Edgar Filing: PROCENTURY CORP

Procentury Corporation 10-Q

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

For the quarterly period ended September 30, 2005


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

000-50641
(Commission File Number)

PROCENTURY CORPORATION

(Exact name of Registrant as specified in its charter)


Ohio
(State or other jurisdiction of		31-1718622
incorporation or organization)		(I.R.S. Employer Identification No.)

465 Cleveland Avenue
Westerville, Ohio		43082
(Address of principal executive offices)		(Zip Code)

(614) 895-2000
(Registrant’s telephone number, including area code)

Indicate by check mark whether 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 report(s)), 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 is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES o NO þ

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 November 10, 2005, the registrant had 13,211,019 outstanding Common Shares, without par value.

PROCENTURY CORPORATION

QUARTERLY REPORT ON FORM 10-Q
For the Quarterly Period Ended September 30, 2005

INDEX


	Page
PART I: FINANCIAL INFORMATION

Item 1. Financial Statements		3
Consolidated Condensed Statements of Operations — For the three and nine months ended September 30, 2005 and 2004		3
Consolidated Condensed Balance Sheets — September 30, 2005 and December 31, 2004		4
Consolidated Condensed Statements of Shareholders’ Equity and Comprehensive Income — For the nine months ended September 30, 2005 and 2004		5
Consolidated Condensed Statements of Cash Flows — For the nine months ended September 30, 2005 and 2004		6
Notes to Consolidated Condensed Financial Statements — September 30, 2005		7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		18
Item 3. Quantitative and Qualitative Disclosures About Market Risk		29
Item 4. Controls and Procedures		29

PART II: OTHER INFORMATION

Item 1. Legal Proceedings		30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		30
Item 3. Defaults Upon Senior Securities		30
Item 4. Submission of Matters to a Vote of Security Holders		30
Item 5. Other Information		30
Item 6. Exhibits		30
SIGNATURES		31

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Operations
(Unaudited)
(Dollars in thousands, except per share data)


	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2005			2004			2005			2004
Premiums earned	$	44,934			39,543			129,479			107,421
Net investment income		3,866			2,719			10,520			7,094
Net realized investment (losses) gains		(66	)		(22	)		(219	)		122

Total revenues		48,734			42,240			139,780			114,637

Losses and loss expenses		36,410			24,518			88,724			64,406
Amortization of deferred policy acquisition costs		10,941			8,526			31,496			24,019
Other operating expenses		3,821			3,385			10,360			10,236
Severance expense		—			—			793			250
Interest expense		483			352			1,359			1,113
Interest expense on the redemption of Class B Shares		—			—			—			518

Total expenses		51,655			36,781			132,732			100,542


(Loss) income before income tax		(2,921	)		5,459			7,048			14,095
Income tax (benefit) expense		(1,128	)		1,747			1,763			4,510

Net (loss) income	$	(1,793	)		3,712			5,285			9,585


Basic net (loss) income per share	$	(0.14	)		0.28			0.40			0.98

Diluted net (loss) income per share	$	(0.14	)		0.28			0.40			0.98


Weighted average of shares outstanding — basic		13,064,909			13,135,450			13,054,764			9,779,529

Weighted average of shares outstanding — diluted		13,124,487			13,179,052			13,126,632			9,803,101


Cash dividend per share	$	0.02			0.02			0.06			0.02

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Balance Sheets
(Unaudited)
(Dollars in thousands)


	September 30, 2005			December 31, 2004
Assets
Investments:
Fixed maturities:
Available-for-sale, at fair value (amortized cost 2005, $298,444; 2004, $262,470)	$	296,160			263,401
Held-to-maturity, at amortized cost (fair value 2005, $1,127; 2004, $1,156)		1,132			1,142
Equities (available-for-sale):
Equity securities, at fair value (cost 2005, $25,987; 2004, $17,944)		25,676			18,228
Bond mutual funds, at fair value (cost 2005, $18,261; 2004, $18,943)		17,821			18,921
Short-term investments, at amortized cost		4,199			4,026

Total investments		344,988			305,718
Cash		11,100			6,681
Premiums in course of collection, net		13,859			11,747
Deferred policy acquisition costs		19,389			17,411
Prepaid reinsurance premiums		10,481			9,382
Reinsurance recoverable on paid losses, net		2,919			3,897
Reinsurance recoverable on unpaid losses, net		51,042			29,485
Deferred federal income tax asset		8,242			5,442
Federal income taxes recoverable		1,700			—
Other assets		6,797			5,164

Total assets	$	470,517			394,927

Liabilities and Shareholders’ Equity
Loss and loss expense reserves	$	215,343			153,236
Unearned premiums		90,179			82,135
Long term debt		25,000			25,000
Accrued expenses and other liabilities		5,308			6,703
Reinsurance balances payable		3,268			2,348
Collateral held		13,818			7,008
Federal income taxes payable		—			3,260

Total liabilities		352,916			279,690

Shareholders’ equity:
Capital stock, without par value		—			—
Additional paid-in capital		100,239			100,103
Retained earnings		20,219			15,727
Unearned share compensation		(925	)		(1,413	)
Accumulated other comprehensive (loss) income, net of taxes		(1,932	)		820

Total shareholders’ equity		117,601			115,237

Total liabilities and shareholders’ equity	$	470,517			394,927

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Shareholders’ Equity
and Comprehensive Income
(Unaudited)
(Dollars in thousands)


	For the Nine Months Ended September 30,
	2005			2004
Shareholders’ Equity
Capital stock:
Beginning of period	$	—			—
Stock issued		—			—

End of period		—			—

Additional paid-in capital:
Beginning of period		100,103			26,866
Issuance of common shares		—			77,931
Issuance cost		—			(1,298	)
Redemption of Class B shares		—			(5,000	)
Shares issued under share compensation plans		136			—
Vesting of restricted common shares		—			111

End of period		100,239			98,610

Retained earnings:
Beginning of period		15,727			8,297
Net income (loss)		5,285			9,585
Dividend of subsidiary available for sale		—			(7,024	)
Dividends		(793	)		(262	)

End of period		20,219			10,596

Unearned share compensation:
Beginning of period		(1,413	)		—
Vesting of restricted shares		488			—

End of period		(925	)		—

Accumulated other comprehensive income, net of taxes:
Beginning of period		820			1,234
Unrealized holding (losses) gains arising during period, net of reclassification adjustment		(2,752	)		370
Dividend of subsidiary available for sale		—			(564	)

End of period		(1,932	)		1,040

Total shareholder’s equity	$	117,601			110,246


Comprehensive Income
Net income	$	5,285			9,585

Other comprehensive income:
Unrealized gains (losses) on securities:
Unrealized holding (losses) gains arising during the period:
Gross		(4,445	)		708
Related federal income tax (expense) benefit		1,550			(259	)

Net unrealized gains (losses)		(2,895	)		449

Reclassification adjustment for (losses) gains included in net income:
Gross		(219	)		122
Related federal income tax benefit (expense)		77			(43	)

Net reclassification adjustment		(142	)		79

Other comprehensive (loss) income		(2,752	)		370

Total comprehensive income (loss)	$	2,533			9,955

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Consolidated Condensed Statements of Cash Flows
(Unaudited)
(Dollars in thousands)


	For the Nine Months Ended September 30,
	2005			2004
Cash flows provided by operating activities:
Net income	$	5,285			9,585
Adjustments:
Net realized investment losses (gains)		219			(122	)
Deferred federal income tax benefit		(1,470	)		(3,413	)
Restricted share compensation		624			111
Changes in assets and liabilities:
Premiums in course of collection, net		(2,112	)		(780	)
Deferred policy acquisition costs		(1,978	)		(5,365	)
Prepaid reinsurance premiums		(1,099	)		(2,673	)
Reinsurance recoverable on paid and unpaid losses, net		(20,579	)		6,616
Federal income taxes payable/recoverable		(4,960	)		1,623
Losses and loss expense reserves		62,107			17,333
Unearned premiums		8,044			18,284
Reinsurance balances payable		920			(1,683	)
Collateral held		6,810			(1,820	)
Receivable from subsidiary available for sale		—			26,687
Other, net		(949	)		(1,328	)

Net cash provided by operating activities		50,862			63,055

Cash flows used in investing activities:
Purchases of equity securities		(50,594	)		(50,591	)
Purchases of fixed maturity securities available-for-sale		(98,324	)		(161,417	)
Proceeds from sales of equity securities		42,849			41,132
Proceeds from sales and maturities of fixed maturities available-for-sale		61,594			30,170
Proceeds from maturities of fixed maturities held-to-maturity		—			325
Acquisition, net of cash acquired		(1,002	)		—
Net change in short-term investments		(173	)		14,482

Net cash used in investing activities		(45,650	)		(125,899	)

Cash flows (used in) provided by financing activities:
Issuance of common shares		—			77,931
Issuance cost		—			(1,298	)
Redemption of Class B common shares		—			(5,000	)
Principal payment on long term debt		—			(9,133	)
Dividend of subsidiary		—			(262	)
Draw on line of credit		2,300			—
Principal payment on line of credit		(2,300	)		—
Dividend paid to shareholders		(793	)		—

Net cash (used in) provided by financing activities		(793	)		62,238

Increase (decrease) in cash and cash equivalents		4,419			(606	)
Cash and equivalents at beginning of year		6,681			5,814

Cash and equivalents at end of year	$	11,100			5,208


Supplemental disclosure of cash flow information:
Interest paid	$	1,357			1,234

Federal income taxes paid	$	8,191			6,300

See accompanying notes to the unaudited consolidated condensed financial statements.

PROCENTURY CORPORATION AND SUBSIDIARIES

Notes to Consolidated Condensed Financial Statements

September 30, 2005

(Unaudited)

(1)		Basis of Presentation

		The accompanying interim unaudited consolidated condensed financial statements and notes include the accounts of ProCentury Corporation , (the “Company” or “ProCentury”) and its wholly owned insurance subsidiary, Century Surety Company (“Century”). The interim unaudited consolidated condensed financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Article 10 of Regulation S-X. Accordingly, the interim unaudited consolidated condensed financial statements 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 of results for the interim periods have been included. These interim unaudited consolidated condensed financial statements and related notes should be read in conjunction with the consolidated financial statements and related notes in the Company’s audited consolidated financial statements, included in the Company’s annual report on Form 10-K Filing as of December 31, 2004. The Company’s results of operations for interim periods are not necessarily indicative of the results to be expected for the entire year.

