For the quarter ended September 30, 2006
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549


FORM 10-QSB



 
(MARK ONE)
  
       
 
x
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  
 
For the quarterly period ended September 30, 2006
  
       
 
¨
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the transition period from __________ to __________
  

Commission File Number: 000-49786


PROFESSIONALS DIRECT, INC.
(Exact Name of Small Business Issuer as Specified in its Charter)


Michigan
(State or Other Jurisdiction of Incorporation or Organization)
38-3324634
(I.R.S. Employer Identification No.)
   
5211 Cascade Road, S.E.
Grand Rapids, Michigan 49546
(Address of Principal Executive Offices)
(616) 456-8899
(Issuer’s Telephone Number, Including Area Code)

Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes    X       No        

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

There were 333,300 shares of Common Stock outstanding as of October 31, 2006.

Transitional Small Business Disclosure Format (check one):  Yes           No    X    .
 
 
1
 

PROFESSIONALS DIRECT, INC.
INDEX

PART I.
FINANCIAL INFORMATION
Page No.
     
 
Item 1.  Financial Statements
  
     
 
Condensed Consolidated Balance Sheet - September 30, 2006 (Unaudited)
3
     
 
Condensed Consolidated Statements of Income (Loss) and Comprehensive Income (Loss) - Three and Nine Months Ended September 30, 2006 (Unaudited) and September 30, 2005 (Unaudited)
4
     
 
Condensed Consolidated Statements of Cash Flows - Nine Months Ended September 30, 2006 (Unaudited) and September 30, 2005 (Unaudited)
5
     
 
Notes to Condensed Consolidated Financial Statements (Unaudited)
6
     
 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
7
     
 
Item 3.  Controls and Procedures
14
     
PART II.
OTHER INFORMATION
  
     
 
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
15
     
 
Item 6.  Exhibits
15
     
Signatures
  
16
 
2

PART I.  FINANCIAL INFORMATION

Item 1. Financial Statements

PROFESSIONALS DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEET
(Unaudited)
September 30,
 
2006
  
   
(000)
  
Assets
     
       
Fixed maturities held to maturity, at amortized cost
  
$
5,180
  
Fixed maturities available for sale, at fair value
    
27,204
  
Other invested asset, at cost which approximates fair value
    
290
  
         
Total investments
    
32,674
  
         
Cash and cash equivalents
    
10,984
  
Receivables:
        
Amounts due from reinsurers
   
20,676
  
Other
    
1,939
  
Prepaid reinsurance premiums
    
4,437
  
Deferred acquisition costs
    
1,450
  
Net deferred federal income taxes
   
1,431
  
Other assets
    
1,379
  
         
Total Assets
  
$
74,970
  
         
Liabilities and Shareholders’ Equity
        
         
Liabilities
        
Loss and loss adjustment expense reserves
 
$
38,203
  
Unearned premiums
    
12,270
  
Amounts due to reinsurers
    
2,395
  
Other liabilities
    
2,043
  
Accrued interest
    
1,328
  
Surplus certificates
   
1,901
  
Trust preferred securities
    
5,000
  
         
Total Liabilities
    
63,140
  
         
Shareholders’ Equity
       
Preferred stock, no par (500,000 shares authorized, no shares issued)
    
-
  
Common stock, no par (5,000,000 shares authorized, 333,300 shares issued and outstanding)
    
3,204
  
Retained earnings
    
8,940
  
Accumulated other comprehensive loss
    
(314
)
         
Total Shareholders’ Equity
    
11,830
  
         
Total Liabilities and Shareholders’ Equity
  
$
74,970
  

See accompanying notes to condensed consolidated financial statements.

