REPORT ON EXAMINATION AS TO THE CONDITION OF PRINCETON

REPORT ON EXAMINATION AS TO THE CONDITION OF PRINCETON INSURANCE COMPANY PRINCETON, NEW JERSEY 08540 AS AT DECEMBER 31, 2005 N.A.I.C. GROUP CODE 1210 N.A.I.C. COMPANY CODE 42226 TABLE OF CONTENTS Salutation................................................................................................ Scope of the Examination.... .......... .... .... .... ...... ........ ......... .... ...... ........ .... ... .... Compliance with Prior Examination Report Recommendations.............................. History and Kind of Business. ... ...... ....... ..... ...... ...... ...... ...... ............ ....... ..... .... Statutory Deposits.. ........ ...... .......... ..... ... ...... ....... ..... ...... ............ ...... ...... ...... Territory and Plan of Operation....... ... ... ...... .... ........ .... ..... ............. ..... ... .... ..... Corporate Records. .......... ...... ..... ... ....... ..... ...... .... ... ... ..... ... ......... ......... .... ... Management and Control.............................................................................. Reinsurance and Retention............. ... ... ......... ...... ...... ..... .... ....... ..... .... ..... ....... Regulation ofInsurance Holding Company Systems. ....... ..... ...... ... ...... ...... ....... .... Inter-Company Agreements........................................................................... Policy on Conflict of Interest......................................................................... Employee Welfare and Pension Plan................................................................ Fidelity Bond and Other Insurance Coverages.................................................. ... Policy Forms and Other Underwriting Practices.... ...... ...... ... ...... .......... ........... ... Accounts and Records.... ............ .... ... ..... .... ..... ... ... .... ..... ... ... .... ...... ......... .... Advertising and Sales Material...................................................................... Treatment of Policyholders........................................................................... Continuity of Operations.............................................................................. Financial Statements and Other Exhibits:....... ......... ...... ...... .... ...... ..... .......... ..... Exhibit A - Balance Sheet at December 31, 2005 and December 31, 2002................... Exhibit B - Summary of Operations for the Three Year Period Ending December 31, 2005..................................................... ................ Exhibit C - Capital and Surplus Account for the Three Year Period Ending December 31, 2005. ...... ... ... ...... ... .... ..... ...... ...... ...... ... ...... ........... Notes to the Financial Statements............. .... ... ........ ...... ...... ...... ... ............ .... ... Summary of Recommendations..... ........... ......... ...... ......... ...... ....... ..... ... ....... ... Subsequent Events. ......... ......... ............... .... ............... ..... ...... ............ ....... ... Conclusion................ ......... ......... ... ...... ....... ........... .... ...... ........... .... ..... .... Certification............................................................................................. 1 2 3 10 12 12 15 15 18 21 23 24 24 25 26 27 28 28 28 29 30 31 32 33 37 38 39 40 ~tatt of Ntw Jtr.&tU STEVEN DEPARTMENT OF BANKING AND INSURANCE PO Box 325 TRENTON, NJ 08625-{)325 JON S. CORZINE M. GOLDMAN Governor TEL (609) 292-5360 Commissioner June 21, 2007 Honorable Steven M. Goldman Commissioner of Banking and Insurance State of New Jersey PO Box 325 Trenton, New Jersey 08625 Commissioner: In accordance with the authority vested in you by the Revised Statutes of New Jersey (N ..J.s.A.), an examination has been made of the assets, liabilities, method of conducting business and other affairs of the: PRINCETON INSURANCE COMPANY 746 Alexander Road Princeton, New Jersey 08540 N.A.I.C. Group Code 1210 N.A.I.C. Company Code 42226 hereinafter referred to as the "Company" or "Princeton". Visit us on the Web J.t www,njdobi.org New Jersey is an Equal Opportunity Employer • Printed on Recycled Paper and Recyclable SCOPE OF EXAMINA TION This financial condition examination was called by the Commissioner of Banking and Insurance of the State of New Jersey pursuant to the authority granted by Section 17:2322 of the New Jersey Revised Statutes. The examination was a full scope comprehensive examination and was conducted at the Company's home office located at 746 Alexander Road, Princeton, New Jersey. The examination was made as at December 31, 2005, and addressed the three-year period from December 31, 2002, the date of the last financial condition examination. During this three-year examination period, the Company's assets decreased from $1,025,240,820 to $1,002,388,693. Liabilities decreased from $918,002,224 to $830,249,742 and surplus as regards to policyholders increased from $107,238,596 to $172,138,951. The conduct of the examination was governed in accordance with the procedures of the National Association of Insurance Commissioners (NAIC) and followed regulatory procedures prescribed or permitted by the New Jersey Department of Banking and Insurance. In determining the emphasis to be placed on specific accounts, consideration was given to the Company's system of internal control, the nature and size of each account, its relative importance to solvency and the results of the analytical reviews performed within the New Jersey Department of Banking and Insurance and by the examination staff. The examination notes that the significant cycles specific to the audit of Princeton include the premium, loss, reinsurance and investment cycles. The material balance sheet accounts included within these cycles and the examination's assessment of emphasis to be placed on each of these accounts is outlined as follows: Account Emphasis Level Medium Medium Medium Medium Medium Medium Medium Medium Medium Medium Medium Medium Medium Medium Medium Losses Loss Adjustment Expenses Premiums and Agents' Balances in Course of Collection Premiums, Agents' Balances and Installments Booked But Deferred and Not Yet Due Contingent Commissions and Other Similar Charges Unearned Premiums Advance Premiums Amounts Withheld or Retained by Company for Account of Others Amounts Recoverable from Reinsurers Agg. Write-ins for Other Than Invested Assets - Receivable from Others Ceded Reinsurance Premiums Payable Funds Held by Company Under Rein~urance Treaties Bonds Preferred Stocks Common Stocks 2 Account Real Estate - Properties Occupied by the Company Cash and Short-tenn Investments Investment Income Due and Accrued Emphasis Level Medium Medium Medium Other forepart items reviewed during this examination included the following: History and Kind of Business Territory and Plan of Operation Reinsurance and Retention Insurance Holding Company System Corporate Records