UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

For the Quarterly Period Ended March 31, 2005

OR

For the Transition Period From ___________ to ___________

000-50511
Commission File Number

UNITED AMERICA INDEMNITY, LTD.

WALKER HOUSE, 87 MARY STREET
P.O. BOX 908GT
GEORGE TOWN, GRAND CAYMAN
CAYMAN ISLANDS
(Address of principal executive office including zip code)

(345) 949-0100
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES þ NO o

As of May 6, 2005, the registrant had outstanding 23,679,789 Class A Common Shares and 12,687,500 Class B Common Shares.

TABLE OF CONTENTS

As used in this quarterly report, unless the context requires otherwise, 1) “United America Indemnity,” “we,” “us,” and “our” refer to United America Indemnity, Ltd., an exempted company incorporated with limited liability under the laws of the Cayman Islands, and its U.S. and Non-U.S. Subsidiaries; 2) our “U.S. Subsidiaries” refers to U.N. Holdings II, Inc., U.N. Holdings Inc., Wind River Investment Corporation, American Insurance Service, Inc., Emerald Insurance Company, Penn-America Group, Inc., our U.S. Insurance Operations and our Agency Operations; 3) our “U.S. Insurance Operations” refers to the insurance and related operations conducted by American Insurance Service, Inc.’s subsidiaries, including American Insurance Adjustment Agency, Inc., International Underwriters, LLC, J.H. Ferguson & Associates, LLC, the United National Insurance Companies and the Penn-America Insurance Companies; 4) the “United National Insurance Companies” refers to the insurance and related operations conducted by United National Insurance Company and its subsidiaries, including Diamond State Insurance Company, United National Casualty Insurance Company, and United National Specialty Insurance Company; 5) the “Penn-America Insurance Companies” refers to the insurance and related operations of Penn-America Insurance Company, Penn-Star Insurance Company, and Penn-Patriot Insurance Company; 6) the “Agency Operations” refers to Penn Independent Corporation, PIC Holdings, Inc., Penn Independent Financial Services, Inc., Penn Oceanic Insurance Co., Ltd. (Barbados), Residential Underwriting Agency, Inc., Stratus Insurance Services, Inc., Stratus Web Builder, Inc., Apex Insurance Agency, Inc., APEX Insurance Services of Illinois, Inc., Summit Risk Services, Inc., Delaware Valley Underwriting Agency, Inc. (“DVUA”), DVUA Pittsburgh, Inc., DVUA Massachusetts, Inc., DVUA of New York, Inc., DVUA of New Jersey, Inc., DVUA West Virginia, Inc., DVUA North Carolina, Inc., DVUA of Ohio, Inc., DVUA South Carolina, Inc., and

DVUA Virginia, Inc.; 7) our “Non-U.S. Subsidiaries” refers to our Non-U.S. Insurance Operations, U.A.I. (Gibraltar) Limited, the Luxembourg Companies, Wind River Services, Ltd., and Loyalty Insurance Company, Inc.; 8) our “Non-U.S. Insurance Operations” refers to the insurance and reinsurance and related operations of Wind River Barbados and Wind River Bermuda; 9) “Wind River Barbados” refers to Wind River Insurance Company (Barbados), Ltd.; 10) “Wind River Bermuda” refers to Wind River Insurance Company, Ltd.; 11) the “Luxembourg Companies” refers to U.A.I. (Luxembourg) I S.ar.l., U.A.I. (Luxembourg) II S.ar.l., U.A.I. (Luxembourg) III S.ar.l., U.A.I. (Luxembourg) IV S.ar.l., U.A.I. (Luxembourg) Investment S.ar.l., and Wind River (Luxembourg) S.ar.l.; 12) “United National Group” refers to our U.S. Insurance Operations, Emerald Insurance Company, and Loyalty Insurance Company; 13) the “Statutory Trusts” refers to United National Group Capital Trust I, United National Group Capital Statutory Trust II, Penn-America Statutory Trust I and Penn-America Statutory Trust II; 14) “Fox Paine & Company” refers to Fox Paine & Company, LLC and affiliated investment funds; and 15) “$” or “dollars” refers to U.S. dollars.

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

UNITED AMERICA INDEMNITY, LTD.

Consolidated Balance Sheets

See accompanying notes to consolidated financial statements.

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UNITED AMERICA INDEMNITY, LTD.

Consolidated Statements of Operations

See accompanying notes to consolidated financial statements.

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UNITED AMERICA INDEMNITY, LTD.

Consolidated Statements of Comprehensive Income

See accompanying notes to consolidated financial statements.

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UNITED AMERICA INDEMNITY, LTD.

Consolidated Statements of Changes in Shareholders’ Equity

See accompanying notes to consolidated financial statements.

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UNITED AMERICA INDEMNITY, LTD.

Consolidated Statements of Cash Flows

See accompanying notes to consolidated financial statements.

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UNITED AMERICA INDEMNITY, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. Principles of Consolidation and Basis of Presentation

United America Indemnity, Ltd. (“United America Indemnity” or the “Company”), incorporated on August 26, 2003, is domiciled in the Cayman Islands. On January 24, 2005, the Company changed its name from United National Group, Ltd. to United America Indemnity, Ltd. The Company’s Class A common stock is publicly traded on the Nasdaq National Market. On March 14, 2005, the Company changed its trading symbol on the Nasdaq National Market from “UNGL” to “INDM.”