3

PROFESSIONALS DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS)
AND COMPREHENSIVE INCOME (LOSS)
(Unaudited)
 
 
Three Months Ended
September 30,
  
Nine Months Ended
September 30,
  
 
2006
  
2005
  
2006
  
2005
  
 
(000)
  
(000)
  
(000)
  
(000)
  
Revenues
                        
Net premiums earned
$
3,936
  
$
3,887
  
$
11,955
  
$
11,443
  
Fees and commissions
  
262
    
222
    
706
    
386
  
Net investment income
 
363
    
289
    
1,090
    
801
  
Finance and other income - including unusual gain of $73 and $230 in 2006 (Note 3)
  
123
    
39
    
374
    
109
  
                         
Total revenues
  
4,684
    
4,437
    
14,125
    
12,739
  
                         
Expenses
                        
Losses and loss adjustment expenses
  
3,096
    
2,590
    
9,066
    
9,866
  
Operating and administrative
 
991
    
951
    
3,067
    
2,831
  
Interest
  
133
    
141
    
414
    
360
  
                         
Total expenses
  
4,220
    
3,682
    
12,547
    
13,057
  
                         
Income (loss) before federal income taxes (benefit)
  
464
    
755
    
1,578
    
(318
)
                         
Federal income taxes (benefit)
  
121
    
243
    
437
    
(138
)
                         
Net income (loss)
  
343
    
512
    
1,141
    
(180
)
                         
Other comprehensive income (loss) (net of tax (benefit) of $135, $(73), $47 and $(85), respectively)
  
262
    
(141
)
  
91
    
(165
)
                         
Comprehensive income (loss)
$
605
  
$
371
  
$
1,232
  
$
(345
)
                         
Per share of common stock (not in thousands):
                        
Basic and diluted net income (loss) per share
$
1.03
  
$
1.54
  
$
3.42
  
$
(.54
)
Basic and diluted comprehensive income (loss) per share
1.81
1.11
3.69
(1.03
 
)

See accompanying notes to condensed consolidated financial statements.

4

PROFESSIONALS DIRECT, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 
Nine Months Ended
September 30,
  
 
2006
  
2005
  
 
(000)
  
(000)
  
Operating Activities
            
Net income (loss)
$
1,141
  
$
(180
)
Adjustments to reconcile net income (loss) to net cash from operating activities:
            
Deferred federal income tax (benefit)
  
100
    
(54
)
Gain from redemption of surplus certificates
  
(230
)
  
-
  
Depreciation and amortization
  
490
    
631
  
Changes in operating assets and liabilities:
            
Amounts due from reinsurers
  
(2,801
)
  
(9,697
)
Other receivables
  
(38
)
  
(286
)
Prepaid reinsurance premiums
  
(262
)
  
(472
)
Federal income taxes recoverable
  
(326
)
  
-
  
Deferred acquisition costs
  
(72
)
  
(104
)
Other assets
  
(52
)
  
368
  
Loss and loss adjustment expense reserves
  
2,735
    
12,854
  
Amounts due to reinsurers
  
540
    
324
  
Unearned premiums
  
494
    
1,980
  
Other liabilities
  
(54
)
  
317
  
Accrued interest
  
(325
)
  
98
  
             
Net cash from operating activities
  
1,340
    
5,779
  
             
Investing Activities
            
Cost of fixed maturities acquired
  
(9,847
)
  
(4,750
)
Proceeds from sales or maturities of fixed maturities
  
11,115
    
5,274
  
Cost of property and equipment acquired
  
(359
)
  
(166
)
             
Net cash from investing activities
  
909
    
358
  
             
Financing Activities
            
Repayments of surplus certificates
  
(400
)
  
-
  
Net repayments under lines of credit
  
(170
)
  
(2,237
)
Repurchase of common stock
  
(4
)
  
-
  
Payment of debt issue costs
  
-
    
(119
)
Proceeds from issuance of trust preferred securities
  
-
    
3,000
  
             
Net cash from (for) financing activities
  
(574
)
  
644
  
             
Net Increase in Cash and Cash Equivalents
  
1,675
    
6,781
  
             
Cash and Cash Equivalents, beginning of period
  
9,309
    
4,394
  
             
Cash and Cash Equivalents, end of period
$
10,984
  
$
11,175
  
             
Supplemental Disclosures of Cash Flow Information
            
Federal income tax payments (recoveries) - net
$
663
  
$
(537
)
Interest payments
  
739
    
262
  

See accompanying notes to condensed consolidated financial statements.

