Increase in Federal and state income tax payments (5)		(20	)
Cash flows attributable to operations acquired from APS (excluding tax payments)		17
Other amounts not individually significant, net		(5	)

Cash provided by operating activities nine months ended September 30, 2011	$	106

(1)

The decline in premium receipts primarily reflects a $11.3 million reduction in gross written premiums exclusive of the business acquired from APS. Written premiums associated with two-year term policies increased by approximately $11.9 million for the nine-month period ended 2011 as compared to 2010, while approximately half of the written amount is not scheduled to be collected until 2012. Additionally, in 2011 more of our insureds have elected to take advantage of payment plans offered to them.

(2)

Reinsurance contracts are generally for premiums written in a specific annual period, but can remain in effect until all claims under the contract have been resolved. Some contracts require annual settlements while others require settlement only after a number of years have elapsed, thus the amounts paid can vary widely from period to period.

(3)	The timing of our loss payments varies from period to period because the process for resolving claims is complex and occurs at an uneven pace depending upon the circumstances of the individual claim.

(4)	The timing of reinsurance recoveries varies from period to period and can depend upon the terms of the applicable reinsurance agreement, the nature of the underlying claim and the timing and amount of underlying loss payments.

(5)	The increase in tax payments primarily reflects:

•

A $17.8 million increase in estimated tax payments during 2011 as compared to 2010.

•

Payments of $5.9 million made in 2011 for the 2008 and 2007 tax years as a result of Federal tax return audits conducted by the Internal Revenue Service. Payments were related to a delay in the deductibility of certain bonus compensation which increased taxes due for 2008 and 2007, but decreased taxes due for the 2009 tax year by an offsetting amount. For additional information regarding the Internal Revenue Service audits, see Note 5 of the Notes to the Condensed Consolidated Financial Statements.

These increases in tax payments were offset by a $3.6 million increase in federal tax refunds from capital loss carry-backs received in 2011 as compared to 2010.

Investment Exposures

The following table provides summarized information regarding our investments as of September 30, 2011:


			Unrealized Gains (Losses) Included in Carrying Value
(In thousands)	Carrying Value		Gains		Losses			Average Rating			% Total Investments

Fixed Maturities
Government
U.S. Treasury	$	310,547	$	17,255	$	(9	)		AA+	(*)		8	%
U.S. Agency		87,079		5,758		(16	)		AA+	(*)		2	%

Total government		397,626		23,013		(25	)		AA+	(*)		10	%

State and Municipal Bonds		1,173,048		72,500		(170	)		AA			29	%

Corporate Debt
Financial institutions		364,839		9,166		(4,967	)		A+			9	%
FDIC insured		49,875		418		—			AA+	(*)		1	%
Communications		54,496		1,999		(348	)		BBB+			1	%
Utilities		111,204		6,204		(626	)		A-			3	%
Energy		51,479		4,507		(44	)		A-			1	%
Industrial		686,244		40,683		(2,753	)		A-			17	%
Transportation		36,008		2,547		—			A-			1	%
Other		17,101		881		—			AA			<1	%

Total corporate debt		1,371,246		66,405		(8,738	)		A			34	%

Asset-backed Securities
Agency mortgage-backed securities		532,768		31,800		(113	)		AA+	(*)		13	%
Non-agency mortgage-backed securities		16,937		263		(76	)		BB+			<1	%
Subprime		8,379		330		(1,563	)		BBB			<1	%
Alt A		5,484		25		(293	)		BB			<1	%
Commercial mortgage-backed securities		81,729		3,849		(78	)		AAA			2	%
Credit card		22,129		437		—			AAA			1	%
Automobile		47,060		323		(13	)		AAA			1	%
Other		18,166		353		(12	)		AA+			<1	%

Total asset-backed securities		732,652		37,380		(2,148	)		AA+			18	%

Total fixed maturities		3,674,572		199,298		(11,081	)		AA-			91	%

Equities
Equity
Financial		14,525		16		—						<1	%
Energy		10,811		—		—						<1	%
Consumer cyclical		7,114		—		—						<1	%
Consumer non-cyclical		15,494		—		—						<1	%
Technology		4,926		—		—						<1	%
Industrial		7,511		—		—						<1	%
Communications		4,802		—		—						<1	%
Index funds		3,549		—		—						<1	%
All Other		5,229		—		—						<1	%

Total equities		73,961		16		—						2	%

Short-Term		96,824		—		—						2	%

Business-owned life insurance (BOLI)		52,174		—		—			AA-			1	%

Investment in Unconsolidated Subsidiaries
Investment in tax credit partnerships		88,449		—		—						2	%
Business LLC interest		1,241		—		—						<1	%
Investment in LPs primarily invested in:
Long/short equities		17,836		—		—						<1	%
Non-public equities		6,994		—		—						<1	%

Total investment in unconsolidated subsidiaries		114,520		—		—						3	%

Other Investments
FHLB capital stock		4,557		—		—						<1	%
Investments in LP/LLCs primarily invested in:
Private equity and debt		16,191		—		—						<1	%
Long/short equities		11,010		—		—						<1	%
Other equities		940		—		—						<1	%
Other		1,762		—		—						<1	%

Total other investments		34,460		—		—						<1	%


Total Investments	$	4,046,511	$	199,314	$	(11,081	)					100	%

*	Average Moody’s rating is Aaa.

A detailed listing of our investment holdings as of September 30, 2011 is presented in an Investor Supplement we make available in the Investor Relations section of our website, www.proassurance.com or directly at www.proassurance.com/investorrelations/supplemental.aspx.

We manage our investments to ensure that we will have sufficient liquidity to meet our obligations, taking into consideration the timing of cash flows from our investments, including interest payments, dividends and principal payments, as well as the expected cash flows to be generated by our operations. In addition to the interest and dividends we will receive, we anticipate that between $50 million and $90 million of our investments will mature (or be paid down) each quarter of the next year and become available, if needed, to meet our cash flow requirements. The primary outflow of cash at our insurance subsidiaries is related to paid losses and operating costs, including income taxes. The payment of individual claims cannot be predicted with certainty; therefore, we rely upon the history of paid claims in estimating the timing of future claims payments. To the extent that we may have an unanticipated shortfall in cash we may either liquidate securities or borrow funds under existing borrowing arrangements through the Federal Home Loan Banking system and a $150 million credit facility. Additional information regarding the credit facility is discussed in Note 9 of the Notes to the Condensed Consolidated Financial Statements. However, given the relatively short duration of our investments, we do not foresee any such shortfall.

Our investment portfolio continues to be primarily composed of high quality fixed income securities with approximately 97% of our fixed maturities being investment grade securities as determined by national rating agencies. The weighted average effective duration of our fixed maturity securities at September 30, 2011 is 3.9 years; the weighted average effective duration of our fixed maturity securities combined with our short-term securities is 3.8 years.

We have increased our investment in tax credit limited partnerships by an additional $32 million during the first nine months of 2011. These investments are comprised of multiple separate limited partner interests designed to generate investment returns by providing tax benefits to fund investors in the form of project operating losses and tax credits. The related properties are principally low income housing properties. The $88.4 million carrying value of the partnerships reflects the commitments to the partnerships (less amortization) of which approximately $57.2 million is not yet funded as of September 30, 2011.

Reinsurance

We use reinsurance to provide capacity to write larger limits of liability, to provide protection against losses in excess of policy limits, and to stabilize underwriting results in years in which higher losses occur. The purchase of reinsurance does not relieve us from the ultimate risk on our policies, but it does provide reimbursement from the reinsurer for certain losses paid by us.