		On April 20, 2004, the common shares of Evergreen National Indemnity Company (“Evergreen”) and its wholly owned subsidiary, Continental Heritage Insurance Company (“Continental”) (formerly controlled subsidiaries of Century) were distributed as dividends from Century to ProCentury and then by ProCentury to ProCentury’s existing Class A shareholders. Prior to the dividends, Evergreen was a controlled subsidiary of Century. The operations of Evergreen and Continental consisted of ProCentury’s historical surety and assumed workers’ compensation lines of insurance, which were re-classified (net of minority interest and income taxes) as discontinued operations in the accompanying interim unaudited consolidated condensed financial statements and notes for 2004.

		On April 26, 2004, the Company issued 8,000,000 common shares at $10.50 per share in the IPO and received net proceeds (before expenses) of $77.9 million. The following transactions occurred in connection with the IPO:

	•		Immediately prior to the completion of the IPO, each outstanding Class A common share was converted into 500 common shares. After the conversion, but prior to the completion of the IPO, the Company had 4,999,995 Class A common shares outstanding. The share conversion is reflected for all periods presented.

	•		Immediately prior to the completion of the IPO, the common shares of Evergreen National Indemnity Company (“Evergreen”) and its wholly owned subsidiary, Continental Heritage Insurance Company (“Continental”) were distributed as dividends from Century to ProCentury and then by ProCentury to ProCentury’s existing Class A shareholders. Prior to the dividends, Evergreen was a controlled subsidiary of Century. The operations of Evergreen and Continental consisted of ProCentury’s historical surety and assumed workers’ compensation lines of insurance, which were re-classified (net of minority interest and income taxes) as discontinued operations in the accompanying interim unaudited consolidated condensed financial statements and notes for all periods presented.

	•		The Company issued 8,000,000 Class A common shares and received net proceeds (before expenses) of $77.9 million.

	•		The Company granted 101,200 restricted common shares and 364,000 stock options to certain employees of ProCentury.

	•		The Company repaid $8.7 million of bank indebtedness outstanding at the closing of the IPO.

	•		The Company redeemed all of its outstanding Class B common shares for an aggregate redemption price of $5.0 million and recorded interest expense of $518,000 in connection with the redemption; and

	•		The Company amended its articles of incorporation to eliminate the authority to issue Class B and Class C common shares.

On June 1, 2005, Century acquired 100% of the outstanding shares of the Fireman’s Fund of Texas (FFTX) for $5.8 million (including direct costs of $100,000). FFTX had statutory surplus of $5.4 million on the date of acquisition. FFTX is a Texas domiciled property and casualty company licensed in Texas, Oklahoma and California. The acquisition is part of the Company’s long-term plan to develop business that requires admitted status, as well as its continued focus on growing its excess and surplus lines business. The total purchase price of the acquisition was allocated to the assets and the liabilities acquired based upon the respective fair values as of the date of acquisition. Intangible assets included in the purchase were valued at $375,000. The excess of the fair value of the net identifiable assets acquired over the purchase price was $193,000. In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” the amortization of goodwill and indefinite-lived intangible assets is not permitted. Goodwill and indefinite-lived intangible assets remain on the balance sheet and are tested for impairment on an annual basis, or when there is reason to suspect that their values may have been diminished or impaired.

In preparing the interim unaudited consolidated condensed financial statements, management was required to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the interim unaudited consolidated condensed financial statements, and the reported amounts of revenue and expenses for the reporting period. Actual results could differ significantly from those estimates.

Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of loss and loss expense reserves, the recoverability of deferred policy acquisition costs, the determination of federal income taxes, the net realizable value of reinsurance recoverables and the determination of other-than-temporary declines in the fair value of investments. Although considerable variability is inherent in these estimates, management believes that the amounts provided are adequate. These estimates are continually reviewed and adjusted as necessary. Such adjustments are generally reflected in current operations.

All significant intercompany balances and transactions have been eliminated.

Share Option Accounting

The Company follows the provisions of Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees (“APB 25”), the Financial Accounting Standards Board (“FASB”) Interpretation No. 44, Accounting for Certain Transactions involving Stock Compensation (an interpretation of APB Opinion No. 25), and other related accounting interpretations for the Company’s share option and restricted common share plans utilizing the “intrinsic value method.” The Company also follows the disclosure provisions of SFAS No. 123, Accounting for Stock-Based Compensation, for the Company’s share option grants, as amended by SFAS No. 148, Accounting for Stock-Based Compensation — Transition and Disclosure; an amendment of FASB Statement No. 123. This disclosure requires pro forma net income and earnings per share information, which is calculated assuming the Company has accounted for its stock option plans under the “fair value method” described in SFAS No. 123 and SFAS No. 148.

If the Company recorded compensation expense for its share option grants based on the “fair value method,” the Company’s net (loss) income and (loss) earnings per share would have been adjusted to the pro forma amounts as indicated in the following table:


	For the Three Months Ended						For the Nine Months Ended
	September 30,						September 30,
	2005			2004			2005			2004
	(Dollars in thousands, except per share data)
Net (loss) income:
As reported	$	(1,793	)		3,712			5,285			9,585
Add: Share-based employee compensation expense included in reported net income, net of related tax effects		97			111			398			111
Less: Additional share-based employee compensation expense determined under fair value-based method for all awards, net of related tax effects		(150	)		(169	)		(649	)		(217	)

Pro Forma	$	(1,846	)		3,654			5,034			9,479

Basic (loss) income per common share:
As reported	$	(0.14	)		0.28			0.40			0.98

Pro Forma	$	(0.14	)		0.28			0.39			0.97

Diluted (loss) income per common share:
As reported	$	(0.14	)		0.28			0.40			0.98

Pro Forma	$	(0.14	)		0.28			0.38			0.97

The fair values of the share options are estimated on the dates of grant using the Black Scholes option pricing model with the following weighted average assumptions:


	For the Three and Nine Months
	Ended September 30, 2005
Risk free interest rate		3.97	%
Dividend yield		0.76	%
Volatility factor		23.15	%
Weighted average expected option life	7.00 Years

		In December 2004, the FASB revised Statement No. 123 (SFAS 123R), “Share-Based Payment,” which requires companies to expense the estimated fair value of employee stock options and similar awards, for all options vesting, granted, or modified after the effective date of this revised statement. The accounting provisions of SFAS 123R were to become effective for interim periods beginning after June 15, 2005. In April 2005, the Securities and Exchange Commission (SEC) adopted a final rule amending Rule 4-01(a) of Regulation S-X regarding the compliance date for SFAS 123R. This ruling delays the effective date of SFAS 123R to the first interim or annual reporting period of the registrant’s first fiscal year beginning on or after June 15, 2005. As a result, the accounting provisions of SFAS 123R will become effective beginning in 2006 for the Company’s financial statements. The Company is evaluating the impact of implementing SFAS 123R and anticipates it will be material to the financial statements.

(2)		Income per Common Share

		Basic income per share (“EPS”) excludes dilution and is calculated by dividing income available to common shareholders by the weighted-average number of common shares outstanding for the period. Diluted EPS reflects the dilution that could occur if securities or other contracts to issue common shares (common share equivalents) were exercised. When inclusion of common share equivalents increases the EPS or reduces the loss per share, the effect on earnings is antidilutive. Under these circumstances, diluted net income or net loss per share is computed excluding the common share equivalents.

		Based on the above and pursuant to disclosure requirements contained in SFAS No. 128, Earnings Per Share, the following information represents a reconciliation of the numerator and denominator of the basic and diluted EPS computations contained in the Company’s interim unaudited consolidated condensed financial statements.


	For the Three Months Ended September 30, 2005
	(Dollars in thousands, except per share data)
	Income			Shares		Per Share
	(Numerator)			(Denominator)		Amount
Basic Net (Loss) Per Share
Net (loss)	$	(1,793	)		13,064,909	$	(0.14	)
Effect of Dilutive Securities
Restricted common shares and share options		—			59,578		—

Diluted EPS
Net (loss)	$	(1,793	)		13,124,487	$	(0.14	)


	For the Three Months Ended September 30, 2004
	(Dollars in thousands, except per share data)
	Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount
Basic Net Income Per Share
Net income	$	3,712		13,135,450	$	0.28
Effect of Dilutive Securities
Restricted common shares and share options		—		43,602		—

Diluted EPS
Net income	$	3,712		13,179,052	$	0.28


	For the Nine Months Ended September 30, 2005
	(Dollars in thousands, except per share data)
	Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount
Basic Net Income Per Share
Net income	$	5,285		13,054,764	$	0.40
Effect of Dilutive Securities
Restricted common shares and share options		—		71,868		—

Diluted EPS
Net income	$	5,285		13,126,632	$	0.40


	For the Nine Months Ended September 30, 2004
	(Dollars in thousands, except per share data)
	Income		Shares		Per Share
	(Numerator)		(Denominator)		Amount
Basic Net Income Per Share
Net income	$	9,585		9,779,529	$	0.98
Effect of Dilutive Securities
Restricted common shares and share options		—		23,572		—

Diluted EPS
Net income	$	9,585		9,803,101	$	0.98

(3)		Investments

		The Company invests primarily in investment-grade fixed-maturity securities. The amortized cost, gross unrealized gains and losses and estimated fair value of fixed-maturity securities classified as held-to-maturity were as follows:


	September 30, 2005
	(Dollars in thousands)
			Gross		Gross			Estimated
	Amortized		unrealized		unrealized			fair
	cost		gains		losses			value
U.S. Treasury securities	$	89		14		—			103
Agencies not backed by the full faith and credit of the U.S. Government		1,043		—		(19	)		1,024

Total	$	1,132		14		(19	)		1,127


	December 31, 2004
	(Dollars in thousands)
			Gross		Gross		Estimated
	Amortized		unrealized		unrealized		fair
	cost		gains		losses		value
U.S. Treasury securities	$	89		13		—		102
Agencies not backed by the full faith and credit of the U.S. Government		1,053		1		—		1,054

Total	$	1,142		14		—		1,156

The amortized cost, gross unrealized gains and losses, and estimated fair value of fixed-maturity and equity securities classified as available-for-sale were as follows:


	September 30, 2005
	(Dollars in thousands)
			Gross		Gross			Estimated
	Amortized		unrealized		unrealized			fair
	cost		gains		losses			value
Fixed maturities:
U.S. Treasury securities	$	3,693		1		(45	)		3,649
Agencies not backed by the full faith and credit of the U.S. Government		14,325		13		(165	)		14,173
Obligations of states and political subdivisions		134,464		444		(819	)		134,089
Corporate securities		38,207		50		(694	)		37,563
Mortgage-backed securities		43,427		74		(580	)		42,921
Collateralized mortgage obligations		27,831		5		(375	)		27,461
Asset-backed securities		36,497		253		(446	)		36,304