Management and Control Policy on Conflict of Interest Fidelity Bond and Other Insurance Coverages Accounts and Records Employees' Welfare and Pension Plans Treatment of Policyholders Continuity of Operations The control risk level will ultimately determine the amount of emphasis placed on each account. Based on our review of Exhibit B, discussions with the Department's EDP Consultant concerning the completion of Exhibit C by the Company, the cycle questions and verification of Company responses to these questions on a test basis, the intended reliance on the Company's control environment has been determined to be medium. The examination report, contained herein, will address significant balance sheet accounts and, if necessary, comment on those accounts which involve departures from laws, regulations or rules, or which are deemed to require special explanation or description. COMPLIANCE WITH PRIOR REPORT ON EXAMINATION RECOMMENDATIONS Compliance With Prior Report Examination Findings Continuity of Operations 2002 Examination Recommendation The Company should formalize, test and distribute to designated employees a business continuity and disaster recovery plan. Company Response The Company indicated in their response that they have contracted with SunGard, Inc. for the next three years for a hot site and to assist Princeton with the development of a 3 comprehensive disaster recovery and business continuity plan. The first stage of this process has been completed including a formalized custom disaster recovery plan utilizing SunGard's pre-recovery program. Two test dates have been included for 2004 8 hrs on June 23rd and 16 hours on October 18th • The first of these tests has been successfully completed and the resulting documentation assembled. 2005 Examination Findings The examination notes that the Company has a disaster recovery plan in place as of December 31, 2005, however Princeton does not have a formal, written business continuity plan in place as of the examination date. It is again recommended, as was in the prior examination report, that the Company formalize, test and distribute to designated employees a business continuity plan. Accounts and Records 2002 Examination Recommendation The Company should ensure that its developed procedures for escheating unclaimed funds are updated annually to include any revisions to N.J.S.A. 46:308-16. Company Response The Company has reviewed and updated their procedures for escheatment of funds to include revisions to NJ.s.A. 46:308-16. The New Jersey regulations will be reviewed annually to ensure that all future revisions are incorporated into the Company's procedures. 2005 Examination Findings The Company now formally reviews its escheatment procedures on an annual basis to ensure that they are in compliance with the provisions of N.,l.S.A. 46:308-16. Reinsurance Payable on Paid Loss and Loss Adjustment Expenses 2002 Examination Recommendation It was again recommended the Company settle reinsurance payables due to the Hospital Trust for Workers' Compensation in a timely manner. Company Response The Company will settle future Hospital Trust reinsurance payables no more than sixty days after the end of each quarter. 2005 Examination Findings A review of documentation supporting settlement of the Company's 2005 outstanding reinsurance balances payable indicated that settlement was not completed within 60 days of calendar year end. It is again recommended that the Company settle reinsurance balances payable due to the Hospital Trust for Workers' Compensation in a timely manner. 4 Territory and Plan of Operation 2002 Examination Recommendation It was recommended the Company prepare a written contract with all reinsurance intermediaries outlining the responsibilities of the reinsurance intermediaries as indicated in N..J.S.A. 17:22E-6. Company Response The Company states that they currently have executed written contracts with all active reinsurance intermediaries. 2005 Examination Findings The Company entered into a broker authorization contract with its reinsurance intermediary, Benfield, Inc. on January 12, 2004. This written contract contains the applicable clauses and wording which puts the Company in compliance with the provisions ofN.,l.S.A.17:22E-6. Reinsurance and Retention 2002 Examination Recommendation The reinsurance contract covering medical hospital and physician liability on Liberty Health Care Systems, Inc. policies was endorsed by both parties over nine months after the effective date of the reinsurance contract. In accordance with SSAP #62.23, any reinsurance agreement signed after nine months from the effective date must be accounted for as retroactive reinsurance. It was recommended the Company account for this reinsurance agreement as retroactive reinsurance and have all reinsurance agreements signed within nine months from the effective date of the reinsurance agreement in accordance with SSAP #62.23. Company Response Princeton will ensure that all future reinsurance agreements are signed within nine months of the corresponding effective date. 2005 Examination Findings The appropriate parties have executed all reinsurance agreements in force at December 31,2005 within nine months from the effective date of the reinsurance agreement. Management and Control 2002 Examination Recommendation Since the Company's Certificate of Incorporation continues to list Donald E. Smith as the registered agent upon whom process may be served, it is recommended the Company subsequently revise its Certificate of Incorporation to reflect a compulsory change in the registered agent upon whom process may be served. 5 Company Response Princeton has initiated action to comply with this recommendation and wiU present a board resolution at the next regularly scheduled Board of Directors meeting. Subsequent to that meeting, the Certificate of Change of Registered Agent wiD be filed as required. 2005 Examination Findings The Company is in compliance with the recommendation. During the first quarter of 2006, the Company submitted an amended and revised Certificate of Incorporation that reflected a compulsory change in the registered agent upon whom process may be served. Policy on Conflict of Interest 2002 Examination Recommendation It was recommended the Company revise its policy statement on conflict of interest to reflect that the Company's Vice President and General Counsel reviews all completed conflict of interest questionnaires. Company Response Princeton will revise its current policy to reflect the review of completed conflict of interest questionnaires by the Company's Vice President and General Counsel. 2005 Examination Findings The Company did comply with this recommendation. The Company's policy statement on conflict of interest was amended in 2005 to include the statement that aU completed conflict of interest questionnaires shall be submitted to the Vice President and General Counsel of Princeton Insurance Company. 