SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

Crum & Forster Holdings Corp.

Crum & Forster Holdings Corp.
305 Madison Avenue, Morristown, New Jersey 07962
(973) 490-6600
(Address, including zip code, and telephone number,
including area code, of registrant’s principal executive offices)

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 the filing requirements for at least the past 90 days.
Yes [X]            No [  ]

Indicate by check mark whether the Registrant is an accelerated filer (as defined in rule 12b-2 of the Exchange Act).
Yes [  ]            No [X]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

CRUM & FORSTER HOLDINGS CORP.

Form 10-Q

Index

2

PART I
FINANCIAL INFORMATION

Item 1. Financial Statements

CRUM & FORSTER HOLDINGS CORP.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)

The accompanying notes are an integral part of the consolidated financial statements.

3

CRUM & FORSTER HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands)

The accompanying notes are an integral part of the consolidated financial statements.

4

CRUM & FORSTER HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF SHAREHOLDER’S EQUITY
(Dollars in thousands)

The accompanying notes are an integral part of the consolidated financial statements.

5

CRUM & FORSTER HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE (LOSS) INCOME
(Dollars in thousands)

The accompanying notes are an integral part of the consolidated financial statements

6

CRUM & FORSTER HOLDINGS CORP.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)

The accompanying notes are an integral part of the consolidated financial statements.

7

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands)

1.		Organization and Basis of Presentation
		Crum & Forster Holdings Corp. (the “Company” or “Crum & Forster”) is a Delaware holding company which is 100% owned by Fairfax Inc. (“Fairfax”), a Wyoming holding company. Fairfax is wholly-owned by FFHL Group Ltd., a Canadian holding company, which is owned by Fairfax Financial Holdings Limited (“Fairfax Financial”), a Canadian financial services holding company which is publicly traded on the Toronto Stock Exchange and on the New York Stock Exchange under the symbol “FFH”. The Company, through its subsidiaries, provides a full range of commercial property and casualty insurance distributed through an independent producer force located across the United States.
		Crum & Forster was established for the purpose of holding the capital stock of Crum & Forster Holding Inc. (“Holding”), another wholly-owned subsidiary of Fairfax, and had no operations prior to becoming the parent of Holding. On June 5, 2003, a merger of entities under common control occurred at historical cost, whereby the capital stock of Holding was contributed to Crum & Forster and, accordingly, Crum & Forster became the parent of Holding. The consolidated financial statements of Holding and its subsidiaries have become the Company’s historical financial statements.
		These consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of the Company, Holding and their wholly-owned subsidiaries, including United States Fire Insurance Company (“US Fire”), The North River Insurance Company (“North River”), Crum & Forster Indemnity Company, Crum and Forster Insurance Company and Crum & Forster Underwriters Co. of Ohio (“CF Underwriters”). Effective July 1, 2004, CF Underwriters was merged into US Fire. US Fire owns 100% of the stock of Crum & Forster Specialty Insurance Company. North River owns 100% of the stock of Seneca Insurance Company, Inc. and its subsidiaries.
		The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses and disclosure of contingent assets and liabilities. Such estimates and assumptions may differ from actual results. Certain financial information that is normally included in annual financial statements, including certain financial statement footnotes, prepared in accordance with GAAP, is not required for interim reporting purposes and has been condensed or omitted herein. These consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements as of December 31, 2003 and related notes thereto included in the Company’s Registration Statement on Form S-4 (Registration No. 333-107722), to which Amendment No. 4 was filed with the Securities and Exchange Commission on March 15, 2004.
		The interim financial data as of September 30, 2004 and for the three and nine months ended September 30, 2004 and 2003 is unaudited. However, in the opinion of management, the interim data includes all adjustments, consisting of normal recurring accruals, necessary for a fair statement of the Company’s results for the interim periods. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. All significant intercompany amounts have been eliminated.
		Certain amounts in the Company’s prior year consolidated financial statements have been reclassified to conform to the 2004 presentation.
2.		New Accounting Pronouncement
		In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46, Consolidation of Variable Interest Entities, (“FIN 46”) to address when it is appropriate to consolidate financial interests in a variable interest entity (“VIE”), a new term to define a business structure that either does not have equity investors with voting or other similar rights or has equity investors that do not provide sufficient financial resources to support its activities. For such entities, FIN 46 imposes a consolidation model that focuses on the relative exposures of the participants to the economic risks or rewards associated with a VIE’s activities, including those conveyed by derivatives, credit enhancements and other arrangements, where one party is the “primary beneficiary” and, therefore, is required to consolidate the VIE.