Total fixed maturities		298,444		840		(3,124	)		296,160

Equities:
Equity securities		25,987		255		(566	)		25,676
Bond mutual funds		18,261		24		(464	)		17,821

Total equities		44,248		279		(1,030	)		43,497

Total	$	342,692		1,119		(4,154	)		339,657


	December 31, 2004
	(Dollars in thousands)
			Gross		Gross			Estimated
	Amortized		unrealized		unrealized			fair
	cost		gains		losses			value
Fixed maturities:
U.S. Treasury securities	$	4,169		35		(32	)		4,172
Agencies not backed by the full faith and credit of the U.S. Government		16,805		98		(84	)		16,819
Obligations of states and political subdivisions		119,893		1,225		(399	)		120,717
Corporate securities		46,249		200		(300	)		46,149
Mortgage-backed securities		33,148		276		(48	)		33,376
Collateralized mortgage obligations		23,825		72		(120	)		23,777
Asset-backed securities		18,383		135		(127	)		18,391

Total fixed maturities		262,470		2,041		(1,110	)		263,401

Equities:
Equity securities		17,944		458		(174	)		18,228
Bond mutual funds		18,943		3		(25	)		18,921

Total equities		36,887		461		(199	)		37,149

Total	$	299,358		2,501		(1,309	)		300,550

		Under the Company’s accounting policy for equity securities and fixed-maturity securities that can be contractually prepaid or otherwise settled in a way that may limit the Company’s ability to fully recover cost, an impairment is deemed to be other-than-temporary unless the Company has both the ability and intent to hold the investment for a reasonable period until the security’s forecasted recovery and evidence exists indicating that recovery will occur within a reasonable period of time.

		For other fixed-maturity and equity securities, an other-than-temporary impairment charge is taken when the Company does not have the ability and intent to hold the security until the forecasted recovery or if it is no longer probable that the Company will recover all amounts due under the contractual terms of the security. Many criteria are considered during this process including, but not limited to, the current fair value as compared to amortized cost or cost, as appropriate, of the security; the amount and length of time a security’s fair value has been below amortized cost or cost; specific credit issues and financial prospects related to the issuer; the Company’s ability and intent to hold or dispose of the security, and current economic conditions.

		Other-than-temporary impairment losses result in a permanent reduction to the cost basis of the underlying investment. Other-than-temporary losses of $79,000 and $114,000 were included in the investment losses for the three and nine months ended September 30, 2005, respectively. No other-than-temporary declines were realized in the nine months ended September 30, 2004.

		The estimated fair value, related gross unrealized losses, and the length of time that the securities have been impaired for held-to-maturity securities that are considered temporarily impaired are as follows:


	September 30, 2005
	(Dollars in thousands)
	Less than 12 months					12 months or longer				Total
	Estimated		Gross			Estimated		Gross		Estimated		Gross
	fair		unrealized			fair		unrealized		fair		unrealized
	value		loss			value		loss		value		loss
Agencies not backed by the full faith and credit of the U.S. Government	$	1,024		(19	)		—		—		1,024		(19	)

Total	$	1,024		(19	)		—		—		1,024		(19	)

The estimated fair value, related gross unrealized losses, and the length of time that the securities have been impaired for available-for-sale securities that are considered temporarily impaired are as follows:


	September 30, 2005
	(Dollars in thousands)
	Less than 12 months					12 months or longer					Total
	Estimated		Gross			Estimated		Gross			Estimated		Gross
	fair		unrealized			fair		unrealized			fair		unrealized
	value		loss			value		loss			value		loss
Fixed maturities:
U.S. Treasury securities	$	3,381		(45	)		—		—			3,381		(45	)
Agencies not backed by the full faith and credit of the U.S. Government		6,071		(64	)		5,253		(101	)		11,324		(165	)
Obligations of states and political subdivisions		66,787		(471	)		16,667		(348	)		83,454		(819	)
Corporate securities		24,249		(448	)		7,594		(246	)		31,843		(694	)
Mortgage-backed securities		36,124		(439	)		5,645		(141	)		41,769		(580	)
Collateralized mortgage obligations		17,152		(242	)		9,348		(133	)		26,500		(375	)
Asset-backed securities		15,758		(240	)		7,954		(206	)		23,712		(446	)

Total fixed maturities		169,522		(1,949	)		52,461		(1,175	)		221,983		(3,124	)

Equities:
Equity securities		10,749		(393	)		2,796		(173	)		13,545		(566	)
Bond mutual funds		8,298		(253	)		9,060		(211	)		17,358		(464	)

Total equities		19,047		(646	)		11,856		(384	)		30,903		(1,030	)

Total	$	188,569		(2,595	)		64,317		(1,559	)		252,886		(4,154	)

		At September 30, 2005, the Company had seventy-five fixed income securities and seven equity securities that have been in an unrealized loss position for one year or longer. Seventy-three of the fixed income securities are investment grade, of which seventy-one of these securities are rated A1/A or better (including fifty-three securities which are rated AAA). The two remaining non-investment grade fixed income securities are rated BB and BB- and have a fair value equal to 99.9% of their book value as of September 30, 2005. Two of the equity securities that have been in an unrealized loss position for one year or longer relate to closed end bond or preferred stock funds, each of which continues to pay its regular dividend on a monthly basis and also has an underlying net asset value per share that exceeds its price per share as of September 30, 2005. One of the equity securities relates to an investment in an open end high quality short duration bond fund, of which the underlying assets are all rated AAA. Finally, the four remaining equity securities that have been in an unrealized loss position for one year or longer relate to preferred share investments in issuers each of which has shown an improved financial performance during 2005. In addition, these seven equity securities have an aggregate fair market value equal to 96.8% of their book value as of September 30, 2005. All seventy-five of the fixed income securities are current on interest and principal and all seven of the equity securities continue to pay dividends at a level consistent with the prior year. Management believes the declines are temporary and are not indicative of other-than-temporary impairments.

(4)		Loss and Loss Expense Reserves

		Liability for losses and loss expenses represents the Company’s best estimate of the ultimate amounts needed to pay both reported and unreported claims. These estimates are based on quarterly internal actuarial studies and certified on an annual basis by an independent actuary. The Company continually reviews these estimates and, based on new developments and information, the Company includes adjustments of the probable ultimate liability in the operating results for the periods in which the adjustments are made.

		Net loss and loss expenses incurred were $36.4 million for the quarter ended September 30, 2005, compared to $24.5 million for the quarter ended September 30, 2004. In the third quarter of 2005, the Company recorded $35.4 million of incurred losses and loss expenses attributable to the 2005 accident year and $978,000 attributable to events of prior years. In the third quarter of 2004, the Company recorded $20.6 million of incurred losses and loss expenses attributable to the 2004 accident year and $3.9 million attributable to events of prior years.

		Net loss and loss expenses incurred were $88.7 million for the nine months ended September 30, 2005, compared to $64.4 million for the nine months ended September 30, 2004. For the nine months ended September 30, 2005, the Company recorded $84.1 million of incurred losses and loss expenses attributable to the 2005 accident year and $4.6 million attributable to events of prior years. For the nine months ended September 30, 2004, the Company recorded $56.4 million of incurred losses and loss expenses attributable to the 2004 accident year and $8.0 million attributable to events of prior years.

		During the quarter ended September 30, 2005, the Company incurred $8.8 million of incurred net loss and loss expenses and $18.3 million of gross loss and loss expenses related to Hurricanes Katrina and Rita. The Company did not incur a significant amount of hurricane losses in 2004.

		The prior year increase for the quarter ended September 30, 2005 resulted principally from the non-construction defect casualty line of business in the property and casualty segment. This increase resulted from unexpected increases in claims severities that caused reassessments of the claim reporting and settlement patterns, which resulted in $944,000 of additional incurred loss and loss expenses. In addition, the most significant components of the prior year increases for the quarter ended September 30, 2005 included $454,000 of favorable development in the Company’s property line as a result of actual reported losses below expectations and $363,000 of prior year increases related to construction defect claims within the other liability line of the property and casualty segment. The development with construction defect claims primarily resulted in anticipated increase in litigation expenses related to the contribution actions which were slightly offset by favorable claim count development. Construction defect claim severities continue to be within the Company’s expectations. The $978,000 prior year increases in the quarter ended September 30, 2005 compares to $3.9 million of prior year increases for the same period in 2004, which primarily resulted from the construction defect line.

		The prior year increase for the nine months ended September 30, 2005 included $3.5 million increases related to construction defect, $2.0 million related to the non-construction defect casualty line and $463,000 of increases related to the exited commercial auto line from adverse new claim information on two claims. The increases were offset by approximately $989,000 of favorable development in the property line of business. The increases related to construction defect primarily relate to reserves established for several contribution action settlements that are anticipated to be paid within the year and increased estimate of litigation reserves related to the contribution actions. The increases related to the non-construction defect casualty line primarily relate to claim severities exceeding the Company’s expectations resulting in reassessments of the initial loss ratio expectations and the claim reporting and settlement patterns. The favorable development for property resulted from actual reported losses below expectations. The prior year increases for the nine months ended September 30, 2005 of $4.6 million compares to $8.0 million during the same period of 2004.

		A significant portion of the nine months ended September 30, 2004 prior year increases resulted principally from construction defect claims in the other liability line in the property and casualty segment. During the first nine months of 2004, new construction defect claim counts exceeded expectations. Based on the claim count experience that emerged, the Company’s actuaries revised the factors used in the estimation of ultimate construction defect claim counts. This re-estimation of claim count projection factors produced an increase in the estimated ultimate cost of construction defect claims, causing adverse development on prior accident years during the nine month periods ended September 30, 2004. In addition, in the nine months ended September 30, 2004, increases in incurred amounts on four claims also increased the amount of incurred development.

		Additionally, during the second quarter of 2004, the Company experienced development related to 19 new contractors’ claims. The 19 new claims were higher than recent experience and the development on pending claims exceeded the Company’s expectations.

		During the first quarter of 2004, the Company recorded increases in paid and incurred losses and loss expenses on seven commercial auto liability claims. The net incurred increases on these claims totaled $778,000. The increases were related to one significant, unanticipated new claim ($155,000), reserve increases related to coverage disputes on three claims ($297,000), and unfavorable changes in conditions relating to three other claims ($326,000).

