UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

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

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 þ No o

     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 þ No o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

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

     As of October 31, 2010, there were 30,721,566 shares of the registrant’s common stock outstanding.

 

 

FORWARD-LOOKING STATEMENTS

     Any statements in this Form 10-Q that are not historical facts are specifically identified as forward-looking statements. These statements are based upon our estimates and anticipation of future events and are subject to certain risks and uncertainties that could cause actual results to vary materially from the expected results described in the forward-looking statements. Forward-looking statements are identified by words such as, but not limited to, “anticipate”, “believe”, “estimate”, “expect”, “hope”, “hopeful”, “intend”, “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 new business, the availability of acceptable reinsurance, actions by regulators and rating agencies, court actions, legislative actions, payment or performance of obligations under indebtedness, payment of dividends, and other matters.

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

	—		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 malpractice 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;
	—		the effect that changes in laws or government regulations affecting the U.S. economy or financial institutions, including the Emergency Economic Stabilization Act of 2008, the American Recovery and Reinvestment Act of 2009 and the Dodd-Frank Act of 2010, may have on 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 (FASB), 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 recently passed 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;

	—		bad faith litigation 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 payments from our reinsurers;
	—		increases in guaranty fund assessments;
	—		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;

—

changes in competition among insurance providers and related pricing weaknesses in our markets;

—

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 and employees, increased operating costs or inability to achieve cost savings, and assumption of greater than expected liabilities, among other reasons;

—

government approvals of proposed transactions may not be obtained, or adverse regulatory conditions may be imposed in connection with required government approvals;

—

the board of directors of proposed acquisition companies may withdraw their recommendation and support a competing acquisition proposal; and

—

the shareholders of proposed acquisition companies may fail to approve the proposed transactions.

     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 Forms 10-Q and 10-K.

     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 the factors listed above 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
(In thousands, except share data)

		September 30				December 31
		2010				2009
		(Unaudited)				(Audited)
Assets
Investments
Fixed maturities available for sale, at fair value		$	3,452,106			$	3,442,995
Equity securities available for sale, at fair value			3,257				3,579
Equity securities, trading, at fair value			32,214				43,826
Short-term investments			338,001				187,059
Business owned life insurance			66,165				65,003
Investment in unconsolidated subsidiaries			69,844				48,502
Other investments			36,411				47,258
Total Investments			3,997,998				3,838,222
Cash and cash equivalents			48,264				40,642
Premiums receivable			117,615				116,403
Receivable from reinsurers on paid losses and loss adjustment expenses			6,384				16,778
Receivable from reinsurers on unpaid losses and loss adjustment expenses			269,871				262,659
Prepaid reinsurance premiums			12,138				11,836
Deferred policy acquisition costs			27,954				25,493
Deferred taxes			33,478				68,806
Real estate, net			44,259				44,496
Amortizable intangible assets			8,456				9,973
Goodwill			122,317				122,317
Other assets			82,705				89,789
Total Assets		$	4,771,439			$	4,647,414
Liabilities and Shareholders’ Equity
Liabilities
Policy liabilities and accruals
Reserve for losses and loss adjustment expenses		$	2,405,828			$	2,422,230
Unearned premiums			249,450				244,212
Reinsurance premiums payable			118,272				113,994
Total Policy Liabilities			2,773,550				2,780,436
Other liabilities			128,457				112,180
Long-term debt, $35,484 and $35,463, at amortized cost, respectively; $15,741 and $14,740 at fair value, respectively			51,225				50,203
Total Liabilities			2,953,232				2,942,819
Shareholders’ Equity
Common stock, par value $0.01 per share, 100,000,000 shares authorized, 34,328,214 and 34,223,346 shares issued, respectively			343				342
Additional paid-in capital			531,297				526,068
Accumulated other comprehensive income (loss), net of deferred tax expense (benefit) of $71,357 and $31,908, respectively			132,517				59,254
Retained earnings			1,325,973				1,196,428
			1,990,130				1,782,092
Treasury stock, at cost, 3,460,374 shares and 1,811,356 shares, respectively			(171,923	)			(77,497	)
Total Shareholders’ Equity			1,818,207				1,704,595
Total Liabilities and Shareholders’ Equity		$	4,771,439			$	4,647,414

ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Changes in Capital (Unaudited)
(In thousands)

						Accumulated
						Other								Other
						Comprehensive				Retained				Capital
		Total				Income (Loss)				Earnings				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				—				—
Repurchase of treasury shares			(94,426	)			—				—				(94,426	)
Common shares issued as 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

Condensed Consolidated Statements of Changes in Capital

						Accumulated
						Other								Other
						Comprehensive				Retained				Capital
		Total				Income (Loss)				Earnings				Accounts
Balance at December 31, 2008		$	1,423,585			$	(35,898	)		$	970,891			$	488,592
Cumulative effect adjustment for accounting change (see Note 1)			—				(3,511	)			3,511				—
Net income			137,449				—				137,449				—
Change in net unrealized gains (losses) on investments, after tax, net of reclassification adjustments			115,803				115,803				—				—
Repurchase of treasury shares			(38,144	)			—				—				(38,144	)
Treasury shares issued in acquisition (see Note 2)			5,161				—				—				5,161
Common shares issued as compensation and net effect of performance shares issued and stock options exercised			756				—				—				756
Share-based compensation			4,850				—				—				4,850
Balance at September 30, 2009		$	1,649,460			$	76,394			$	1,111,851			$	461,215

ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Income (Unaudited)
(In thousands, except per share data)

		Three Months Ended								Nine Months Ended
		September 30								September 30
		2010				2009				2010				2009
Revenues
Gross premiums written		$	158,998			$	168,559			$	414,697			$	434,714
Net premiums written		$	149,693			$	158,705			$	383,783			$	401,634
Premiums earned		$	140,802			$	143,477			$	411,006			$	398,212
Premiums ceded			(10,502	)			(11,521	)			(31,882	)			(34,621	)
Net premiums earned			130,300				131,956				379,124				363,591
Net investment income			35,639				38,573				110,348				112,839
Equity in earnings (loss) of unconsolidated subsidiaries			(1,281	)			1,637				2,544				328
Net realized investment gains (losses):
Other-than-temporary impairment losses (OTTI)			(698	)			(88	)			(13,077	)			(7,482	)
Portion of OTTI losses recognized in other comprehensive income, before taxes			113				—				119				172
Net impairment losses recognized in earnings			(585	)			(88	)			(12,958	)			(7,310	)
Other net realized investment gains (losses)			15,297				7,363				21,765				12,132
Total net realized investment gains (losses)			14,712				7,275				8,807				4,822
Other income			1,764				3,153				5,769				7,224
Total revenues			181,134				182,594				506,592				488,804
Expenses
Losses and loss adjustment expenses			86,866				78,674				251,944				231,309
Reinsurance recoveries			(7,055	)			(9,108	)			(24,908	)			(25,601	)
Net losses and loss adjustment expenses			79,811				69,566				227,036				205,708
Underwriting, acquisition and insurance expenses			32,095				29,905				94,940				83,896
Interest expense			832				808				2,472				2,638
Loss on extinguishment of debt			—				2,839				—				2,839
Total expenses			112,738				103,118				324,448				295,081
Income before income taxes			68,396				79,476				182,144				193,723
Provision for income taxes
Current expense (benefit)			24,155				21,595				56,080				31,257
Deferred expense (benefit)			(6,811	)			2,680				(3,481	)			25,017
			17,344				24,275				52,599				56,274
Net income		$	51,052			$	55,201			$	129,545			$	137,449
Earnings per share:
Basic		$	1.61			$	1.69			$	4.03			$	4.17
Diluted		$	1.59			$	1.67			$	3.99			$	4.13
Weighted average number of common shares outstanding:
Basic			31,642				32,701				32,135				32,988
Diluted			32,047				33,023				32,508				33,267

ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
(In thousands)

		Three Months Ended								Nine Months Ended
		September 30								September 30
		2010				2009				2010				2009
Comprehensive income:
Net income		$	51,052			$	55,201			$	129,545			$	137,449
Change in net unrealized gains (losses) on investments, after tax, net of reclassification adjustments			27,878				67,050				73,263				115,803
Comprehensive income		$	78,930			$	122,251			$	202,808			$	253,252