We have not experienced significant collection difficulties due to the financial condition of any reinsurer; however, periodically, reinsurers may dispute our claim for reimbursement from them. We have established appropriate reserves for any balances that we believe may not be ultimately collected. Should future events lead us to believe that any reinsurer will not meet its obligations to us, adjustments to the amounts recoverable would be reflected in the results of current operations. Such an adjustment has the potential to be significant to the results of operations in the period in which it is recorded; however, we would not expect such an adjustment to have a material effect on our capital position or our liquidity.

Debt

Our long-term debt as of September 30, 2011 is comprised of the following:


($ in thousands)	Contractual Rate		Outstanding Principal		Carrying Value September 30, 2011

Trust Preferred Securities due 2034		4.1% (1)	$	22,992	$	22,992
Surplus Notes due May 2034		4.2% (1)		12,000		12,000
Note Payable due February 2019 (2)		6.6% (3)		17,193		14,411
Note Payable due February 2012		3.3% (4)		517		511

					$	49,914

(1)	Adjusted quarterly based on LIBOR.

(2)	The 2019 Note Payable is valued at fair value. See Note 9.

(3)	A related interest rate swap fixes rate at 6.6%. Swap is settled monthly. See Note 9.

(4)	Adjusted quarterly based on the U.S. prime rate.

All of our long-term debt is currently repayable or redeemable, with proper notice, at a date no later than the next quarterly or semi-annual interest payment date. Insurance department approval is required for redemption of surplus notes.

During the second quarter of 2011, we entered into a revolving credit agreement that expires April 15, 2014. The agreement allows us to borrow up to $150 million that would be used for general corporate purposes, including, but not limited to, short-term working capital, share repurchases as authorized by the Board, and support for other activities we enter into in the normal course of business. To date, we have not borrowed any funds under the agreement.

ProAssurance is currently in compliance with all covenants. Additional information regarding our debt is provided in Note 9 of the Notes to the Condensed Consolidated Financial Statements.

Treasury Shares

We reacquired approximately 341,000 common shares having a total cost of $21.0 million during the nine-month period ended September 30, 2011 (including approximately 82,000 shares at a total cost of $5.6 million during the three-month period ended September 30, 2011). During 2011 we also reacquired approximately 7,000 forfeited employer match shares (cost basis of $0.4 million) due to the termination of the ProAssurance Corporation Stock Ownership Plan. Additional information regarding the termination of the ProAssurance Corporation Stock Ownership Plan is provided in Note 10 of the Notes to the Condensed Consolidated Financial Statements.

At September 30, 2011 we have approximately $188.4 million in prior authorizations from our Board of Directors available for use for the repurchase of common shares or the retirement of outstanding debt.

Litigation

In accordance with GAAP for insurance entities, claim-related actions are considered as a part of our loss reserving process. We evaluate the likely outcomes from these actions giving consideration to the facts and laws applicable to each case, appellate issues, coverage issues, potential recoveries from our insurance and reinsurance programs, and settlement discussions as well as our historical claims resolution practices. This data is then considered in the overall evaluation of our reserve for losses which is discussed herein in detail under “Critical Accounting Estimates – Reserve for Losses and Loss Adjustment Expenses (reserve for losses or reserve).”

There are risks, as outlined in our Risk Factors in Part 1 of our 2010 Form 10-K, that any of these actions could cost us more than our estimates. In particular, we or our insureds may receive adverse verdicts; post-trial motions may result in unfavorable rulings; any appeals that may be undertaken may be unsuccessful; and we may be unsuccessful in our legal efforts to limit the scope of coverage available to insureds.

For non-claim related actions, we evaluate each case separately and establish what we believe is an appropriate reserve based on GAAP guidance related to contingent liabilities.

To the extent that the cost of resolving legal actions exceeds our estimates, the excess could materially affect our results of operations in the period of resolution.

Overview of Results–Three and Nine Months Ended September 30, 2011 and 2010

Net income is $43.7 million and $146.5 million for the three and nine months ended September 30, 2011, respectively, as compared to $51.1 million and $129.5 million for the same respective periods in 2010. Net income per diluted share is $1.42 and $4.75 for the three and nine months ended September 30, 2011, respectively, as compared to $1.59 and $3.99 for the same respective periods in 2010.

Operating income, a non-GAAP financial measure, is $48.4 million and $147.0 million for the three and nine months ended September 30, 2011, respectively, as compared to $41.5 million and $123.4 million, for the same respective periods in 2010. Operating income per diluted share is $1.57 and $4.77 for the three and nine months ended September 30, 2011, respectively, as compared to $1.30 and $3.80, for the same respective periods in 2010.

Results from the three and nine months ended September 30, 2011 and 2010 compare as follows:

Revenues

Net premiums earned increased by $4.3 million or 3.3% and $24.6 million or 6.5% for the 2011 three- and nine-month periods, respectively, including $14.7 million and $43.6 million, respectively, attributable to the business acquired from APS. Our results reflect the effects of a competitive market place and rate reductions that reflect improved loss trends.

Our 2011 net investment result (which includes both net investment income and earnings from unconsolidated subsidiaries) decreased by $2.5 million or 7.3% for the three-month period and decreased by $12.4 million or 11.0% for the nine-month period.

Net realized investment losses in 2011 are $12.0 million and $5.6 million for the three- and nine-month periods, respectively, as compared to net realized gains of $14.7 million and $8.8 million for the same respective periods in 2010. Results primarily reflect unrealized trading portfolio losses in 2011 of $11.7 million and $13.0 million for the three- and nine-month periods, respectively, as compared to unrealized trading portfolio gains of $3.4 million and unrealized trading portfolio losses of $3.1 million for the three- and nine-month periods in 2010, respectively. Also, gains realized on sales of securities during the 2010 third quarter were $12.4 million higher than during the 2011 third quarter.

Other income increased by $5.7 million and $6.0 million for the three- and nine-month periods, respectively. The increase is primarily due to a $4.9 million confidential settlement received during the third quarter of 2011 related to litigation with a service provider.

Expenses

Current accident year net losses increased by $2.1 million or 2% for the 2011 three-month period and increased by $17.4 million or 5% for the 2011 nine-month period. Approximately $11.7 million and $32.2 million of the increase for the three- and nine-month periods, respectively, are attributable to the business acquired from APS. We reduced net losses by $52.1 million and $142.3 million for the 2011 three- and nine-month periods, respectively, and by $33.4 million and $95.9 million for the same respective periods in 2010 as a result of our review of net losses incurred for prior accident years.

Underwriting, policy acquisition and operating expenses increased in 2011 as compared to 2010 by $2.9 million or 8.9% and by $8.6 million or 9.1% for the three- and nine-month periods, respectively, reflecting the acquisition of APS, which added expenses of approximately $3.8 million and $10.2 million for the three- and nine-month periods, respectively.

Ratios

Our net loss ratio decreased in 2011 by 14.4 percentage points and 10.9 percentage points for the three- and nine-month periods, respectively, primarily because favorable development was higher in 2011 as compared to 2010. Approximately 0.2 percentage points and 1.2 percentage points of the decrease for the three- and nine-month periods, respectively, relates to a lower loss ratio for the business acquired in the APS transaction.

Our 2011 underwriting expense ratio reflects increases of 1.8 percentage points and 0.8 percentage points for the three- and nine-month periods, respectively, primarily due to lower net premiums earned, exclusive of the business acquired from APS.