The consolidated financial statements include the accounts of United America Indemnity and its wholly owned subsidiaries, Wind River Insurance Company (Barbados) Ltd. (“Wind River Barbados”), U.A.I. (Gibraltar) Limited, U.A.I. (Luxembourg) I S.ar.l., U.A.I. (Luxembourg) II S.ar.l., U.A.I. (Luxembourg) III S.ar.l., U.A.I. (Luxembourg) IV S.ar.l., U.A.I. (Luxembourg) Investment S.ar.l., Wind River (Luxembourg) S.ar.l., Wind River Insurance Company, Ltd. (“Wind River Bermuda”), Wind River Services, Ltd., U.N. Holdings II, Inc., U.N. Holdings Inc., Wind River Investment Corporation, American Insurance Service, Inc. (“AIS”), American Insurance Adjustment Agency, Inc. (“AIAA”), International Underwriters, LLC. (“IUI”), United National Insurance Company (“UNIC”), Penn Independent Corporation (“PIC”), PIC Holdings, Inc. (“PIC Holdings”), Residential Underwriting Agency, Inc., Delaware Valley Underwriting Agency, Inc., DVUA Pittsburgh, Inc., DVUA Massachusetts, Inc., DVUA of New York, Inc., DVUA of New Jersey, Inc., DVUA West Virginia, Inc., DVUA North Carolina, Inc., DVUA of Ohio, Inc., DVUA South Carolina, Inc., DVUA Virginia, Inc., Penn Oceanic Insurance Company, Inc., Penn Independent Financial Services, Inc., Apex Insurance, Inc., Apex Insurance Services of Illinois, Inc., Summit Risk Services Inc., Stratus Insurance Services, Inc., Stratus Web Builder, Inc., Penn-America Insurance Company, Penn-Star Insurance Company, Penn Patriot Insurance Company, Diamond State Insurance Company (“Diamond State”), United National Specialty Insurance Company (“United National Specialty”), United National Casualty Insurance Company (“United National Casualty”), J.H. Ferguson & Associates, LLC (“J.H. Ferguson”), Emerald Insurance Company, and Loyalty Insurance Company. All significant intercompany balances and transactions have been eliminated in consolidation.

The consolidated financial statements as of March 31, 2005 and for the quarter ended March 31, 2005 and 2004 are unaudited, but in the opinion of management have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and on the same basis as the annual audited consolidated financial statements. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

The consolidated financial statements include all adjustments that are, in the opinion of management, necessary for a fair statement of results for the interim periods. Results of operations for the quarter ended March 31, 2005 and 2004 are not necessarily indicative of the results of a full year. The accompanying notes to the consolidated financial statements should be read in conjunction with the notes to the consolidated financial statements contained in the Company’s 2004 Annual Report on Form 10-K.

The Company’s wholly-owned business trust subsidiaries, United National Group Capital Trust I (“United National Capital Trust I”), United National Group Capital Statutory Trust II (“United National Statutory Trust II”), Penn-America Statutory Trust I (“Penn America Statutory Trust I) and Penn-America Statutory Trust II (“Penn America Statutory Trust II”), are not consolidated pursuant to Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”). The Company’s business trust subsidiaries have issued $60.0 million in floating rate capital securities (“Trust Preferred Securities”). The sole assets of the Company’s business trust subsidiaries are $61.9 million of junior subordinated debentures issued by the Company, which have the same terms with respect to maturity, payments and distributions as the Trust Preferred Securities.

Certain prior period amounts have been reclassified to conform to the current period presentation.

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UNITED AMERICA INDEMNITY, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

Description of Business

The Company offers two general classes of insurance products. These two classes of products are property and general liability insurance products and non-medical professional liability insurance products. Collectively, the Company’s U.S. insurance subsidiaries are licensed in all 50 states and the District of Columbia. The Company’s non-U.S. insurance subsidiaries are licensed in Bermuda and Barbados and Wind River Bermuda is eligible to write surplus lines business in certain U.S. jurisdictions.

2. Acquisition of Penn Independent Corporation and Merger with Penn-America Group, Inc.

Through a series of transactions on January 24, 2005, the Company acquired 100% of the voting equity interest of Penn-America Group, Inc. (together with its subsidiaries, “Penn-America Group”). The Company acquired 67.3% through the merger with Penn-America Group, 30.5% through the purchase of Penn Independent Corporation, which held common shares of Penn-America Group, Inc., and 2.2% in two separate transactions with individual shareholders. In connection with these transactions, the Company paid a $6.0 million transaction fee to Fox Paine & Company. Fox Paine & Company beneficially owns shares having approximately 85.4% of the Company’s total voting power.

Acquisition of Penn Independent Corporation

On January 24, 2005, the Company acquired 100% of the voting equity interest of Penn Independent Corporation (together with its subsidiaries, “Penn Independent Group”), a wholesale broker of commercial insurance for small and middle market businesses, public entities, and associations, from Penn Independent Group’s shareholders for $98.5 million in cash. Penn Independent Group also owns, through its wholly owned subsidiary PIC Holdings, 30.5% of the voting equity interest of Penn-America Group, Inc. Upon the acquisition of Penn Independent Group, the Company also indirectly acquired Penn Independent Group’s shares of Penn-America Group, Inc. common stock. Penn Independent Group’s results of operations are included in the Company’s results of operations subsequent to the date of the acquisition.

The $98.5 million purchase price, which includes transaction related expenses, was allocated to the estimated fair values of the acquired assets and liabilities as follows (dollars in thousands):

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UNITED AMERICA INDEMNITY, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

The transaction was accounted for using the purchase method of accounting. In connection with the acquisition of Penn Independent Group, the assets and liabilities acquired by the Company were adjusted to estimated fair value. The $34.4 million excess of cash and acquisition costs over the estimated fair value of assets acquired was recognized as goodwill.

Acquired intangible assets of $2.7 million were as follows:

Purchases of Penn-America Group, Inc. Common Shares from Individual Shareholders

On January 24, 2005, in a series of related transactions, the Company acquired all shares of Penn-America Group, Inc. common stock owned by members of the Saltzman family, including all shares of common stock issued upon the exercise of vested options to acquire shares of Penn-America Group, Inc. common stock, for $13.53 a share in cash. The Saltzman family and trusts controlled by them constituted 100% of the Penn Independent Group shareholders prior to the acquisition by United America Indemnity.

Merger with Penn-America Group, Inc.