ProAssurance Corporation and Subsidiaries
Condensed Consolidated Statements of Cash Flows (Unaudited)
(In thousands)

		Nine Months Ended
		September 30
		2010				2009
Operating Activities
Net income		$	129,545			$	137,449
Loss on extinguishment of debt			—				2,839
Depreciation and amortization			19,571				14,346
Net realized investment (gains) losses			(8,807	)			(4,822	)
Share-based compensation			4,509				4,850
Deferred income taxes			(3,481	)			25,017
Changes in assets and liabilities due to operating activities:
Premiums receivable			(1,212	)			(20,844	)
Reserve for losses and loss adjustment expenses			(16,402	)			(70,768	)
Unearned premiums			5,238				36,780
Reinsurance related assets and liabilities			7,158				(15,663	)
Other liabilities			(25,302	)			(82,521	)
Other assets			(9,423	)			475
Other			7,232				(11,197	)
Net cash provided by operating activities			108,626				15,941
Investing Activities
Purchases of:
Fixed maturities available for sale			(663,341	)			(754,888	)
Equity securities available for sale			—				(140	)
Equity securities trading			(13,450	)			(23,278	)
Other investments			(5,383	)			(292	)
Cash invested in unconsolidated subsidiaries			(15,399	)			(2,542	)
Proceeds from sale or maturities of:
Fixed maturities available for sale			777,596				580,635
Equity securities available for sale			271				5,264
Equity securities trading			26,887				18,698
Other investments			1,242				1,740
Net sales or maturities (purchases) of short-term investments			(150,942	)			320,874
Cash paid for acquisitions, net of cash received			—				(124,208	)
Unsettled security transactions, net			40,561				15,624
Other			(2,752	)			(2,474	)
Net cash provided (used) by investing activities			(4,710	)			35,013
Financing Activities
Repurchase of treasury stock			(94,426	)			(38,143	)
Excess tax benefit from share-based payment arrangements			99				—
Book overdraft			—				9,661
Debt repayment			(227	)			(7,190	)
Other			(1,740	)			2,017
Net cash provided (used) by financing activities			(96,294	)			(33,655	)
Increase (decrease) in cash and cash equivalents			7,622				17,299
Cash and cash equivalents at beginning of period			40,642				3,459
Cash and cash equivalents at end of period		$	48,264			$	20,758
Significant Non-cash Transactions:
Common shares issued in acquisition		$	—			$	5,161

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2010

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, 2010 are not necessarily indicative of the results that may be expected for the year ending December 31, 2010. The accompanying Condensed Consolidated Financial Statements should be read in conjunction with the Consolidated Financial Statements and notes contained in ProAssurance’s December 31, 2009 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, 2010, for recognition or disclosure in its financial statements and notes to financial statements.

Accounting Changes Not Yet Adopted

     Effective for fiscal years beginning after December 15, 2011, the Emerging Issues Task Force has reached a consensus that revised the definition of insurance contract acquisition costs as those costs “directly related” to the acquisition of new and renewal insurance contracts. The definition excludes the portion of internal selling agent and underwriter salaries and benefit costs allocated to unsuccessful contracts, as well as advertising costs. Adoption of this guidance is not expected to have a material effect on our results of operations or financial position.

Accounting Changes

Fair Value Measurements

     Effective for interim and annual reporting periods beginning after December 15, 2009 or December 15, 2010, as specified, the FASB revised GAAP guidance related to fair value measurement to require additional disclosures and to clarify certain existing disclosure requirements. The guidance is intended to improve disclosure and increase transparency in financial reporting. ProAssurance adopted the revised guidance on January 1, 2010 except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity of Level 3 fair value measurements which are effective for interim and annual reporting periods beginning on or after December 15, 2010. Adoption had no effect on our results of operations or financial position.

Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance

     Effective for interim and annual reporting periods beginning on or after December 15, 2009 for outstanding arrangements and effective otherwise for reporting periods beginning on or after June 15, 2009, the FASB issued guidance related to share-lending arrangements for an entity’s own shares executed in contemplation of a convertible debt offering or other financing. ProAssurance adopted the guidance on January 1, 2010; adoption had no effect on ProAssurance’s results of operations or financial position.

Consolidation of Variable Interest Entities

     Effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009, the FASB revised guidance which changes how a reporting entity determines whether or not to consolidate its interest in an entity that is insufficiently capitalized or is not controlled through voting (or similar) rights. The determination of whether a reporting entity is required to consolidate another entity will now be based on, among other things, the other entity’s purpose and design and the reporting entity’s ability to direct the activities that most significantly impact the other entity’s economic performance. The revised guidance also requires the reporting entity to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement. A reporting entity will be required to disclose how its involvement with a variable interest entity affects the reporting entity’s financial statements. ProAssurance adopted the revised

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2010

1. Basis of Presentation (continued)

guidance on January 1, 2010; adoption had no effect on ProAssurance’s results of operations or financial position.

Transfers and Servicing-Accounting for Transfers of Financial Assets

     Effective at the start of a reporting entity’s first fiscal year beginning after November 15, 2009, the FASB revised guidance that requires additional disclosure regarding transfers of financial assets, including securitization transactions, where entities have continuing exposure to risks related to the transferred financial assets. ProAssurance adopted the revised guidance on January 1, 2010; adoption had no effect on ProAssurance’s results of operations or financial position.

Investment Disclosures; Other-than-temporary Impairments

     Effective for interim and annual reporting periods ending on or after June 15, 2009, the FASB revised GAAP to require expanded disclosures related to investments in debt and equity securities. Guidance regarding other-than-temporary impairments was also revised. Previous investment guidance required that an impairment of a debt security be considered as other-than-temporary unless management could assert both the intent and the ability to hold the impaired security until recovery of value. The revised impairment guidance specifies that an impairment be considered as other-than-temporary unless an entity can assert that it has no intent to sell the security and that it is not more likely than not that the entity will be required to sell the security before recovery of its anticipated amortized cost basis.

     The new guidance also establishes the concept of credit loss. Credit loss is defined as the difference between the present value of the cash flows expected to be collected from a debt security and the amortized cost basis of the security. The new guidance states that “...in instances in which a determination is made that a credit loss exists but the entity does not intend to sell the debt security and it is not more likely than not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis” an impairment is to be separated into (a) the amount of the total impairment related to the credit loss and (b) the amount of total impairment related to all other factors. The credit loss component of the impairment is to be recognized in income of the current period. The non-credit component is to be recognized as a part of other comprehensive income (OCI). Transition provisions require a cumulative effect adjustment to reclassify the non-credit component of a previously recognized other-than-temporary impairment from retained earnings to accumulated other comprehensive income “...if an entity does not intend to sell and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis.” ProAssurance adopted the revised guidance as of the beginning of the quarter ended June 30, 2009. As of April 1, 2009, its debt securities included non-credit impairment losses previously recognized in earnings of approximately $5.4 million. In accordance with the transition provisions of the revised guidance, ProAssurance reclassified these non-credit losses, net of tax, from retained earnings to accumulated other comprehensive income as of April 1, 2009 (a $3.5 million increase to retained earnings; a $3.5 million decrease to accumulated other comprehensive income).

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2010

1. Basis of Presentation (continued)

Revenue Recognition-Multiple Deliverable Revenue Arrangements, Milestone Method

     Effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, the FASB issued guidance addressing revenue recognition. New guidance regarding multiple-deliverable arrangements eliminates the residual method of allocation and requires that arrangement consideration be allocated at inception using the relative selling price method. The guidance also establishes a selling price hierarchy and expands required disclosures related to a vendor’s multiple-deliverable revenue arrangements. New guidance has also been issued defining a milestone and determining when use of the milestone method of revenue recognition is appropriate. ProAssurance adopted the guidance on July 1, 2010. Adoption had no effect on ProAssurance’s results of operations or financial position.

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.