Our operating ratio declined in 2011 by 10.5 percentage points and 7.4 percentage points for the three- and nine-month periods, respectively, reflecting the improved net loss ratio, offset by a higher expense ratio and lower investment income.

Return on equity is 8.8% and 10.1% for the three- and nine-month periods of 2011, respectively, on an annualized basis.

Book Value Per Share

Our book value per share at September 30, 2011 is $66.23 compared to $60.35 at December 31, 2010. The change primarily reflects our 2011 income, and an increase in accumulated other comprehensive income. Dividends declared during the period reduced book value per share by $0.25. Due to the size of our Shareholders’ Equity (approximately $2.0 billion at September 30, 2011), the growth rate of our book value per share may slow. The past growth rates of our book value per share do not necessarily predict similar future results.

Non-GAAP Financial Measure – Operating Income

Operating income is a non-GAAP financial measure that is widely used to evaluate the performance of insurance entities. Operating income excludes the after-tax effects of realized gains or losses, guaranty fund assessments and, in 2011, a confidential settlement of litigation with a service provider. We believe operating income presents a useful view of the performance of our insurance operations, but should be considered in conjunction with net income computed in accordance with GAAP.

The following table is a reconciliation of Net income to Operating income:


	Three Months Ended September 30						Nine Months Ended September 30

(In thousands, except per share data)	2011			2010			2011			2010

Net income	$	43,705		$	51,052		$	146,494		$	129,545
Items excluded in the calculation of operating income:
Net realized investment (gains) losses		11,972			(14,712	)		5,648			(8,807	)
Guaranty fund assessments (recoupments)		99			91			41			(659	)
Confidential settlement of litigation with a service provider		(4,900	)		—			(4,900	)		—

Pre-tax effect of exclusions		7,171			(14,621	)		789			(9,466	)

Tax effect, at 35%		(2,510	)		5,117			(276	)		3,313


Operating income	$	48,366		$	41,548		$	147,007		$	123,392

Per diluted common share:
Net income	$	1.42		$	1.59		$	4.75		$	3.99
Effect of exclusions		0.15			(0.29	)		0.02			(0.19	)

Operating income per diluted common share	$	1.57		$	1.30		$	4.77		$	3.80

Results of Operations–Three and Nine Months Ended September 30, 2011 Compared to Three and Nine Months Ended September 30, 2010

Selected consolidated financial data for each period is summarized in the table below.


	Three Months Ended September 30									Nine Months Ended September 30

($ in thousands, except share data)	2011			2010			Change			2011			2010			Change

Revenues:
Gross premiums written	$	174,680		$	158,998		$	15,682		$	450,795		$	414,697		$	36,098

Net premiums written	$	164,798		$	149,693		$	15,105		$	421,692		$	383,783		$	37,909


Premiums earned	$	145,844		$	140,802		$	5,042		$	429,627		$	411,006		$	18,621
Premiums ceded		(11,217	)		(10,502	)		(715	)		(25,861	)		(31,882	)		6,021

Net premiums earned		134,627			130,300			4,327			403,766			379,124			24,642
Net investment income		34,116			35,639			(1,523	)		106,573			110,348			(3,775	)
Equity in earnings (loss) of unconsolidated subsidiaries		(2,264	)		(1,281	)		(983	)		(6,044	)		2,544			(8,588	)
Net realized investment gains (losses)		(11,972	)		14,712			(26,684	)		(5,648	)		8,807			(14,455	)
Other income		7,471			1,764			5,707			11,745			5,769			5,976

Total revenues		161,978			181,134			(19,156	)		510,392			506,592			3,800


Expenses:
Losses and loss adjustment expenses		71,777			86,866			(15,089	)		218,270			251,944			(33,674	)
Reinsurance recoveries		(8,601	)		(7,055	)		(1,546	)		(20,319	)		(24,908	)		4,589

Net losses and loss adjustment expenses		63,176			79,811			(16,635	)		197,951			227,036			(29,085	)
Underwriting, policy acquisition and operating expenses		34,954			32,095			2,859			103,534			94,940			8,594
Interest expense		932			832			100			2,645			2,472			173

Total expenses		99,062			112,738			(13,676	)		304,130			324,448			(20,318	)


Income before income taxes		62,916			68,396			(5,480	)		206,262			182,144			24,118
Income taxes		19,211			17,344			1,867			59,768			52,599			7,169

Net income	$	43,705		$	51,052		$	(7,347	)	$	146,494		$	129,545		$	16,949


Earnings per share:
Basic	$	1.43		$	1.61		$	(0.18	)	$	4.79		$	4.03		$	0.76

Diluted	$	1.42		$	1.59		$	(0.17	)	$	4.75		$	3.99		$	0.76


Net loss ratio		46.9	%		61.3	%		(14.4	)		49.0	%		59.9	%		(10.9	)
Underwriting expense ratio		25.8	%		24.0	%		1.8			25.2	%		24.4	%		0.8

Combined ratio		72.7	%		85.3	%		(12.6	)		74.2	%		84.3	%		(10.1	)

Operating ratio		47.4	%		57.9	%		(10.5	)		47.8	%		55.2	%		(7.4	)

Return on equity*		8.8	%		11.3	%		(2.5	)		10.1	%		9.8	%		0.3

*Annualized

In all the tables that follow, the abbreviation “nm” indicates that the percentage change is not meaningful.

As required by GAAP, our results include acquired entities only for the portion of the reporting period that is after the acquisition date. Our 2011 operating results include three and nine months of APS activity for the three- and nine-month periods, respectively, while our 2010 operating results do not include any APS activity. In many of the supporting tables that follow, the effect of the additional 2011 APS activity is separately disclosed.

Premiums Written

Changes in our premium volume are driven by four primary factors: (1) the amount of new business we are able to generate, including business that comes to PRA as a result of acquisitions, (2) the timing of premium written for business generated by multi-period policies, (3) our retention of existing business, and (4) the premium charged for business that is renewed, which is affected both by rates charged and by the amount and type of coverage an insured chooses to purchase. The professional liability market remains competitive with some competitors choosing to compete primarily on price.

Gross and net premiums written are as follows:


	Three months ended September 30									Nine months ended September 30

($ in thousands)	2011		2010		Change					2011		2010		Change

Gross premiums written:
Physician	$	143,673	$	127,220	$	16,453		12.9	%	$	365,198	$	325,439	$	39,759		12.2	%
Non-physician healthcare providers		14,233		12,537		1,696		13.5	%		36,848		31,583		5,265		16.7	%
Hospital and facility		5,494		5,481		13		0.2	%		19,079		20,351		(1,272	)	(6.3	%)
Other		4,770		3,603		1,167		32.4	%		14,455		12,114		2,341		19.3	%
Non-continuing		69		1,007		(938	)	(93.1	%)		268		6,593		(6,325	)	(95.9	%)
Tail premium, all policy types		6,441		9,150		(2,709	)	(29.6	%)		14,947		18,617		(3,670	)	(19.7	%)

Total gross premiums written	$	174,680	$	158,998	$	15,682		9.9	%	$	450,795	$	414,697	$	36,098		8.7	%


Net premiums written	$	164,798	$	149,693	$	15,105		10.1	%	$	421,692	$	383,783	$	37,909		9.9	%

Results for 2011 include premiums attributable to the APS acquisition as detailed in the following table:


	September 30, 2011

($ in thousands)	Three Months		Nine Months

Gross premiums written:
Physician	$	14,858	$	44,434
Non-physician healthcare providers		1,544		1,721
Tail premium, all policy types		535		1,193

Total gross premiums written	$	16,937	$	47,348


Net premiums written	$	16,433	$	46,303

Gross Premiums Written

Physician Premiums

Our 2011 results reflect new business of $21 million and $63 million for the three and nine months ended September 30, 2011, respectively, including $15 million and $44 million, respectively, that is attributable to the acquisition of APS. New physician business for the three and nine months ended September 30, 2010 approximated $6 million and $12 million, respectively.