8

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in thousands)

		The consolidation requirements of FIN 46 began to be phased-in during the first quarter of 2003, with immediate application to all new VIEs created after January 31, 2003. In December 2003, the FASB issued a revision to FIN 46 which, among other things, delayed the required implementation for VIEs existing prior to February 1, 2003 and held by public companies to the first interim period ending after March 15, 2004. The adoption of FIN 46 had no impact on the Company’s consolidated financial statements.
3.		Unpaid Losses and Loss Adjustment Expenses
		Changes in the Company’s liability for unpaid losses and loss adjustment expenses (“LAE”) are summarized as follows:

		During the third quarter of 2004, the Company incurred losses and LAE of approximately $89,700 (excluding reinsurance reinstatement premiums of approximately $10,300) principally associated with hurricanes Charley, Frances, Ivan and Jeanne.
4.		Asbestos and Environmental Unpaid Losses and Loss Adjustment Expenses
		The Company has exposure to asbestos and environmental claims arising from the sale of general liability, commercial multi-peril and umbrella insurance policies, the majority of which were written for accident years 1985 and prior.
		Estimation of ultimate liabilities for these exposures is unusually difficult due to outstanding issues such as whether or not coverage exists, definition of an occurrence, determination of ultimate damages and allocation of such damages to financially responsible parties.

9

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in thousands)

Changes in the Company’s liability for asbestos and environmental exposures are summarized as follows:

		The Company also maintains reserves for other latent exposures such as those associated with silica, lead, chemicals, sick building syndrome, mold and gas and vapors of $23,144 and $26,701, net of reinsurance, as of September 30, 2004 and December 31, 2003, respectively.
5.		Reinsurance
		The components of the Company’s net premiums written and premiums earned are summarized as follows:

10

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in thousands)

     The components of the Company’s total reinsurance recoverable are summarized as follows:

6.		Long-Term Debt
		On June 5, 2003, concurrent with the merger of entities under common control described in Note 1 above, Crum & Forster Funding Corp., an unaffiliated special purpose entity, issued $300,000 aggregate principal amount of senior notes (the “Notes”) in a private placement, with the sole intent of having obligations under such Notes only until the Company could assume such obligations. On June 30, 2003, the Company assumed Crum & Forster Funding Corp.’s obligations under the Notes. The Notes, which bear interest payable semi-annually at 10.375%, mature on June 15, 2013. The net proceeds from the offering of approximately $290,955 were used to fund an interest escrow account in the amount of approximately $63,115 to make the first four semi-annual interest payments on the Notes and to pay a dividend to Fairfax in the amount of $217,885, with the remainder used to pay related financing costs. The Notes contain certain restrictions on incurrence of additional indebtedness, dividend payments to Fairfax, asset sales and certain transactions with affiliates. In addition, the Company was required by the terms of the Notes to use its best efforts to register the Notes, or similar instruments with substantially the same terms to be exchanged for the Notes, with the Securities and Exchange Commission. Pursuant to an exchange offer, which was completed on April 20, 2004, the Company issued $300,000 aggregate principal amount of registered notes with substantially the same terms as the Notes, in exchange for all of the outstanding Notes. As required by the terms of the Notes, additional interest of $279 was incurred for the period from December 28, 2003 through April 19, 2004, after which such additional interest was no longer payable on the Notes.
		For the nine months ended September 30, 2004, total interest expense on the Notes was $24,942, including additional interest described above, accretion of the discount on the Notes and amortization of related deferred financing costs.
		Concurrent with the issuance of the Notes, the Company entered into a non-interest bearing standby credit agreement, subordinate to the Notes, whereby Fairfax Financial agreed, under certain conditions, to lend up to $40,000 to Crum & Forster in order to meet certain corporate obligations. Borrowings under this agreement, if any, are due in June 2018. Through September 30, 2004, there have been no borrowings under this agreement.

11

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in thousands)

7.		Investments
		In July 2004, as an economic hedge against a decline in the equity markets, the Company executed a short sale of approximately $200,000 of Standard & Poor’s Depositary Receipts (“SPDRs”). Simultaneously, the Company purchased two-year S&P Index call options (“Options”) limiting the potential loss on the future purchase of the SPDRs to $40,000. The cost of the Options was $6,000. Both the obligation to purchase the SPDRs and the Options are carried at fair value in the consolidated financial statements. The fair value of the obligation to purchase the SPDRs is included in securities sold, not yet purchased and the fair value of the Options is included in other invested assets in the consolidated balance sheet. As of September 30, 2004, the net change in the fair values of the SPDRs and the Options totaled a loss of $2,733 and was included in realized investment (losses) gains on the consolidated statement of operations. The Company also incurs interest expense in an amount equal to the dividend earnings on the SPDRs sold. Interest expense of $844 was recorded for the three months ended September 30, 2004.
		The Company pledged approximately $278,000 in cash and United States Treasury securities as collateral for the obligation to purchase the SPDRs. These assets are recorded in assets pledged for securities sold, not yet purchased on the consolidated balance sheet.
		In April 2004, the Company invested $30,000 in shares of HWIC Asia Fund (“HWIC”), bringing the total investment in HWIC to $76,210. HWIC is an investment fund owned 100% by Fairfax Financial affiliates that invests in a diversified portfolio of listed equity and equity-related securities in Asia.
8.		Commitments and Contingencies
		The Company’s subsidiaries are involved in various lawsuits and arbitration proceedings arising in the ordinary course of business. While the ultimate outcome of such matters cannot be predicted with certainty, in the opinion of management, no such matter is likely to have a material adverse effect on the Company’s consolidated financial position. However, it should be noted that the frequency of large damage awards, including large punitive damage awards that bear little or no relation to actual economic damages incurred by plaintiffs in some jurisdictions, continues to create the potential for an unpredictable judgment in any given matter.
9.		Segment Reporting
		The Company operates in the commercial property and casualty insurance business. Premiums earned for the Company’s lines of business are summarized as follows:

