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

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 April 26, 2011, there were 30,574,504 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 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;

-

the effect that changes in laws or government regulations affecting the U.S. economy or financial institutions 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, 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 and employees, 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 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 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)

		March 31				December 31
		2011				2010
Assets
Investments
Fixed maturities available for sale, at fair value		$	3,635,683			$	3,603,754
Equity securities, available for sale, at fair value			152				3,637
Equity securities, trading, at fair value			36,336				37,286
Short-term investments			145,490				168,438
Business owned life insurance			50,948				50,484
Investment in unconsolidated subsidiaries			102,290				88,754
Other investments			36,710				38,078
Total Investments			4,007,609				3,990,431
Cash and cash equivalents			59,504				50,851
Premiums receivable			123,628				120,950
Receivable from reinsurers on paid losses and loss adjustment expenses			4,589				4,582
Receivable from reinsurers on unpaid losses and loss adjustment expenses			280,866				277,436
Prepaid reinsurance premiums			12,657				11,023
Deferred policy acquisition costs			28,109				27,281
Deferred taxes			45,267				56,862
Real estate, net			43,601				43,951
Intangible assets			57,094				60,031
Goodwill			161,453				161,453
Other assets			80,802				70,205
Total Assets		$	4,905,179			$	4,875,056
Liabilities and Shareholders’ Equity
Liabilities
Policy liabilities and accruals
Reserve for losses and loss adjustment expenses		$	2,411,358			$	2,414,100
Unearned premiums			275,598				256,050
Reinsurance premiums payable			107,509				111,680
Total Policy Liabilities			2,794,465				2,781,830
Other liabilities			174,925				186,259
Long-term debt, $35,494 and $35,488, at amortized cost, respectively; $15,555 and $15,616 at fair value, respectively			51,049				51,104
Total Liabilities			3,020,439				3,019,193
Shareholders’ Equity
Common shares, par value $0.01 per share, 100,000,000 shares authorized, 34,499,377 and 34,419,383 shares issued, respectively			345				344
Additional paid-in capital			533,124				532,213
Accumulated other comprehensive income (loss), net of deferred tax expense (benefit) of $40,296 and $42,607, respectively			74,833				79,124
Retained earnings			1,475,719				1,428,026
			2,084,021				2,039,707
Treasury shares, at cost, 3,924,970 shares and 3,666,149 shares, respectively			(199,281	)			(183,844	)
Total Shareholders’ Equity			1,884,740				1,855,863
Total Liabilities and Shareholders’ Equity		$	4,905,179			$	4,875,056

See accompanying notes

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, 2010		$	1,855,863			$	79,124			$	1,428,026			$	348,713
Net income			47,693				—				47,693				—
Change in net unrealized gains (losses) on investments, after tax, net of reclassification adjustments			(4,291	)			(4,291	)			—				—
Repurchase of treasury shares			(14,993	)			—				—				(14,993	)
Common shares issued for compensation and net effect of performance shares issued and stock options exercised			(1,269	)			—				—				(1,269	)
Share-based compensation			1,737				—				—				1,737
Balance at March 31, 2011		$	1,884,740			$	74,833			$	1,475,719			$	334,188

						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			38,112				—				38,112				—
Change in net unrealized gains (losses) on investments, after tax, net of reclassification adjustments			13,244				13,244				—				—
Common shares issued for compensation and net effect of performance shares issued and stock options exercised			352				—				—				352
Share-based compensation			1,400				—				—				1,400
Balance at March 31, 2010		$	1,757,703			$	72,498			$	1,234,540			$	450,665