     ProAssurance acquired 100% of the outstanding shares of Mid-Continent General Agency, Inc., now ProAssurance Mid-Continent Underwriters, Inc., (Mid-Continent), and Georgia Lawyers Insurance Company (Georgia Lawyers) during the first quarter of 2009 as a means of expanding its professional liability business. Assets acquired and liabilities assumed were recorded based on estimated fair values as of the date of acquisition. The excess of the purchase price over the fair values of the identifiable net assets acquired was recognized as goodwill totaling $13.4 million for the two acquisitions. Approximately $12 million of the goodwill is expected to be tax deductible. The consideration for these acquisitions included 100,533 ProAssurance common shares valued at fair value on the acquisition date ($5.2 million), which were reissued from treasury stock.

     On April 1, 2009 ProAssurance acquired Podiatry Insurance Company of America and subsidiaries (PICA) through a cash sponsored demutualization as a means of expanding its professional liability insurance operations. PICA provides professional liability insurance primarily to podiatric physicians, chiropractors and other healthcare providers throughout the United States. Total purchase consideration transferred had a fair value of $133.8 million on the acquisition date, April 1, 2009 and was allocated to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. Goodwill of $36.7 million was recognized equal to the excess of the purchase price over the net fair value of the identifiable assets acquired and liabilities assumed. None of the goodwill is expected to be tax deductible.

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2010

2. Acquisitions (continued)

     The following table discloses supplemental pro forma information reflecting the combined results of ProAssurance and PICA as if the acquisition had occurred at the beginning of the prior year annual reporting period (January 1, 2009), adjusted to exclude transaction costs, normalize amortization of deferred policy acquisition costs and include pro forma amortization of certain intangibles recognized in the purchase price allocation.

		Actual PICA Results Included in				Supplemental Pro forma
		ProAssurance Consolidated Results				Combined Results
		Nine Months Ended				Nine Months Ended
		September 30				September 30
(In thousands)		2009				2009
Revenue		$	58,329			$	514,118
Earnings		$	5,769			$	144,047

     For additional information regarding the acquisitions, see Note 3 of the Notes to the Consolidated Financial Statements in ProAssurance’s 2009 Form 10-K.

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, and adjustments to externally quoted prices that are based on management judgment or estimation.

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2010

3. Fair Value Measurement (continued)

     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, 2010 and December 31, 2009, 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.

     Assets and liabilities measured at fair value on a recurring basis as of September 30, 2010 and December 31, 2009, including financial instruments for which ProAssurance has elected fair value accounting, are as follows:

		September 30, 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		$	—			$	194,543			$	—			$	194,543
U.S. Agency obligations			—				64,973				—				64,973
State and municipal bonds			—				1,259,223				8,220				1,267,443
Corporate bonds			—				1,201,936				24,302				1,226,238
Residential mortgage-backed securities			—				528,863				—				528,863
Commercial mortgage-backed securities			—				104,936				—				104,936
Other asset-backed securities			—				64,106				1,004				65,110
Equity securities, available for sale
Financial			267				—				—				267
Energy			192				—				—				192
Consumer cyclical			467				—				—				467
Consumer non-cyclical			645				—				—				645
Technology			685				—				—				685
Industrial			621				—				—				621
Communications			132				—				—				132
All Other			248				—				—				248
Equity securities, trading
Financial			12,515				—				—				12,515
Energy			5,585				—				—				5,585
Consumer cyclical			861				—				—				861
Consumer non-cyclical			3,480				—				—				3,480
Technology			1,729				—				—				1,729
Industrial			1,124				—				—				1,124
Communications			1,379				—				—				1,379
All Other			5,541				—				—				5,541
Short-term investments (1)			84,849				253,152				—				338,001
Investment in unconsolidated subsidiaries (2)			—				—				25,079				25,079
Total assets		$	120,320			$	3,671,732			$	58,605			$	3,850,657
Liabilities:
2019 Note Payable		$	—			$	—			$	15,741			$	15,741
Interest rate swap agreement			—				—				4,832				4,832
Total liabilities		$	—			$	—			$	20,573			$	20,573