2002 Examination Recommendation It was recommended by this examination that the Company improve its record keeping of all completed conflict of interest questionnaires so that they will be available for review in subsequent examination periods. ' Company Response The Company will revamp its record keeping system to ensure that all completed questionnaires are readily accessible. 2005 Examination Findings The examination found the Company to be in compliance with this recommendation. The examination requested from the Company and was provided with all completed director, officer and key employee conflict of interest questionnaires for the current period under examination. 6 Bonds and Stocks 2002 Examination Recommendation It was recommended the Company revise its custodial agreement with Mellon Bank, NA to include a clause for the replacement of securities or the value of such securities (including the loss of rights and privileges) as a result of the custodian's loss of securities. Company Response The Company has had discussions with Mellon Bank, NA and is in the process of updating its custodial agreement to in~lude the recommended clause. 2005 Examination Findings A review of the Company's current custodial agreement with Mellon Bank, NA notes that the agreement contains the proper indemnification clause concerning the replacement of securities as a result of custodian negligence, dishonesty, theft, etc. Reinsurance Recoverable on Loss and Loss Adjustment Expense Payments 2002 Examination Recommendation It was recommended the Company list each L10yds Syndicate separately on Schedule FPart 3 of their annual statement and indicate the status (authorized or unauthorized) of each Syndicate in Schedule F. Company Response Princeton will comply with this recommendation in future annual statement Schedule F statutory filings. 2005 Examination Findings The Company is in compliance with this recommendation, as a review of the 2005 annual statement Schedule F-Part 3 now lists each Lloyd's Syndicate separately and classifies each Syndicate as either authorized or unauthorized. Equities and Deposits in Pools and Associations 2002 Examination Recommendation It was recommended the Company record premiums, losses and expenses from underwriting pools and associations in the same fashion as any other reinsurance agreement in accordance with SSAP No. 63-8. Company Response The Company acknowledges that it will comply with this recommendation in future statutory filings. 2005 Examination Findings The Company is in compliance with the above recommendation as of December 31, 2005. 7 Loss and Loss Adjustment Expense Reserves 2002 Examination Recommendations It was recommended that the Company maintain loss and loss adjustment expense reserves at a level adequate to meet its incurred loss and loss adjustment expense obligations. Company Response Princeton has taken steps to significantly improve its reserve position in two areas: 1. Princeton implemented operational and procedural changes within the Claims Department which have precipitated a more conservative approach in setting individual case reserves. These changes generated reserve strengthening and earlier recognition of ultimate losses. Note that Spinella and Associates' final actuarial report stated that 'Preliminary analysis of PIC's closed-claim transaction database provides strong, though not conclusive, evidence of a stronger reserving attitude currently than has existed during the past decade'. 2. Princeton has also adopted a more conservative reserving posture in recording bulk reserves. At December 31, 2003, Princeton recorded reserves consistent with the point estimate of its independent actuary, Milliman USA. During 2003, Princeton booked $58 million of additional reserves for incurred year 2002 and prior. 2005 Examination Findings The examination has contracted with the independent actuarial consulting firm (MBA Actuaries, Inc.) to perform an actuarial review as to the reasonableness of Princeton's loss and loss adjustment expense reserves as of December 31, 2005. Their findings have been summarized and documented under the examination section entitled Notes to Financial Statements under the note for Loss and Loss Adjustment Expense Reserves. 2002 Examination Recommendation To provide insight into the Company's claim reserving procedures and to aid in the actuarial analysis of the Company, the NJDOBI utilized the services of Spinella & Associates, Inc. to perform a comprehensive claims operational audit on the Company's claim handling and claims administration. The following is a list of some of the observations and recommendations noted from this audit: • It was recommended the Company improve its claims administration of expense reserves and revise its expense reserve guidelines to ensure proper assessment of claims expense reserves. It was recommended the Company reduce the claim consultant caseload to a more reasonable 140 to 150 claims per consultant. It was recommended the Company produce additional reports which can be beneficial and aid in the Company's claims administration and analysis. • • 8 Company Response Regarding the Spinella and Associates recommendations, the Company offers the following responses: • • • Princeton is currently revISIng its expense reserving process based on recommendations from its consulting actuaries. Princeton has added additional staff, reduced case loads, and will continue to address this issue through the remainder of 2004. Princeton is continually accessing its reporting process to accommodate current needs and requirements. 2005 Examination Findings The examination found the Company to be in compliance with the recommendations resulting from the Spinella and Associates claims operational audit. Contingent Commissions and Other Similar Charges 2002 Examination Recommendation It was recommended that the Company review the amount of commissions payable due to agents and write-off commissions payable on those policy premiums non-admitted and subsequently written off. Company Response The Company has established procedures and initiated a process to review and write-off all subject balances. 