On January 24, 2005, the Company acquired 67.3% of the voting equity interest of the Penn-America Group, Inc., a specialty property and casualty insurance holding company, for $15.3 million in cash and approximately 7.9 million Class A common shares of United America Indemnity in a transaction classified as a merger. Under the terms of the merger agreement, Penn-America Group, Inc. shareholders received $15.375 of value for each share of Penn-America Group, Inc. common stock as follows: 1) 0.7756 of a Class A common share of United America Indemnity, based on $13.875 divided by the volume weighted average sales price of United America Indemnity’s Class A common shares for the 20 consecutive trading days ending January 21, 2005, which was $17.89, and 2) $1.50 per share in cash. Penn-America Group’s results of operations are included in the Company’s results of operations subsequent to the date of the merger.

The primary reason for the merger was that the Company anticipated that it would allow United America Indemnity to: 1) strengthen its position in the highly competitive specialty property and casualty insurance industry; 2) achieve enhanced growth opportunities arising from a balanced business model, improved financial flexibility, and strong cash flow; and 3) achieve a financial base and scale capable of delivering enhanced value to customers.

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UNITED AMERICA INDEMNITY, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

In connection with the merger with Penn-America Group, Inc., the acquisition of Penn Independent Corporation, and the transactions with individual shareholders on January 24, 2005, the $235.8 million purchase price, which includes transaction related expenses, was allocated to the estimated fair values of the acquired assets and liabilities as follows (dollars in thousands):

The transaction was accounted for using the purchase method of accounting. In connection with the merger with Penn-America Group, the assets and liabilities acquired by the Company were adjusted to estimated fair value. The $63.7 million excess of cash, fair value of United America Indemnity’s Class A common shares exchanged, other consideration, and acquisition costs over the estimated fair value of the net assets acquired was recognized as goodwill.

Acquired intangible assets of $37.4 million were as follows:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

As mentioned in Note 10, Penn-America Group leases its home office facility in Hatboro, Pennsylvania from Irvin Saltzman, and the lease is accounted for as a capital lease.

3. Summary of Significant Accounting Policies

Investments

The Company’s investments in bonds are classified as available for sale and are carried at their fair value. The difference between book value and fair value of bonds, excluding the derivative components, net of the effect of deferred income taxes, is reflected in accumulated other comprehensive income in shareholders’ equity and, accordingly, has no effect on net income other than for impairments deemed to be other than temporary. The difference between book value and fair value of the derivative components of the bonds is included in income.

As a result of the purchase price allocation, as disclosed above in Note 2, all of Penn-Independent Corporation’s and Penn-America Group, Inc.’s investments at January 24, 2005 were adjusted to their fair value on that date. Therefore, the book value of all Penn-Independent Corporation’s and Penn-America Group, Inc.’s investments on January 24, 2005 were adjusted to fair value prospectively for the Company.

The Company regularly performs various analytical procedures with respect to its investments, including identifying any security the fair value of which is below its cost. Upon identification of such securities, a detailed review of all such securities meeting predetermined thresholds is performed to determine whether such decline is other than temporary. If it is determined that a decline in value is other than temporary based upon this detailed review, or if a decline in value for an investment has persisted for 12 continuous months, or if the value of the investment has been 20% or more below cost for six continuous months or more, or significantly declines in value for shorter periods of time, the security is evaluated to determine whether the cost basis of the security should be written down to its fair value. The factors considered in reaching the conclusion that a decline below cost is other than temporary include, among others, whether the issuer is in financial distress, the investment is secured, a significant credit rating action occurred, scheduled interest payments were delayed or missed and changes in laws or regulations have affected an issuer or industry. The amount of any write-down is included in earnings as a realized loss in the period in which the impairment arose.

During the quarter ended March 31, 2005, the Company recorded realized investment losses for other than temporary impairments of $0.1 million on its common stock portfolio. There were no realized investment losses for other than temporary impairments for the quarter ended March 31, 2004 as a result of the Company’s other than temporary impairment evaluation.

Fair value is defined as the amount at which the instrument could be exchanged in a current transaction with willing parties. The fair values of the Company’s investments in bonds and stocks are determined on the basis of quoted market prices. The Company also holds other invested assets, including investments in several limited partnerships, which were valued at $52.1 million and $53.8 million as of March 31, 2005 and December 31, 2004, respectively. Several of these partnerships invest solely in securities that are publicly traded and are valued at the net asset value as reported by the investment manager. As of March 31, 2005 and December 31, 2004, the Company’s other invested assets portfolio includes $17.9 million and $20.4 million, respectively, in securities for which there is no readily available independent market price. The estimated fair value of such securities is determined by the general partner of each limited partnership based on comparisons to transactions involving similar investments. Material assumptions and factors utilized in pricing these securities include future cash flows, constant default rates, recovery rates and any market clearing activity that may have occurred since the prior month-end pricing period.

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UNITED AMERICA INDEMNITY, LTD.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

Derivative Instruments

The Company accounts for derivative instruments under Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”), as amended, which established accounting reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities. All derivatives, whether designated in hedging relationships or not, are required to be recorded on the balance sheet at fair value.

As of March 31, 2005, the Company holds a single derivative instrument, an interest rate swap. In accordance with SFAS 133, the interest rate swap is designated as a cash flow hedge, and is recorded on the balance sheet at fair value. Changes in fair value are recorded in other comprehensive income (loss) and are reclassified to net income when impacted by the variability of the cash flow of the hedged item.

The primary objective of the Company’s interest rate swap was to hedge risk arising from interest rate volatility related to $15.0 million of floating rate capital securities (“Trust Preferred Securities”) issued by Penn-America Statutory Trust I. The Company has designated the $15.0 million of junior subordinated debentures issued by Penn-America Group, Inc. to Penn-America Statutory Trust I as the hedged item. The junior subordinated debentures have the same terms with respect to maturity, payment and distributions as the Trust Preferred Securities issued by Penn-America Statutory Trust I. The Company’s strategy is to convert distributions based on a floating rate on its junior subordinated debentures with Penn-America Statutory Trust I to a fixed-rate basis.