See accompanying notes

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

		Three Months Ended
		March 31
		2011				2010
Revenues
Gross premiums written		$	160,813			$	157,178
Net premiums written		$	149,883			$	145,222
Premiums earned		$	141,373			$	134,272
Premiums ceded			(9,296	)			(10,845	)
Net premiums earned			132,077				123,427
Net investment income			36,161				37,628
Equity in earnings (loss) of unconsolidated subsidiaries			(1,364	)			2,986
Net realized investment gains (losses):
Other-than-temporary impairment losses (OTTI)			(1,837	)			(6,305	)
Portion of OTTI losses recognized in (reclassified from) other comprehensive income (before taxes)			(568	)			972
Net impairment losses recognized in earnings			(2,405	)			(5,333	)
Other net realized investment gains (losses)			6,529				2,929
Total net realized investment gains (losses)			4,124				(2,404	)
Other income			2,587				2,321
Total revenues			173,585				163,958
Expenses
Losses and loss adjustment expenses			77,101				87,908
Reinsurance recoveries			(6,678	)			(9,207	)
Net losses and loss adjustment expenses			70,423				78,701
Underwriting, policy acquisition and operating expenses			35,709				31,203
Interest expense			795				813
Total expenses			106,927				110,717
Income before income taxes			66,658				53,241
Provision for income taxes
Current expense (benefit)			5,059				8,819
Deferred expense (benefit)			13,906				6,310
Total income tax expense (benefit)			18,965				15,129
Net income		$	47,693			$	38,112
Earnings per share:
Basic		$	1.56			$	1.17
Diluted		$	1.55			$	1.16
Weighted average number of common shares outstanding:
Basic			30,616				32,447
Diluted			30,853				32,764

See accompanying notes

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

		Three Months Ended
		March 31
		2011				2010
Comprehensive income:
Net income		$	47,693			$	38,112
Change in net unrealized gains (losses) on investments, after tax, net of reclassification adjustments			(4,291	)			13,244
Comprehensive income		$	43,402			$	51,356

See accompanying notes

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

		Three Months Ended
		March 31
(In thousands)		2011				2010
Operating Activities
Net income		$	47,693			$	38,112
Depreciation and amortization			9,115				6,108
Net realized investment (gains) losses			(4,124	)			2,404
Share-based compensation			1,737				1,400
Deferred income taxes			13,906				6,310
Other			(757	)			(6,470	)
Changes in assets and liabilities, excluding the effects of business combinations:
Premiums receivable			(2,678	)			950
Other assets			650				3,565
Reserve for losses and loss adjustment expenses			(2,742	)			1,082
Unearned premiums			19,548				23,572
Reinsurance related assets and liabilities			(9,242	)			5,083
Other liabilities			(48,245	)			(34,340	)
Net cash provided by operating activities			24,861				47,776
Investing Activities
Purchases of:
Fixed maturities available for sale			(252,043	)			(238,380	)
Equity securities trading			(15,750	)			(3,933	)
Other investments			—				(2,647	)
Cash invested in unconsolidated subsidiaries			(15,000	)			—
Proceeds from sale or maturities of:
Fixed maturities available for sale			211,573				165,080
Equity securities available for sale			3,589				—
Equity securities trading			18,621				3,322
Other investments			—				603
Net sales or maturities (purchases) of short-term investments, excluding unsettled redemptions			22,948				35,252
Unsettled security transactions, net			39,092				15,487
Cash received (paid) for other assets			(12,227	)			(13,176	)
Net cash provided (used) by investing activities			803				(38,392	)
Financing Activities
Repurchase of treasury shares			(14,993	)			—
Other			(2,018	)			(1,178	)
Net cash provided (used) by financing activities			(17,011	)			(1,178	)
Increase (decrease) in cash and cash equivalents			8,653				8,206
Cash and cash equivalents at beginning of period			50,851				40,642
Cash and cash equivalents at end of period		$	59,504			$	48,848

See accompanying notes

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 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 period ended March 31, 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 March 31, 2011, for recognition or disclosure in its financial statements and notes to financial statements.

Reclassifications

          As of March 31, 2011, ProAssurance has reported amortizable and unamortizable intangible assets as one line item, Intangible Assets, 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

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. The portion of internal selling agent and underwriter salary and benefit costs allocated to unsuccessful contracts, as well as advertising costs, are excluded. The guidance should 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 our 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)
March 31, 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, November 30, 2010 and included cash of $233 million and deferred compensation commitments of $4 million.