2005 Examination Findings The Company is in compliance with this recommendation, as it now properly writes off commissions payable associated with any policy premiums that have been non-admitted and subsequently written off. Provision for Reinsurance 2002 Examination Recommendation It was recommended the Company only record letter of credit amounts in effect as of the financial reporting date. Company Response Princeton will ensure that all letters of credit reported in future Schedule F statutory filings are in effect as of the reporting date. 2005 Examination Findings The examiner noted the correct reporting of letter of credit amounts in the Company's 2005 annual statement Schedule F. 9 HISTORY AND KIND OF BUSINESS The Princeton Insurance Company filed for incorporation on December 3, 1981 under and pursuant to the provisions of Chapter 17 of the Revised Statutes of the State of New Jersey. The Certificate of Incorporation was approved by the Deputy Attorney General of the New Jersey on January 12, 1982 and filed with the Department of Insurance on January 16, 1982. The Company was officially incorporated on January 16, 1982, with active business operations commencing on February 1, 1982. The Company was originally Cormed to write non-assessable medical malpractice coverage for physicians, dentists and other health care providers in an effort to combat the medical malpractice crisis in New Jersey. The Company's former sole shareholder, Nassau Holding Company, approved an amended and restated Certificate oC Incorporation on December 22, 1995. This approved amendment was filed and approved by the New Jersey Department of Banking and Insurance (NJDOBI) on March 18, 1996. The amendment revised the "Third", "Fourth" and "Fifth" Articles oC the Company's original Certificate oC Incorporation. At the Company's inception, all of issued and outstanding shares of common capital stock were owned by the Nassau Holding Company, a non-insurer downstream holding company. Nassau Holding Company was a wholly-owned subsidiary of the Health Care Insurance Company, Princeton's ultimate parent. The Health Care Insurance Company, originally known as the Health Care Insurance Exchange, was organized as a reciprocal inter-insurance exchange concurrent with the incorporation of its attorney-in-Cact, NJHA Underwriters, Inc., a not-for-profit corporation on November 3, 1975. The Certificate of Incorporation was duly filed and recorded by the Secretary of State and the Mercer County Clerk on November 6, 1975. The Health Care Insurance Company would offer medical malpractice insurance to New Jersey hospital and other health care institutions. On January 1, 1991, the Health Care Insurance Exchange reorganized from a reciprocal inter-insurance exchange to a stock insurance company. A re-capitalization plan was developed and implemented during 1999 and 2000 in an effort to simplify the capital structure of the Health Care Insurance Company. The recapitalization plan involved the formation of the Princeton Insurance Company Merger Corporation (PICMC) and the Princeton Insurance Holdings, Inc., a new holding company. Princeton Insurance Holdings, Inc. was formed under the laws of the State of Delaware on December 10, 1999 and became the sole owner (shareholder) of PICMC. PICMC filed a Certificate of Incorporation with the Commissioner of Banking and Insurance on December 29, 1999. The re-capitalization plan was authorized by the Commissioner on January 21, 2000 and a Certificate of Authority was issued to PICMC to write the kinds of insurance authorized by paragraph "e" of N.,J.S.A. 17:17-1. Ultimately, PICMC merged into the 10 Health Care Insurance Company under an Agreement and Plan of Merger, and Princeton Insurance Holdings, Inc, became the ultimate parent, On February 15,2000, in accordance with the provisions of N,J.S.A. 17:27A-2, the Medical Liability Mutual Insurance Company ("MLMIC") filed an application with the New Jersey Department of Banking and Insurance to acquire control of the Health Care and Princeton Insurance Companies. On September 12, 2000 the Commissioner of Banking and Insurance, Karen L. Suter, signed an Administrative Decision and Order approving the acquisition of Health Care and Princeton Insurance Companies by MLMIC. The acquisition was completed with the merger of the MLMIC Holding Company (a corporation established for the purposes of completing this merger transaction) and Princeton Holdings, Inc. Under the merger, Princeton Holdings, Inc. emerged as the surviving corporation, but was renamed MLMIC Holding Company, Inc. In accordance with the merger agreement, all Class A common stock of Princeton Holdings, Inc. was canceled, retired and terminated. The Board of Directors and sole shareholders of the Princeton and Health Care Insurance Companies approved an Agreement of Merger (Merger) on November 13,2001, whereby at 12:00 noon on December 31, 2001, the Health Care Insurance Company (HCIC) would merge with and into Princeton, the separate existence of HCIC would cease, and Princeton would continue as the surviving corporation under the name Princeton Insurance Company and be governed by the laws of New Jersey. This Agreement of Merger was submitted to the NJDOBI for approval, and a certificate of approval was issued by Donald Bryan, the Acting Commissioner of Banking and Insurance, on November 8, 2001. The merger was effectuated on December 31, 2001. At the completion of the merger, the cancellation and conversion of securities was as follows: "The shares of common stock in Princeton issued to Nassau Holding Company, the shares of common stock in Nassau Holding Company issued to HCIC and the shares of common stock in HCIC issued to MLMIC Holding Company, Inc. shall all be cancelled. Each share of common stock of HCIC owned by MLMIC Holding Company, Inc. immediately prior to the merger shall be converted automatically upon the merger into four and two-tenths (4.2) fully paid and non-assessable shares of common stock in Princeton, which shares shall constitute all the issued and outstanding shares of the common stock of Princeton immediately following the merger, and thereafter." As a result of the merger, the Company filed a Second Amended and Restated Certificate of Incorporation on November 13, 2001 with the NJDOBI. This amended Certificate of Incorporation was approved by the Attorney General of New Jersey on December 20, 2001 and filed with the NJDOBI on December 26, 2001. Under the revised Certificate of Incorporation, the Company's principal office is located at 746 Alexander Road, P.O. Box 5322, Princeton, New Jersey and the agent upon whom process may be served is Donald E. Smith. The Company shall have $4,200,000 of common capital stock, consisting of 42,000 shares at a par value of $100 per share. II On March 28, 2002 the NJDOBI approved and the Company received a cash infusion of $40,000,000 from its ultimate parent, MLMIC in the form of a surplus note pursuant to a Form D filing in accordance with N.J.s.A. 17:27A-4a(2). The note will mature on March 29, 2012 and will earn 6% interest annually. All interest payments are subject to approval by the NJDOBI. As of the examination date, there have been no approvals of interest payments by the NJDOBI and the Company has not made any interest payments on this note. The Company made a decision in calendar year 2002 to exit its small risk workers' compensation program that was administered by one of its wholly-owned subsidiaries, The Princeton Agency, Inc. On December 30, 2002 Princeton Insurance Company entered into an agreement to sell The Princeton Agency and the renewal rights to its Small Risk Workers' Compensation business to AmTrust Financial Services. Effective January 1, 2003, for a period of five years, Princeton shall receive 2 percent of the gross premium relating to new and renewal business of AmTrust. On March 4, 2003 the Princeton Insurance Company