(5)		Reinsurance

		In the ordinary course of business, Century assumes and cedes reinsurance with other insurers and reinsurers. These arrangements provide greater diversification of business and limit the maximum net loss potential on large risks. There have been no significant changes in the Company’s reinsurance program. The amounts of ceded loss and loss expense reserves and ceded unearned premiums would represent a liability of the Company in the event that its reinsurers would be unable to meet existing obligations under reinsurance agreements.


		The effects of assumed and ceded reinsurance on premiums written, premiums earned and loss and loss expenses incurred were as follows:


	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2005			2004			2005			2004
	(Dollars in thousands)
Premiums written:
Direct	$	52,491			49,963			154,444			141,939
Assumed		993			38			1,945			135
Ceded		(7,703	)		(6,535	)		(19,965	)		(19,042	)

Net premiums written	$	45,781			43,466			136,424			123,032

Premiums earned:
Direct	$	51,575			45,768			147,457			124,235
Assumed		475			95			888			375
Ceded		(7,116	)		(6,320	)		(18,866	)		(17,189	)

Net premiums earned	$	44,934			39,543			129,479			107,421

Losses and loss expenses incurred:
Direct	$	50,850			29,397			114,521			76,612
Assumed		(229	)		575			(641	)		2,521
Ceded		(14,211	)		(5,453	)		(25,156	)		(14,727	)

Net losses and loss expenses incurred	$	36,410			24,518			88,724			64,406

(6)		Deferred Policy Acquisition Costs

		The following table reflects the amounts of policy acquisition costs deferred and amortized:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
	(Dollars in thousands)
Balance at beginning of period	$	18,919			15,616			17,411			11,714
Policy acquisition costs deferred		11,411			9,989			33,474			29,384
Amortization of deferred policy acquisition costs		(10,941	)		(8,526	)		(31,496	)		(24,019	)

Balance at end of period	$	19,389			17,079			19,389			17,079

		Amortization of deferred policy acquisition costs for the nine months ended September 30, 2004 included a reduction of amortization expense of $2.5 million relating to the transfer of capitalized acquisition costs from Evergreen and Continental for the property and casualty segment, which was partially offset by $1.9 million of capitalized acquisition costs for the surety segment that was transferred from Century to Evergreen and Continental. These transactions occurred in conjunction with the termination of the intercompany pooling agreement and the implementation of the loss portfolio agreements among Century, Evergreen and Continental, as disclosed in the Company’s Form 10-K filing for the year ended December 31, 2004.

(7)		Federal Income Taxes

		The income tax provision for the nine months ended September 30, 2005 and 2004, has been computed based on our estimated annual effective tax rate of 25.0% and 32.0%, respectively, which differ from the federal income tax rate of 35% principally because of tax-exempt investment income. The income tax provision for the quarter ended September 30, 2005 was 38.6% primarily due to the pretax loss recorded for the quarter and the effect of tax-exempt investment income. The income tax provision for the quarter ended September 30, 2004 was 32.0% primarily due to the effect of tax-exempt investment income.

(8)		Commitments and Contingencies

		The Company is a defendant in various lawsuits in the ordinary course of its business. In the opinion of management, the effects, if any, of such lawsuits are not expected to be material to the Company’s consolidated financial position or results from operations.

(9)		Segment Reporting Disclosures

		The Company operates in the Property and Casualty Lines (“P/C”) (including general liability, multi-peril, and commercial property) segment of the specialty insurance market.

		All investment activities are included in the Investing segment. Exited programs (including workers’ compensation and commercial auto) are included in Other (including Exited Lines) for purposes of segment reporting.

		The Company considers many factors, including economic similarity, the nature of the underwriting units’ insurance products, production sources, distribution strategies and regulatory environment in determining how to aggregate operating segments.

		Segment profit or loss for each of the Company’s segments is measured by underwriting profit or loss. The property and casualty insurance industry commonly defines underwriting profit or loss as earned premium net of loss and loss expenses and underwriting, acquisition and insurance expenses. Underwriting profit or loss does not replace operating income or net income computed in accordance with GAAP as a measure of profitability. Segment profit for the Investing segment is measured by net investment income and net realized gains or losses.

		The Company does not allocate assets to the P/C and Other (including exited lines) segments for management reporting purposes. The total investment portfolio and cash are allocated to the Investment operating segment.

		The following is a summary of segment disclosures:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
	(Dollars in thousands)						(Dollars in thousands)
Segment revenue:
P/ C	$	44,625			39,550			129,065			107,427
Investing		3,800			2,697			10,301			7,216
Other (including exited lines)		309			(7	)		414			(6	)

Segment revenue	$	48,734			42,240			139,780			114,637

Segment (loss) profit:
P/ C	$	(5,602	)		2,895			(389	)		8,469
Investing		3,800			2,697			10,301			7,216
Other (including exited lines)		(100	)		(4	)		(180	)		(1,119	)

Segment (loss) profit	$	(1,902	)		5,588			9,732			14,566

Segment assets:
Investing	$	344,988			290,981			344,988			290,981
Assets not allocated		125,529			87,958			125,529			87,958

Total consolidated assets	$	470,517			378,939			470,517			378,939

The following summary reconciles significant segment items to the Company’s interim unaudited consolidated condensed financial statements:


	Three Months						Nine Months
	Ended September 30,						Ended September 30,
	2005			2004			2005			2004
	(Dollars in thousands)
(Loss) income before income taxes:
Segment (loss) profit	$	(1,902	)		5,588			9,732			14,566
Unallocated amounts:
Corporate expenses		(536	)		223			(1,325	)		1,160
Interest expense		(483	)		(352	)		(1,359	)		(1,113	)
Interest expense on redemption of Class B shares		—			—			—			(518	)

(Loss) income before income tax	$	(2,921	)		5,459			7,048			14,095

The following is a summary of segment earned premium by group of products:


	Property		Casualty		Other			Consolidated
	(Dollars in thousands)
Three Months Ended September 30, 2005
P/ C	$	13,983		30,642		—			44,625
Other (including exited lines)		—		—		309			309

Earned premiums	$	13,983		30,642		309			44,934

Three Months Ended September 30, 2004
P/ C	$	14,858		24,692		—			39,550
Other (including exited lines)		—		—		(7	)		(7	)

Earned premiums	$	14,858		24,692		(7	)		39,543


Nine Months Ended September 30, 2005
P/ C	$	42,329		86,736		—			129,065
Other (including exited lines)		—		—		414			414

Earned premiums	$	42,329		86,736		414			129,479

Nine Months Ended September 30, 2004
P/ C	$	42,152		65,275		—			107,427
Other (including exited lines)		—		—		(6	)		(6	)

Earned premiums	$	42,152		65,275		(6	)		107,421

		The Company does not manage property and casualty products at this level of detail.

(10)		Dividend to Common Shareholders

		On March 24, 2005, the Board of Directors declared a dividend of $0.02 per common share that was paid on April 28, 2005 to shareholders of record as of April 7, 2005. On May 19, 2005, the Board of Directors declared a dividend of $0.02 per common share that was paid on June 22, 2005 to shareholders of record as of June 1, 2005. On August 17, 2005, the Board of Directors declared a dividend of $0.02 per common share that was paid on September 21, 2005 to shareholders of record as of August 31, 2005.

(11)		Line of Credit

		The Company has a $5.0 million line of credit with a maturity date of September 8, 2006, and interest only payments due quarterly based on LIBOR plus 2.5% of the outstanding balance. All of the outstanding shares of Century are pledged as collateral. In April 2005, the Company made a $2.3 million draw on the line of credit for general corporate purposes. The $2.3 million draw was paid off on May 17, 2005. Interest paid on the line of credit was $5,000. Due to the late filing of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, the Company became non-compliant with the debt covenants for the line of credit. On September 7, 2005, the Company received a waiver from the bank and now has the ability to draw on the line of credit. The Company does not have any borrowings outstanding under the line of credit at September 30, 2005.

Item 2. Management’s Discussion And Analysis Of Financial Condition And Results Of Operations

The following discussion of our financial condition and results of operations should be read in conjunction with our interim unaudited consolidated condensed financial statements and the notes to those statements included in this Form 10-Q. Some of the statements in this report, including those set forth in the discussion and analysis below, are “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements are derived from information that we currently have and assumptions that we make and may be identified by words such as “believes,” “anticipates,” “expects,” “plans,” “should,” “estimates” and similar expressions. We cannot assure you that anticipated results will be achieved, since actual results may differ materially because of both known and unknown risks and uncertainties we face. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Factors that could cause actual results to differ materially from our forward-looking statements are described under the heading “Risks Related to Our Business and Industry” in our Annual Report on Form 10-K for the year ended December 31, 2004, and elsewhere in this report, and include, but are not limited to, the following factors:

	•		our actual incurred losses and loss expenses, including those related to recent hurricanes, may be greater than our loss and loss expense reserves, which could have a material adverse effect on our financial condition and results of operations;

	•		a decline in our financial rating may result in a reduction of new or renewal business;

	•		we are subject to extensive regulation, which may adversely affect our ability to achieve our business objectives, and if we fail to comply with these regulations, we may be subject to penalties, including fines and suspensions, which may adversely affect our financial condition and results of operations;

	•		changes in our operating environment may adversely affect our performance;

	•		our general agents may exceed their authority and could bind us to business outside our underwriting guidelines;

	•		if we lose key personnel or are unable to recruit qualified personnel, our ability to implement our business strategies could be delayed or hindered;

	•		our investment results and, therefore, our financial condition may be impacted by changes in the business, financial condition or operating results of the entities in which we invest, as well as changes in interest rates, government monetary policies, general economic conditions and overall market conditions;

	•		we distribute our products through a select group of general agents, and there can be no assurance that such relationships will continue, or if they do continue, that they will remain profitable for us;

	•		we rely on our information technology and telecommunication systems, and the failure of these systems could materially and adversely affect our business;

	•		our reinsurers may not pay claims made by us on losses in a timely fashion;

	•		if we are not able to renew our existing reinsurance or obtain new reinsurance, either our net exposure would increase or we would have to reduce the level of our underwriting commitment;

	•		our business is cyclical in nature, which may affect our financial performance;

	•		we compete with a large number of companies in the insurance industry for underwriting revenues;

	•		severe weather conditions and other catastrophes may result in an increase in the number and amount of claims filed against us; and

	•		as a holding company, we are dependent on the results of operations of our insurance subsidiaries and the regulatory and contractual capacity of our subsidiaries to pay dividends to us. Some states limit the aggregate amount of dividends our subsidiaries may pay to us in any twelve-month period, thereby limiting our funds to pay expenses and dividends.

You are cautioned not to place undue reliance on forward-looking statements, which speak only as of their respective dates.