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2010

3. Fair Value Measurement (continued)

		December 31, 2009
		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		$	—			$	153,544			$	—			$	153,544
U.S. Agency obligations			—				67,026				—				67,026
State and municipal bonds			—				1,439,154				9,495				1,448,649
Corporate bonds			—				1,049,677				24,335				1,074,012
Residential mortgage-backed securities			—				556,863				—				556,863
Commercial mortgage-backed securities			—				91,627				940				92,567
Other asset-backed securities			—				50,334				—				50,334
Equity securities, available for sale
Financial			488				—				—				488
Energy			182				—				—				182
Consumer cyclical			425				—				—				425
Consumer non-cyclical			638				—				—				638
Technology			780				—				—				780
Industrial			598				—				—				598
Communications			134				—				—				134
All Other			334				—				—				334
Equity securities, trading
Financial			8,831				—				—				8,831
Energy			7,781				—				—				7,781
Consumer cyclical			3,222				—				—				3,222
Consumer non-cyclical			8,889				—				—				8,889
Technology			4,085				—				—				4,085
Industrial			3,560				—				—				3,560
Communications			4,063				—				—				4,063
All Other			3,395				—				—				3,395
Short-term investments (1)			168,060				18,999				—				187,059
Investment in unconsolidated subsidiaries(2)			—				—				48,502				48,502
Other investments (3)			—				—				10,932				10,932
Total assets		$	215,465			$	3,427,224			$	94,204			$	3,736,893
Liabilities:
2019 Note Payable		$	—			$	—			$	14,740			$	14,740
Interest rate swap agreement			—				—				2,937				2,937
Total liabilities		$	—			$	—			$	17,677			$	17,677

     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 will be adjusted, if necessary. No such adjustments have been necessary in 2010 or 2009.

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2010

3. Fair Value Measurement (continued)

     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. government and agency obligations, and corporate bonds (exclusive of privately placed debt) 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.

     Municipal securities 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.

     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. Both agency and non-agency collateralized mortgage obligations are 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.

     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.

     Privately placed corporate debt is 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.

     Bank loans are also valued by an outside vendor. The valuation is 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.

     Short term securities, primarily U. S. Treasury securities and commercial paper maturing within one year, are carried at cost which approximates the fair value of the security due to the short term to maturity.

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2010

3. Fair Value Measurement (continued)

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

          Auction rate municipal bonds are 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.

          Private placement senior notes are valued internally using a model based on discounted cash flows using yields currently available on securities that are similar in term, payment features, and issuer credit rating. All are rated A+ or better and are unconditionally guaranteed by large regional banks.

          Asset-backed bonds held in a private investment fund and classified as a part of Other Investments that are valued using a broker dealer quote.

          Interests in private investment funds are valued using the net asset value provided by the fund.

          The following table provides additional information regarding investments in private investment funds valued using the net asset value provided by the fund at September 30, 2010:

						Unfunded
(In thousands)		Fair Value				Commitments				Fund Description
Private fund primarily invested in long/short equities		$	18,908				None				(1	)
Private fund primarily invested in non-public equities, including other private funds			6,171			$	3,500				(2	)
		$	25,079

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2010

3. Fair Value Measurement (continued)

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

     The following 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. All transfers were to or from Level 2. Transfers are as of the end of the period, unless otherwise specified.

		September 30, 2010
		Level 3 Fair Value Measurements — Assets
		State and								Asset-								Investment in
		Municipal				Corporate				backed				Equity				Unconsolidated				Other
(In thousands)		Bonds				Bonds				Securities				Securities				Subsidiaries				Investments				Total
Assets
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
Realized investment gains (losses)			—				59				—				—				—				—				59
Included in other comprehensive income			(1,131	)			(130	)			—				—				—				74				(1,187	)
Purchases, sales or settlements			(50	)			(796	)			—				—				(33,042	)			—				(33,888	)
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
		State and								Asset-								Investment in
		Municipal				Corporate				backed				Equity				Unconsolidated				Other
(In thousands)		Bonds				Bonds				Securities				Securities				Subsidiaries				Investments				Total
Assets
Balance January 1, 2010		$	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
Realized investment gains (losses)			—				59				—				—				—				(10,698	)			(10,639	)
Included in other comprehensive income			(1,049	)			(106	)			60				—				—				11,953				10,858
Purchases, sales or settlements			(226	)			515				—				—				(28,041	)			(511	)			(28,263	)
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, 2010

3. Fair Value Measurement (continued)

     Transfers between Level 3 categories for the three and nine months ended September 30, 2010 include:

–

Asset-backed securities valued at $1 million that were previously held in a private investment fund became directly held during the third quarter (see Note 4 of the Notes to the Condensed Consolidated Financial Statements) and were reclassified from Other Investments to Asset-backed Securities.