In accordance with SFAS 133, the Company formally documents the cash flow hedging relationship between the hedging instrument and the hedged item, the risk management objective and strategy for undertaking the hedge, and how the effectiveness of hedging the exposure to variability in interest rates will be assessed. At inception, the Company determined its cash flow hedge to be highly effective in achieving offsetting cash flows attributable to the hedge risk during the term of the hedge, as it meets the criteria for assuming “no ineffectiveness”, pursuant to SFAS 133.

By using derivative instruments, the Company is exposed to credit risk based on current market conditions and potential payment obligations between the Company and its counterparty. The Company has entered into the interest rate swap with a high quality counterparty, which is rated “A1” by Moody’s Investors Service Inc. (“Moody’s). The Company’s interest rate swap contract is governed by an International Swaps and Derivatives Association Master Agreement, and includes provisions that require collateral to be pledged by the Company or its counterparty if the current value of the interest rate swap exceeds certain thresholds. As of March 31, 2005, approximately $0.7 million of collateral was held by the Company’s counterparty.

Valuation of Accounts Receivable

The Company evaluates the collectibility of premiums receivable based on a combination of factors. In circumstances in which the Company is aware of a specific agent’s inability to meet its financial obligations to the Company, a specific allowance for bad debts against amounts due is recorded to reduce the net receivable to the amount reasonably believed to be collectible. No such instances occurred in the quarter ended March 31, 2005. For all remaining balances, allowances are recognized for bad debts based on historical statistics of the length of time the receivables are past due.

Goodwill and Intangible Assets

Effective July 1, 2001, the Company adopted the provisions of SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”). On January 24, 2005, the Company recorded $98.1 million of goodwill as a result of the acquisition of Penn Independent Corporation and the merger with Penn-America Group, Inc. The carrying amount of the Company’s goodwill as of March 31, 2005 was $98.1 million.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

In accordance with SFAS 142, the Company is required to perform a test for impairment of goodwill at least annually. No impairment of the goodwill was recognized for the quarter ended March 31, 2005.

In accordance with SFAS 142, the Company is required to perform a test for impairment of indefinite-lived intangible assets at least annually. No impairment of the indefinite-lived intangible assets was recognized for the quarter ended March 31, 2005.

Other intangible assets that are not deemed to have an indefinite useful life are amortized over their useful lives. The carrying amount of intangible assets that are not deemed to have an indefinite useful life is regularly reviewed for indicators of impairments in value in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” Impairment is recognized only if the carrying amount of the intangible asset is not recoverable from its undiscounted cash flows and is measured as the difference between the carrying amount and the fair value of the asset. No impairments of intangible assets that are not deemed to have indefinite life were recognized in the quarter ended March 31, 2005.

As of March 31, 2005, intangible assets are as follows:

Capitalized Leases

Fair value is based upon the present value of the underlying cash flows discounted at the Company’s incremental borrowing rate. The carrying amounts approximate fair value and are included in “Other liabilities” on the balance sheet.

Notes and Loans Payable

Fair value is based upon the present value of the underlying cash flows discounted at the Company’s incremental borrowing rate. The carrying amounts reported in the balance sheet approximate fair value.

Premium Payables

The carrying amounts reported in the balance sheet for this instrument approximate its fair value.

Junior Subordinated Debentures

In accordance with SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” which establishes standards for classifying and measuring certain financial instruments with characteristics of both liabilities and equity, the Company’s junior subordinated debentures are classified as a liability on the balance sheets and the related distributions are recorded as interest expense in the Statement of Operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

In accordance with FIN 46, the Company is not permitted to consolidate the Company’s business trust subsidiaries, which in the aggregate issued $60.0 million of floating rate capital securities. The sole assets of the Company’s business trust subsidiaries are $61.9 million of junior subordinated debentures issued by the Company, which have the same terms with respect to maturity, payments and distributions as the Trust Preferred Securities. Therefore, the Company’s junior subordinated debentures are presented as a liability in the balance sheet at March 31, 2005.

Revenue Recognition

Premiums written are recognized as earned ratably over the terms of the respective policies.

Commissions earned by the Company’s agency operations are recognized based on the policy effective date. Contingent profit commissions are based on the claims experience of the policies underwritten for insurance companies and are recognized when received.

Finance income earned by Penn Independent Financial Services, Inc., included in agency commission and fee revenue, is recognized on the pro rata interest method over the terms of the insurance contracts using the accrual basis.

Agency Commissions and Operating Expenses

Agency expenses include commissions retained by agents and producers on policies bound by the Agency Operations. Operating expenses include personnel expenses and general operating expenses.

Extraordinary Gain

The extraordinary gain of $1.4 million for the quarter ended March 31, 2005 represents the recognition of tax benefits derived from acquisition costs incurred in connection with the Company’s acquisition of Wind River Investment Corporation, which are currently considered to be deductible for federal tax purposes.

Earnings Per Share

Basic earnings per share has been calculated by dividing net income available to common shareholders by the weighted-average common shares outstanding. Diluted earnings per share has been calculated by dividing net income available to common shareholders by the sum of the weighted-average common shares outstanding and the weighted-average share equivalents outstanding.

New Accounting Pronouncements

In March 2004, the FASB issued Emerging Issues Task Force (“EITF”) Issue No. 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” which provides new guidance for assessing impairment losses on debt and equity investments. Additionally, EITF Issue No. 03-01 includes new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB delayed the accounting provisions of EITF Issue No. 03-01; however, the disclosure requirements remain effective and have been adopted for the year ended December 31, 2004. The Company will evaluate the effect, if any, of EITF 03-01 when final guidance is released.

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment” (“SFAS 123R”), which revises the original SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). The Company has previously adopted the requirements of SFAS 123, which require companies to expense the estimated fair value of employee stock options and similar awards. The accounting provisions of SFAS 123R will be effective at the beginning of the next fiscal year beginning after December 15, 2005. The Company is in the process of determining how the new

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

method of valuing stock-based compensation as prescribed in SFAS 123R will be applied to valuing stock-based awards granted, modified or vested and the impact on compensation expense related to such awards will have on the Company’s consolidated financial statements.