12

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
(Dollars in thousands)

The losses and LAE and loss and LAE ratios of the Company’s lines of business are summarized as follows:

In the three months ended September 30, 2004, the Company incurred losses and LAE of approximately $89,700 (excluding reinsurance reinstatement premiums of approximately $10,300) principally associated with hurricanes Charley, Frances, Ivan and Jeanne. Such losses primarily affected the property line of business. In addition, in the normal course of periodic re-estimation of loss and LAE reserves, the Company reallocated its reserves among lines of business and prior accident years which adversely affected the 2004 calendar year loss and LAE ratios of the workers’ compensation, general liability and surety lines of business and favorably affected the other lines of business.

The Company does not allocate investment results or certain corporate expenses for the purpose of evaluating the financial performance of each line of business.

13

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

The following discussion relates to the consolidated results of operations, financial condition, liquidity and capital resources and critical accounting policies and estimates of the Company for the interim periods indicated. References within this discussion to the “Company” or “Crum & Forster” refer to Crum & Forster Holdings Corp. and its direct and indirect subsidiaries, including United States Fire Insurance Company (“US Fire”), The North River Insurance Company (“North River”), Crum & Forster Indemnity Company (“CF Indemnity”), Crum and Forster Insurance Company (“CF Insurance”) and Crum & Forster Underwriters Co. of Ohio (“CF Underwriters”). Effective July 1, 2004, CF Underwriters was merged into US Fire. US Fire owns 100% of the stock of Crum & Forster Specialty Insurance Company. North River owns 100% of the stock of Seneca Insurance Company, Inc. and its subsidiaries. References to “Fairfax” refer to Fairfax Inc., Crum & Forster’s parent company. References to “Fairfax Financial” refer to Fairfax Financial Holdings Limited, which holds a 100% indirect interest in Fairfax Inc.

Certain financial information that is normally included in annual financial statements, including certain financial statement footnotes, prepared in accordance with GAAP, is not required for interim reporting purposes and has been condensed or omitted herein. This discussion, and the related consolidated financial statements, should be read in conjunction with the Company’s consolidated financial statements as of December 31, 2003 and related notes thereto included in the Company’s Registration Statement on Form S-4 (Registration No. 333-107722), to which Amendment No. 4 was filed with the Securities and Exchange Commission on March 15, 2004. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year.

All dollar amounts are in thousands, unless otherwise indicated.

Forward-looking Statements

This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, Section 21E of the Securities Exchange Act of 1934 and the Private Securities Litigation Reform Act of 1995. These are statements that relate to future periods and include statements regarding the Company’s anticipated performance. In addition, the outcome of pending motions or appeals, if any, related to litigation discussed herein is unknown.

Generally, the words, “anticipates”, “believes”, “expects”, “intends”, “estimates”, “projects”, “plans”, “target”, “potential”, “likely”, “may”, “could”, “should” and similar expressions identify forward-looking statements. These forward-looking statements involve known and unknown risks, uncertainties and other important factors that could cause the Company’s actual results, performance or achievements, or industry results, to differ materially from any future results, performance or achievements expressed or implied by these forward-looking statements. These risks, uncertainties and other important factors include, but are not limited to, the following:

•

Lowering or loss of one of the Company’s financial strength ratings;

•

Insufficient loss reserves, including reserves for asbestos, environmental and other latent claims;

•

Occurrence of natural or unnatural catastrophic events;

•

Competitive conditions in the insurance market;

•

Exposure to emerging claims and coverage issues;

•

Loss of key producers;

•

Inability to realize the Company’s investment objectives;

•

Inability of certain of the Company’s insurance subsidiaries to pay dividends;

•

Inability to obtain reinsurance coverage on reasonable terms and prices;

•

Exposure to credit risk, in the event reinsurers or insureds that owe the Company premiums or reimbursement of deductibles paid by the Company on their behalf fail to pay;

•

Adverse developments in the prospects or results of operations of Fairfax or its affiliates;

•

Loss of key employees;

•

Changes in governmental regulations;

•

Exposure to credit risks on novated policies; and

•

Limited ability to borrow.