Two-year term policies also contributed to the increase in gross written premium. Gross written premium associated with two-year term policies is $8.1 million and $20.7 million for the three and nine months ended September 30, 2011, respectively, as compared to $3.2 million and $8.8 million for the same respective periods in 2010. We offer two-year term policies (as opposed to a one-year term) to our physician insureds in one selected jurisdiction. The premium associated with both years is included in written premium in the period the policy is written.

Our retention rate for physician business is 89% for both the three and nine months ended September 30, 2011, as compared to 90% and 89% for the 2010 three- and nine-month periods, respectively. We calculate our retention rate as retained premium divided by all premium subject to renewal. Retention rates are affected by a number of factors. We may lose insureds to competitors or to self-insurance mechanisms (often when physicians join hospital-based practice groups) or due to pricing or other issues. We may choose not to renew an insured as a result of our underwriting evaluation. Insureds may also terminate coverage because they have left the practice of medicine for various reasons, principally for retirement but also due to disability or other personal reasons.

Charged rates for our renewed physician business have averaged 1% higher than the expiring premiums during the three months ended September 30, 2011, driven by our podiatric line of business. Approximately 50% of our podiatric business renews in the third quarter and this line had a 7% increase in charged rates during the quarter. Rates on our MD/DO business declined 1% during the quarter. During the nine months ended September 30, 2011, charged rates decreased an average of 1%. Our charged rates include the effects of filed rates, surcharges and discounts. Despite competitive pressures, we continue to base our rates on expected losses, as indicated by our historical loss data and available industry loss data. We are committed to a rate structure that will allow us to fulfill our obligations to our insureds, while generating competitive returns for our shareholders.

We have included APS policies subject to renewal in our retention and rate change calculations. The business acquired from APS experienced a retention rate of 87% and 89% for the three and nine months ended September 30, 2011, respectively.

Non-physician Premiums

Our healthcare providers included in non-physician premiums are primarily dentists, chiropractors, optometrists, and allied health professionals. The 2011 increase is primarily related to allied health coverages.

Hospital and facility premiums decreased for the nine-month period of 2011. The decline reflects the same competitive pressures in this area as we are seeing in our physician business.

Non-physician “other” premiums are primarily legal professional liability premiums. The increase in premium volume for the three- and nine-month periods of 2011 principally relates to legal professional liability premiums.

Non-continuing in the above table separately identifies premium generated by certain types of miscellaneous liability coverages which we no longer provide.

Tail Premiums

We offer extended reporting endorsement or “tail” policies to insureds that are discontinuing their claims-made coverage with us. The amount of tail premium written and earned can vary widely from period to period.

Net Premiums Written

The principal components of the change in net premiums written for the three and nine months ended September 30, 2011 as compared to net premiums written for the same periods in 2010 are as follows:


	Increase (Decrease) in Net Premiums Written

($ in thousands)	Three-Month Period			Nine-Month Period

Increase in gross premiums written, previously discussed	$	15,682		$	36,098
Additional premiums ceded, due to business acquired from APS		(504	)		(1,046	)
Decrease in premiums ceded due to commutation, see separate discussion below in Premiums Ceded		—			5,600
Other increases (decreases) in premiums ceded, net		(73	)		(2,743	)

Increase in Net Premiums Written	$	15,105		$	37,909

Exclusive of the effects of the APS acquisition and the commutation, both the three- and the nine- month periods reflect ceded premium reductions attributable to lower premium volume, offset to an extent by higher ceded premium associated with the start up of a new program with Ascension Health facilities (Ascension). Our arrangements with Ascension provide that a substantial portion of the initial policies written under the program will be heavily reinsured by an Ascension affiliate. The nine-month period additionally reflects an increase in ceded premium due to certain large policies written in 2011 that are heavily reinsured on a facultative basis.

Premiums Earned/Premiums Ceded


	Three Months Ended September 30									Nine Months Ended September 30

($ in thousands)	2011		2010		Change					2011		2010		Change

Premiums earned:
PRA all other	$	130,624	$	140,802	$	(10,178	)	(7.2	%)	$	384,976	$	411,006	$	(26,030	)	(6.3	%)
APS Acquisition		15,220		—		15,220		nm			44,651		—		44,651		nm

		145,844		140,802		5,042		3.6	%		429,627		411,006		18,621		4.5	%
Premiums ceded:
PRA all other		10,713		10,502		211		2.0	%		24,815		31,882		(7,067	)	(22.2	%)
APS Acquisition		504		—		504		nm			1,046		—		1,046		nm

		11,217		10,502		715		6.8	%		25,861		31,882		(6,021	)	(18.9	%)
Net premiums earned:
PRA all other		119,911		130,300		(10,389	)	(8.0	%)		360,161		379,124		(18,963	)	(5.0	%)
APS Acquisition		14,716		—		14,716		nm			43,605		—		43,605		nm

	$	134,627	$	130,300	$	4,327		3.3	%	$	403,766	$	379,124	$	24,642		6.5	%

Premiums Earned

Because premiums are generally earned pro rata over the entire policy period, fluctuations in premiums earned tend to lag those of premiums written. Generally, our policies carry a term of one year, but as discussed above, we renew certain policies with a two-year term. Tail premiums are generally 100% earned in the period written because the policies insure only incidents that occurred in prior periods and are not cancellable.

Of the premiums attributable to the APS acquisition earned during the three and nine months ended September 30, 2011, approximately $2.7 million and $20.0 million, respectively, are attributable to premiums written prior to acquisition.

Premiums Ceded

Premiums ceded represent the portion of earned premiums that we pay our reinsurers for their assumption of a portion of our losses. The premium that we cede to our reinsurers is determined, in part, by the loss experience (subject to minimums and maximums) of the business ceded to them. It takes a number of years before all losses are known, and in the intervening period, premiums due to the reinsurers are based on estimates.

During the second quarter of 2011, ProAssurance commuted (terminated) certain of its reinsurance arrangements with Colisee Re (formerly AXA Reassurance S.A.) for approximately $4.3 million in cash. The effect of the commutation was to reduce Premiums Ceded by approximately $5.6 million and to reduce Reinsurance Recoveries by approximately $4.0 million. The commutation also affected our reinsurance expense ratio for the nine-month period, as reflected in the table below.


	Three Months Ended September 30								Nine Months Ended September 30

	2011			2010			Change		2011			2010			Change

Reinsurance expense ratio:*
PRA all other:
Before commutation effect		8.2	%		7.5	%		0.7		7.9	%		7.8	%		0.1
Commutation effect		—			—			nm		(1.5	%)		—			nm

PRA all other		8.2	%		7.5	%		0.7		6.4	%		7.8	%		(1.4	)
APS Acquisition		3.3	%		—			nm		2.3	%		—			nm
Consolidated		7.7	%		7.5	%		0.2		6.0	%		7.8	%		(1.8	)

*	Calculated as premiums ceded as a percentage of premiums earned

Exclusive of the APS acquisition, the increase in our reinsurance expense ratio for both the three- and the nine-month periods is due to higher premiums ceded in 2011 related to premiums associated with the Ascension program, as previously discussed, and to a lesser extent, to an increase in premiums ceded associated with certain facultatively reinsured policies.