4. Investments

Bonds available for sale with an estimated fair market value of approximately $311.4 million and $374.2 million, were deposited with various governmental authorities in accordance with statutory requirements at March 31, 2005 and December 31, 2004, respectively. In addition, bonds with an estimated fair market value of $5.4 million and $5.5 million at March 31, 2005 and December 31, 2004, respectively, were held in a trust fund to meet the regulatory requirements applicable to Wind River Bermuda, one of the Company’s subsidiaries.

The cost and estimated fair value of investments classified as available for sale were as follows as of March 31, 2005 and December 31, 2004:

The Company held no debt or equity investments in a single issuer that was in excess of 10% of shareholders’ equity at March 31, 2005 or December 31, 2004.

The following table contains an analysis of the Company’s securities with gross unrealized losses, categorized by the period that the securities were in a continuous loss position as of March 31, 2005:

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

Subject to the risks and uncertainties in evaluating the impairment of a security’s value, the impairment evaluation conducted by the Company as of March 31, 2005, concluded the unrealized losses discussed above are not other than temporary impairments.

The Company regularly performs various analytical procedures with respect to its investments, including identifying any security with a fair value below its cost. Upon identification of such securities, a detailed review of all such securities meeting predetermined thresholds is performed to determine whether such decline is other than temporary. If it is determined that a decline in value is other than temporary based upon this detailed review, or if a decline in value for an investment has persisted for 12 continuous months, or if the value of the investment has been 20% or more below cost for six continuous months or more, or significantly declines in value for shorter periods of time, the security is evaluated to determine whether the cost basis of the security should be written down to its fair value. The factors considered in reaching the conclusion that a decline below cost is other than temporary include, among others, whether the issuer is in financial distress, the investment is secured, a significant credit rating action occurred, scheduled interest payments were delayed or missed and changes in laws or regulations have affected an issuer or industry. The amount of any write-down is included in earnings as a realized loss in the period in which the impairment arose.

During the quarter ended March 31, 2005, the Company recorded other than temporary losses of $0.1 million on its common stock portfolio. There were no realized losses recorded for the quarter ended March 31, 2004 as a result of the Company’s other than temporary impairment evaluation.

The amortized cost and estimated fair value of bonds classified as available for sale at March 31, 2005, by contractual maturity, are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

There were no investments in bonds that were non-income producing for the quarters ended March 31, 2005 and 2004.

5. Reinsurance

The Company cedes insurance to unrelated insurers on a pro rata and excess of loss basis in the ordinary course of business to limit its net loss exposure. Reinsurance ceded arrangements do not discharge the Company of primary liability as the originating insurer.

At March 31, 2005, the Company carried reinsurance receivables of $1,530.6 million. At December 31, 2004 and 2003, the Company carried reinsurance receivables of $1,531.9 million and $1,763.0 million, respectively. These amounts are net of a purchase accounting adjustment of $49.4 million arising from (1) discounting the reinsurance receivables balances and (2) applying a risk margin to the reinsurance receivables balance. Also, at the Wind River acquisition date, reinsurance receivables were reduced by an estimate of uncollectible reinsurance of $49.1 million. The $49.4 million discounting/risk margin adjustment will accrete through incurred losses in the future in a manner consistent with the related fair value adjustment for unpaid loss and loss adjustment expenses. The $49.1 million

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Unaudited)

estimate of uncollectible reinsurance at the time of the acquisition has been subsequently reduced to $28.8 million and $28.7 million at March 31, 2005 and December 31, 2004, respectively, primarily as a result of the commutation agreement with Trenwick America Reinsurance Corp. recorded in 2003. At March 31, 2005 and December 31, 2004, the Company held collateral securing its reinsurance receivables of $700.5 million and $705.6 million, respectively.

Since the Wind River acquisition date, no allowance for uncollectible reinsurance has been established since management believes its reinsurance receivables are recorded at their net realizable amounts. The need for an allowance for uncollectible reinsurance is based on the results of the Company’s regular review of the collectibility of recorded reinsurance receivables due from its external reinsurers.

Our Non-U.S. Insurance Operations commenced offering reinsurance to Penn-America Insurance Companies through a quota share arrangement. This reinsurance arrangement resulted in 30% of Penn-America Insurance Companies’ net retained insurance liability on new and renewal business bound after February 1, 2005 being ceded to Wind River Bermuda, an affiliated company. The agreement also stipulates that 30% of Penn-America Insurance Companies’ February 1, 2005 net unearned premium be ceded to Wind River Bermuda.

6. Income Taxes

Under current Cayman Islands law, the Company is not required to pay any taxes in the Cayman Islands on its income or capital gains. The Company has received an undertaking that, in the event of any taxes being imposed, the Company will be exempted from taxation in the Cayman Islands until the year 2023. Under current Bermuda law, the Company and its Bermuda subsidiaries are not required to pay any taxes in Bermuda on its income or capital gains. The Company has received an undertaking from the Minister of Finance in Bermuda that, in the event of any taxes being imposed, the Company will be exempt from taxation in Bermuda until March 2016. Under current Barbados law, the Company and its Barbados subsidiary are not required to pay any taxes in Barbados on its income or capital gains. The Company has received an undertaking that in the event of any taxes being imposed, the Company will be exempted from taxation in Barbados until the year 2033.

U.N. Holdings II and its respective subsidiaries are subject to income taxes imposed by U.S. authorities and file U.S. tax returns.

The Company is not subject to income taxation other than as stated above. There can be no assurance that there will not be changes in applicable laws, regulations or treaties, which might require the Company to change the way it operates or become subject to taxation.