     Transfers into Level 3 for the three and nine months ended September 30, 2010 include:

–

A corporate bond valued at $151,000. Multiple observable inputs have not been available for use in valuing the bond since March 31, 2010.

     Transfers from Level 3 for the three and nine months ended September 30, 2010 include:

–

A corporate bond valued at $491,000. Multiple observable inputs were available for use in valuing the security at September 30, 2010. Such information was not available for valuing the bond at June 30, 2010.

–

A corporate bond valued at $161,000. There was no active market for the bond or a nearly identical bond during 2009. Market activity increased during the first quarter of 2010, which provided multiple observable inputs that could be used to value the bond.

–

A commercial mortgage-backed security valued at $1 million. Multiple observable inputs have been available for use in valuing the security since June 30, 2010.

–

Beneficially owned asset-backed securities held in a private investment fund were previously 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. During the second quarter of 2010 the fund manager provided additional information regarding the valuation methodologies followed, and assets (having a combined fair value of $10.7 million) valued using multiple observable inputs were transferred to the Level 2 category.

		September 30, 2009
		Level 3 Fair Value Measurements – Assets
		State and								Asset-								Investment in
		Municipal				Corporate				backed				Equity				Unconsolidated				Other
(In thousands)		Bonds				Bonds				Securities				Securities				Subsidiaries				Investments				Total
Assets
Balance June 30, 2009		$	8,954			$	23,050			$	759			$	72			$	45,755			$	14,082			$	92,672
Total gains (losses) realized and unrealized:
Included in earnings, as a part of:
Equity in earnings of unconsolidated subsidiaries			—				—				—				—				1,637				—				1,637
Realized investment gains (losses)			—				(16	)			—				(72	)			—				—				(88	)
Included in other comprehensive income			706				427				146				—				—				1,006				2,285
Purchases, sales or settlements			(75	)			(689	)			—				—				—				(278	)			(1,042	)
Transfers in			—				—				—				—				—				—				—
Transfers out			—				(2,087	)			—				—				—				—				(2,087	)
Balance September 30, 2009		$	9,585			$	20,685			$	905			$	—			$	47,392			$	14,810			$	93,377
Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end		$	—			$	(16	)		$	—			$	(72	)		$	1,637			$	—			$	1,549

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
September 30, 2010

3. Fair Value Measurement (continued)

		September 30, 2009
		Level 3 Fair Value Measurements – Assets
		State and								Asset-								Investment in
		Municipal				Corporate				backed				Equity				Unconsolidated				Other
(In thousands)		Bonds				Bonds				Securities				Securities				Subsidiaries				Investments				Total
Assets
Balance January 1, 2009		$	—			$	36,472			$	1,327			$	357			$	—			$	14,576			$	52,732
Total gains (losses), realized and unrealized:
Included in earnings, as a part of:
Equity in earnings of unconsolidated subsidiaries			—				—				—				—				1,756				—				1,756
Realized investment gains (losses)			—				(342	)			—				(357	)			—				(536	)			(1,235	)
Included in other comprehensive income			(315	)			196				114				—				—				1,081				1,076
Purchases, sales or settlements			(125	)			(11,385	)			(21	)			—				407				(311	)			(11,435	)
Transfers in			10,025				2,000				—				—				45,229				—				57,254
Transfers out			—				(6,256	)			(515	)			—				—				—				(6,771	)
Balance September 30, 2009		$	9,585			$	20,685			$	905			$	—			$	47,392			$	14,810			$	93,377
Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end		$	—			$	(342	)		$	—			$	(357	)		$	1,756			$	(536	)		$	521