          The following table discloses the amount of APS revenues and earnings, from the acquisition on November 30, 2010, that are included in ProAssurance’s consolidated results for the three months ended March 31, 2011. The table also includes supplemental pro forma information reflecting the combined results of ProAssurance and APS as if the acquisition had occurred as of January 1, 2010.

		Actual APS Results
		Included in ProAssurance				Supplemental Pro forma
		Consolidated Results				Combined Results
		Three Months Ended				Three Months Ended
		March 31				March 31
(In thousands)		2011				2011				2010
Revenue		$	15,872			$	173,585			$	183,812
Earnings		$	4,661			$	48,011			$	42,052

          Pro forma combined results shown above have been adjusted, net of related tax effects, to reflect the following: 1) workforce reductions as if the reductions had occurred January 1, 2010, 2) the exclusion of transaction costs, 3) the reversal of the effect of writing off policy acquisition costs as of the acquisition date, 4) the amortization of intangibles recorded as a result of the purchase price allocation and 5) the amortization of the investment purchase adjustments.

          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)
March 31, 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 March 31, 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)
March 31, 2011

3. Fair Value Measurement (continued)

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

		March 31, 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		$	—			$	232,963			$	—			$	232,963
U.S. Agency obligations			—				76,513				—				76,513
State and municipal bonds			—				1,220,240				7,450				1,227,690
Corporate bonds			—				1,321,518				16,880				1,338,398
Residential mortgage-backed securities			—				580,892				—				580,892
Commercial mortgage-backed securities			—				95,498				—				95,498
Other asset-backed securities			—				83,729				—				83,729
Equity securities, available for sale
Financial			20				—				—				20
Energy
Consumer cyclical
Consumer non-cyclical
Technology
Industrial			132				—				—				132
Communications
All Other
Equity securities, trading
Financial			3,324				—				—				3,324
Energy			6,789				—				—				6,789
Consumer cyclical			552				—				—				552
Consumer non-cyclical			1,392				—				—				1,392
Technology			2,145				—				—				2,145
Industrial			924				—				—				924
Communications			1,045				—				—				1,045
Index funds			18,791				—				—				18,791
All Other			1,374				—				—				1,374
Short-term investments (1)			132,267				13,223				—				145,490
Investment in unconsolidated subsidiaries (2)			—				—				25,662				25,662
Total assets		$	168,755			$	3,624,576			$	49,992			$	3,843,323
Liabilities:
2019 Note Payable			—				—				15,555				15,555
Interest rate swap agreement			—				—				3,415				3,415
Total liabilities		$	—			$	—			$	18,970			$	18,970

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2011

3. Fair Value Measurement (continued)

		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 bonds			—				1,312,035				21,229				1,333,264
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
Communications			—				—				—				—
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 (1)			150,344				18,094				—				168,438
Investment in unconsolidated subsidiaries (2)			—				—				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)
March 31, 2011

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. 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.

          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.

          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.

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2011

3. Fair Value Measurement (continued)

          Corporate debt instruments are 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. Corporate debt instruments include private placement senior notes valued at approximately $4.1 million and $9.3 million at March 31, 2011 and December 31, 2010, respectively. The notes are all rated A+ or better at March 31, 2011 and December 31, 2010 and are unconditionally guaranteed by large regional banks. The remaining Level 3 corporate securities are not guaranteed or fully collateralized. Approximately $11.3 million have an average NRSRO rating of A at March 31, 2011, and approximately $10.4 million had an average NRSRO rating of A- at December 31, 2010. Approximately $1.4 million and $1.5 million at March 31, 2011 and December 31, 2010, respectively, do not have an NRSRO rating.

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

          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 March 31, 2011:

										Unfunded
		Fair Value								Commitments
		March 31,				December 31,				March 31,
(In thousands)		2011				2010				2011
Private fund primarily invested in long/short equities (1)		$	19,053			$	18,801			None
Private fund primarily invested in non-public equities, including other private funds (2)			6,609				6,311			$	1,708
		$	25,662			$	25,112

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2011

3. Fair Value Measurement (continued)

          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. Transfers are as of the end of the period, unless otherwise specified.