The reinsurance expense ratio associated with the business acquired from APS is lower than the ratio for our other business. In recent years, largely due to the advantageous legal climate within the state of Texas, only a small percentage of APS paid losses have met reinsurance coverage limits; consequently, APS has been able to obtain reinsurance coverage for 2010 and 2011 at favorable rates. The APS reinsurance arrangements base the amounts due to reinsurers, in part, on expected losses, and the increase in the ratio between the 2011 three-month and nine-month periods reflects shifts in the actuarial estimate of losses that will reach reinsurance coverage limits.

Net Investment Income, Equity in Earnings (Loss) of Unconsolidated Subsidiaries, Net Realized Investment Gains (Losses)

Net Investment Income

Net investment income is primarily derived from the income earned by our fixed maturity securities and also includes income from our short-term and cash equivalent investments, dividend income from equity securities, earnings from other investments and increases in the cash surrender value of business owned life insurance contracts. Investment fees and expenses are deducted from investment income.

Net investment income by investment category is as follows:


	Three Months Ended September 30											Nine Months Ended September 30

($ in thousands)	2011			2010			Change					2011			2010			Change

Fixed maturities	$	33,939		$	35,952		$	(2,013	)	(5.6	%)	$	106,573		$	110,349		$	(3,776	)	(3.4	%)
Equities		569			142			427		300.7	%		985			597			388		65.0	%
Short-term investments		20			115			(95	)	(82.6	%)		93			279			(186	)	(66.7	%)
Other invested assets		573			548			25		4.6	%		2,137			2,153			(16	)	(0.7	%)
Business owned life insurance		635			340			295		86.8	%		1,571			1,161			410		35.3	%
Investment expenses		(1,620	)		(1,458	)		(162	)	11.1	%		(4,786	)		(4,191	)		(595	)	14.2	%

Net investment income	$	34,116		$	35,639		$	(1,523	)	(4.3	%)	$	106,573		$	110,348		$	(3,775	)	(3.4	%)

Fixed Maturities

The decrease in income for both the three- and nine-month periods primarily reflects lower yields partially offset by higher average investment balances. During the first six months of 2011, our Treasury Inflation-Protected Securities (TIPS) portfolio outperformed our other fixed maturities, and thus the 2011 nine-month period includes higher earnings from our TIPS of approximately $1.5 million. We do not expect further significant increases from TIPS for the remainder of 2011.

The overall yield on our portfolio declined for both the three- and nine-month periods because we were not able to reinvest proceeds from maturities, pay-downs and sales at rates comparable to expiring rates while maintaining our asset quality and the duration of our portfolio. Additionally, the yields on fixed maturity securities acquired in the APS transaction, after adjustment as required by GAAP purchase accounting rules, approximated market yields on the acquisition date of November 30, 2010 and lowered our average consolidated tax equivalent yield by approximately 8 basis points and 29 basis points for the three- and nine-month periods, respectively. Average yields for our available-for-sale fixed maturity securities during 2011 and 2010 are as follows:


	Three Months Ended September 30						Nine Months Ended September 30

	2011			2010			2011			2010

Average income yield		3.9	%		4.4	%		4.1	%		4.4	%
Average tax equivalent income yield		4.4	%		5.0	%		4.6	%		5.0	%

The level of our investment in fixed maturity securities varies depending upon a number of factors, including, among others, our operating cash needs, anticipated shifts in credit markets, the attractiveness of other investment alternatives, and cash needed for acquisitions or other capital purposes. In 2011 as compared to 2010, our average investment in fixed maturities increased by approximately 6% and 4% for the three- and nine-month periods, respectively.

Equity in Earnings (Loss) of Unconsolidated Subsidiaries

Equity in earnings (loss) of unconsolidated subsidiaries is derived from our investment interests accounted for under the equity method, as follows:


	Three Months Ended September 30									Nine Months Ended September 30

(In thousands)	2011			2010			Change			2011			2010			Change

Investment LPs:
Currently held	$	(297	)	$	633		$	(930	)	$	(281	)	$	1,507		$	(1,788	)
Liquidated in 2010		—			—			—			—			3,097			(3,097	)
Business LLC interest		(456	)		(663	)		207			(1,866	)		(663	)		(1,203	)
Tax credit partnerships		(1,511	)		(1,251	)		(260	)		(3,897	)		(1,397	)		(2,500	)

Equity in earnings (loss) of unconsolidated subsidiaries	$	(2,264	)	$	(1,281	)	$	(983	)	$	(6,044	)	$	2,544		$	(8,588	)

We hold interests in certain LPs that derive earnings from trading portfolios. The performance of the LPs is affected by the volatility of equity and credit markets. One LP, shown separately in the table, was liquidated in July 2010.

Our business LLC interest is a non-controlling interest in an entity that began active business in 2011. While we expect this investment to provide a positive return over time, operating losses are expected to continue through 2011 and into 2012 due to the start up nature of this entity. Our potential for loss is limited to the carrying amount of our investment, currently $1.3 million.

We began investing in tax credit limited partnerships in 2010. Our tax credit investments are designed to generate investment returns by providing tax benefits to fund investors in the form of project operating losses and tax credits. Our tax credit partnerships reduced our tax expenses by approximately $1.2 million and $4.3 million during the three and nine months ended September 30, 2011, respectively, while we recognized $1.5 million and $3.9 million of pre-tax amortization during the same respective periods on these investments noted in the table above.

Non-GAAP Financial Measure – Tax Equivalent Investment Result

We believe that to fully understand our investment returns it is important to consider the current tax benefits associated with certain investments; therefore, we impute a proforma tax-equivalent investment result by adjusting the current tax benefit into the amount of investment income a taxable investment would need to produce to fairly compare to an investment with preferential tax treatment. We believe this better reflects the economies of our decision to invest in certain asset classes that are either taxed at lower rates and/or result in reductions to our current federal income tax expense.


	Three months ended September 30						Nine months ended September 30

(In thousands)	2011			2010			2011			2010

Investment results, as reported for GAAP :
Net investment income	$	34,116		$	35,639		$	106,573		$	110,348
Equity in earnings of unconsolidated subsidiaries		(2,264	)		(1,281	)		(6,044	)		2,544

		31,852			34,358			100,529			112,892
Taxable equivalent adjustments for *:
State and municipal bonds		4,658			5,113			14,500			17,009
BOLI		342			183			846			625
Dividends received deduction		182			45			316			191
Tax credit partnerships		1,777			1,145			6,637			1,145

Proforma tax-equivalent investment results	$	38,811		$	40,844		$	122,828		$	131,862

*	All adjustments were calculated using the 35% federal statutory tax rate.

Net Realized Investment Gains (Losses)

The following table provides detailed information regarding our net realized investment gains (losses).