5

PROFESSIONALS DIRECT, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Basis of Presentation

The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries (Professionals Direct Insurance Company (PDIC), a property and casualty insurance company providing professional liability insurance to attorneys; Professionals Direct Employer Organization, Inc., an inactive Michigan professional employer organization; Professionals Direct Finance, Inc. (Finance), a premium finance company; and Professionals Direct Insurance Services, Inc. (Services), a company providing underwriting, claims, accounting, information technology services and selling professionals liability and other insurance), plus Lawyers Direct Risk Purchasing Group, which the Company controls. Professionals Direct Statutory Trust I and II are accounted for under the equity method in the accompanying financial statements. They are not consolidated because the Company is not the primary beneficiary.

The condensed consolidated financial statements and notes as of and for the three and nine month periods ended September 30, 2006 and 2005 are unaudited. The condensed consolidated financial statements reflect all adjustments (consisting of normal recurring accruals) that are, in the opinion of management, necessary for the fair presentation of the financial position, results of operations and cash flows for the interim periods. The results of operations for the interim periods should not be considered indicative of results to be expected for the full year.

2. Income per Share

Basic income per share is computed by dividing net income or loss by the weighted average number of shares of common stock outstanding for the period (333,346 and 333,448 for the three and nine months ended September 30, 2006 respectively, and 333,500 for the three and nine months ended September 30, 2005). Diluted income per share is equal to basic income per share because there are no dilutive instruments outstanding. 
 
3.  Unusual Gain
 
Other income includes an unusual gain of $73,000 and $230,000 for the three and nine months ended September 30, 2006, respectively, the portion of principal surplus certificate holders forgave in return for early redemption.


6

Item 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis for the nine months ended September 30, 2006 should be read in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this report. The following discussion of our financial condition and results of operations contains certain forward-looking statements. A discussion of the limitations of forward-looking statements appears at the end of this section.

Introduction

Revenues increased for all lines when compared to 2005. Losses and loss adjustment expenses decreased when compared to 2005 because there was significantly less adverse development in 2006. The following table and discussion compares the financial results for 2006 and 2005:

 
Nine Months Ended September 30,
2006   
 
2005   
 
Change   
Percent Change   
   
(in thousands of dollars, except for per share data)
Revenues:
                    
Net premiums earned
$
11,955
  
$
11,443
$
512
  
4.5%
  
Fees and commissions
  
706
    
386
  
320
  
82.9%
  
Net investment income
  
1,090
    
801
  
289
  
36.1%
  
Finance and other income
  
374
    
109
  
265
  
243.1%
  
Total revenues
  
14,125
    
12,739
  
1,386
  
10.9%
  
Expenses:
                    
Losses and loss adjustment expenses
  
9,066
    
9,866
  
(800
)
(8.1%
)
Operating and administrative
  
3,067
    
2,831
  
236
  
8.3%
  
Interest
 
414
    
360
  
54
  
15.0%
  
Total expenses
  
12,547
    
13,057
  
(510
)
(3.9%
)
Income (loss) before federal income taxes (benefit)
  
1,578
    
(318
)
1,896
  
596.2%
  
Federal income taxes (benefit)
  
437
    
(138
)
575
  
416.7%
  
      Net income (loss)
$
1,141
  
$
(180
) $
1,321
  
733.9%
  
Selected Balance Sheet Data:
      (at end of period)
                    
Total investments and cash
$
43,658
  
$
44,063
$
(405
)
(0.9%
)
Total assets
  
74,970
    
71,083
  
3,887
  
5.5%
  
Total liabilities
  
63,140
    
61,140
  
2,000
  
3.3%
  
Total shareholders’ equity
 
11,830
    
9,943
  
1,887
  
19.0%
  
Per Share Data (not in thousands):
                    
Net income (loss)
$
3.42
  
$
(.54
) $
3.96
  
733.3%
  
Shareholders’ equity
$
35.49
  
$
29.81
$
5.68
  
19.1%
  
 
7

Results of Operations (000 omitted):

The following is a summary and analysis of the material revenue and expense components of our operational results for the first nine months and third quarter of 2006 with comparisons to 2005.