14

Additional information regarding these factors, and others that could cause actual results to differ materially from expectations, is included in the Company’s Registration Statement on Form S-4 (Registration No. 333-107722), to which Amendment No. 4 was filed with the SEC on March 15, 2004. The information appearing under “Risk factors” in such Registration Statement is incorporated by reference into, and made a part of, Part II of this Form 10-Q. Any forward-looking statements made in this quarterly report are made by the Company as of the date of this quarterly report. Except as otherwise required by federal securities laws, the Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Critical Accounting Policies and Estimates

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. These principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of material contingent assets and liabilities as of the balance sheet dates and the revenues and expenses reported during the relevant periods. In general, management’s estimates are based on historical experience, evaluation of current trends, information from third party professionals and various other assumptions that are believed to be reasonable under the known facts and circumstances.

The accounting policies and estimates summarized below are those that require Crum & Forster to make assumptions about highly uncertain matters. If management were to make different assumptions about those matters, or if actual results were to differ significantly from those estimates, the reported consolidated results of operations and financial condition could be materially affected.

The Company’s significant accounting policies are described in full detail in Note 2 to the Company’s consolidated financial statements as of December 31, 2003 included in its Registration Statement on Form S-4 (Registration No. 333-107722), to which Amendment No. 4 was filed with the SEC on March 15, 2004.

Unpaid Losses and Loss Adjustment Expenses

Unpaid losses and loss adjustment expenses (“LAE”) include reserves for unpaid reported losses and for losses incurred but not reported (“IBNR”). For reported losses, the Company establishes case reserves within the parameters of coverage provided in the insurance policy, which represent the estimated ultimate cost of events or conditions that have been reported to, or specifically identified by the Company. The estimates reflect the judgment of claims personnel based on general reserving practices, the experience and knowledge of such personnel regarding the nature of the specific claim and, where appropriate, advice of counsel, with the goal of setting the reserve at the ultimate expected loss amount as soon as information becomes available. For IBNR losses, reserves are estimated using established actuarial methods.

Because much of the coverage the Company offers involves claims that may not ultimately be settled for many years after they are incurred, subjective judgments as to the ultimate exposure to losses are an integral and necessary component of the loss reserving process. For certain catastrophic events, there is considerable uncertainty underlying the assumptions and associated estimated reserves for losses and LAE. The Company’s reserves are continually reviewed using a variety of statistical and actuarial techniques to analyze current claim costs, frequency and severity data and prevailing economic, social and legal factors. Other variables such as past loss experience, changes in legislative conditions, changes in judicial interpretation of legal liability and policy coverage, changes in claims handling practices and inflation are also taken into consideration. Reserves are also established to provide for the estimated expense of settling claims, including legal and other fees, and the general expenses of administering the claims adjustment process.

Reserves for asbestos and environmental exposures cannot be estimated solely with the traditional loss reserving techniques, which rely on historical accident year development factors and take into consideration the previously mentioned variables. Asbestos and environmental reserves are more difficult to estimate than other loss reserves because of legal issues, societal factors and difficulty in determining the parties who may ultimately be held liable. Therefore, in addition to taking into consideration the traditional variables that are utilized to arrive at other loss reserve amounts, Crum & Forster also looks at past and anticipated future asbestos claim filings against each insured, past settlement values of similar asbestos claims, an analysis of each insured’s potential liability, the jurisdictions involved, the potential role of other insurance, the length of time necessary to clean up polluted sites, controversies surrounding the identity of the responsible party, the degree of remediation deemed to be necessary, the estimated time period for litigation expenses, judicial expansions of coverage, case law and the history of prior claim development. Generally, case reserves are established when sufficient information has been obtained to indicate coverage under a specific insurance policy. End of period reserves in relation to paid losses in a period are also considered. Furthermore, IBNR reserves are established to cover additional estimated exposures on both known and unasserted claims. The reserves are continually reviewed and updated as additional information is obtained.

15

In recent years, the Company has continued to see the emergence of asbestos trends noted above, including an increased number of claimants filing asbestos claims against its insureds, an increased value of claims against viable asbestos defendants as co-defendants seek bankruptcy protection and an increased number of insureds asserting that their asbestos claims are not subject to aggregate limits and that each individual bodily injury claim should be treated as a separate occurrence. Management is currently studying these trends and has engaged an independent actuary to conduct a ground-up review of the Company’s asbestos reserves, which is expected to be completed during the fourth quarter of 2004. Due to the inherent uncertainties described above and to the potential impact of recent trends, the Company’s ultimate liability for asbestos claims may vary substantially from the amount currently reserved.

