SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

For the Quarterly Period Ended September 30, 2004

or

For the Transition Period from ____ to ____.

Commission File Number 1-15202

W. R. BERKLEY CORPORATION

(203) 629-3000

None

Indicate by check mark whether the registrant (1) 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 and (2) has been subject to such filing requirements for the past 90 days.
Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act.)
Yes x No o

Number of shares of common stock, $.20 par value, outstanding as of November 1, 2004: 84,144,023

Table of Contents

Part I – FINANCIAL INFORMATION

ITEM 1. Financial Statements

W. R. Berkley Corporation and Subsidiaries

See accompanying notes to consolidated financial statements.

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W. R. Berkley Corporation and Subsidiaries

See accompanying notes to consolidated financial statements.

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W. R. Berkley Corporation and Subsidiaries

See accompanying notes to consolidated financial statements.

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W. R. Berkley Corporation and Subsidiaries

See accompanying notes to consolidated financial statements.

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W. R. Berkley Corporation and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
September 30, 2004

1. GENERAL

     The accompanying consolidated financial statements should be read in conjunction with the following notes and with the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003. Reclassifications have been made in the 2003 financial statements as originally reported to conform them to the presentation of the 2004 financial statements.

     The income tax provision has been computed based on the Company’s estimated annual effective tax rate, which differs from the federal income tax rate of 35% principally because of tax-exempt investment income.

     Basic earnings per share data are based upon the weighted average number of shares outstanding during the period. Diluted earnings per share data reflect the potential dilution that would occur if options granted under employee stock-based compensation plans were exercised.

     In the opinion of management, the financial information reflects all adjustments that are necessary for a fair presentation of financial position and results of operations for the interim periods. Seasonal weather variations and natural and man-made catastrophes can have a significant impact on the results of any one or more reporting periods.

2. RECENT ACCOUNTING PRONOUNCEMENTS

     In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), which was replaced in December 2003 by FIN 46R. FIN 46R addresses consolidation issues surrounding special purpose entities and certain other entities, collectively termed variable interest entities (“VIE”). A VIE is an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. FIN 46R requires VIEs to be consolidated by their primary beneficiaries. The Company adopted FIN 46R in 2003, except for the consolidation provisions which were adopted on January 1, 2004.

     As a result of adopting the consolidation provisions of FIN 46R, the Company deconsolidated the W. R. Berkley Capital Trust (the “Trust”). The Company owns preferred securities of the Trust that were previously accounted for at the date of purchase as an extinguishment of debt and eliminated in consolidation. The impact of de-consolidating the Trust was to increase fixed maturity securities by $13,787,000 and to increase junior subordinated debentures by $14,906,000, as of January 1, 2004. The difference between these two amounts, which was $727,000 after income taxes, was reported on the Company’s consolidated statement of operations as a cumulative effect of change in accounting principle.

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W. R. Berkley Corporation and Subsidiaries
Notes to Unaudited Consolidated Financial Statements (Continued)
September 30, 2004

3. COMPREHENSIVE INCOME

     The following is a reconciliation of comprehensive income (dollars in thousands):

4. STOCK-BASED COMPENSATION

     The Company adopted FASB Statement No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of FASB Statement No. 123”, effective as of January 1, 2003. Under the prospective method of adoption selected by the Company, the fair value recognition provisions of FASB 148 are applied to all employee awards granted, modified or settled after January 1, 2003. The following table illustrates the effect on net income and earnings per share as if the fair value based method had been applied to all outstanding and unvested awards in each period (dollars in thousands, except per share data).

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W. R. Berkley Corporation and Subsidiaries
Notes to Unaudited Consolidated Financial Statements (Continued)
September 30, 2004

5. INVESTMENTS

     The cost, fair value and carrying value of fixed maturity securities and equity securities are as follows (dollars in thousands):

6. REINSURANCE CEDED

     The Company reinsures a portion of its exposures principally to reduce its net liability on individual risks and to protect against catastrophic losses. Estimated amounts recoverable from reinsurers are reported net of reserves for uncollectible reinsurance ($2.5 million as of September 30, 2004). The following amounts arising under reinsurance ceded contracts have been deducted in arriving at the amounts reflected in the statement of operations (dollars in thousands):

7. RETIREMENT BENEFITS

     Effective August 19, 2004, the Company entered into an agreement to provide retirement benefits to the Company’s chief executive officer and chairman of the board. Retirement benefits are reported in accordance with FASB Statement No. 87, “Employers’ Accounting for Pensions”. As of August 19, 2004, the projected benefit obligation of $17,277,000 was recorded as a liability with a corresponding deferred asset that will be amortized as a prior service cost over the estimated remaining service period. For the three months ended September 30, 2004, the retirement benefit expense was $283,000. The key actuarial assumptions used to derive the projected benefit obligation and related expense are a discount rate of 6.0%, a rate of compensation increase of 5.0% per year and a retirement age of 72.