Net Premiums Earned. Net premiums earned is equal to direct premiums earned (premiums earned for policies written) less ceded premiums earned (amounts ceded to reinsurers) and is our primary source of revenue. The increase in net premiums earned is the result of higher beginning net unearned premium partially offset by lower net premiums written. The higher beginning unearned premium resulted from increased direct premiums written in 2005 when compared to 2004.

The effects of these changes are seen in the table below:

 
Nine Months Ended September 30,
 
2006
2005
Change
Percent Change
   
(in thousands of dollars)
     
Beginning gross unearned premium
$
11,776
$
10,738
$
1,038
  
9.7%
  
Beginning ceded unearned premium
  
(4,175
)
(4,163
)
(12
)
(0.3%
)
Beginning net unearned premium
  
7,601
  
6,575
  
1,026
  
15.6%
  
                   
Direct premiums written
  
19,354
  
20,413
  
(1,059
)
(5.2%
)
Ceded premiums written
  
(7,168
)
(7,462
)
294
  
3.9%
  
Net premiums written
  
12,186
  
12,951
  
(765
)
(5.9%
)
                   
Ending gross unearned premium
  
12,270
  
12,718
  
(448
)
(3.5%
)
Ending ceded unearned premium
  
(4,437
)
(4,635
)
198
  
4.3%
  
Ending net unearned premium
  
7,833
  
8,083
  
(250
)
(3.1%
)
Net premiums earned
$
11,954
$
11,443
$
511
  
4.5%
  

During the first nine months of 2006, direct and net premiums written decreased. This decrease resulted from competitive pressure on renewal rates for larger law firms, primarily in Michigan and Florida.

For policies with 2006 effective dates, PDIC’s retention is unchanged from 2005. Decisions on the appropriate level of reinsurance are impacted by a variety of factors from pricing, to availability and credit quality of reinsurers, and our level of surplus. As such, retentions may vary from year to year. After analyzing our surplus, we decided to maintain our retention level, which market conditions allowed us to do.

Fees and Commissions. Fees and commissions originate from two primary sources. First are membership fees, which are earned by Lawyers Direct Risk Purchasing Group ("Lawyers Direct"), an affiliate organized and managed by Services, as part of the Lawyers Direct® program for one to five person law firms. Second are commissions, which are earned from placing insurance with unrelated third parties and performing management services. Fees and commissions earned in the first nine months of 2006 were $706, an increase of $320 when compared to the first nine months of 2005. While fees from Lawyers Direct were $16 less than in 2005, commission income increased $336. This resulted from placing more business with other carriers in 2006 and the reversal of contingent ceding commissions in 2005 caused by adverse loss development.
 
 
8

Net Investment Income. Net investment income is comprised of interest on fixed maturity investments and realized investment gains and losses. The net investment income increase of $289 or 36% in the first nine months of 2006 as compared to 2005 is primarily attributable to an improvement in average yield resulting from an increase in interest rates. The tax equivalent book yield on the portfolio increased 89 basis points from a year ago and is now over 4.4%.

Finance and Other Income. Finance income is generated from premium financing incidental to the sale of PDIC’s insurance policies. Premium financing is offered to PDIC policyholders in Michigan and selected other states. Finance income was $35 higher in the first nine months of 2006 than in the first nine months of 2005, principally because the rate being charged was increased in the fourth quarter of 2005. During the first nine months of 2006, PDIC redeemed 630 surplus certificates as part of a redemption program. This redemption resulted in an unusual gain of $230, the portion of principal surplus certificate holders forgave in return for early redemption.

Losses and Loss Adjustment Expenses. Overall profitability is materially influenced by the loss estimate for current year claims, plus the favorable or adverse development related to estimates for prior years’ claims. During the first nine months of 2006, PDIC recorded losses and loss adjustment expenses of $9,066 of which $8,681 was for claims made and reported in 2006 and $385 was for claims made and reported in prior years. During the first nine months of 2005, PDIC recorded losses and loss adjustment expenses of $9,866 of which $7,910 was for claims made and reported in 2005 and $1,956 was for claims made and reported in prior years. The increases in prior years’ losses resulted from adjusting those years’ loss ratios to reflect current experience.