Other Than Temporary Declines in Value of Investments

Declines in the market values of invested assets below carrying value are evaluated for other than temporary impairment on a quarterly basis. Recognition of impairment losses for declines in the value of fixed income investments and equity securities attributable to issuer-specific events is based upon all relevant facts and circumstances for each investment. For fixed income investments with unrealized losses due to market conditions or industry-related events, management considers the Company’s intent and ability to hold the investments for a period of time to allow a market recovery, or to maturity, in the process of evaluating whether securities with unrealized losses have suffered an other than temporary decline. Significant assumptions and management judgment are involved in determining if the decline is other than temporary. See “Liquidity and Capital Resources—Insurance Operating Subsidiaries” below for further discussion of investments in an unrealized loss position.

Reinsurance Recoverable

Amounts recoverable from reinsurers are initially estimated in conjunction with the establishment of reserves for unpaid losses and LAE. These amounts may be adjusted as actual case reserves are recorded and reinsured claims are settled. The ceding of risk to reinsurers does not relieve an operating company of its primary obligation to policyholders as the direct insurer. Accordingly, the Company is exposed to the risk that any reinsurer may be unable, or unwilling, to meet its obligations assumed under reinsurance agreements. The Company attempts to mitigate this risk by entering into reinsurance arrangements only with reinsurers that have credit ratings and statutory surplus above certain levels and by obtaining collateral.

An estimated allowance for uncollectible reinsurance recoverable is recorded on the basis of periodic evaluation of balances due from reinsurers, judgments regarding reinsurer solvency, known disputes, reporting characteristics of the underlying reinsured business, historical experience, current economic conditions and the state of insurer/reinsurer relations in general, and at Crum & Forster’s insurance operating companies in particular.

Overview

The Company is a national commercial property and casualty insurance company with a focused underwriting strategy, targeting specialty classes of business and overlooked market opportunities. Operating through its home office and regional branch network, the Company writes a broad range of commercial coverage, including workers’ compensation, general liability, property, commercial automobile, commercial multi-peril and surety. The Company generally conducts business on a brokerage basis through approximately 1,000 producers located throughout the United States. The Company’s two largest producers accounted for approximately 14% and 6% of gross premiums written for the nine months ended September 30, 2004.

The Company’s objective is to expand opportunistically into classes of business or market segments that are consistent with its underwriting expertise and have the potential to generate an underwriting profit. Management believes the Company’s ability to identify and react to changing market conditions provides it with a competitive advantage. Based on the experience and underwriting expertise of management, the Company seeks to write new lines of business and expand existing classes of business based on market conditions and expected profitability. The Company offers insurance products designed to meet specific insurance needs of targeted insured groups, underwriting specific types of coverage for markets that are generally underserved by the industry, while focusing on markets within its areas of underwriting expertise.

16

The profitability of property and casualty insurance companies is primarily determined by its underwriting results and investment performance. Underwriting results are the net result of a company’s premiums earned and amounts paid, or expected to be paid, to settle insured claims and other general and administrative expenses. The insurance business is unique in that premiums charged for insurance coverage are set without certainty of the ultimate claim costs to be incurred on a given policy. This requires that liabilities be estimated and recorded in recognition of future loss and settlement obligations. Due to the inherent uncertainty in estimating these liabilities, there can be no assurance that actual liabilities will not exceed recorded amounts or premiums received. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural disasters, regulatory measures and court decisions that define and expand the extent of coverage. Insurance premium prices are also influenced by available insurance capacity or the industry’s willingness to deploy capital to cover each insurable risk.

Premiums collected are invested until funds are required to pay settled claims. Insurance company investment portfolios generally must provide a balance between total return, capital preservation and liquidity in order to have adequate funds available for payment of claims as they are settled. The Company follows a long-term, value-oriented investment philosophy, with the goal of optimizing investment returns viewed on a total return basis, without reaching for yield, while maintaining a sensitivity to liquidity requirements. The Company intends to protect its capital from loss and invest in debt and equity securities that it believes are selling at prices below their intrinsic value.

Management measures the results of operations by monitoring certain indicators of growth and profitability. Growth is generally measured in terms of gross premiums written. Management further reviews growth in its gross premiums written in terms of its rate of retention of existing insureds, increases or decreases in the pricing of renewed policies and the growth in new business premiums.

Underwriting profitability is measured both in dollars and by the combined ratio, a standard industry measure. Underwriting profit or loss equals premiums earned less losses and LAE, policy acquisition costs and other underwriting expenses, and excludes investment results, interest expense and other income or expense. The combined ratio expresses underwriting results as a percentage of premiums earned and generally comprises two components: the loss ratio which is the percentage of losses and LAE to premiums earned and the expense ratio which is the percentage of the sum of policy acquisition costs and other underwriting expenses to premiums earned. A combined ratio less than 100% indicates an underwriting profit; a combined ratio greater than 100% indicates an underwriting loss.