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W. R. Berkley Corporation and Subsidiaries
Notes to Unaudited Consolidated Financial Statements (Continued)
September 30, 2004

8. INDUSTRY SEGMENTS

     The Company’s operations are presently conducted in five segments of the insurance business: specialty lines of insurance, regional property casualty insurance, alternative markets, reinsurance, and international.

     Our specialty segment underwrites complex and sophisticated third-party liability risks, principally within the excess and surplus lines, professional liability, and commercial transportation markets. The specialty business is conducted through nine operating units. The companies within the segment are divided along the different customer bases and product lines that they serve. The specialty units deliver their products through a variety of distribution channels depending on the customer base and particular risks insured. The customers in this segment are highly diverse.

     Our regional subsidiaries provide commercial insurance products to customers primarily in 32 states. Key clients of this segment are small-to-mid-sized businesses and governmental entities. The regional subsidiaries are organized geographically, which provides them with the flexibility to adapt to local market conditions, while enjoying the superior administrative capabilities and financial strength of the Company. The regional operations are conducted through four geographic regions based on markets served: Midwest, New England, Southern (excluding Florida) and Mid Atlantic.

     Our alternative markets operations specialize in developing, insuring, reinsuring and administering self-insurance programs and other alternative risk transfer mechanisms. Our clients include employers, employer groups, insurers, and alternative market funds seeking less costly, more efficient ways to manage exposure to risks. In addition to providing primary and excess workers’ compensation insurance, the alternative markets segment also provides a wide variety of fee-based third-party administrative services.

     Our reinsurance operations specialize in underwriting property casualty reinsurance on both a treaty and a facultative basis. The principal reinsurance units are facultative reinsurance, which writes individual certificates and program facultative business, treaty reinsurance, which functions as a traditional reinsurer in specialty and standard reinsurance lines, and Lloyd’s reinsurance, which writes quota share reinsurance with certain Lloyd’s syndicates.

     Our international segment includes our operations in Argentina and the Philippines. In Argentina, we currently offer commercial and personal property casualty insurance. In the Philippines, we provide savings and life products to customers, including endowment policies to pre-fund education costs and retirement income. Our operations in the U.K. are reported in our specialty segment.

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W. R. Berkley Corporation and Subsidiaries
Notes to Unaudited Consolidated Financial Statements (Continued)
September 30, 2004

8. INDUSTRY SEGMENTS (continued)

     Summary financial information about the Company’s operating segments is presented in the following table. Income (loss) before income taxes by segment consists of revenues less expenses related to the respective segment’s operations, including allocated investment income. Identifiable assets by segment are those assets used in or allocated to the operation of each segment.

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     Identifiable assets by segment are as follows (dollars in thousands):

     Net premiums earned by major line of business are as follows (dollars in thousands):

9. DEBT

     In August 2004, the Company issued $150 million aggregate principal amount of 6.15% senior notes due in August 2019. The notes were issued at 99.375% of their face value amount and the net proceeds to the Company after expenses were $147,817,000.

10. COMMITMENTS, LITIGATION AND CONTINGENT LIABILITIES

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

     The New York State Attorney General and other regulators have commenced investigations, legal actions and general inquiries concerning alleged anti-competitive activities in the insurance industry. These allegations include improper sales practices as well as other non-competitive behaviors. Upon learning of this, the Company on its own initiative commenced an internal review with the assistance of outside counsel. The internal review is focused on our relationships with our distribution channels. The internal review is not yet complete.

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SAFE HARBOR STATEMENT

     This is a “Safe Harbor” Statement under the Private Securities Litigation Reform Act of 1995. Any forward-looking statements contained herein, including statements related to our outlook for the industry and for our performance for the year 2004 and beyond, are based upon the Company’s historical performance and on current plans, estimates and expectations. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. They are subject to various risks and uncertainties, including but not limited to, the cyclical nature of the property casualty industry, the long-tail and potentially volatile nature of the reinsurance business, product demand and pricing, claims development and the process of estimating reserves, the uncertain nature of damage theories and loss amounts, natural and man-made catastrophic losses, including as a result of terrorist activities, increases in the level of our retention, the impact of competition, the availability of reinsurance, the ability of our reinsurers to pay reinsurance recoverables owed to us, investment risks, including those relating to fixed income securities, merger arbitrage investments, and other equity securities, exchange rate and political risks relating to our international operations, legislative and regulatory developments, including those related to alleged anti-competitive or other improper sales practices in the insurance industry, changes in the ratings assigned to us by ratings agencies, the availability of dividends from our insurance company subsidiaries, our ability to successfully acquire and integrate companies and invest in new insurance ventures, our ability to attract and retain qualified employees, and other risks detailed from time to time in the Company’s filings with the Securities and Exchange Commission. These risks could cause actual results of the industry or our actual results for the year 2004 and beyond to differ materially from those expressed in any forward-looking statement made by or on behalf of the Company. Any projections of growth in the Company’s net premiums written and management fees would not necessarily result in commensurate levels of underwriting and operating profits. Forward-looking statements speak only as of the date on which they are made.