The increase in incurred losses in the third quarter of 2006 over 2005 resulted from using a current report year loss ratio greater than that used to estimate June 30, 2006 reserves. The higher loss ratio approximates our historic loss ratio which is recommended by our outside actuary for interim use pending the actuarial valuation to be performed as of December 31, 2006.
 
Loss ratios are the sum of losses and loss adjustment expenses incurred expressed as a percentage of net premiums earned. The loss ratio for the first nine months of 2006 was 75.8% compared to 86.2% in 2005. Adjustments to prior years’ claim estimates contributed 3.2% and 17.1% to the respective 2006 and 2005 loss ratios.

PDIC maintains reserves for payment of losses and loss adjustment expenses for reported claims and for claims incurred but not reported arising from policies that have been issued. PDIC provides for the estimated ultimate cost of those claims without regard to how long it takes to settle them or the time value of money. The determination of reserves involves actuarial and statistical projections of what PDIC expects to be the cost of the ultimate settlement and administration of such claims based on facts and circumstances then known, estimates of future trends in claim severity, and other variable factors such as inflation and changing judicial theories of liability.

Management estimates of the loss reserve liability are reviewed by independent actuaries twice each year. Several variables and methodologies are used to calculate the appropriate amount of the loss reserve liability that should be recorded. Key variables utilized to develop the loss reserve estimate include:
 
●
Loss reporting patterns
●
Payment patterns
●
Loss severity trend rates
●
Application of Michigan loss patterns and loss to premium relationships to non-Michigan business
●
Case reserve setting patterns
 
 
9

The key actuarial methodologies used include:

●
Incurred development method
●
Paid development method
●
Case development method
●
Incurred Bornhuetter-Ferguson method
●
Paid Bornhuetter-Ferguson method
●
Frequency/severity method
 
Small changes to any of the assumptions regarding the key variables can significantly alter the outcome of the actuarial analysis. Because of the number of factors considered, it is neither practical nor meaningful to isolate a single variable and calculate the impact of changing that item.

An in-depth review of loss reserves is undertaken on a semi-annual basis. However, management continually reviews and updates the data underlying the estimation of its loss reserves and makes adjustments when we believe the emerging data supports a change. Any adjustments necessary are reflected in current operations. As a result of the variety of variables and methodologies that are considered, there is a significant risk that actual incurred losses will develop differently from these estimates.

In the years after a claim is reported, there is a significant amount of uncertainty over what the ultimate loss will be. Therefore, the estimate of future loss costs for claims recently reported tends to be less accurate. As claims get older, the estimate of future loss costs may be less inaccurate, but are still subject to material fluctuations until the claims are paid or otherwise closed. Eventually, all claims in a particular year are paid or closed and no additional development, favorable or adverse, will be experienced because the amount of the loss is certain.

Another factor that impacts incurred losses is development related to claims reported in prior years. Favorable or adverse development occurs when subsequent estimates of the loss change. A subsequent decrease in estimate results in favorable development; a subsequent increase in estimate results in adverse development. Favorable or adverse development is reflected as a decrease or increase in the current year’s losses and loss adjustment expenses.

The estimation of ultimate liability for losses and loss adjustment expenses is an inherently uncertain process and does not represent an exact calculation of that liability. Claims may not be brought until several years after the acts or omissions that gave rise to the claim occurred. Ultimate loss costs, even for similar events, vary significantly depending upon many factors. Professional liability claims are typically resolved over an extended period of time, often three years or more. The combination of changing conditions and the extended time required for claim resolution results in a loss cost estimation process that requires actuarial expertise and the application of significant judgment. Such estimates require periodic revision. PDIC’s current reserve policy recognizes this uncertainty by maintaining case supplement reserves (commonly referred to as IBNR reserves) to provide for the possibility that actual results may be less favorable compared to the estimated costs as developed during the normal case reserve estimation process. The case supplement reserve is determined by estimating the ultimate liability for all claims which have been made and reported and then subtracting the case reserves. Case supplement reserves as a percentage of total reserves at September 30, 2006 were 33.8%. PDIC does not discount its reserves to recognize the time value of money.