		March 31, 2011
		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 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			—				—				—				—				550				—				550
Realized investment gains (losses)			—				—				314				—				—				—				314
Included in other comprehensive income			—				(180	)			(15	)			—				—				—				(195	)
Purchases			—				—				—				—				—				—				—
Sales			(100	)			(5,195	)			(1,921	)			—				—				—				(7,216	)
Transfers in			—				3,447				—				—				—				—				3,447
Transfers out			—				(2,421	)			(598	)			—				—				—				(3,019	)
Balance March 31, 2011		$	7,450			$	16,880			$	—			$	—			$	25,662			$	—			$	49,992
Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end		$	—			$	—			$	—			$	—			$	550			$	—			$	550

          There were no transfers between Level 1 and Level 2 categories for the three months ended March 31, 2011.

          Transfers from Level 2 to Level 3 for the three months ended March 31, 2011 include:

-

Two corporate bonds having a combined value of $3.4 million. Multiple observable inputs were not available for use in valuing the bonds at March 31, 2011. Such information was available for valuing the bonds at December 31, 2010.

          Transfers from Level 3 to Level 2 for the three months ended March 31, 2011 include:

-

Five corporate bonds having a combined value of $2.4 million. Multiple observable inputs were available for use in valuing the securities at March 31, 2011. Such information was not available for valuing the bonds at December 31, 2010.

-

Two asset-backed securities valued at $0.6 million. Multiple observable inputs were available for use in valuing the security at March 31, 2011. Such information was not available for valuing the securities at December 31, 2010.

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2011

3. Fair Value Measurement (continued)

		March 31, 2010
		Level 3 Fair Value Measurements - Assets
		State and																Investment in
		Municipal				Corporate				Asset- backed				Equity				Unconsolidated				Other
(In thousands)		Bonds				Bonds				Securities				Securities				Subsidiaries				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:
Net investment income			—				—				—				—				2,986				—				2,986
Realized investment gains (losses)			—				—				—				—				—				(1,943	)			(1,943	)
Included in other comprehensive income			195				11				60				—				—				2,385				2,651
Purchases			—				1,060				—				—				—				363				1,423
Sales			(100	)			(72	)			—				—				—				(603	)			(775	)
Transfers in			—				—				—				—				—				—				—
Transfers out			—				(161	)			—				—				—				—				(161	)
Balance March 31, 2010		$	9,590			$	25,173			$	1,000			$	—			$	51,488			$	11,134			$	98,385
Change in unrealized gains (losses) included in earnings for the above period for Level 3 assets held at period-end		$	—			$	—			$	—			$	—			$	2,986			$	(1,943	)		$	1,043

          There were no transfers between Level 1 and Level 2 for the three months ended March 31, 2010.

          There were no transfers from Level 2 to Level 3 for the three months ended March 31, 2010.

          Transfers from Level 3 to Level 2 for the three months ended March 31, 2010 include:

-

Corporate bond valued at $0.2 million. There was no active market for the bond or a nearly identical bond during the prior period. Market activity increased during the first quarter of 2010, which provided multiple observable inputs that could be used to value the bond.

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2011

3. Fair Value Measurement (continued)

		March 31, 2011
		Level 3 Fair Value Measurements - Liabilities
						Interest
						rate swap
(In thousands)		2019 Note Payable				agreement				Total
Liabilities
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			19				(243	)			(224	)
Included in other comprehensive income			—				—				—
Settlements			(80	)			—				(80	)
Transfers in			—				—				—
Transfers out			—				—				—
Balance March 31, 2011		$	15,555			$	3,415			$	18,970
Change in unrealized (gains) losses included in earnings for the above period for Level 3 liabilities outstanding at period-end		$	19			$	(243	)		$	(224	)

		March 31, 2010
		Level 3 Fair Value Measurements - Liabilities
						Interest rate
						swap
(In thousands)		2019 Note Payable				agreement				Total
Liabilities
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			631				238				869
Included in other comprehensive income			—				—				—
Settlements			(75	)			—				(75	)
Transfers in			—				—				—
Transfers out			—				—				—
Balance March 31, 2010		$	15,296			$	3,175			$	18,471
Change in unrealized (gains) losses included in earnings for the above period for Level 3 liabilities outstanding at period-end		$	631			$	238			$	869

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 the PICA 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.