Overview

ProCentury is a holding company that underwrites selected property and casualty and surety insurance through its subsidiaries collectively known as the Century Insurance Group®. As a “niche” company, we offer specialty insurance products designed to meet specific insurance needs of targeted insured groups. The excess and surplus lines market provides an alternative market for customers with hard-to-place risks and risks that insurance companies licensed by the state in which the insurance policy is sold, which are also referred to as “admitted insurers,” specifically refuse to write. When we underwrite within the excess and surplus lines market, we are selective in the lines of business and types of risks we choose to write. Typically, the development of these specialty insurance products is generated through proposals brought to us by an agent or broker seeking coverage for a specific group of clients.

We evaluate our insurance operations by monitoring key measures of growth and profitability. We measure our growth by examining gross written premiums. We generally measure our operating results by examining our net income, return on equity and loss, expense and combined ratios. The following provides further explanation of the key measures that we use to evaluate our results:

Gross Written Premiums. Gross written premiums is the sum of direct written premiums and assumed written premiums. We use gross written premiums, which excludes the impact of premiums ceded to reinsurers, as a measure of the underlying growth of our insurance business from period to period.

Net Written Premiums. Net written premiums is the sum of direct written premiums and assumed written premiums less ceded written premiums. We use net written premiums, primarily in relation to gross written premiums, to measure the amount of business retained after cessions to reinsurers.

Loss Ratio. Loss ratio is the ratio (expressed as a percentage) of losses and loss expenses incurred to premiums earned. Loss ratio generally is measured on both a gross (direct and assumed) and net (gross less ceded) basis. We use the gross loss ratio as a measure of the overall underwriting profitability of the insurance business we write and to assess the adequacy of our pricing. Our net loss ratio is meaningful in evaluating our financial results, which are net of ceded reinsurance, as reflected in our consolidated financial statements.

Expense Ratio. Expense ratio is the ratio (expressed as a percentage) of net operating expenses to premiums earned and measures a company’s operational efficiency in producing, underwriting and administering its insurance business. We reduce our operating expenses by ancillary income (excluding net investment income and realized gains (losses) on securities) to calculate our net operating expenses. Due to our historically high levels of reinsurance, we calculate our expense ratio on both a gross basis (before the effect of ceded reinsurance) and a net basis (after the effect of ceded reinsurance). Although the net basis is meaningful in evaluating our financial results that are net of ceded reinsurance, as reflected in our consolidated financial statements, we believe that the gross expense ratio better reflects the operational efficiency of the underlying business and is a better measure of future trends. Interest expense is not included in the calculation of the expense ratio.

Combined Ratio. Combined ratio is the sum of the loss ratio and the expense ratio and measures a company’s overall underwriting profit. If the combined ratio is at or above 100, an insurance company cannot be profitable without investment income (and may not be profitable if investment income is insufficient). We use the combined ratio in evaluating our overall underwriting profitability and as a measure for comparing our profitability relative to the profitability of our competitors.

Critical Accounting Policies

It is important to understand our accounting policies in order to understand our financial statements. Management considers certain of these policies to be critical to the presentation of our financial results, since they require management to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets, liabilities, revenues, expenses and related disclosures at the financial reporting date and throughout the period being reported upon. Certain of the estimates result from judgments that can be subjective and complex and consequently actual results may differ from these estimates, which would be reflected in future periods.

Our most critical accounting policies involve the reporting of loss and loss expense reserves (including losses that have occurred but were not reported to us by the financial reporting date), reinsurance recoverables, the impairment of investments, deferred policy acquisition costs and federal income taxes.

Loss and Loss Expense Reserves. Loss and loss expense reserves represent an estimate of the expected cost of the ultimate settlement and administration of losses, based on facts and circumstances then known. We use actuarial methodologies to assist us in establishing these estimates, including judgments relative to estimates of future claims severity and frequency, length of time to develop to ultimate resolution, judicial theories of liability and other third-party factors that are often beyond our control. Due to the inherent uncertainty associated with the cost of unsettled and unreported claims, the ultimate liability may be different from the original estimate. Such estimates are regularly reviewed and updated and any resulting adjustments are included in the current period’s results. See Note 4 to our unaudited consolidated condensed financial statements included in this Form 10-Q.

Reinsurance Recoverables. Reinsurance recoverables on paid and unpaid losses, net, are established for the portion of our loss and loss expense reserves that are ceded to reinsurers. Reinsurance recoverables are determined based in part on the terms and conditions of reinsurance contracts which could be subject to interpretations that differ from our own based on judicial theories of liability. In addition, we bear credit risk with respect to our reinsurers which can be significant considering that certain of the reserves remain outstanding for an extended period of time. We are required to pay losses even if a reinsurer fails to meet its obligations under the applicable reinsurance agreement. See Note 5 to our unaudited consolidated condensed financial statements included in this Form 10-Q.

Impairment of Investments. Impairment of investment securities results in a charge to operations when a market decline below cost is deemed to be other-than-temporary. Under the Company’s accounting policy for equity securities and fixed-maturity securities that can be contractually prepaid or otherwise settled in a way that may limit the Company’s ability to fully recover cost, an impairment is deemed to be other-than-temporary unless the Company has both the ability and intent to hold the investment for a reasonable period until the security’s forecasted recovery and evidence exists indicating that recovery will occur in a reasonable period of time.

For other fixed-maturity and equity securities, an other-than-temporary impairment charge is taken when the Company does not have the ability and intent to hold the security until the forecasted recovery or if it is no longer probable that the Company will recover all amounts due under the contractual terms of the security. Many criteria are considered during this process including, but not limited to, the current fair value as compared to amortized cost or cost, as appropriate, of the security; the amount and length of time a security’s fair value has been below amortized cost or cost; specific credit issues and financial prospects related to the issuer; the Company’s ability and intent to hold or dispose of the security; and current economic conditions. Other-than-temporary impairment losses result in a permanent reduction to the cost basis of the underlying investment. For additional detail regarding our investment portfolio at September 30, 2005 and December 31, 2004, including disclosures regarding other-than-temporary declines in investment value, see Note 3 to our unaudited consolidated condensed financial statements included in this Form 10-Q.

Deferred Policy Acquisition Costs. We defer commissions, premium taxes and certain other costs that vary with and are primarily related to the acquisition of insurance contracts. These costs are capitalized and charged to expense in proportion to premium revenue recognized. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value, which gives effect to the premium to be earned, related investment income, anticipated losses and settlement expenses and certain other costs expected to be incurred as the premium is earned. Judgments as to ultimate recoverability of such deferred costs are highly dependent upon estimated future loss costs associated with the written premiums. See Note 6 to our unaudited consolidated condensed financial statements included in this Form 10-Q.

Federal Income Taxes The Company provides for federal income taxes based on amounts the Company believes it ultimately will owe. Inherent in the provision for federal income taxes are estimates regarding the deductibility of certain items and the realization of certain tax credits. In the event the ultimate deductibility of certain items or the realization of certain tax credits differs from estimates, the Company may be required to significantly change the provision for federal income taxes recorded in the consolidated financial statements. Any such change could significantly affect the amounts reported in the consolidated statements of income.

We utilize the asset and liability method of accounting for income tax. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Valuation allowances are established when necessary to reduce the deferred tax assets to the amounts more likely than not to be realized. See Note 7 to our unaudited consolidated condensed financial statements included in this Form 10-Q.

Results of Operations

The table below summarizes certain operating results and key measures used in monitoring and evaluating operations. The information is intended to summarize and supplement information contained in the interim unaudited consolidated condensed financial statements and to assist the reader in gaining a better understanding of results of operations.


	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
	(Dollars in thousands)						(Dollars in thousands)
Selected Financial Data:
Gross written premiums	$	53,484			50,001			156,389			142,074
Premiums earned		44,934			39,543			129,479			107,421
Net investment income		3,866			2,719			10,520			7,094
Net realized investment (losses) gains		(66	)		(22	)		(219	)		122
Total revenues		48,734			42,240			139,780			114,637
Total expenses		51,655			36,781			132,732			100,542
Net (loss) income		(1,793	)		3,712			5,285			9,585
Key Financial Ratios:
Loss and loss expense ratio		81.0	%		62.0	%		68.5	%		60.0	%
Expense ratio		32.9	%		30.1	%		32.9	%		32.1	%

Combined ratio		113.9	%		92.1	%		101.4	%		92.1	%

Overview of Operating Results

For the three months ended September 30, 2005, net loss was $1.8 million compared to net income of $3.7 million for the three months ended September 30, 2004. Net income decreased to $5.3 million, for the nine months ended September 30, 2005, from $9.6 million for the nine months ended September 30, 2004.

The decrease in net income for the three and nine months ended September 30, 2005 was primarily attributable to an increase in loss and loss expenses related to Hurricanes Katrina and Rita, which were partially offset by an increase in net earned premium and net investment income. During the quarter ended September 30, 2005, we incurred $6.0 million after-tax ($9.3 million, pre-tax) of losses and reinstatement premium related to the hurricanes. We did not incur a significant amount of hurricane losses in 2004. The increase in net earned premium resulted principally from an increase in the volume of business which was offset by slight rate declines in both the property and casualty lines of business. Net investment income for the nine months ended September 30, 2005 increased due to higher invested assets as a result of the proceeds from the Company’s initial public offering that occurred in April of 2004, the operational cash flows that occurred during the first nine months of 2005, as well as higher yield on invested assets as our tax equivalent yield increased to 5.46% at September 30, 2005 from 4.65% at September 30, 2004.

The increase in total revenue was offset by an increase in total expenses that resulted from an increase in net loss and loss expenses, and amortization of deferred acquisition costs and the $793,000 severance expense associated with the departure of our former Chief Operating Officer that occurred in the first quarter in 2005. The loss and loss expense ratios for the three months ended September 30, 2005 and 2004 were 81.0% and 62.0%, respectively. The loss and loss expense ratios for the nine months ended September 30, 2005 and 2004 were 68.5% and 60.0%, respectively. The loss and loss expense ratio for the first nine months of 2005 includes 7.1% related to the loss estimates for hurricane Katrina and Rita and higher current accident year ultimate loss and loss expense ratios driven by the decreasing rate environment throughout 2004 and into 2005. The loss and loss expense ratio for the first nine months of 2005 also reflects a decreasing amount of increases related to prior accident years, compared to the same period during 2004. The expense ratios for the three months ended September 30, 2005 and 2004 were 32.9% and 30.1%, respectively. The expense ratios for the nine months ended September 30, 2005 and 2004 were 32.9% and 32.1%, respectively. The increase in the expense ratio for the quarter and the year is directly attributable to higher costs related to our efforts to become Sarbanes-Oxley compliant and the severance payment associated with the departure of our former Chief Operating Officer.