The property and casualty insurance business is cyclical and influenced by many factors, including price competition, economic conditions, natural and man-made disasters (for example, hurricanes, earthquakes and terrorism), interest rates, state regulations, court decisions and changes in the law. Market competition has intensified throughout 2004, particularly in the third quarter. Renewal pricing in the casualty lines increased by approximately 8% through June 30, 2004 but declined by approximately 1% in the third quarter of 2004, resulting in an overall renewal price increase of approximately 4% for the nine months ended September 30, 2004. Renewal pricing in the property lines declined by approximately 6% through September 30, 2004. Management continues to believe that rates remain adequate relative to the risks assumed in both the casualty and property lines of business. Management is committed to maintaining rate adequacy even at the expense of premium growth. The Company’s renewal retention rate has improved overall to approximately 66% in the first nine months of 2004 from approximately 61% in the first nine months of 2003. The casualty renewal retention rate increased by approximately 10 percentage points in the third quarter of 2004, following a decline of approximately five percentage points through June 30, 2004, while the 2004 renewal retention rate in the property line of business has consistently exceeded the 2003 rate by 10 or more points. New business for the nine months ended September 30, 2004 was approximately 18% lower than the prior year, principally in the property lines, due to more competitive market conditions, including expanded availability of coverage from higher rated companies.

17

Results of Operations

The components of the Company’s net income, and certain ratios based thereon, are summarized as follows:

Net loss for the three months ended September 30, 2004 was $44,777 and net income for the nine months ended September 30, 2004 was $9,468, compared with net income of $13,854 and $175,080, for the three and nine months ended September 30, 2003, respectively. The lower net income was principally the net result of lower underwriting results, lower realized investment gains and higher interest expense, partially offset by increased investment income for the three and nine months ended September 30, 2004, as compared to the same periods in 2003. During the third quarter of 2004, underwriting results were adversely affected by net catastrophe losses of approximately $100,000, principally associated with hurricanes Charley, Frances, Ivan and Jeanne. The 2003 realized investment gains reflect the significant rally in the fixed income markets in the spring of 2003. Higher interest expense in 2004 arose primarily from the issuance of $300,000 aggregate principal amount of 10.375% senior notes (the “Notes”) effective June 5, 2003. Investment income for the three and nine months ended September 30, 2004 increased due to the combined effects of reinvestment of cash balances into longer duration fixed income securities in 2004 as compared to 2003 and higher earnings from an equity method investee that was not purchased until the second quarter of 2003. The increase in the combined ratio principally reflects the adverse effect of catastrophe losses in the third quarter of 2004, which added 46.8 and 15.0 points to the combined ratio for the three and nine months ended September 30, 2004, respectively.

18

Underwriting Results

Gross Premiums Written

The Company’s gross premiums written by line of business are summarized as follows:

For the three months ended September 30, 2004, gross premiums written decreased as compared to the three months ended September 30, 2003, the first year over year quarterly decline since March 2002. This decline was primarily due to a reduction in new business of approximately 29% and a price decrease on renewal policies of approximately 3%, partially offset by an increase in the renewal retention rate of approximately 10 percentage points. For the nine months ended September 30, 2004, gross premiums written increased over the nine months ended September 30, 2004 primarily due to an increase in the renewal retention rate of approximately five percentage points and an increase in pricing on renewal policies of approximately 1%, partially offset by a decrease in new business of approximately 18%. New business declined for both the three and nine months ended September 30, 2004 as the market has softened and competition for new business, particularly from higher rated companies, has intensified. Renewal retention rates increased for both the three and nine months ended September 30, 2004, despite the softening market, as a result of the maturing of the Company’s book of business.

Casualty

For the three months ended September 30, 2004, gross premiums written in casualty lines, which include the workers’ compensation, general liability and commercial automobile lines of business, decreased by $6,867, or 3.4%, compared to the three months ended September 30, 2003 due to a reduction in new business and price decreases as a result of increased competition in the marketplace. Partially offsetting these decreases was an increase in the renewal retention rate. For the nine months ended September 30, 2004, gross premiums written increased by $39,268, or 7.5%, as compared to the same period in 2003 due to price increases on renewal policies and a modest increase in the renewal retention rate, partially offset by a reduction in new business. The renewal retention rate was negatively affected by increased competition and the discontinuance of certain business programs accounting for approximately $17,000 of gross premiums written in 2003.

19

Property

For the three and nine months ended September 30, 2004, gross premiums written in property lines, which include the property, commercial multi-peril and surety lines of business, decreased by $2,312, or 2.2%, and $10,584, or 3.6%, respectively, as compared to the three and nine months ended September 30, 2003, due to reductions in new business and price decreases on renewal policies, partially offset by an increase in the renewal retention rate. For both the three and nine months ended September 30, 2004, property production was affected by softening market conditions, characterized by increased capacity in the marketplace and decreasing rates.

Net Premiums Written

For the three months ended September 30, 2004, net premiums written decreased by $23,472, or 9.2%, as compared to the three months ended September 30, 2003. For the nine months ended September 30, 2004, net premiums written increased by $26,046, or 4.0%, over the nine months ended September 30, 2003. The change in net premiums written was generally in line with the growth in gross premiums written after giving effect in the third quarter of 2004 to reinsurance reinstatement premiums associated with catastrophe losses and aggregate stop loss reinsurance premiums arising from the reallocation of prior years’ loss reserves.