When a claim is reported to PDIC, claims personnel establish a case reserve for the estimated amount of the ultimate payment. This estimate reflects an informed judgment based upon general insurance reserving practices and on the experience and knowledge of the estimator regarding the nature and value of the specific claim, the severity of injury or damage, and the policy provisions relating to the type of loss. The claims staff periodically adjusts the loss estimate as more information becomes available.
 
 
10

Each quarter, PDIC computes its estimated liability using appropriate principles and procedures. Because the establishment of loss reserves is an inherently uncertain process, however, there can be no assurance that losses will not exceed reserves. Adjustments in aggregate reserves, if any, are reflected in the operating results of the period during which such adjustments are made. As required by insurance regulatory authorities, PDIC annually receives a statement of opinion from its appointed actuary concerning the reasonableness of its reserves.

Operating and Administrative Expenses. Operating and administrative expenses for the first nine months of 2006 compared to the same period for 2005 increased $236 or 8.3%. This increase is the result of reduced ceding commissions (consistent with the decrease in ceded written premiums) earned in 2006 compared to 2005 of $109 and increased compensation costs and insurance assessments of $127.

Interest Expense. Interest expense for the first nine months of 2006 increased $54 from the same period in 2005 because of increases in interest rates and net outstanding debt.

Income Taxes. The effective federal income tax rate for the 2006 expense is 27.7% and for the 2005 benefit is 43.4%. Both years’ rates depart from the expected rate as a result of the impact of tax-exempt interest income.

Financial Condition, Liquidity, and Capital Resources (000 omitted):

Professionals Direct, Inc. is a legal entity separate and distinct from its subsidiaries. Because the parent holding company has no other business operations, management fees and dividends from its subsidiaries represent the principal source of funds for its obligations, including debt service. The management fees paid by PDIC are pre-approved by the Office of Financial and Insurance Services, the regulatory body in Michigan responsible for the oversight of the insurance subsidiary. Under the terms of the plan that governed the Company’s conversion from a mutual insurance company to a stock insurance company, PDIC is prohibited from making any dividend payments to Professionals Direct, Inc. until such time as the surplus certificates are repaid in full. The management fees paid by the remaining subsidiaries are determined from time-to-time by the Board of Directors. The payment of management fees and dividends by the other subsidiaries is limited only by solvency requirements.

The primary sources of liquidity, on both a short-term and long-term basis, are funds provided by insurance premiums collected, net investment income, recoveries from reinsurance, and proceeds from the maturity or sale of invested assets. The primary uses of cash, on both a short-term and long-term basis, are losses, loss adjustment expenses, operating expenses, reinsurance premiums, taxes, debt repayment and acquisition of investments.

Trends or uncertainties that may have an impact on short-term or long-term liquidity include changes in the cost and availability of reinsurance, changes in interest rates and changes in investment income. As the costs of obtaining reinsurance may change in the future, we intend to adjust the rates we charge our customers. However, such rate changes may be limited by competition or regulation. We believe that we will be able to manage reinsurance costs so the impact on overall liquidity is minimized.

When interest rates decline, the cost of borrowing decreases and the market value of our investment portfolio, which primarily consists of debt securities, generally increases. At the same time, the overall yield on new investments tends to decrease. When interest rates increase, the opposite effects are realized. Interest rates continue to climb from the historical lows experienced in the last few years. We believe that it is unlikely material gains will be realized on portfolio assets or be a source of liquidity during 2006.
 

 
11
 
At September 30, 2006, cash and cash equivalents totaled $10,984. This amount is higher than would be typical in anticipation of a significant claim to be paid out shortly after the close of the quarter. Management believes the total cash and cash equivalents represent the liquid assets necessary to meet operating, loss and reinsurance payments.