Revenues

Premiums

Premiums include insurance premiums underwritten by Century (which are referred to as direct premiums) and insurance premiums assumed from other insurers generally in states where Century is not licensed (which are referred to as assumed premiums). We refer to direct and assumed premiums together as gross premiums.

Written premiums are the total amount of premiums billed to the policyholder less the amount of premiums returned, generally as a result of cancellations, during a given period. Written premiums become premiums earned as the policy ages. Barring premium changes, if an insurance company writes the same mix of business each year, written premiums and premiums earned will be equal, and the unearned premium reserve will remain constant. During periods of growth, the unearned premium reserve will increase, causing premiums earned to be less than written premiums. Conversely, during periods of decline, the unearned premium reserve will decrease, causing premiums earned to be greater than written premiums.

We have historically relied on quota share, excess of loss, and catastrophe reinsurance primarily to manage our regulatory capital requirements and also to limit our exposure to loss. Generally, we have ceded a significant portion of our premiums to unaffiliated reinsurers in order to maintain a net written premiums to statutory surplus ratio of less than 2-to-1.

Our underwriting business is currently divided into two primary segments:

	•		property/casualty; and

	•		other (including exited lines).

Our property/casualty segment primarily includes general liability, commercial property and multi-peril insurance for small and mid-sized businesses. The other (including exited lines) segment primarily includes our surety business, including landfill and specialty surety that is written in order to maintain Century’s U.S. Treasury listing, workers’ compensation, which was exited in January 2002, and commercial auto, which was exited in May 2000.

The following table presents our gross written premiums in our primary segments and provides a summary of gross, ceded and net written premiums and net premiums earned for the periods indicated.


	Three Months Ended September 30,						Nine Months Ended September 30,
	2005			2004			2005			2004
	(Dollars in thousands)						(Dollars in thousands)
Gross written premiums:
Property/casualty	$	52,015			50,001			154,154			142,074
Other (including exited lines)		1,469			—			2,235			—

Total gross written premiums		53,484			50,001			156,389			142,074
Ceded written premiums		(7,703	)		(6,535	)		(19,965	)		(19,042	)

Net written premiums	$	45,781			43,466			136,424			123,032

Net premiums earned	$	44,934			39,543			129,479			107,421

Net written premiums to gross written premiums		85.6	%		86.9	%		87.2	%		86.6	%
Net premiums earned to net written premiums		98.1	%		91.0	%		94.9	%		87.3	%
Net writings ratio (1)		1.5			1.6			1.5			1.5


(1)		The ratio of net written premiums to our insurance subsidiaries’ combined statutory surplus. This ratio is not restated to exclude discontinued operations as the insurance subsidiaries’ combined statutory surplus is not allocated by line of business. Therefore, in computing the ratio of net written premiums to our insurance subsidiaries’ combined statutory surplus we do not restate the net written premium for discontinued operations to be consistent with that of the subsidiaries’ combined statutory surplus. Management believes this measure is useful in gauging our exposure to pricing errors in the current book of business. It may not be comparable to the definition of net writings ratio used by other companies.

Gross Written Premiums

Gross written premiums increased to $53.5 million for the quarter ended September 30, 2005, an increase of 7.0% from $50.0 million for the same period in 2004. Gross written premiums increased to $156.4 million for the nine months ended September 30, 2005, an increase of 10.1% from $142.1 million for the same period in 2004. This increase was primarily due to an increase in volume of our property/casualty segment which was slightly offset by overall rate declines across our book of business. While our casualty line of business continued to grow with an increase of gross written premiums of $3.1 million in the third quarter of 2005 and $15.5 million for the nine months ended September 30, 2005, we experienced a decline in our overall casualty growth rate due to rate declines and increased market competition. Although, we expect these rate declines and increased market competition to continue throughout 2005, we believe that there are still opportunities for profitable growth in our casualty lines. Gross written premiums for our property lines decreased in the third quarter by $1.3 million and in the nine months ended September 30, 2005 by $3.1 million. This decrease is a result of declining rates across our property book of business, causing the loss of some of our individually significant property accounts. We continue to assess the property market to ensure that it will deliver the appropriate profitability.

Net Written Premiums and Premiums Earned

Net written premiums for the three months ended September 30, 2005 were $45.8 million, representing an increase of 5.3% compared to the same period in 2004. Net written premiums for the nine months ended September 30, 2005 were $136.4 million, representing an increase of 10.9% compared to the same period in 2004. Net written premiums represented 85.6% and 87.2% of gross written premiums for the three and nine months ended September 30, 2005. For the quarter ended September 30, 2005, the relationship of net written premiums to gross written premiums remained relatively stable compared to the same period of 2004. The increase in the relationship of net written premiums to gross written premiums for the nine months ended September 30, 2005 compared to the same period in 2004 reflects lower retention of business with effective dates of 2003 that was not recorded until the first quarter of 2004.

Premiums earned, a function of net written premiums, were $44.9 million for the three months ended September 30, 2005, or 98.1% of net written premiums. Premiums earned were $129.5 million for the nine months ended September 30, 2005, or 94.9% of net written premiums. The relationship of premiums earned to net written premiums during the same periods in 2004 is higher, reflecting the slower growth rate at the end of 2004 and into the first three quarters of 2005.

Net Investment Income

Our investment portfolio generally consists of liquid, readily marketable and investment-grade fixed-maturity and equity securities. Net investment income is comprised of interest and dividends earned on these securities, net of related investment expenses.

Net investment income increased to $3.9 million for the three months ended September 30, 2005, compared to $2.7 million for the same period in 2004. For the nine months ended September 30, 2005, net investment income increased to $10.5 million compared to $7.1 million for the same period in 2004. The increase was primarily due to an increase in invested assets, including cash, as a result of higher invested assets due to the proceeds from the Company’s initial public offering in April 2004, an increase in operating cash flows throughout 2004 and into 2005 and higher investment yields. Invested assets, including cash, increased by $59.9 million to $356.1 million as of September 30, 2005 and from $296.2 million as of September 30, 2004. Pre-tax investment yield for the three months ended September 30, 2005 was 4.75%, compared to 4.12% for the same period in 2004. For the nine months ended September 30, 2005, pre-tax investment yield was 4.54%, compared to 3.93% for the same period in 2004.

In addition, as part of our effort to increase our tax equivalent yield, we raised our allocation to tax-exempt municipals throughout 2004 and into 2005, which contributed to an increase in our tax equivalent yield to 5.47% as of September 30, 2005 from 4.65% as of September 30, 2004.

Realized Gains (Losses) on Securities

Realized gains and losses on securities are principally affected by changes in interest rates, the timing of sales of investments and changes in credit quality of the securities held as investments.

We realized net investment losses of $66,000 and $22,000 on the sale of securities for the three months ended September 30, 2005 and 2004, respectively. For the nine months ended September 30, 2005 and 2004, we realized net investment losses of $219,000 and net investment gains of $122,000, respectively, on the sale of securities. Other-than-temporary losses of $79,000 and $114,000 were included in net realized investment losses for the three and nine months ended September 30, 2005, respectively. No other-than-temporary declines were realized in 2004.

Expenses

Losses and Loss Expenses

Losses and loss expenses represent our largest expense item and include (1) payments made to settle claims, (2) estimates for future claim payments and changes in those estimates for current and prior periods, and (3) costs associated with settling claims. The items that influence the incurred losses and loss expenses for a given period include, but are not limited to, the following:

	•		the number of exposures covered in the current year;

	•		trends in claim frequency and claim severity;

	•		changes in the cost of adjusting claims;

	•		changes in the legal environment relating to coverage interpretation, theories of liability and jury determinations; and

	•		the re-estimation of prior years’ reserves in the current year.

We continue to perform an internal quarterly actuarial analysis and establish or adjust (for prior accident quarters) our best estimate of the ultimate incurred losses and loss expenses to reflect loss development information and trends that have been updated for the most recent quarter’s activity. As of December 31 of each year, an independent actuary performs an analysis of the adequacy of our reserves. Our estimate of ultimate loss and loss expenses is evaluated and re-evaluated by accident year and by major coverage grouping. Changes in estimates are reflected in the period the additional information becomes known.

Our reinsurance program significantly influences our net retained losses. In exchange for premiums ceded to reinsurers under quota share and excess of loss reinsurance agreements, our reinsurers assume a portion of the losses and loss expenses incurred. We remain obligated for amounts ceded in the event that the reinsurers do not meet their obligations under the agreements (due to, for example, disputes with the reinsurer or the reinsurer’s insolvency).

Net losses and loss expenses increased to $36.4 million for the three months ended September 30, 2005 from $24.5 million for the same period in 2004. Net losses and loss expense ratios for the three months ended September 30, 2005 and 2004 were 81.0% and 62.0%, respectively. Hurricanes Katrina and Rita impacted the third quarter 2005 loss ratio by 20.2 percentage points. For the nine months ended September 30, 2005, net losses and loss expenses increased to $88.7 from $64.4 million for the same period in 2004. Net losses and loss expense ratios for the nine months ended September 30, 2005 and 2004 were 68.5% and 60.0%, respectively. The net losses and loss expense ratio for the nine months ended September 30, 2005 was impacted by Hurricanes Katrina and Rita by 7.0 percentage points.

Our reserve for losses and loss expenses at September 30, 2005 was $215.3 million (before the effects of reinsurance) and $164.3 million (after the effects of reinsurance), as estimated through our actuarial analysis. For the third quarter of 2005 and the first nine months of 2005, we concluded through our actuarial analysis that the December 31, 2004 reserve for losses and loss expenses of $123.8 million (after the effects of reinsurance) was deficient by $978,000 and $4.6 million, respectively, primarily in our construction defect and non-construction defect casualty, offset by favorable development in our property reserves.

Our reserve for losses and loss expenses (net of the effects of reinsurance) at September 30, 2005 and December 31, 2004 by line was as follows:


	September 30, 2005		December 31, 2004
	(Dollars in thousands)
Property/casualty:
Casualty	$	131,693		102,430
Property		28,766		16,115
Other (including exited lines):
Commercial auto		1,082		1,780
Workers’ compensation		2,718		3,426
Other		42		—

Net reserves for losses and loss expenses		164,301		123,751
Plus reinsurance recoverables on unpaid losses at end of period		51,042		29,485

Gross reserves for losses and loss expenses	$	215,343		153,236

Net loss and loss expenses incurred was $36.4 million for the quarter ended September 30, 2005, compared to $24.5 million for the quarter ended September 30, 2004. In the third quarter of 2005, we recorded $35.4 million of incurred losses and loss expenses attributable to the 2005 accident year and $978,000 attributable to events of prior years. In the third quarter of 2004, we recorded $20.6 million of incurred losses and loss expenses attributable to the 2004 accident year and $3.9 million attributable to events of prior years.