The weighted average expected tax provision has been calculated using income (loss) before income taxes in each jurisdiction multiplied by that jurisdiction’s applicable statutory tax rate. The Company’s income before income taxes for the quarter ended March 31, 2005 of $14.1 million represents $12.3 million from the Non-U.S. Subsidiaries and $1.8 million from the U.S. Subsidiaries. The following table summarizes the differences between the tax provision under APB 28 for interim financial statement periods and the expected tax provision at the weighted average tax rate:

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In the quarter ended March 31, 2005, the Company recognized an extraordinary gain of $1.4 million for tax benefits derived from acquisition costs included as a reduction in equity as a result of the Company’s acquisition of Wind River Investment Corporation, that have been or will be deducted in the future from income for federal tax purposes.

7. Liability for Unpaid Losses and Loss Adjustment Expenses

Activity in the liability for unpaid losses and loss adjustment expenses is summarized as follows:

There was no development during the quarter ended March 31, 2005 on net losses and loss adjustment expense incurred prior to December 31, 2004. There were no net loss and loss adjustment expenses relating to prior accident years for the quarters ended March 31, 2005 and 2004.

In 2003, Penn-America Group received an unexpected increase in the number of new claims reported relating to four policies issued to a single insured between January 1, 1980 and April 1, 1983. The insured was a manufacturer of safety equipment including industrial masks and the new claims reported allege existing and potential bodily injury due to a medical condition called silicosis. The original policies covered products and completed operations only and were issued each with a $500,000 indemnity policy aggregate limit of liability. At March 31, 2005, the Company’s loss and loss adjustment expense reserves included its best estimate for its ultimate obligations for these claims based on current information.

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8. Junior Subordinated Debentures

The junior subordinated debentures described below were assumed by the Company in its merger with Penn-America Group, Inc.

On May 15, 2003, Penn-America Statutory Trust II, a business trust subsidiary formed by Penn-America Group, Inc., issued $15.0 million of floating rate Trust Preferred Securities. These securities have a thirty-year maturity, with a provision that allows the Company to call these securities at par after five years from the date of issuance. Cash distributions are paid quarterly in arrears at a rate of 410 basis points over three-month London Interbank Offered Rates. Distributions on these securities can be deferred for up to five years, but in the event of such deferral, the Company may not declare or pay cash dividends on its common stock. Penn-America Group guarantees all obligations of Penn-America Statutory Trust II with respect to distributions and payments of these securities.

Proceeds from the sale of the Trust Preferred Securities of $15.0 million and $0.5 million of floating rate capital securities issued to Penn-America Group, Inc. by Penn-America Statutory Trust II were used to acquire $15.5 million of Floating Rate Junior Subordinated Deferrable Interest Rate Debentures issued by Penn-America Group, Inc. These junior subordinated debentures have the same terms with respect to maturity, payments, and distributions as the floating rate Trust Preferred Securities issued by Penn-America Statutory Trust II. The proceeds from these junior subordinated debentures are being used to support growth in the Company’s insurance subsidiaries and for general corporate purposes.

On December 4, 2002, Penn-America Statutory Trust I, a business trust subsidiary formed by Penn-America Group, issued $15.0 million of floating rate Trust Preferred Securities. These securities have a thirty-year maturity, with a provision that allows the Company to call these securities at par after five years from the date of issuance. Cash distributions are paid quarterly in arrears at a rate of 400 basis points over three-month London Interbank Offered Rates. Distributions on these securities can be deferred for up to five years, but in the event of such deferral, the Company may not declare or pay cash dividends on it common stock. Penn-America Group guarantees all obligations of Penn-America Statutory Trust I with respect to distributions and payments of these securities.

Proceeds from the sale of Trust Preferred Securities of $15.0 million and $0.5 million of floating rate capital securities issued to Penn-America Group, Inc. by Penn-America Statutory Trust I were used to acquire $15.5 million of Floating Rate Junior Subordinated Deferrable Interest Rate Debentures issued by the Company. These junior subordinated debentures have the same terms with respect to maturity, payments, and distributions as the floating rate Trust Preferred Securities issued by Penn-America Statutory Trust I. In 2002, Penn-America Group, Inc. contributed net proceeds of $14.5 million for these junior subordinated debentures to Penn-America Insurance Company to support the business growth in its insurance subsidiaries.

9. Notes and Loans Payable

Notes Payable

Notes payable and term loans assumed through the acquisition of Penn Independent Corporation are comprised of the following:

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The Company has agreed to a pledge agreement granting the bank a first priority perfected lien on a money market deposit account of United National Insurance Company at the bank. This account shall always have on deposit the $4.5 million required by the pledge agreement. The Company has also agreed to a security agreement granting the bank a first priority perfected lien on its finance receivables.

Interest expense resulting from the note payable and term loan was $.03 million for the quarter ended March 31, 2005.

Loans Payable

Loans payable assumed through the acquisition of Penn Independent Corporation are comprised of the following:

Interest expense related to loans payable was $.02 million for the quarter ended March 31, 2005.

10. Related Party Transactions

In connection with the merger with Penn-America Group, Inc. and the acquisition of Penn Independent Corporation, the Company paid a $6.0 million transaction fee to Fox Paine & Company. Fox Paine & Company beneficially owns shares having approximately 85.4% of the Company’s total voting power.

Penn Independent Group leases its home office facility in Hatboro, Pennsylvania from Irvin Saltzman, father of United America Indemnity’s President, Jon S. Saltzman, and a director of Penn Independent Corporation through January 24, 2005. The lease is accounted for as a capital lease, and management believes that the lease terms are at market rates. Penn-America Group also leases a portion of the building in which Penn Independent Group’s home office facility is located. Capital lease obligations on these leases was $1.9 million as of March 31, 2005. In connection with the acquisition, the Company is under a post-closing obligation to either (i) enter into a lease for the Hatboro facility for a term of at least 10 years or (ii) purchase the Hatboro facility and related land on terms to be agreed upon. At this time, the Company is still exploring both options.