	Three Months Ended September 30						Nine Months Ended September 30

(In thousands)	2011			2010			2011			2010

Total other-than-temporary impairment losses:
Residential mortgage-backed securities	$	(13	)	$	(166	)	$	(782	)	$	(189	)
Other investments		(1,376	)		—			(3,509	)		(3,373	)
High yield asset-backed securities		—			(532	)		—			(9,515	)
Portion recognized in (reclassified from) Other Comprehensive Income:
Residential mortgage-backed securities		(142	)		113			(823	)		119

Net impairment losses recognized in earnings		(1,531	)		(585	)		(5,114	)		(12,958	)
Net gains (losses) from sales		1,145			13,169			10,080			23,065
Net realized gains (losses), trading securities		(357	)		26			2,558			4,926
Change in unrealized holding gains (losses), trading securities		(11,702	)		3,360			(13,043	)		(3,102	)
Decrease (increase) in the fair value of liabilities carried at fair value		473			(1,258	)		(129	)		(3,124	)

Net realized investment gains (losses)	$	(11,972	)	$	14,712		$	(5,648	)	$	8,807

We recognized impairments of $3.5 million during the nine months ended September 30, 2011 and $3.4 million during the nine months ended September 30, 2010 related to an interest in an LLC which we account for using the cost method. The LLC has notified us of its intention to be sold publicly in the next few months, and we have reduced the carrying value of our interest in the LLC to reflect the expected market value of the assets.

We recognized credit-related impairments in earnings of $1.6 million in 2011, related to residential mortgage-backed securities. Expected future cash flows were less than our carrying value for these securities; therefore, we reduced the carrying value of our interest in these securities and recognized the loss in our 2011 net income.

Trading portfolio losses during 2011 reflect the overall decline in stock market yields, further impacted by higher average balances in our portfolio in 2011 as compared to 2010.

Fair value adjustments are attributable to our election of fair value treatment for both the 2019 Note Payable and related interest rate swap, as discussed in Notes 3 and 9 of the Notes to the Condensed Consolidated Financial Statements.

Other Income

Other Income is typically comprised primarily of commission and fee income from our agency operations, other fee revenues, rental income and other miscellaneous revenues. The revenue is not a principal source of income and often varies among periods. During the third quarter of 2011, we recognized other income of $4.9 million related to a confidential settlement of litigation with a service provider. The remaining increase for both the three- and nine-month periods is primarily attributable to a gain of approximately $0.8 million recognized on the sale of a building in the third quarter of 2011.

Losses and Loss Adjustment Expenses

The determination of calendar year losses involves the actuarial evaluation of incurred losses for the current accident year and the actuarial re-evaluation of incurred losses for prior accident years, including an evaluation of the reserve amounts required for losses in excess of policy limits.

Accident year refers to the accounting period in which the insured event becomes a liability of the insurer. For claims-made policies, which represent over 90% of the Company’s business, the insured event generally becomes a liability when the event is first reported to the insurer; for occurrence policies the insured event becomes a liability when the event takes place. We believe that measuring losses on an accident year basis is the best measure of the underlying profitability of the premiums earned in that period since it associates policy premiums earned with the estimate of the losses incurred related to those policy premiums.

The following tables summarize calendar year net losses and net loss ratios for the three and nine months ended September 30, 2011 and 2010 by separating losses between the current accident year and all prior accident years.


	Net Losses
	Three Months Ended September 30									Nine Months Ended September 30
($ in millions)	2011			2010			Change			2011			2010			Change

Current accident year:
PRA all other	$	103.6		$	113.2		$	(9.6	)	$	308.1		$	322.9		$	(14.8	)
APS Acquisition		11.7			—			11.7			32.2			—			32.2

Consolidated	$	115.3		$	113.2		$	2.1		$	340.3		$	322.9		$	17.4


Prior accident years:
PRA all other	$	(47.1	)	$	(33.4	)	$	(13.7	)	$	(127.1	)	$	(95.9	)	$	(31.2	)
APS Acquisition		(5.0	)		—			(5.0	)		(15.2	)		—			(15.2	)

Consolidated	$	(52.1	)	$	(33.4	)	$	(18.7	)	$	(142.3	)	$	(95.9	)	$	(46.4	)


Calendar year:
PRA all other	$	56.5		$	79.8		$	(23.3	)	$	181.0		$	227.0		$	(46.0	)
APS Acquisition		6.7			—			6.7			17.0			—			17.0

Consolidated	$	63.2		$	79.8		$	(16.6	)	$	198.0		$	227.0		$	(29.0	)


	Net Loss Ratios*
	Three Months Ended September 30									Nine Months Ended September 30
	2011			2010			Change			2011			2010			Change

Current accident year:
PRA all other		86.4	%		86.9	%		(0.5	)		85.5	%		85.2	%		0.3
APS Acquisition		79.7	%		—			nm			73.8	%		—			nm
Consolidated		85.6	%		86.9	%		(1.3	)		84.3	%		85.2	%		(0.9	)

Prior accident years:
PRA all other		(39.3	%)		(25.6	%)		(13.7	)		(35.3	%)		(25.3	%)		(10.0	)
APS Acquisition		(34.0	%)		—			nm			(34.7	%)		—			nm
Consolidated		(38.7	%)		(25.6	%)		(13.1	)		(35.3	%)		(25.3	%)		(10.0	)

Calendar year:
PRA all other		47.1	%		61.3	%		(14.2	)		50.2	%		59.9	%		(9.7	)
APS Acquisition		45.7	%		—			nm			39.1	%		—			nm
Consolidated		46.9	%		61.3	%		(14.4	)		49.0	%		59.9	%		(10.9	)

Net losses as specified divided by net premiums earned

The decrease in our current accident year net loss ratio is principally attributable to the effect of the business acquired from APS. We expect lower losses related to the business acquired from APS. APS operates primarily in Texas, which is currently experiencing a favorable legal climate due to tort reform. The APS net loss ratio increased during the third quarter of 2011 as we applied a reserving approach similar to that utilized for our historical business.

During the three and nine months ended September 30, 2011, we recognized favorable loss development of $52.1 million and $142.3 million, respectively, on a net basis, related to reserves previously established for prior accident years. Principally this is due to favorable net loss development within our retained layers of coverage ($1 million and below) for accident years 2004 to 2009. Approximately $5.0 million of the three months’ and $15.2 million of the nine months’ favorable development in 2011 relates to reserves assumed in the acquisition of APS based on 2011 claims activity which indicates claims severity has declined below our December 31, 2010 estimates.

During the three and nine months ended September 30, 2010, we recognized favorable loss development of $33.4 million and $95.9 million, respectively, on a net basis, related to our previously established (prior accident year) reserves, principally for the 2004 to 2008 accident years within our retained layers of coverage ($1 million and below). We also recognized unfavorable development of $1.6 million related to the commutation of a captive reinsurance arrangement during the three- and nine-month period ended September 30, 2010.

Substantially all of the development recognized during the first nine months of 2011 and 2010 relates to medical professional liability claims-made reserves. The favorable development for medical professional claims-made policies in both years is based upon observation of actual claims data that indicates that claims severity (i.e., the expected average cost of claims) is trending below our initial expectations. With the decline in the frequency of claims that both we and the industry have observed over the past five years, we had anticipated that the quality of claims would improve which would lead to higher average claim values and a higher severity trend. While the increase in severity has not been at the level we anticipated, management continues to believe that an increase in severity is a likely ultimate outcome of a lower frequency environment. An extended period of time is required to get a clear estimate of the loss cost for a given accident year. As an example, at the end of 2009 we had resolved 69.7% of the known claims for the 2007 accident year. This statistic is based on the number of reported claims; since many non-meritorious claims are resolved early, the percentage of ultimate loss payments known at the same point in time is considerably lower. At the end of 2010 this had increased by 15% to 82.5% of the known claims. Historically we have resolved more than 85% of our physician and hospital professional liability claims with no indemnity payment and generally these claims are the first to be resolved. As an accident year matures we see an increase in the number of claims that are resolved with indemnity

payments. In a similar fashion we typically expend more in loss adjustment expenses (legal fees) as claims mature. Based upon the additional claims closed in both 2011 and 2010 and the continuation of better than expected severity trends, management reduced its expected ultimate losses in both 2011 and 2010 resulting in the recognition of corresponding amounts of favorable development in the income statement of those periods.