Net loss and loss expenses incurred was $88.7 million for the nine months ended September 30, 2005, compared to $64.4 million for the nine months ended September 30, 2004. For the nine months ended September 30, 2005, we recorded $84.1 million of incurred losses and loss expenses attributable to the 2005 accident year and $4.6 million attributable to events of prior years. For the nine months ended September 30, 2004, we recorded $56.4 million of incurred losses and loss expenses attributable to the 2004 accident year and $8.0 million attributable to events of prior years. The accident year losses and loss expense ratios for the property and casualty segment for accident years 2005 and 2004 were 65.1% and 51.7%, respectively.

The prior year increase for the quarter ended September 30, 2005 resulted principally from the non-construction defect casualty line of business in the property and casualty segment. This increase resulted from unexpected increases in claims severity trends that caused reassessments of the initial loss ratio expectations and the claim reporting and settlement patterns, which resulted in $944,000 of additional incurred loss and loss expenses. In addition, the most significant components of the prior year increases for the quarter ended September 31, 2005 included $454,000 of favorable development in our property line as a result of actual reported losses below expectations and $363,000 of prior year increases related to construction defect claims within the other liability line of the property and casualty segment. This development with construction defect claims primarily resulted in anticipated increase in litigation expenses related to the contribution actions which were slightly offset by favorable claim count development. Construction defect claim severities continue to be within our expectations. The $978,000 prior year increases in the quarter ended September 30, 2005 compares to $3.9 million of prior year increases for the same period in 2004, which primarily resulted from the construction defect line.

The prior year increase for the nine months ended September 30, 2005 included $3.5 million increases related to construction defect, $2.0 million related to the non-construction defect casualty line and $463,000 of increases related to the exited commercial auto line from adverse new claim information on two claims. The increases were offset by $989,000 of favorable development in the property line of business. The increases related to construction defect primarily relate to reserves established for several contribution action settlements that are anticipated to be paid within the year and increased estimate of litigation reserves related to the contribution actions. The increases related to the non-construction defect casualty line primarily relate to claim severities exceeding our expectations resulting in reassessments of the initial loss ratio expectations and the claim reporting and settlement patterns. The favorable development for property resulted from actual reported losses below expectations. The prior year increases for the nine months ended September 30, 2005 of $4.6 million compares to $8.0 million during the same period of 2004.

A significant portion of the nine months ended September 30, 2004 prior year increases resulted principally from construction defect claims in the other liability line in the property and casualty segment. During the first nine months of 2004, new construction defect claim counts exceeded expectations. Based on the claim count experience that emerged, our actuaries revised the factors used in the estimation of ultimate construction defect claim counts. This re-estimation of claim count projection factors produced an increase in the estimated ultimate cost of construction defect claims, causing adverse development on prior accident years during the nine month periods ended September 30, 2004. In addition, in the nine months ended September 30, 2004, increases in incurred amounts on four claims also increased the amount of incurred development.

Additionally, during the second quarter of 2004, the Company experienced development related to 19 new contractors’ claims. The 19 new claims were higher than recent experience and the development on pending claims exceeded our expectations.

During the first quarter of 2004, we recorded increases in paid and incurred losses and loss expenses on seven commercial auto liability claims. The net incurred increases on these claims totaled $778,000. The increases were related to one significant, unanticipated new claim ($155,000), reserve increases related to coverage disputes on three claims ($297,000), and unfavorable changes in conditions relating to three other claims ($326,000).

At September 30, 2005 we had 493 open claims relating to construction defect compared to 566 open claims as of December 31, 2004. During the third quarter of 2005, 195 new claims were reported and 278 existing claims were settled or dismissed. During the nine months ended September 30, 2005, 634 new claims were reported and 707 existing claims were settled or dismissed. Our net loss and loss expense reserves for construction defect claims at September 30, 2005 were $17.1million compared to $19.0 million at December 31, 2004.

At September 30, 2004 we had 575 open claims relating to construction defect compared to 597 open claims as of December 31, 2003. During the third quarter of 2004, 269 new claims were reported and 272 existing claims were settled or dismissed. During the nine months ended September 30, 2004, 773 new claims were reported and 795 existing claims were settled or dismissed. Our net loss and loss expense reserves for construction defect claims at September 30, 2004 were $18.8 million compared to $18.6 million at December 31, 2003.

Operating Expenses

Operating expenses include the costs to acquire a policy (included in amortization of deferred policy acquisition costs), other operating expenses (including corporate expenses) and interest expense. The following table presents our amortization of deferred policy acquisition costs, other operating expenses and related ratios and interest expense for the periods indicated:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2005			2004			2005			2004
	(Dollars in thousands)
Amortization of deferred policy acquisition costs (“ADAC”)	$	10,941			8,526			31,496			24,019
Other operating expenses		3,821			3,385			10,360			10,236

ADAC and other operating expenses		14,762			11,911			41,856			34,255
Severance expense		—			—			793			250
Interest expense		483			352			1,359			1,113
Interest expense on the redemption of the Class B shares		—			—			—			518

Total operating expenses	$	15,245			12,263			44,008			36,136

Expense ratio:
ADAC		24.3	%		21.5	%		24.3	%		22.4	%
Other operating expenses		8.6	%		8.6	%		8.0	%		9.5	%
Severence		0.0	%		0.0	%		0.6	%		0.2	%

Total expense ratio (1)		32.9	%		30.1	%		32.9	%		32.1	%


(1)		Interest expense is not included in the calculation of the expense ratio.

Operating expenses increased $3.0 million, or 24.3%, to $15.2 million for the three month period ended September 30, 2005 from the same period in 2004. For the nine months ended September 30, 2005, operating expenses increased $7.9 million, or 21.8%, to $44.0 million compared to the nine months ended September 30, 2004. The increase is primarily attributable to an increase in ADAC as a result of an increase in the volume of insurance written. The increase in the ADAC ratio to 24.3% for the nine months ended September 30, 2005 from 21.5% in the same period in 2004, is directly related to the fact that the 2004 expense includes a reduction of amortization expense of $2.5 million relating to the transfer of capitalized acquisition costs from Evergreen and Continental for the property and casualty segment, which was partially offset by $1.9 million of capitalized acquisition costs for the surety segment that was transferred from Century to Evergreen and Continental. These transactions occurred in the first quarter of 2004 in conjunction with the termination of the intercompany pooling agreement and the implementation of the loss portfolio transfer agreements.

The increase in other operating expenses for the three months ended September 30, 2005 compared to the three months ended September 30, 2004 is primarily due to higher costs related to Sarbanes-Oxley compliance. The overall expense ratio for the three months ended September 30, 2005 was 32.9%, which is 2.8 percentage points higher than that of the same period in 2004. Other operating expenses remained relatively stable in the nine months ended September 30, 2005, compared to the same periods in 2004.

The increase in the expense ratio for the nine month period ended September 30, 2005 is also a result of an increase in ADAC as noted above. In addition, the expense ratio for the nine months ended September 30, 2005 includes the impact of the severance agreement with our former Chief Operating Officer.

Interest expense continues to increase throughout 2005 with the increase in interest rates on our Trust Preferred securities due to the increasing interest rate environment.

Income Taxes

The income tax provision for the nine months ended September 30, 2005 and 2004, has been computed based on our estimated annual effective tax rate of 25.0% and 32.0%, respectively, which differ from the federal income tax rate of 35% principally because of tax-exempt investment income. The income tax provision for the quarter ended September 30, 2005 was 38.6% primarily due to the pretax loss recorded for the quarter and the effect of tax-exempt investment income. The income tax provision for the quarter ended September 30, 2004 was 32.0% primarily due to the effect of tax-exempt investment income.

Liquidity and Capital Resources

ProCentury is a holding company, the principal asset of which is the common shares of Century. Although we have the capacity to generate cash through loans from banks and issuances of equity securities, our primary source of funds to meet our short-term liquidity needs, including the payment of dividends to our shareholders and corporate expenses, is dividends from Century. Century’s principal sources of funds are underwriting operations, investment income and proceeds from sales and maturities of investments. Century’s primary use of funds is to pay claims and operating expenses, to purchase investments and to make dividend payments to ProCentury. ProCentury’s future liquidity is dependent on the ability of Century to pay dividends.

Century is restricted by statute as to the amount of dividends it may pay without the prior approval of regulatory authorities. Century may pay dividends to ProCentury without advance regulatory approval only from unassigned surplus and only to the extent that all dividends in the current twelve months do not exceed the greater of 10% of total statutory surplus as of the end of the prior fiscal year or statutory net income for the prior year. Using these criteria, the available ordinary dividend payable by Century to ProCentury in 2005 is $13.8 million. Century distributed ordinary dividends of $1.3 million for the nine months ended September 30, 2005. Century distributed ordinary dividends of $3.7 million and $5.4 million of extraordinary dividends for the nine months ended September 30, 2004. Of the total dividends in 2004, $7.6 million consisted of the dividend of Century’s interest in Evergreen. Century’s ability to pay future dividends to ProCentury without advance regulatory approval is dependent upon maintaining a positive level of unassigned surplus, which in turn, is dependent upon Century generating net income in excess of dividends to ProCentury.

Century is required by law to maintain a certain minimum level of surplus on a statutory basis. The National Association of Insurance Commissioners (“NAIC”) has a risk-based capital standard designed to identify property and casualty insurers that may be inadequately capitalized based on inherent risks of each insurer’s assets and liabilities and its mix of net written premiums. Insurers falling below a calculated threshold may be subject to varying degrees of regulatory action. At December 31, 2004, the statutory surplus of Century was in excess of the prescribed risk-based capital requirements that correspond to any level of regulatory action. Century’s statutory surplus at December 31, 2004 was $115.8 million and the regulatory action level was $29.3 million. Century’s statutory surplus at September 30, 2005 was $118.9 million.

Consolidated net cash provided by operating activities was $50.9 million for the first nine months of 2005, compared to $63.1 million for the same period in 2004. Of the total decrease, $26.7 is a direct result of the settlement we received in 2004 from Evergreen and Continental related to the termination of the intercompany pooling arrangement, which was primarily offset by our positive net income and overall profitable growth.