fIled a request with the NJDOBI to withdraw from writing Business Owner Protection insurance in New Jersey, citing a reduction in its business capacity due to the overall deterioration in the Company's financial condition, among other reasons. On May 20, 2003, the NJDOBI issued Consent Order No. C03-105 approving this withdrawal. Per the Company's amended Certificate of Authority dated August 25, 1997, the Princeton Insurance Company is authorized to engage in the kinds of insurance as specified in paragraphs "a", "b", "e", "r t , "g", "j", "k", "I", "0_1" and "0_3" ofN ..I.S.A.17:17-1 et seq. STATUTORY DEPOSITS The following statutory deposits are registered with the Commissioner of Banking and Insurance of the State of New Jersey, as trustee, and are being held in trust for the benefit and security of all the policyholders of Princeton Insurance Company: US Treasury Note, 6.125%, due 8/15/07 US Treasury Note, 3.50%, due 11/15/06 Total TERRITORY AND PLAN OF OPERATION The Company is licensed to transact business in 16 states and the District of Columbia as of December 31, 2005. The Company made a business decision in the first quarter of 2003 to cease writing new and renewal business in all states outside of New Jersey and to withdraw from writing small business workers' compensation countrywide. Princeton changed it~ overall business plan to focus its premium writings on its core book of business - medical malpractice insurance within the State of New Jersey. $2,100,000 245,000 $2.345.000 12 Princeton Insurance Company is a domestic for-profit stock property-casualty insurance company. Organized in 1982, it was originally formed to write non-assessable coverage for individual health care providers in New Jersey. The Company has gradually expanded its product lines and territories. As of December 31, 2005, the Company wrote the following lines of business: commercial multiple-peril, medical malpractice (occurrence and claims-made), other liahility (occurrence and claims-made), commercial auto liability, auto physical damage and surety. The Company also assumes coverage for fire, allied lines, commercial multipleperil, medical malpractice claims-made, workers' compensation, commercial auto liability, auto physical damage, burglary and theft and non-proportional reinsurance. Year 2003 2004 2005 Gross Direct Premiums Written $274,896,938 234,264,068 223,648,330 Gross premiums written in 2005 were allocated among the following lines of business: Lines of Business Written Medical Malpractice - Claims Made Medical Malpractice' Occurrence Other Liability - Occurrence Commercial Multiple Peril All Other Lines Total Gross Direct Premiums Written $188473,584 22,384,067 10,364,765 2,618,578 (92664) $223,648,330 Princeton has no career agents, but rather markets its product predominately through a network of approximately 96 independent contract agents. The Company utilizes an agency contract for individual risks and a broker's contract for institutional risks. The Company utilizes direct billing procedures, and had no MGA relationships in place as of December 31, 2005. Princeton maintains various service agreements with vendors who are not affiliated with the Company. These include the following: • A Claims Servicing Agreement with Integrated Claims Strategies, Inc. (ICS), a Florida corporation, that was entered into on January 28, 2002. Under the terms of this agreement, ICS agrees to perform all facets of workers' compensation claims servicing and handling including accepting and servicing all claims and loss reports, investigating claims, establishing claim files and providing a liaison between ICS and Princeton. The Agreement shall cover all workers' compensation claims as outlined in Addendum A of the Agreement which were reported during the 24 month period commencing March 1, 2002 and ending February 28, 2004. 13 • • • A Claims Servicing Agreement with Crawford & Company (C&C) that was entered into on May 12, 1999 and which provides certain services with respect to the investigation and payment of workers' compensation insurance claims. Under the terms of this agreement, C&C agrees to provide all services as outlined within the agreement to the insurer in connection with the insurer's claims occurring under policies in the states of Connecticut, Delaware, Georgia, Illinois, Indiana, Maryland, North Carolina and Virginia during the period commencing May 12, 1999 and ending May 11, 2000. C&C wiII provide the Company with a monthly claims report. In return for services rendered by C&C, Princeton agrees to pay C&C various servicing fees as prescribed and outlined in Exhibit B of the Claims Service Agreement. A Recovery Services Agreement entered into on December 22, 2003 between SunGard Recovery Services LP and Princeton Insurance Company that provides computer recovery services by SunGard to Princeton in the event of a disaster, which is dermed as "any unplanned event or condition that renders Subscriber (Princeton) unable to use a Location for its intended computer processing and related services". Within this agreement are various schedules which specify a Subscriber location ("Location"), the recovery services to be provided by SunGard to Subscriber for that Location ("Recovery Services"), the fees to be paid Subscriber to SunGard for those services, and any other applicable terms. Recovery services as outlined in this agreement generally include center based recovery services as they relate to Work Group Space and MegaVoice and Mobile Recovery Services (Replacement Recovery System). The term of this Agreement shall commence on December 22, 2003 and continue for a period of 36 months where, thereafter, the agreement shall automatically renew for successive one (1) month renewal terms, not to exceed six (6) consecutive one-month renewal terms, unless either party gives written notice of termination to the other at least thirty (30) days before the end of the then current term. A Securities Lending Agreement with Mellon Bank, NA. This Agreement, entered into by the parties on April 4, 1997, authorizes Mellon Bank (the "Lending Agent") to establish, manage and administer a Securities Lending Program in accordance with the provisions of the Lending Agreement and with respect to the lendable securities held by Princeton Insurance Company Client (''the Client"). The Lending Agent shall have the responsibility for negotiating the terms of each loan and, for collecting all required collateral, whether in the form of cash, U.S. government securities, irrevocable letters of credit issued by banks independent of the Borrowers or other forms approved by the Client for use as collateral (the "Collateral"), on behalf of the Client. The Lending Agent shall also have authority to do or cause to be done all acts by and on behalf of the Client as it shall determine to be desirable, necessary or appropriate to implement and administer the Program. By the close of the business day on which the securities are delivered to the Borrower, the Lending Agent shall obtain from such Borrower Collateral in an amount equal, as of such date, to 102% in the case of securities of United States issuers, and 105% in the case of securities on non-United States issuers, of the market value of any securities loaned, including any accrued interest. 