          The 2019 Note Payable had an outstanding principal balance of $17.4 million at March 31, 2011 and $17.7 million at March 31, 2010.

ProAssurance Corporation and Subsidiaries
Notes to Condensed Consolidated Financial Statements (Unaudited)
March 31, 2011

3. Fair Value Measurement (continued)

Financial Instruments Not Measured At Fair Value

           Financial assets and liabilities which are not measured at fair value on a recurring basis on the Condensed Consolidated Balance Sheets as of March 31, 2011 and December 31, 2010 are as follows:

		March 31, 2011								December 31, 2010
						Estimated								Estimated
		Carrying				Fair				Carrying				Fair
(In thousands)		Value				Value				Value				Value
Financial assets:
Other investments		$	36,710			$	43,981			$	38,078			$	44,387
Investment in Unconsolidated Subsidiaries		$	76,628			$	82,473			$	63,642			$	66,862
BOLI		$	50,948			$	50,948			$	50,484			$	50,484
Other assets		$	8,367			$	8,367			$	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
Surplus Notes due February 2012		$	502			$	523			$	496			$	521
Other liabilities		$	22,610			$	22,197			$	22,367			$	21,837

Other investments listed in the table above primarily includes investments in private investment funds, investments in FHLB common stock, and an annuity investment. The fair value of the private investment fund is estimated as the net asset value provided by the underlying fund. 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.

Investments in Unconsolidated Subsidiaries consist primarily of investments in tax credit partnerships, and an investment in a development stage limited liability company. The fair value of the investments in tax credit partnerships is 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 development stage entity 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 interests in certain investment funds and liabilities related to funded and unfunded 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 unfunded deferred compensation liability and 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)
March 31, 2011

4. Investments

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

		March 31, 2011
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
(In thousands)		Cost				Gains				Losses				Value
Fixed maturities
U.S. Treasury obligations		$	226,380			$	8,125			$	(1,542	)		$	232,963
U.S. Agency obligations			72,773				3,856				(116	)			76,513
State and municipal bonds			1,190,082				41,864				(4,256	)			1,227,690
Corporate bonds			1,296,534				48,904				(7,040	)			1,338,398
Residential mortgage-backed securities			559,506				25,176				(3,790	)			580,892
Commercial mortgage-backed securities			92,254				3,272				(28	)			95,498
Other asset-backed securities			83,036				847				(154	)			83,729
			3,520,565				132,044				(16,926	)			3,635,683
Equity securities			138				14				—				152
		$	3,520,703			$	132,058			$	(16,926	)		$	3,635,835

		December 31, 2010
						Gross				Gross				Estimated
		Amortized				Unrealized				Unrealized				Fair
(In thousands)		Cost				Gains				Losses				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 bonds			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

          The recorded cost basis and estimated fair value of available-for-sale fixed maturities at March 31, 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.

		March 31, 2011
										Due after				Due after
										one year				five years
		Amortized				Due in one				through				through ten				Due after				Total Fair
(In thousands)		Cost				year or less				five years				years				ten years				Value
Fixed maturities, available for sale
U.S. Treasury obligations		$	226,380			$	2,612			$	116,309			$	110,448			$	3,594			$	232,963
U.S. Agency obligations			72,773				4,472				42,220				23,401				6,420				76,513
State and municipal bonds			1,190,082				25,162				297,621				604,806				300,101				1,227,690
Corporate bonds			1,296,534				71,261				692,374				541,554				33,209				1,338,398
Residential mortgage-backed securities			559,506																				580,892
Commercial mortgage-backed securities			92,254																				95,498
Other asset-backed securities			83,036																				83,729
		$	3,520,565																			$	3,635,683