Consolidated net cash used by investing activities was $45.7 million for the first nine months of 2005, compared to $125.9 million for the same period in 2004. This decrease is directly due to the efforts in 2004 to invest the IPO proceeds, the proceeds from the settlement from Evergreen and Continental and to invest our operational cash float into higher yielding fixed-maturity securities. In 2005, we have continued our effort to minimize idle operational cash float by investing our operating cash flows into higher yielding fixed-maturity securities.

Consolidated net cash used in financing activities was $0.8 million for the first nine months of 2005, compared to net cash provided by financing activities of $62.2 million for the same period in 2004. The $0.8 million in the first nine months of 2005 were dividends paid. The $62.2 million in the first nine months of 2004 relate to activities that occurred in conjunction with our IPO that occurred in April of 2004.

Interest on our debt issued to a related party trust is variable and resets quarterly based on a spread over three-month London Interbank Offered Rates (“LIBOR”). As part of our asset/liability matching program, we have short-term investments, investments in bond mutual funds, as well as available cash balances from operations and investment maturities, that are available for reinvestment during periods of rising or falling interest rates.

Line of Credit. ProCentury has a $5.0 million line of credit. Interest on the note is payable quarterly and is based on a floating rate of LIBOR plus 2.5%. The note matures on September 8, 2006. Under the terms of the line of credit, 100% of the common shares of Century are pledged as collateral. In April 2005, we made a $2.3 million draw on the line of credit for general corporate purposes. The $2.3 million draw was paid off on May 17, 2005. Interest paid on the line of credit was $5,000. Due to the late filing of the Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, we became non-compliant with the debt covenants in its line of credit. On September 7, 2005, we received a waiver from the bank and now have the ability to draw on the line of credit. We do not have any borrowings outstanding under the line of credit at September 30, 2005.

The following table summarizes information about contractual obligations and commercial commitments. The minimum payments under these agreements at September 30, 2005 were as follows:


	Payments Due by Year
	2005		2006		2007		2008		2009		Thereafter		Total
					(Dollars in thousands)
Long Term Debt:
Debt issued to a related party trust (1)(2)	$	515		2,060		2,060		2,060		2,060		72,790		81,545
Loss and loss expense payments, net of the effects of reinsurance (3)		16,966		56,242		37,376		24,703		11,831		17,183		164,301
Operating lease on facilities		239		978		998		1,018		734		2,339		6,306
Other operating leases		60		212		212		152		—		—		636

Total contractual obligations	$	17,780		59,492		40,646		27,933		14,625		92,312		252,788


(1)		Amounts include interest payments associated with these obligations using applicable interest rates as of September 30, 2005.

(2)		In connection with the adoption of FIN 46R, ProCentury has deconsolidated the trusts established in connection with the issuance of trust preferred securities effective December 31, 2003. As a result, ProCentury reports as a component of long term debt the junior subordinated debentures payable by ProCentury to the trusts. See Note 8(b) to our 2004 audited consolidated financial statements included in the Form 10-K.

(3)		The timing for payment of our estimated losses, net of the effects of reinsurance is determined by periods based on our historical claims payment experience. Due to the uncertainty in estimating the timing of such payments, there is a risk that the amounts paid in any period can be significantly different than the amounts disclosed above.

Given our historical cash flow, we believe cash flow from operating activities in 2005 will provide sufficient liquidity for our operations, as well as to satisfy debt service obligations and to pay other operating expenses. Although we anticipate that we will be able to meet our cash requirements, we cannot give assurances in this regard.

Investment Portfolio

Our investment strategy is designed to capitalize on our ability to generate positive cash flow from our underwriting activities. Preservation of capital is our first priority, with a secondary focus on maximizing appropriate risk adjusted return. We seek to maintain sufficient liquidity from operations, investing and financing activities to meet our anticipated insurance obligations and operating and capital expenditure needs. The majority of our fixed-maturity portfolio is rated investment grade to protect investments. Our investment portfolio is managed by two outside independent investment managers that operate under investment guidelines approved by Century’s investment committee. Century’s investment committee meets at least quarterly and reports to Century’s board of directors. In addition, we employ stringent diversification rules and balance our investment credit risk and related underwriting risks to minimize total potential exposure to any one security. In limited circumstances, we will invest in non-investment grade fixed-maturity securities that have an appropriate risk adjusted return, subject to satisfactory credit analysis performed by us and our investment managers.

Our cash and investment portfolio increased to $356.1 million at September 30, 2005 from $312.4 million at December 31, 2004 and is summarized by type of investment in Note 3 to the interim unaudited consolidated condensed financial statements included in this Form 10-Q filing. The Company’s taxable equivalent yield increased from 4.65% at December 31, 2004 to 5.47% at September 30, 2005. The increase in the taxable equivalent yield during the first nine months of 2005 was a result of the investment of proceeds from maturities and operating cash flows at higher interest rates, which were partially driven by the overall rise in market interest rates. The fair value of our fixed-maturity securities at September 30, 2005 increased to $297.3 million from $264.6 million at December 31, 2004. The fair value of our equity securities increased from $37.1 million at December 31, 2004 to $43.5 million at September 30, 2005. During the nine months ended September 30, 2005, the duration of the fixed income portfolio remained constant at 4.5 years at both December 31, 2004 and at September 30, 2005. The overall credit quality of the portfolio remained investment grade.

Accounting Standards

In December 2004, the FASB revised Statement No. 123 (SFAS 123R), “Share-Based Payment,” which requires companies to expense the estimated fair value of employee stock options and similar awards, for all options vesting, granted, or modified after the effective date of this revised statement. The accounting provisions of SFAS 123R were to become effective for interim periods beginning after June 15, 2005. In April 2005, the Securities and Exchange Commission (SEC) adopted a final rule amending Rule 4-01(a) of Regulation S-X regarding the compliance date for SFAS 123R. This ruling delays the effective date of SFAS 123R to the first interim or annual reporting period of the registrant’s first fiscal year beginning on or after June 15, 2005. As a result, the accounting provisions of SFAS 123R will become effective beginning in 2006 for our financial statements. In December 2004, the FASB revised Statement No. 123 (SFAS 123R), “Share-Based Payment,” which requires companies to expense the estimated fair value of employee stock options and similar awards, for all options vesting, granted, or modified after the effective date of this revised statement. The accounting provisions of SFAS 123R were to become effective for interim periods beginning after June 15, 2005. In April 2005, the Securities and Exchange Commission (SEC) adopted a final rule amending Rule 4-01(a) of Regulation S-X regarding the compliance date for SFAS 123R. The effect of this ruling is to delay the effective date of SFAS 123R to the first interim or annual reporting period of the registrant’s first fiscal year beginning on or after June 15, 2005. As a result, the accounting provisions of SFAS 123R will become effective for our financial statements beginning in 2006. The Company is evaluating the impact of implementing SFAS 123R and anticipates it will be material to the financial statements.

In March 2004, the FASB approved the consensus reached on the EITF Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” The objective of this consensus is to provide guidance for identifying impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. Originally, the accounting provisions of EITF 03-1 were effective for all reporting periods beginning after June 15, 2004, while the disclosure requirements are effective only for annual periods ending after June 15, 2004. In September 2004, the FASB issued two FASB Staff Positions (FSP), FSP EITF 03-1-a and FSP EITF 03-1-1, which delayed the measurement and recognition paragraphs of the consensus for further discussion. The disclosure requirements remain effective as originally issued under EITF 03-1. In June 2005, the FASB issued a final FSP EITF 03-1-a (retitled FSP FAS 115-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”) which will replace the guidance set forth in paragraphs 10-18 of Issue 03-1 and clarifies when an investor should recognize an impairment loss. The provisions of FSP FAS 115-1 are effective for other-than-temporary impairment analysis conducted in periods beginning after December 15, 2005. The Company has evaluated the provisions of FSP FAS 115-1 and believes the impact will be immaterial on its overall results of operations or financial position.

Item 3. Quantitative And Qualitative Disclosures About Market Risk

The Company is exposed to market risk, which is the potential economic loss principally arising from adverse changes in the fair value of financial instruments. The major components of market risk affecting us are credit risk, equity price risk and interest rate risk.

As of September 30, 2005, there had not been a material change in any of the market risk information disclosed by the Company under Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in its Annual Report on Form 10-K for the year ended December 31, 2004.

Item 4. Controls And Procedures

As of the end of the period covered by this quarterly report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Chairman and Chief Executive Officer (“CEO”) and the Executive Vice President and Chief Financial Officer (“CFO”), of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Securities Exchange Act Rule 13a-15 (“Disclosure Controls”).

The Company’s management, including the CEO and CFO, does not expect that its Disclosure Controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

In August, 2005, management concluded a “significant deficiency” existed in the Company’s Disclosure Controls. Subsequently, management implemented corrective actions to enhance the Company’s Disclosure Controls. Based on management’s evaluation of the Company’s Disclosure Controls as of September 30, 2005, management concluded that they provide reasonable assurance that information required to be disclosed by the Company in its periodic reports is accumulated and communicated to management, including the CEO and CFO, as appropriate to allow timely decisions regarding disclosure and is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There were no changes in the Company’s internal control over financial reporting during the Company’s most recent fiscal quarter that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II: OTHER INFORMATION

Item 1. Legal Proceedings

The Company’s subsidiaries are regularly engaged in the defense of claims arising out of the conduct of the insurance business. The Company does not believe that such litigation, individually or in the aggregate, will have a material effect on its consolidated financial condition or results of operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits


3.1		Amended and Restated Articles of Incorporation of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the Securities and Exchange Commission “SEC” on September 4, 2004.)

3.2		Amended and Restated Code of Regulations of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the SEC on September 4, 2004.)

10.1		Consulting Agreement, dated September 20, 2005, between the ProCentury Corporation and Charles D. Hamm, Jr.

31.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act

31.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act

32.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)

32.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)

(1) These certifications are not deemed to be “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section. These certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates them by reference.

SIGNATURE

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


	PROCENTURY CORPORATION
Date: November 10, 2005	By:	/s/ Erin E. West
		Erin E. West
		Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer)

EXHIBIT INDEX


3.1		Amended and Restated Articles of Incorporation of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the Securities and Exchange Commission (“SEC”) on September 4, 2004.)

3.2		Amended and Restated Code of Regulations of ProCentury (Incorporated by reference from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2004, filed with the SEC on September 4, 2004.)

10.1		Consulting Agreement, dated September 20, 2005, between the ProCentury Corporation and Charles D. Hamm, Jr.

31.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act

31.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act

32.1		Certification of Principal Executive Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)

32.2		Certification of Principal Financial Officer pursuant to Rule 13a-14(b) of the Exchange Act and 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (1)