14 The Company conducts it~ everyday business operations from its statutory home and main administrative office located at 746 Alexander Road, Princeton, NJ 08540. These operations include cash and investment management, underwriting and claims handling, among others. Princeton maintains an in-house claims department which handles the notification, processing, adjusting and payment of New Jersey physician claims, hospital claims and workers' compensation claims. Open workers' compensation claims outside the state of New Jersey are handled by one of two independent third party administrators (Crawford & Company and Integrated Claims Strategies, Inc.) under the terms and conditions of claim servicing agreements with each of these third party administrators. Princeton also maintains two field offices in Hunt Valley, Maryland and Downers Grove, Illinois, which deal predominately with the run-off of small business workers' compensation claims. CORPORATE RECORDS A review of the minutes of the Board of Directors, Audit Committee and Finance Committee indicated that all meetings were well attended. The Company's Board of Directors meets five times per year. The examination noted that the proceedings at each meeting were done in compliance with Princeton's state charter and By-laws. The Board minutes also indicated that the Company's overall transactions and events were adequately supported and approved. A review of the signed affidavits by each member of the Board indicated that he or she had received and reviewed a copy of the December 31, 2002 f"mancial condition examination report. MANAGEMENT AND CONTROL The business, property and affairs of the Princeton Insurance Company shall be conducted and managed under the guidance of the Company's Board of Directors. Directors Princeton's amended and restated By-laws specify that the Board of Directors shall consist of at least nine (9) but no more than twenty-one (21) members. At least one-third of directors serving in this capacity must not be officers or employees of the Company or any entity controlling, controlled by, or under common control with the Company, and who are not beneficial owners of a controlling interest in the voting stock of the Company (i.e. "Outside Directors"). Each director shall be elected by the Shareholders at their annual meeting in May. Directors can be removed from office upon a majority vote of shareholders, and any director vacancies may be filled by a shareholder's majority vote. Any director may resign at any time upon written notice to the Company. Any person appointed to fill a vacancy will hold office until the next annual election of Directors. 15 In addition to the Annual Meeting, the Board is required to have at least three scheduled quarterly meetings per year. Regular meetings of the Board may be held with or without notice at such time and at such place as shall be determined by the Board. Special meetings of the Board may be called by the Chairman or any four (4) Directors on ten (10) days notice. The notice is not required to specify the purpose of or business to be transacted at the meeting. At all meetings of the Board of Directors, a majority of Directors then in office shall constitute a quorum for the transaction of business provided the quorum consists of at least one Outside Director. A listing of the nine directors serving the Company at December 31, 2005, with their principal occupation and current home or business address, is presented as follows: Principal Occupation Kenneth Aitchison Retired from Healthcare Industry Government Consultant BusinesslResidential Address 74 Kahdena Road Morristown, NJ 07960 117 West End Avenue Somerville, NJ 08876 205 West End Avenue New York, NY 10023 82 Susan Drive Newburgh, NY 12550 221 Mill Road New Canaan, CT 06840 53 Sydney Court Atlantic Highlands, NJ 07716 4045 Bristol Road Clinton, NY 13323 Raymond H. Bateman John F. Dwyer, MD Stanley L. Grossman, MD Retired Physician Retired Physician Harold Herzog Retired from Finance Industry Retired from HeaIthcare Industry Retired Physician Keith McLaughlin Robert A. Menotti, MD Andrew H. Patterson, MD Physician and President of Medical Liability Mutual Insurance Company Semi Retired; at times serves as Interim President of Raritan Valley Community College 2 Park Avenue New York, NY 10016 Richard F. Schaub 128 Bermuda Drive Neshanic Station, NJ 08853 16 The Company's By-laws stipulate that the Board of Directors shall establish an Audit and Compensation Committee consisting entirely of Outside Directors_ The duties and functions of this Committee shall include, but not be limited to, recommending the selection of independent certified public accountants; reviewing the Company's fmancial condition; reviewing the scope and results of independent CPA or internal audits; nominating director candidates for election by Shareholders; evaluating the performance of Company officers and recommending to the Board of Directors the selection and compensation of Company officers. Members serving on the Audit and Compensation Committee at December 31, 2005 were as follows: Kenneth Aitchison, Chairman John F. Dwyer, MD Keith McLaughlin Additionally, the Company's By-laws allow for the establishment of one or more other committees consisting of directors appointed by a majority vote of the entire Board. For each such adopted committee, at least one-third of the directors serving on that committee shall be Outside Directors. At December 31, 2005 the Company maintained a Finance Committee consisting of three members whose responsibilities include reviewing investment guidelines and evaluating and approving investment portfolios and/or results. The members serving on this Committee at the examination date were as follows: Richard F. Schaub, Chairman Harold Herzog Andrew H. Patterson, MD Princeton is required to comply with the provisions of N.J.8.A. 17:27A-4d(3) which states that "not less than one third of the directors of a domestic insurer shall be persons who are not officers or employees of that insurer or of any entity controlling, controlled by, or under common control with, that insurer and who are not beneficial owners of a controlling interest in the voting securities of that insurer or any such entity." The examination notes that the Company is in compliance with the provisions of this statute, as the Board of Directors consists of nine members, of which eight members are considered Outside Directors. The Company is also required to comply with the provisions of N.J.S.A. 17:27A-4d(4) which states that "the board of directors of a domestic insurer shall establish one or more committees comprised solely of directors who are not officers or employees of the insurer or of any entity controlling, controlled by, or under common control with, the insurer and who are not beneficial owners of a controlling interest in the voting securities of the insurer or any such entity." The Company was determined to be in compliance with the provisions of this statute as of the examination date, as the Audit and Compensation Committee is comprised solely of Directors who are not employees or controlling shareholders of the Company or any affiliate. 