Assumptions used in establishing our reserve are regularly reviewed and updated by management as new data becomes available. Any adjustments necessary are reflected in the current operations. Due to the size of our reserve, even a small percentage adjustment to the assumptions can have a material effect on our results of operations for the period in which the change is made, as was the case in 2010 and has been thus far in 2011.

Underwriting, Policy Acquisition and Operating Expenses

The table below provides a comparison of 2011 and 2010 underwriting, policy acquisition and operating expenses for the three- and nine-month periods ended September 30:


	Three months ended September 30									Nine months ended September 30
($ in thousands)	2011		2010		Change					2011		2010		Change

Insurance operation expenses:
PRA all other	$	30,962	$	31,225	$	(263	)	(0.8	%)	$	91,628	$	92,345	$	(717	)	(0.8	%)
APS Acquisition		3,782		—		3,782		nm			10,200		—		10,200		nm

		34,744		31,225		3,519		11.3	%		101,828		92,345		9,483		10.3	%
Agency expenses		210		870		(660	)	(75.9	%)		1,706		2,595		(889	)	(34.3	%)

	$	34,954	$	32,095	$	2,859		8.9	%	$	103,534	$	94,940	$	8,594		9.1	%

Insurance Operation Expenses

Exclusive of the effect of the APS acquisition, insurance operation expenses for the 2011 three- and nine-month periods reflect relatively flat operating expenses, lower amortization of deferred policy acquisition costs consistent with the decline in premiums earned and, for the nine-month period, a reduced amount of Guaranty Fund recoupments.

Expenses associated with APS include salary and benefit expenses of approximately $1.1 million and $2.1 million for the three- and nine-month periods, respectively, that are related to workforce reductions. APS policy acquisition expenses are approximately $0.2 million and $1.5 million lower for the three- and nine-month periods, respectively, than would be considered normal due to the application of GAAP purchase accounting rules whereby the capitalized policy acquisition costs for policies written prior to the acquisition date were written off rather than being expensed ratably over the term of the associated insurance policy.

Underwriting Expense Ratio


	Underwriting Expense Ratio *
	Three months ended September 30								Nine months ended September 30
	2011			2010			Change		2011			2010			Change

Underwriting expense ratio, consolidated		25.8	%		24.0	%		1.8		25.2	%		24.4	%		0.8

*	Our expense ratio computations exclude agency expenses as discussed below.

The change in our consolidated underwriting expense ratio for the 2011 three- and nine-month periods reflects increases of 0.7 percentage points and 0.1 percentage points, respectively, that are attributable to expenses associated with APS workforce reductions which are partially offset by lower amortization of deferred policy acquisition costs due to the application of GAAP purchase accounting rules. Otherwise, our ratio increased primarily as a result of the decline in net premiums earned at our subsidiaries other than APS.

Agency expenses

We have historically operated several non-insurance subsidiaries, principally insurance agencies that have generated commission and service fee revenues. Expenses of our agency operations that are associated with the generation of premium revenues by our insurance subsidiaries are included in insurance operation expenses in the above table. Expenses of our agency operations that are directly associated with external commission and service fee revenues are included in agency expenses in the above table. In 2011 we discontinued most external agency operations. The declines in agency expenses of $0.7 million and $0.9 million for the three- and nine-month periods, respectively, reflect the discontinuation of these operations. The nine-month period decline is partially offset by costs incurred during the first six months of 2011 related to workforce reductions.

Interest Expense

The increase in interest expense for the three and nine months ended September 30, 2011 reflects commitment fees and amortization of the initial loan costs related to the credit agreement entered into during the second quarter of 2011. The credit agreement is discussed in Note 9 of the Notes to the Condensed Consolidated Financial Statements.

Interest expense by debt obligation is provided in the following table:


	Three Months Ended September 30							Nine Months Ended September 30
(In thousands)	2011		2010		Change			2011		2010		Change

Trust Preferred Securities due 2034	$	240	$	250	$	(10	)	$	722	$	733	$	(11	)
Surplus Notes due May 2034		127		131		(4	)		379		380		(1	)
Note Payable due February 2019		291		297		(6	)		867		884		(17	)
Revolving credit agreement		152		—		152			287		—		287
Other		122		154		(32	)		390		475		(85	)

	$	932	$	832	$	100		$	2,645	$	2,472	$	173

Taxes

Our effective tax rate for each period is lower than the 35% statutory rate because a considerable portion of our net investment income is tax-exempt. Other factors affecting our effective tax rate include the following:


	Three Months Ended September 30						Nine Months Ended September 30
	2011			2010			2011			2010

Statutory rate		35.0	%		35.0	%		35.0	%		35.0	%
Tax-exempt income		(4.8	%)		(5.1	%)		(4.8	%)		(6.3	%)
Tax credits		(1.8	%)		(1.1	%)		(2.1	%)		(0.4	%)
Valuation allowance		—			(1.3	%)		—			(0.5	%)
BOLI redemption		—			—			—			0.7	%
Other, including estimate revisions		2.1	%		(2.1	%)		0.9	%		0.4	%

Effective tax rate		30.5	%		25.4	%		29.0	%		28.9	%

The 2011 increase in the effective tax rate reflects the following:

–

For both the three- and nine- month periods, the total amount of tax-exempt income was lower in 2011; also, tax-exempt income represents a smaller percentage of total pretax income for the 2011 nine-month period as compared to 2010.

–

Tax expense was increased in the 2011 third quarter but decreased in the 2010 third quarter due to the re-estimation of the effect of permanent tax differences based on annual tax returns filed during the third quarter period.

–

For the nine-month period, tax expense was lower in 2010 due to the reversal of a valuation allowance recorded in 2009.

The effect of the above increases was mitigated by the following:

–

Tax credit investments generated tax credits of approximately $1.2 million and $4.3 million for the three and nine months ended September 30, 2011, respectively, as compared to approximately $0.8 million for the three and nine months ended September 30, 2010 (tax credits directly reduce our tax expense).

–

A partial redemption of our BOLI increased tax expense for the 2010 nine-month period by approximately $1.3 million; there were no BOLI redemptions during 2011.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

We believe that we are principally exposed to three types of market risk related to our investment operations. These risks are interest rate risk, credit risk and equity price risk.

Interest Rate Risk

Our fixed maturities portfolio is exposed to interest rate risk. Fluctuations in interest rates have a direct impact on the market valuation of these securities. As interest rates rise, market values of fixed income portfolios fall and vice versa. Certain of the securities are held in an unrealized loss position; we do not intend to sell and believe we will not be required to sell any of the debt securities held in an unrealized loss position before its anticipated recovery.

The following table summarizes estimated changes in the fair value of our available-for-sale fixed maturity securities for specific hypothetical changes in interest rates by asset class at September 30, 2011 and December 31, 2010. There are principally two factors that determine interest rates on a given security: market interest rates and credit spreads. As different asset classes can be affected in different ways by movements in those two factors, we have broken out our portfolio by asset class in the following table.