The following describes the minority equity interests in the Penn Independent subsidiaries:

On February 24, 1993, Apex Insurance Agency, Inc. issued ten shares of common stock to a minority shareholder. As of March 31, 2005, this represented an 11.11% ownership. As of March 31, 2005, PIC Holdings owned 88.89% of the outstanding common stock of Apex Insurance Agency, Inc. Minority interest as of March 31, 2005 was approximately $0.3 million. Under the terms of an agreement executed March 22, 2005, these shares were repurchased in April 2005 by Apex Insurance Agency, Inc. in exchange for a note payable over 84 months.

On December 22, 2003, Stratus Insurance Services, Inc. entered into a shareholders’ agreement with two minority shareholders issuing ten shares to each shareholder. As of March 31, 2005, these minority shareholders owned

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(Unaudited)

20.0% of the outstanding shares of Stratus Insurance Services, Inc. As of March 31, 2005, PIC Holdings owned 80.0% of the outstanding common stock of Stratus Insurance Services, Inc. Minority interest as of March 31, 2005 was $0.06 million.

On October 15, 2004, DVUA Massachusetts, Inc. entered into a shareholders’ agreement with a minority shareholder issuing twenty shares. As of March 31, 2005, the minority shareholder owned 20.0% of the outstanding shares of DVUA Massachusetts, Inc. As of March 31, 2005, PIC Holdings owned 80.0% of the outstanding common stock of DVUA Massachusetts Agency, Inc. Minority interest as of March 31, 2005 was $0.08 million.

11. Commitments and Contingencies

Capital Leases

The Company has lease agreements for the main offices of Penn-America Group, Inc. and Penn Independent Corporation, which are accounted for as capital leases. Interest is payable at 8.5% on the outstanding principal balance. The total of future minimum payments under capital lease obligations is $2.8 million which is comprised of interest of $0.9 million and the present value of net minimum payments of $1.9 million.

Property under capital leases is comprised of the following:

Amortization of $.03 million has been recorded on property under capital leases for the quarter ended March 31, 2005.

Lease Commitments

Total rental expense under operating leases for the quarters ended March 31, 2005 and 2004 aggregated $0.8 million, and $0.8 million, respectively. At March 31, 2005, future minimum payments under non-cancelable Capital and operating leases were as follows:

Legal Proceedings

Various lawsuits against the Company have arisen in the ordinary course of the Company’s business, including defending coverage claims brought against the Company by its policyholders or others. The Company’s litigation, including coverage claims matters, is subject to many uncertainties, and given their complexity and scope, the outcomes cannot be predicted with certainty. It is possible that the results of operations in a particular quarterly or annual period could be materially affected by an ultimate unfavorable outcome of litigation and/or coverage claim matters. Management believes, however, that the ultimate outcome of all litigation and coverage claim matters after

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(Unaudited)

consideration of applicable reserves should not have a material adverse effect on the Company’s financial condition.

12. Shareholders’ Equity

In connection with the merger with Penn-America Group, Inc., the Company issued 7.9 million Class A common shares valued at $141.9 million and issued options to purchase 0.2 million shares with a fair value of $1.6 million in the quarter ended March 31, 2005. The Company accrued awards under the share incentive plan of $0.2 million for restricted stock and $0.8 million for options to purchase the Company’s Class A common stock in the quarter ended March 31, 2005.

13. Compensation Plans

The Company follows SFAS 123, which establishes a fair value-based method of accounting for stock-based compensation plans.

Deferred Compensation

On April 6, 1992, Apex Insurance Agency, Inc. (“Apex”) entered into an agreement with its minority shareholders which provides for certain payments to such shareholders based upon the appraised fair value of the company. Vesting was conditioned upon Apex achieving certain financial benchmarks as set forth in the agreement, with payment to be made upon the occurrence of events as specified in the agreement. The vested value of such deferred compensation has been recorded as a liability as of March 31, 2005. Effective December 29, 2003, deferred compensation due to one of the minority shareholders was converted into a term loan payable.

As of March 29, 2005, Apex entered into a separation agreement with the sole remaining participant of this plan. In accordance with the terms of the plan and in connection with such separation, Apex will pay out the balance in the plan in three annual installments, with the first installment due April 1, 2006. Payment of such monies is conditioned on the participant’s ongoing compliance with certain restrictive covenants contained in the separation agreement, including non-compete, non-solicit and confidentiality obligations.

Share Incentive Plan

In September and October 2003, the Company’s Board of Directors approved the Company’s Share Incentive Plan and Amendment No. 1 thereto (as so amended, the “Plan”). The purpose of the Plan is to enable the Company to offer key employees stock options, restricted stock and other stock-based awards. Under the Plan, the Company has reserved 2,500,000 Class A common shares for issuance pursuant to awards granted under the Plan.

In accordance with Penn-America Group’s Stock Incentive Plan, the merger with United America Indemnity on January 24, 2005 caused immediate vesting of all the Penn-America Group’s unvested stock options. As of January 24, 2005, Penn-America Group had 203,635 stock options outstanding, all of which were exercisable. Each holder of the Penn-America Group stock options received converted stock options of United America Indemnity. In exchange for outstanding options to purchase Penn-America Group, Inc.’s Class A common shares, the Company granted 175,007 stock options at the acquisition date.

See subsequent events for amendment to the Share Incentive Plan.

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During the quarter ended March 31, 2005, the Company granted 30,000 Time-Based Options under the plan. The Time-Based Options vest in 20% increments over a five-year period, with any unvested options forfeited upon termination of employment for any reasons, and expire 10 years after grant date.

The options exercisable at March 31, 2005 include the following:

During the quarter ended March 31, 2005, the Company granted an aggregate of 73,904 Class A common shares, subject to certain restrictions, to key employees of the Company under the Plan (“Restricted Shares”). Of this grant, 3,872 Restricted shares vested immediately and the remainder vest in 20% increments over a five-year period. During the quarter ended March 31, 2005, an aggregate of 2,240 Class A common shares with a weighted average grant date value of $18.84 per share were granted, subject to certain restrictions, to the Board of Directors of the Company under the plan (“Director Restricted Shares”).