17 The Board of Directors has the power to fill the office of the Chairman; President; Vice President(s); Secretary; Treasurer and Other Officers as stipulated in Article IV of the Corporate By-laws. The Board may also designate additional offices to be served including one or more Assistant Secretaries and one or more Assistant Treasurers. All officers shall perform duties in the conduct and management of the business and property of the Company as designated by the Board. More than one person may hold an office of the same title, but the person serving as President may not serve simultaneously as Secretary. The following senior officers have been elected and were serving the Company as of December 31, 2005: Office William J. McDonough Andrea C. Kanefsky Charles W. Lefevre Stanley L. Grossman, MD Kiernan E. Pillion, Jr. President and Chief Executive Officer Senior Vice President, Chief Financial Officer & Treasurer Senior Vice President and Chief Operating Officer Secretary Vice President and General Counsel REINSURANCE AND RETENTION The Princeton Insurance Company has various external reinsurance agreements in force as of December 31, 2005. Those agreements in effect, the coverage provided and the maximum limits of reinsurance, are summarized in the following table: Business Covered and Tvpe of Contract HospitalJPhysician Medical Malpractice and General Liability, Reinrurance Limits 1d Excess of Loss (4I1J05 _ 411106) 2 Excess of Loss (411/05 - 411/06) 95 % COV£raRe for aU losses $5,000 000 excess of $1 000,000 100% co~e for all losses $10,000 000 excess 0($6,000 000 1" Excess of Loss (411104 - 411105) 2 100% covCI"a2e for all losses $S 000,000 excess of $1,000,000 95 % COVeI"a2e Excess of Loss (411104 - 4IIJ05 for aU losses $10,000 000 excess of $6,000,000 HospiJallJrnlividual Providen Med. Mal. and General Liabilir/ (Occurrencelclaims m.atkloccurrence plus policies effectiv. at 411103), 1st Excess of Loss (411/03 - 4/1/04) 2 Excess of Loss (41lJ03 - 4/1104) 95 % coverage for aU losses $4,000 000 excess of $2,000 000 97.5% coverae.e for alilo-sses $5,000,000 excess of $6,000,000 3 rt' Excess of Loss (4/1103 - 4111(4) 96.5% coverage for all losses $10 000,000 excess of $11 000,000 80% Quota share l!P.to $6,000,000 Ouota Share (effective 7/lJ02· cancelled 3/31/03) Physicians Occurrence Plus Tail Coverage: Excess of Loss·Coverage for 1987 through}997 Cancel Years Excess of Loss·Coverage for 1998 Cancellation Year $172,500,000 aggregate excess of $50,000,000 retention $31,745,000 lIt aggregate - .uu~~ ______ ~ _~~,, __ 18 BllSin~ Coyered and Tvoe of Contract _;;, Reinsur.mce Limits Quota Shan·Policies in Force as of 12/3U98 for $180,000,000 in aggregate those polices cancelled or not renewed after January 1.2001 Small Business Workers Compensation: In force and Renewal (100% quota shareIIIn(03) Old Business (100% quota share -12/31102 and ,,-rior) Business Office Policies - Property and General Liabilit>I' 110% (EP net of ceding com) pIlLS ULAE in the aggregate $102,500.000 (plus ULAE) in the aggregate 1>{ Excess of Loss (411105 - 41lJ06) 2 Excess ot Loss (411105 - 4/1106) Facultative Excen Physician Property: $250,000 excess 0($250,000 $500.000 excess ot $500 000 1- Excess ot Loss (411105 - 4111(6) Equipment Breakdown: $9 000.000 excess of $1 000 000 Quota Share 100% quota share up to $25 000,000 The Company maintains a Property Facultative Excess of Loss Binding Agreement with American Re-Insurance Company that provides coverage for all risk property and physical damage to business classified as Non-HPR hospitals, nursing facilities, clinics and the offices of physicians, surgeons and other health care professionals. The reinsurer's maximum limit of liability under this agreement shall be $9,000,000 each risk, each occurrence, with a Company retention limit of $1,000,000. Reinsurance ceded to other insurance companies as outlined in the above chart is done in the normal course of business. Reinsurance is ceded to permit the recovery of a portion of direct losses and to protect Princeton against excess losses on large risks; however, Princeton is liable for such reinsurance ceded in the event its reinsurers do not meet their obligations. Insurance liabilities are presented in the financial statements net of reinsurance ceded. In addition to the Company's participation and assumption of reinsurance from mandatory and voluntary insurance pools and associations (including NJCAIP, National Council of Compensation Insurance [NCCI], New Jersey Insurance Underwriter Association, Fair Plan New York and HCIF Excess Liability Pool), the Company also assumes reinsurance from the Hospital Trust for Workers' Compensation. The Hospital Trust for Workers' Compensation (the Trust) was created in cooperation with the Company to self-insure participating hospital workers' compensation insurance and employer's liability insurance under the authority of N ..I.A.C. 11:15. Workers' compensation and employer's liability insurance is assumed by the Company to the extent indicated below: Per Accident: Amounts in excess of the Trust's retention of $100,000 on loss indemnity payments. Loss adjustment expenses shall be shared in the proportion that the loss incurred by the reinsurer bears to the total amount of loss incurred by the Trust. 19 In Aggregate: The Company shall pay to the Trust the amount of losses and loss adjustment expense payments not reimbursed by the Company which exceed the participating hospital's percentage retention level (i.e. 40% or 80%) of its Trust contributions for the applicable agreement year and the amount of the Trust's investment income accrued on the applicable participating hospital's trust contributions. As of January 1,2002, the contract with The Hospital Trust for Workers' Compensation has no in-force business. Effective December 31, 2005, Princeton commuted their $1 million excess $1 million contract effective April 1, 2003 and expiring March 31, 2004, which covered certain medical malpractice and general liability claims. As a result of the commutation, Princeton booked a reinsurance paid loss of $5,759,000 offset by reinsurance IBNR of $4,831,000, resulting in a profit of $928,000. Effective January 1, 2003, Princeton entered into a reinsurance contract for their small business workers compensation program. This reinsurance contract was necessary due to the Company's decision to withdraw from its small business workers' compensation program effective December 31, 2002. This contract represented a loss portfolio transfer of all unpaid claim liabilities