Premiums Earned

For the three and nine months ended September 30, 2004, premiums earned increased by $7,732, or 3.8%, and $116,072, or 21.1%, as compared to the three and nine months ended September 30, 2003, respectively. Premiums earned reflect the amount of net premiums written applicable to the portion of the policy term that expires in a given period. The Company generally earns premiums on a pro rata basis over the period in which the coverage is provided. The larger increase in premiums earned relative to net premiums written was principally attributable to the lag in recognition of the increased premiums written in the latter part of 2003. Premiums earned were also affected by reinstatement premiums associated with the catastrophe losses and aggregate stop loss reinsurance premiums arising from the reallocation of prior years’ loss reserves in the third quarter of 2004.

Losses and LAE

For the three and nine months ended September 30, 2004, the Company’s calendar year loss and LAE ratio increased to 109.9% and 83.3%, respectively, from 67.8% and 70.2% for the three and nine months ended September 30, 2003, respectively. The deterioration in the calendar year loss and LAE ratios in 2004 versus 2003 is attributable to catastrophe losses incurred in the third quarter of 2004. The accident year loss and LAE ratio increased to 84.4% in 2004 from 69.5% in 2003, also principally attributable to catastrophe losses in the third quarter of 2004.

Underwriting Expenses

Underwriting expenses are comprised of policy acquisition costs and other underwriting expenses. Policy acquisition costs are comprised principally of commissions paid to producers and premium taxes. Other underwriting expenses consist of other operating expenses associated with the Company’s underwriting activities and include salaries and benefits, information technology and rent, but exclude interest expense and other corporate income and expense items.

The Company’s acquisition expense ratio increased to 14.7% and 14.0% for the three and nine months ended September 30, 2004, respectively, from 12.8% and 13.1% for the three and nine months ended September 30, 2003, respectively, primarily due to reinsurance reinstatement premiums associated with catastrophe losses, aggregate stop loss reinsurance premiums arising from the reallocation of prior years’ loss reserves and lower amounts of ceded premiums on which a ceding commission is paid to the Company by reinsurers.

The Company’s other underwriting expense ratio declined to 15.2% and 14.5% for the three and nine months ended September 30, 2004, respectively, from 16.6% and 17.2% for the three and nine months ended September 30, 2003, respectively, due to higher premiums earned.

20

Investment Results

For the three months ended September 30, 2004, the Company reported realized investment losses of $1,953, compared to realized investment gains of $13,913 for the three months ended September 30, 2003. For the nine months ended September 30, 2004, the Company reported realized investment gains of $45,493, compared to realized investment gains of $231,960 for the nine months ended September 30, 2003. These declines in realized investment gains primarily reflect the significant rally in the fixed income markets in the spring of 2003. The components of those investment gains are summarized as follows:

The Company’s investment income was $27,516 and $79,983 for the three and nine months ended September 30, 2004, respectively, as compared to $13,902 and $53,804 for the three and nine months ended September 30, 2003, respectively. For the three and nine months ended September 30, 2004, the increase in investment income of $13,614, or 97.9%, and $26,179, or 48.7%, respectively, was due to the combined effects of reinvestment of cash balances into longer duration fixed income securities in 2004 compared to 2003 and higher earnings from an equity method investee that was not purchased until the second quarter of 2003.

Other Income and Expense

For the three and nine months ended September 30, 2004, other expense, net was $1,554 and $7,120, respectively, as compared to $5,399 and $4,864 for the three and nine months ended September 30, 2003, respectively. The lower expense for the three months ended September 30, 2004 was primarily the result of non-recurring corporate expenses incurred in August 2003. The increased expense in the nine months ended September 30, 2004 was primarily the result of a retirement benefits agreement with the former Chairman of the Company’s insurance operating subsidiaries.

Liquidity and Capital Resources

Holding Company

As a holding company with no direct operations, Crum & Forster Holdings Corp.’s assets consist primarily of its investments in the capital stock of its insurance subsidiaries, $31,516 of restricted cash and investments held in an interest escrow account for the payment of the next two interest payments on the Notes and deferred tax assets associated with holding company net operating losses. Crum & Forster’s ability to satisfy corporate obligations, principally interest on the Notes, is primarily dependent on the dividend paying capacity of such subsidiaries. State insurance laws restrict the amount of shareholder dividends that insurance companies may pay without prior approval of regulatory authorities.