September 30, 2011

Interest Rate Shift in Basis Points

(200)

(100)

Current

100

200

Fair Value (in millions):

U.S. Treasury obligations

322

318

311

302

293

U.S. Agency obligations

State and municipal bonds

1,238

1,214

1,173

1,121

1,070

Corporate debt

1,434

1,415

1,371

1,317

1,266

Asset-backed securities

753

750

733

709

684

All fixed maturity securities

3,836

3,786

3,675

3,533

3,393

Duration:

U.S. Treasury obligations

3.69

3.65

3.58

3.49

3.40

U.S. Agency obligations

2.83

2.84

3.08

3.65

3.82

State and municipal bonds

4.04

4.30

4.41

4.52

4.59

Corporate debt

4.10

4.08

4.02

3.93

3.85

Asset-backed securities

1.16

1.62

2.97

3.57

3.92

All fixed maturity securities

3.44

3.60

3.87

4.00

4.06

December 31, 2010

Fair Value (in millions):

U.S. Treasury obligations

237

232

226

220

215

U.S. Agency obligations

State and municipal bonds

1,367

1,308

1,244

1,181

1,122

Corporate debt

1,428

1,383

1,333

1,281

1,232

Asset-backed securities

757

750

732

708

680

All fixed maturity securities

3,863

3,744

3,604

3,456

3,313

Duration:

U.S. Treasury obligations

3.53

3.64

3.78

3.70

3.62

U.S. Agency obligations

3.47

3.66

3.82

3.77

State and municipal bonds

3.88

4.91

5.02

5.08

5.09

Corporate debt

3.35

3.83

4.01

3.92

3.82

Asset-backed securities

1.84

2.25

3.02

3.56

3.81

All fixed maturity securities

3.24

3.88

4.14

4.23

4.24

Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including the maintenance of the existing level and composition of fixed income security assets, and should not be relied on as indicative of future results.

Certain shortcomings are inherent in the method of analysis presented in the computation of the fair value of fixed rate instruments. Actual values may differ from those projections presented should market conditions vary from assumptions used in the calculation of the fair value of individual securities, including non-parallel shifts in the term structure of interest rates and changing individual issuer credit spreads.

ProAssurance’s cash and short-term investment portfolio at September 30, 2011 is on a cost basis which approximates its fair value. This portfolio lacks significant interest rate sensitivity due to its short duration.

Credit Risk

We have exposure to credit risk primarily as a holder of fixed income securities. We control this exposure by emphasizing investment grade credit quality in the fixed income securities we purchase.

As of September 30, 2011, 97% of our fixed maturity securities are rated investment grade as determined by Nationally Recognized Statistical Rating Organizations (NRSROs), such as A.M. Best, Fitch, Moody’s, and Standard & Poor’s. We believe that this concentration in investment grade securities reduces our exposure to credit risk on our fixed income investments to an acceptable level. However, investment grade securities, in spite of their rating, can rapidly deteriorate and result in significant losses. Ratings published by the NRSROs are one of the tools used to evaluate the credit worthiness of our securities. The ratings reflect the subjective opinion of the rating agencies as to the credit worthiness of the securities, and therefore, we may be subject to additional credit exposure should the rating prove to be unreliable.

We hold $1.2 billion of municipal bonds. We require the bonds that we purchase to meet our credit criteria on a stand-alone basis. As of September 30, 2011, on a stand-alone basis, our municipal bonds have a weighted average rating of AA.

We also have exposure to credit risk related to our receivables from reinsurers. Our receivables from reinsurers (on both paid and unpaid losses) approximate $286 million at September 30, 2011 and $282 million at December 31, 2010.

Equity Price Risk

At September 30, 2011 our equity holdings had an approximate fair value of $74 million, almost all of which is attributable to investments in common stocks. These securities are subject to equity price risk, which is defined as the potential for loss in fair value due to a decline in equity prices. The weighted average beta of this group of securities is 0.96. Beta measures the price sensitivity of an equity security or group of equity securities to a change in the broader equity market, in this case the S&P 500 Index. If the value of the S&P 500 Index increased by 10%, the fair value of these securities would be expected to increase by 10% to $81.1 million. Conversely, a 10% decrease in the S&P 500 Index would imply a decrease of 10% in the fair value of these securities to $66.8 million. The selected hypothetical changes of plus or minus 10% do not reflect what could be considered the best or worst case scenarios and are used for illustrative purposes only.

ITEM 4.

CONTROLS AND PROCEDURES.

The Chief Executive Officer and Chief Financial Officer of the Company participated in management’s evaluation of our disclosure controls and procedures (as defined in SEC Rule 13a-15(e)) as of September 30, 2011. ProAssurance’s disclosure controls and procedures are designed to reasonably assure that information required to be disclosed by us in reports we file or submit under the Exchange Act is accumulated and communicated to our management as appropriate to allow timely decisions regarding disclosure and is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective.

Changes in Internal Control over Financial Reporting

On November 30, 2010 we completed the acquisition of American Physicians Service Group, Inc. (APS). We have excluded APS’s systems and processes from Management’s Report on Internal Control over Financial Reporting as of December 31, 2010 and will include APS in Management’s Report on Internal Control over Financial Reporting as of December 31, 2011.

There have been no significant changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, those controls during the quarter.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

See Note 8 of the Notes to the Condensed Consolidated Financial Statements.

ITEM 1A. RISK FACTORS.

With the exception of the risk factor listed below, there are no changes to the “Risk Factors” in Part 1, Item 1A of the 2010 Form 10-K.

U.S. Government debt rating has been downgraded.

In August, 2011, one of the major rating agencies downgraded the rating of U.S. Government Debt. Another major agency has published a negative outlook for U.S. debt. The rating agencies have previously indicated that debt instruments of other issuers dependent upon federal support and distributions, including state and local municipalities, may also be downgraded, but this has not yet occurred to any widespread extent except with respect to U.S. Agency debt or U.S. Agency guaranteed debt. If ratings downgrades become more widespread, the average credit rating of our investment portfolio will be reduced. Due to the unpredictable nature of this situation, we are unable to provide a reliable estimate regarding the extent to which our portfolio might be affected. As of September 30, 2011 debt securities represent 91% of our total investments and include U.S. government debt, U.S. Agency debt, and U.S. Agency guaranteed debt having a combined fair value of $980 million and state and municipal securities having a combined fair value of $1,173 million.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

(a)

Not applicable.

(b)

Not applicable.

(c)

Information required by Item 703 of Regulation S-K.


Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs

July 1 – 31, 2011		—	$	—		—	$	194,024,530
August 1 – 31, 2011		82,084	$	67.92		82,084	$	188,449,201
September 1 – 30, 2011		—	$	—		—	$	188,449,201

Total		82,084	$	67.92		82,084

ITEM 6. EXHIBITS


31.1		Certification of Principal Executive Officer of ProAssurance as required under SEC rule 13a-14(a).

31.2		Certification of Principal Financial and Accounting Officer of ProAssurance as required under SEC rule 13a-14(a).

32.1		Certification of Principal Executive Officer of ProAssurance as required under SEC Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code, as amended (18 U.S.C. 1350).

32.2		Certification of Principal Financial and Accounting Officer of ProAssurance as required under SEC Rule 13a-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code, as amended (18 U.S.C. 1350).

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Labels Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

PROASSURANCE CORPORATION

November 2, 2011

/s/ Edward L. Rand, Jr.

Edward L. Rand, Jr.

Chief Financial and Accounting Officer

(Duly authorized officer and principal financial and
accounting officer)