as of January 1, 2003, which is accounted for as a non-risk transfer. The initial cost for this first coverage was $96 million and was accounted for as deposit accounting on Princeton's balance sheet. In 2003, this contract exceeded the maximum aggregate of $102.5 million and therefore $6.5 million was recorded as other income to increase the recoverable to its aggregate. At December 31, 2005, Princeton's ending receivable balance, which is included in other admitted assets, was $31.8 million. This amount is down from $44.5 million in 2004 due to claim payment activity. Princeton's reinsurance program for its occurrence plus product, which includes activated tail coverage for insureds that terminated coverage on or before December 31, 1998, is reinsured with American Re-Insurance Company. For insureds that terminated coverage prior to December 31, 1997, Princeton retained liability for the first $50,000,000 of loss settled. American Re provides coverage for losses in excess of $50,000,000 up to $222,500,000. For insureds that terminated coverage during 1998, American Re provides ground up coverage up to an aggregate limit of $31,745,000. On November 29, 2000, Princeton entered into a Quota Share Reinsurance Agreement with MLMIC, effective January 1, 2001. Under the terms of this agreement, the Company ceded to MLMIC 100% of the aggregate ultimate losses settled on policies canceled or not renewed after January 1, 2001 for those policies in force as of December 31, 1998, subject to an aggregate overall limit of liability of $180,000,000. Princeton ceded an initial premium of $51,000,000 to MLMIC for this coverage and such premium is adjusted quarterly for annual renewals and is carried on a funds held basis. At December 31, 2005 and 2004 the funds held balance for this tail coverage was $80,665,000 and $86,703,000, respectively. 20 Reinsurance agreements were reviewed to ensure contracts had acceptable clauses and conditions, that they were in compliance with the provisions of SSAP No. 62 - Property & Casualty Reinsurance, and to ensure that the contracts exhibited proper transfer of risk. The examination noted that the contracts contained no unusual clauses or conditions, and that they were in compliance with the provisions of SSAP No. 62. The Company reported in its 2005 annual statement general interrogatories page that their largest net aggregate amount insured in anyone risk (excluding workers' compensation) was $1,250,000. A review of the Company's policy counts and premium summaries at December 31, 2005 indicated that the Company's largest net aggregate amount insured in anyone risk should have been reported as $2,250,000. The examination recommends that the Company update and amend its general interrogatories page to properly reflect their largest net aggregate amount insured in anyone risk. REGULATION OF INSURANCE HOLDING COMPANY SYSTEMS Princeton Insurance Company is a member of an insurance holding company system as dermed in N.J.S.A. 17:27A-1. Princeton is a whoUy-owned subsidiary of MLMIC Holding Company, a Delaware domiciled insurance holding company. Princeton's ultimate parent is the Medical Liability Mutual Insurance Company, a New York domiciled insurance company. Since the Company is a member of an insurance holding company system, it is subject to the various registration requirements of N.,J.S.A. 17:27A-3. One of these requirements stipulates that the Company must fIle an annual holding company registration statement with the New Jersey Commissioner of Banking and Insurance by April 1st of each calendar year. At December 31, 2005 it was determined by this examination that the Company did fIle the proper holding company registration statement in compliance with N.,l.S.A. 17:27A-3. The interrelationships of Princeton Insurance Company with its ultimate parent and various subsidiaries is outlined in the organization chart presented below: 21 Mediral LiabiJit,' Mutua! !nStlfil.Iiet Company FEIN 14·15i4861 New York NAIC 121()'34231 I I MLMIC Holding CompOlY, Inc. FEIN 5z.2257935 100% DE I OHIC Insurance Company 100% 011 FEIN 31.D92W59 NAIC 121()'35@ I HUM Mill"keting uoup, Inc. FEIN 1"1789101 100% NY I Professional Services Broker~, Inc.. 100% NY PrincetOD Insurance Company FEIN 22.2J86692 100% NJ NAIC 121().42226 Princeton Advertising & Marlering Groop, Inc. FEIN 2n015%5 100% NJ Princeton Ri~ Protection, Inc. FEIN J2. )085112 100% NJ Akundar Roal lruurl9,6.34 77.816,.130 0 R«t-in\llf (or S-.cwities [n."fMtJaeur 77,816.130 0 6,951$65 • • 0 0 0 0 0 0 0 8,871.750 -W.794,591 6.553.075 31,931,136 4.867,778 mcome D-u .... _",-ccneel 6.951,.565 33,747 13,.l78,8U 0 12.188.263 34.073 13.417.,2-49 599,928 1..578 11,992 0 41.307.139 1>.191.715 8..144,048 A,e.u' Balanus or [".ulk-ctell Pro.hullS: l"I1UUIfcttd Proti.." u.4 A&:na:ts' .B.al.ance! la C_rn ofCoUKtUa DfiHTe'Ii Prem.huas,A&~IItS· ~UlIlB4lIa::tallmeJlU 33,747 13,.278,.896 ItHkN B .. Dfierred aM. NM 'hot Dae- 7,788.,..J4S 0 12,625,.356 673M3 }.(,8}7,040 ACCnled retrHpectin pnllliJaas AIII.uats Recen..-.J.e fn. RdulU'US 0 11.188,26.3 ftutds Hdd r.y.,. Depeslted wttb Re.bastIHCI C.apaades ~IetDefHTMTU._~SK 34,078 13.,417.,249 599.918 • 0 Dc-rln.aic n.t. P~:5ia& ~ aJMII s.b"are ~t1: .-\.djlUtlHDtDae .. fereip ucftaJ.e Rate 1.578 11,992 0 Receiulile fro .. P~t. SU5idb.rles aM Affiliates Iquities ad ~it:5 iA P.oJ.s aU .obwciatMas .\.cirea:ate Wrire-uu r.r Odter ru. lan~ted .~nts • 0 0 ~ 0 1,135.124 0 1,605.837 1.110,401 2 ~J 11"~ 41.88l.l39 ~J m;rn ljg a"'j} DiU aWlIi2i3 ~! fJ:Sl" .all ti2~ '~1~ UifIl LIUmrlu L.nn aad lAss Adju.stmflll: [xpelUf" Rdllsu.nJl« Pa~""'le _ PaW IAn aM LA!: C ••ali.ni...s PayUle Utd 0dlH' Si.mil&r C1l.arcn 0tit1Pr [~SM 5634,670,101 S616.738,101 500,14:2 S17.932,OOO 0 0 0 0 0 0 0 0 0 0 0 0 6 3 S702.161,094 655,672 500.142 1,771,113 7,711,416 74,223 1.771,173 7,721.416 14,123 6,458..B89 TUlfs, Licerue& aad. £«5 Carrcsd feden.!:lad. hrdp meOlllto Taus t"lIearuci Prutilllll. .~.Ul.U 8.740,752 1.869,983 0 37.8ll.906 13J34.414 1.247.913 79,.993,484 1.147,913 19..993.484 Prellli1lJlU 1l,6M.638 45.us 4.448,.367 Prtiai1Ull1 PayMk 11,690,638 45.2484,448,.367 P.lkyJl.Wt-.r DhWea4b D-eclaretI aU Uapid Ceded Rlfiru:~e .......... Funds Held ~ emil,...,. I;n.der RewllnIlce Treaties r... Acao1Ul( or 0tJaH'S 138.694.613 70,980,473 SO,664,74S 1,.218,406 8O.664,74S 1.118,406 1.851.174 0 50 Amoa.nu Withladd. er Retained Iry" COmpa.a:l" 5.110,919 Prorlsiou for Rd.slln.n« :'-iM Adjustmellt, o.e to Feffip I:tdl. . PI"~"J.Ole PJ.~...\It" (0 ,e 2,851.174 R.a.te~ 5.56.3,11-0 1.161 0 1~,.100,.8.38 0 50 2,494,361 ~ ~g"";12~f' Punt. Sullsidiaries and Affiliate, 0 0 fol" 5«uritits 1,41>4,361 ~ _-\t:~~,a(e Writ~ins fer LiDilldes 2 ~p 2~'" 127.&22 Total U.t,UidM ~n~p""oi" QQSl 51 Q£I:i ~g~ ~">: Sa!"!I,'!; ;and Othtr Fu.nd; CQrnmolS Capital StlKk 'Sarpl's :-ott3 54';00.000 40,000,000 6.150,708 111688.143 ~1.~.J_~..2~.l S4.200,000 {O.OOO.OOO SO 0 $4.100.000 -10.000.000 Gros, Pud in ud C ollni.lIuttd Surplus rll;usis:ud Faad, (SUrpills) 6,.250.708 140.045,14,3 Sl9