Our net cash flow from operations for the first nine months of 2006 was $1,340 compared to $5,779 for the first nine months of 2005, a decrease of $4,439. As written and ceded premiums have stabilized, so has cash flow from operations. Cash flow for both periods was invested in fixed maturities and used to repay lines of credit and redeem surplus certificates.

To provide additional liquidity, we have two lines of credit available from a bank. The first line is a $1,800 revolving line used by Finance to finance insurance premiums and bears interest at .5% over the bank’s prime rate. The second line for $1,000 can be used for general corporate purposes and bears interest at 1% over the bank’s prime rate. Neither of the lines had outstanding balances as of September 30, 2006. These lines of credit require, among other things, that we maintain a minimum tangible net worth of $7,500, that PDIC maintain a minimum surplus of not less than 240% of the Authorized Control Level Risk Based Capital (as defined by the National Association of Insurance Commissioners), and that we deliver periodic financial reports to the bank. The Company was in compliance with all covenants as of September 30, 2006. Debt under these lines is secured by substantially all assets of Services, Finance and the Company, including shares of PDIC subject to the rights of policyholders under insurance laws and the authority of insurance regulators. A third line of credit matured October 1, 2006 and was not renewed.

Based on historical trends, market conditions and our business plans, we believe that our existing resources and sources of funds will be sufficient to meet our short-term and long-term liquidity needs over the next year and beyond. Because economic, market and regulatory conditions may change, however, there can be no assurance that our funds will be sufficient to meet these liquidity needs. In addition, competition, pricing, the frequency and severity of losses and interest rates could significantly affect our short-term and long-term liquidity needs.

Critical Accounting Estimates and Judgments:
 
The Company’s significant accounting policies are presented on pages 20 through 23 of the Annual Report to Shareholders for the year ended December 31, 2005. Certain of these policies are important to the portrayal of the Company’s financial condition, because they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain.
 
The condensed consolidated financial statements include certain amounts, based upon informed estimates and judgments made by management, for transactions not yet complete or for which the ultimate resolution is not certain. Such estimates and judgments affect the reported amounts in the financial statements. Although management believes that they are making the best decisions based upon information then available, it is possible that as conditions and experience develop, these estimates may change and may be materially different from originally reported in the financial statements. Our reserves for unpaid losses and loss adjustment expenses and the related amounts due from reinsurers represent the most critical estimates present within the financial statements. Amounts recoverable from reinsurers are estimated in a manner consistent with the provisions of the reinsurance agreement and the establishment of the liability for loss and loss adjustment expenses.
 
12

Forward-Looking Statements:

This report contains forward-looking statements, including, but not limited to, statements relating to the Company’s business objectives and strategy. Such forward-looking statements are based on current expectations, management beliefs, certain assumptions made by the Company’s management, and estimates and projections about the Company’s industry. Words such as “believes”, “estimates”, “expects”, “forecasts”, “intends”, “judgment”, “objective”, “plans”, “predicts”, “projects”, and variations of such words and similar expressions are intended to identify such forward-looking statements. Determination of loss and loss adjustment expense reserves and amounts due from reinsurers are based substantially on estimates and the amounts so determined are inherently forward-looking.

Forward-looking statements are not guarantees of future performance and are subject to certain risks, uncertainties and assumptions that are difficult to predict with respect to timing, extent, likelihood and degree of occurrence. Therefore, actual results and outcomes may differ materially from those expressed, forecasted, or contemplated by any such forward-looking statements. Other factors, some of which are listed below, also influence our results of operations, financial condition and business of the Company and its subsidiaries:

 
●
Future economic conditions and the legal and regulatory environment in the markets served by the Company’s subsidiaries;
     
 
●
Reinsurance market conditions, including changes in pricing and availability of reinsurance;
     
 
●
Financial market conditions, including, but not limited to, changes in interest rates and the values of investments;
     
 
●
Inflation;
     
 
●
Credit worthiness of the issuers of investment securities, reinsurers and others with whom the Company and its subsidiaries do business;
     
 
●
Estimates of loss reserves and trends in losses and loss adjustment expenses;
     
 
●
Changing competition;
     
 
●
The Company’s ability to execute its business plan;
     