Annual Incentive Awards Plan

In December 2003, the Company’s Board of Directors approved an Annual Incentive Awards Plan (the “Awards Plan”). The Awards Plan is administered by the compensation committee of the Company’s Board of Directors. All officers are eligible to participate in the Awards Plan, as selected by the compensation committee.

Incentive awards under the Awards Plan are determined and paid in cash based upon objective performance-based criteria as set forth in the Awards Plan. The criteria relate to certain performance goals, such as net income and individual performance expectations as established and approved by the compensation committee.

See subsequent events disclosed for amendments to the Annual Incentive Awards Plan.

401(k) Plans

The Company maintains two 401(k) defined contribution plans covering substantially all U.S. employees.

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For our U.S. Subsidiaries, exclusive of the Penn-America Insurance Companies and the Agency Operations, the Company matches 75% of the first 6% contributed by the employee. In addition, the Company contributes 1% of the employee’s salary regardless of whether the employee contributes to the plan. Eligible employees are vested in the Company’s contribution and relative investment income after three years of service. Total expenses related to this plan for the quarter ended March 31, 2005 and 2004 were $0.3 million and $0.2 million, respectively.

For our Penn-America Insurance Companies’ and Agency Operations’ employees, the Company matches 50% of the first 6% contributed by the employee. Vesting is immediate for eligible employees in the Company’s contribution. Total expenses related to this plan for the quarter ended March 31, 2005 were $ 0.09 million.

14. Earnings Per Share

Basic earnings per share is computed using the weighted average number of common shares outstanding during the period.

The following table sets forth the computation of basic and diluted earnings per share.

15. Statutory Financial Information

GAAP differs in certain respects from Statutory Accounting Principles (“SAP”) as prescribed or permitted by the Insurance Departments. The principal differences between SAP and GAAP are as follows:

	•	Under SAP, investments in debt securities are carried at amortized cost, while under GAAP the Company records its debt securities at estimated fair value.
	•	Under SAP, policy acquisition costs, such as commissions, premium taxes, fees and other costs of underwriting policies are charged to current operations as incurred, while under GAAP such costs are

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(Unaudited)

		deferred and amortized on a pro rata basis over the period covered by the policy.
	•	Under SAP, certain assets designated as “Non-admitted Assets” (such as prepaid expenses) are charged against surplus.
	•	Under SAP, net deferred income tax assets are admitted following the application of specified criteria, with the resulting admitted deferred tax amount being credited directly to surplus.
	•	Under SAP, receivables are non-admitted and are charged against surplus based upon aging criteria.
	•	Under SAP, the costs and related receivables for guaranty funds and other assessments are recorded based on management’s estimate of the ultimate liability and related receivable settlement, while under GAAP such costs are accrued when the liability is probable and reasonably estimable and the related receivable amount is based on future premium collections or policy surcharges from in-force policies.
	•	Under SAP, unpaid losses and loss adjustment expenses and unearned premiums are reported net of the effects of reinsurance transactions, whereas under GAAP, unpaid losses and loss adjustment expenses and unearned premiums are reported gross of reinsurance.

The NAIC issues model laws and regulations, many of which have been adopted by state insurance regulators, relating to: (a) risk-based capital (“RBC”) standards; (b) codification of insurance accounting principles; (c) investment restrictions; and (d) restrictions on the ability of insurance companies to pay dividends.

The Company’s U.S. insurance subsidiaries are required by law to maintain certain minimum surplus on a statutory basis, and are subject to regulations under which payment of a dividend from statutory surplus is restricted and may require prior approval of regulatory authorities. Applying the current regulatory restrictions as of December 31, 2004, approximately $37.4 million is available for distribution from the Company’s U.S. insurance subsidiaries during 2005. The Company paid no dividends during 2004 or 2003.

The NAIC’s risk-based capital model provides a tool for insurance regulators to determine the levels of statutory capital and surplus an insurer must maintain in relation to its insurance and investment risks, as well as its reinsurance exposures, to assess the potential need for regulatory attention. The model provides four levels of regulatory attention, varying with the ratio of an insurance company’s total adjusted capital to its authorized control level RBC (“ACLRBC”): (a) if a company’s total adjusted capital is less than or equal to 200%, but greater than 150% of its ACLRBC (the “Company Action Level”), the company must submit a comprehensive plan to the regulatory authority proposing corrective actions aimed at improving its capital position; (b) if a company’s total adjusted capital is less than or equal to 150%, but greater than 100% of its ACLRBC (the “Regulatory Action Level”), the regulatory authority will perform a special examination of the company and issue an order specifying the corrective actions that must be followed; (c) if a company’s total adjusted capital is less than or equal to 100%, but greater than 70% of its ACLRBC (the “Authorized Control Level”), the regulatory authority may take any action it deems necessary, including placing the company under regulatory control; and (d) if a company’s total adjusted capital is less than or equal to 70% of its ACLRBC (the “Mandatory Control Level”), the regulatory authority must place the company under its control. Based on the standards currently adopted, each of the Company’s U.S. Insurance Subsidiaries’ capital and surplus are in excess of the prescribed 200% company action level risk-based capital requirements of $196.8 million.

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(Unaudited)

The following is selected information for the Company’s and the Predecessor’s U.S. Insurance Subsidiaries, net of intercompany eliminations, where applicable, as determined in accordance with SAP:

16. Segment Information

In connection with the Company’s merger with Penn-America Group and acquisition of Penn Independent Group, the Company has reevaluated its segment classifications and determined that the Company will operate and manage its business through two business segments during 2005 and thereafter. The Insurance Operations segment includes the operations of our United National Insurance Companies, Penn-America Insurance Companies and Non-U.S. Insurance Operations. The Agency Operations segment includes the operations of Penn Independent.

The segments follow the same accounting policies used for the Company’s consolidated financial statements as described in the summary of significant accounting policies.

Gross premiums written by product class are as follows:

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Following is a tabulation of business segment information. Corporate information is included to reconcile segment data to the consolidated financial statements.