The ability of the Company’s insurance subsidiaries to pay dividends depends, among other things, on such subsidiaries having positive statutory earned surplus. The Company’s principal insurance subsidiaries are US Fire and North River. On March 29, 2004, US Fire

21

paid a cash shareholder dividend of $80,000. On March 30, 2004 and June 25, 2004, Crum & Forster paid cash shareholder dividends to Fairfax in the amounts of $42,500 and $19,000, respectively. The remaining amount was allocated for the payment of corporate expenses. US Fire may not pay further shareholder dividends in 2004. North River is not permitted to pay dividends in 2004, as it did not have positive statutory earned surplus at December 31, 2003. As of September 30, 2004, US Fire had statutory earned surplus of approximately $94,000 and North River reported negative statutory earned surplus of approximately $6,000. Based on consolidated net income through September 30, 2004, the Company may not pay further shareholder dividends under the terms of the Senior Notes.

The Notes, which bear interest payable semi-annually at 10.375%, mature on June 15, 2013. The net proceeds from the offering of $290,955 were used to fund an interest escrow account of approximately $63,115 to make the first four semi-annual interest payments and to pay a dividend to Fairfax in the amount of $217,885, with the remainder used to pay related financing costs.

Under the terms of the Notes, the Company has significant restrictions on the amount of new debt that may be incurred. Pursuant to a non-interest bearing standby credit agreement between Fairfax Financial and the Company, under certain circumstances, the Company has the ability to borrow up to $40,000 from Fairfax Financial to meet certain corporate obligations. Borrowings under this agreement, if any, bear no interest and are due in June 2018. Through September 30, 2004, there have been no borrowings under this agreement.

Insurance Operating Subsidiaries

At Crum & Forster’s insurance operating subsidiaries, cash provided by operating activities primarily consists of premium collections, reinsurance recoveries and investment income. Cash provided from these sources is generally used for payment of losses and LAE, policy acquisition costs, operating expenses, ceded reinsurance premiums, income taxes and shareholder dividends, when permitted. Management believes that, for the foreseeable future, cash flows from operations at the Company’s operating subsidiaries will be sufficient to pay their operating expenses.

Cash provided by operating activities for the nine months ended September 30, 2004 was $117,568, as compared to $89,545 for the nine months ended September 30, 2003. The principal reasons for improved cash flows from operations in 2004 were growth in premiums written, partially offset by increased income tax payments. Income tax payments were higher by $40,823 for the nine months ended September 30, 2004, as compared to the same period in 2003, as the majority of the Company’s subsidiary net operating losses were utilized in late 2003.

Purchases of available-for-sale securities comprised the majority of cash used in investing activities for the nine months ended September 30, 2004. Cash used in investing activities was $1,802,353 for the nine months ended September 30, 2004, reflecting primarily purchases of United States Treasury securities in the first quarter of 2004, as compared to cash provided by investing activities of $1,586,595 for the nine months ended September 30, 2003, which primarily reflected significant sales of investments in the second quarter of 2003.

Certain operating subsidiaries have entered into securities repurchase agreements that allow these companies to sell securities to, and repurchase such securities from, Fairfax Financial. Under these agreements, US Fire and North River may sell a maximum of $100,000 of securities to Fairfax Financial at any one time and CF Indemnity, CF Insurance and CF Underwriters are limited to sales of $5,000 each. These arrangements have not been utilized since 2000. Effective July 1, 2004, CF Underwriters was merged into US Fire and CF Underwriters’ securities repurchase agreement was no longer in effect.

Shareholder’s equity was $800,799 at September 30, 2004 as compared to $906,115 at December 31, 2003. The decrease was primarily the result of dividends paid to Fairfax and unrealized losses on investments during 2004. The Company’s combined statutory policyholders’ surplus was approximately $1,067,385 at September 30, 2004, as compared to $1,107,435 at December 31, 2003. Effective March 30, 2004, the State of Delaware enacted legislation to adopt certain insurance accounting standards promulgated by the National Association of Insurance Commissioners. The adoption of such standards resulted in an increase in the Company’s combined statutory policyholders’ surplus of $28,138, principally relating to the recognition of goodwill. The decline in the Company’s combined statutory surplus was attributable to a dividend payment of $80,000 offset by the aforementioned goodwill adjustment.

22

The aggregate carrying value of the Company’s investment portfolio, including cash and cash equivalents, was $3,080,589 at September 30, 2004. Investments in available-for-sale fixed income and equity securities are summarized as follows:

Certain individual investments within the Company’s available-for-sale securities portfolio had gross unrealized losses as of September 30, 2004 totaling $106,551, of which $68,811 was attributed to fixed income securities, and $37,740 was attributed to equity securities. United States Treasury securities, the majority of which mature in 2018 or beyond, accounted for $48,280 of the gross unrealized losses in the fixed income portfolio. Gross unrealized losses of $106,551 represented 5.1% of the cost of such securities in the aggregate. An aging of available-for-sale securities in a loss position follows:

The amortized cost and fair value of fixed income securities by contractual maturity are shown below. Actual maturities may differ from maturities shown below due to the existence of call or put features. At September 30, 2004, securities containing call and put features represented 2.3% and 2.4%, respectively, of total fair value of the fixed income portfolio.

23