 
●
The effects of war and terrorism on investment and reinsurance markets;
     
 
●
The effects of hurricanes, earthquakes and other natural disasters on investment and reinsurance markets;
     
 
●
Changes in financial ratings issued by independent organizations, including A.M. Best, Standard & Poors and Moody’s;
     
 
●
The Company’s ability to enter new markets successfully and capitalize on growth opportunities;
     
 
●
The Company’s ability to comply with internal control audit requirements that are expected to become effective in 2007; and
     
 
●
Changes in the laws, rules and regulations governing insurance holding companies and insurance companies, as well as applicable tax and accounting matters.
 

 
13
 
Changes in any of these factors, or others, could have an adverse affect on the business or results of operations of the Company or its subsidiaries. Unless required by law, the Company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.


Item 3.  Controls and Procedures

The Company’s Chief Executive Officer and Vice President of Finance, after evaluating the effectiveness of the Company’s disclosure controls and procedures (as defined in Sections 13a-15(e) and 15d-15(e) of the regulations promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the most recent fiscal quarter covered by this quarterly report (the “Evaluation Date”), have concluded that as of the Evaluation Date, the Company’s disclosure controls and procedures are effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and are designed to ensure that information required to be disclosed in those reports is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure. There were no changes in the Company’s internal control over financial reporting identified in connection with the Company’s evaluation of controls that occurred during the Company’s last fiscal quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
 
 
14

PART II.  OTHER INFORMATION
 
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds
 
SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES
 
Period
  
Total Number of
Shares Purchased(1)
  
Average Price Paid per Share
  
Total Number of Shares
Purchased as Part of Publicly
Announced Plans or Programs
  
Maximum Number of Shares
That May Yet Be Purchased
Under the Plans or Programs
                 
July 1 - 31, 2006
  
200
  
$20.00
        
August 1 - 31, 2006
                
September 1 - 30, 2006
                
Total
  
200
  
$20.00
        
_____________________ 
(1)
200 shares of Common Stock were repurchased by the Company from one shareholder in a single private transaction and not pursuant to a publicly announced plan or program.
 
 
Item 6.  Exhibits

 
(a)
Exhibits.  The following documents are filed as exhibits to this report on Form 10-QSB:

 
Exhibit No.
  
            Document
       
 
3.1
  
Amended and Restated Articles of Incorporation. Previously filed as an exhibit to the Company’s Registration Statement on Form 10-SB/A filed on July 8, 2002. Here incorporated by reference.
       
 
3.2
  
Amended and Restated Bylaws. Previously filed as an exhibit to the Company’s Registration Statement on Form 10-SB/A filed on July 8, 2002. Here incorporated by reference.
       
 
31.1
  
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
31.2
  
Certification of the Vice President of Finance pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
       
 
32
  
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit, except for those portions expressly incorporated by reference in this filing, is furnished for the information of the Commission and is not deemed “filed” as part of this filing.


15

SIGNATURES

In accordance with the requirements of the Exchange Act, the Company caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


 
PROFESSIONALS DIRECT, INC.
   
  /s/ Stephen M. Tuuk
Date:  November 14, 2006
Stephen M. Tuuk, President and Chief Executive Officer (authorized to sign on behalf of company)
   
   
  /s/ Stephen M. Westfield
 
Stephen M. Westfield, Vice President of Finance (principal financial and accounting officer)





16


EXHIBIT INDEX

Exhibit No.
  
Document
     
3.1
  
Amended and Restated Articles of Incorporation. Previously filed as an exhibit to the Company’s Registration Statement on Form 10-SB/A filed on July 8, 2002. Here incorporated by reference.
     
3.2
  
Amended and Restated Bylaws. Previously filed as an exhibit to the Company’s Registration Statement on Form 10-SB/A filed on July 8, 2002. Here incorporated by reference.
     
31.1
  
Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2
  
Certification of the Vice President of Finance pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32
  
Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. This exhibit, except for those portions expressly incorporated by reference in this filing, is furnished for the information of the Commission and is not deemed “filed” as part of this filing.