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Item 2.

Management’s Discussion and Analysis of Financial
Condition and Results of Operations

Overview

     W. R. Berkley Corporation is an insurance holding company that provides, through its subsidiaries, commercial property casualty insurance products and services. The Company’s principal focus is casualty business. The Company’s primary sources of revenues and earnings are insurance and investments.

     The profitability of the Company’s insurance business is affected primarily by the adequacy of premium rates. The ultimate adequacy of premium rates is not known with certainty at the time a property casualty insurance policy is issued because premiums are determined before claims are reported. The ultimate adequacy of premium rates is affected mainly by the severity and frequency of claims, which are influenced by many factors, including natural and other disasters, regulatory measures and court decisions that define and change the extent of coverage and the effects of economic inflation on the amount of compensation due for injuries or losses. General insurance prices are also influenced by the available insurance capacity, i.e., the level of policyholders’ surplus employed in the industry and the industry’s willingness to deploy that capital.

     An insurer’s profitability is also affected by its investment income. The Company’s invested assets, which are derived from its own capital and cash flow from its insurance business, are invested principally in fixed income securities. The return on fixed income securities is affected primarily by general interest rates and the credit quality and duration of the securities. The Company also invests in equity securities, including equity securities related to merger arbitrage and convertible arbitrage strategies. Investment returns are impacted by government policies and overall economic activity.

Critical Accounting Estimates

     Management considers estimates and assumptions relating to reserves for losses and loss expenses to be critical to the portrayal of the Company’s financial condition and results since these estimates and assumptions are based on complex and subjective judgments, often including the interplay of specific uncertainties with related accounting and actuarial measurements. Such estimates are also susceptible to change as significant periods of time may elapse between the occurrence of an insured loss, the report of the loss to the insurer, the ultimate determination of the cost of the loss and the insurer’s payment of that loss.

     To recognize liabilities for unpaid losses, either known or unknown, insurers establish reserves, which is a balance sheet account representing estimates of future amounts needed to pay claims and related expenses with respect to insured events which have occurred. Our loss reserves reflect our best estimates of the cost of settling all such claims.

     In general, when a claim is reported, claims personnel establish a “case reserve” for the estimated amount of the ultimate payment. The estimate represents an informed judgment based on general reserving practices and reflects the experience and knowledge of the claims personnel regarding the nature and value of the specific type of claim. Reserves are also established on an aggregate basis to provide for losses incurred but not yet reported to the insurer, potential inadequacy of case reserves, the estimated expenses of settling claims, including legal and other fees and general expenses of administrating the claims adjustment process, and a provision for potentially uncollectible reinsurance. Reserves are established based upon the then current legal interpretation of coverage provided.

     In examining reserve adequacy, several factors are considered in addition to the economic value of losses. These factors include historical data, legal developments, changes in social attitudes and economic conditions, including the effects of inflation. The actuarial process relies on the basic assumption that past experience, adjusted judgmentally for the effects of current developments and anticipated trends, is an appropriate basis for predicting future

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outcomes. Reserve amounts are necessarily based on management’s informed estimates and judgments using data currently available. As additional experience and other data become available and are reviewed, these estimates and judgments are revised. This may result in increases or decreases to reserves for insured events of prior years. The reserving process implicitly recognizes the impact of inflation and other factors affecting loss costs by taking into account historical claim patterns and perceived trends.

     Reserves do not represent an exact calculation of liability. Rather, reserves represent an estimate of what management expects the ultimate settlement and claim administration will cost. While the methods for establishing the reserves are well tested over time, some of the major assumptions about anticipated loss emergence patterns are subject to unanticipated fluctuation. These estimates, which generally involve actuarial projections, are based on management’s assessment of facts and circumstances then known, as well as estimates of future trends in claims severity and frequency, judicial theories of liability and other factors, including the actions of third parties which are beyond the Company’s control. The variables described above are affected by both internal and external events, such as inflation, judicial and litigation trends, reinsurance coverage and legislative changes.

     The inherent uncertainties of estimating reserves are greater for certain types of liabilities, where long periods of time elapse before a definitive determination of liability is made. In periods with increased economic volatility, it becomes more difficult to accurately predict claim costs. Reserve estimates are continually refined in an ongoing process as experience develops and further claims are reported and settled. Adjustments to reserves are reflected in the results of the periods in which such estimates are changed. Because setting reserves is inherently uncertain, the Company cannot assure that its current reserves will prove adequate in light of subsequent events.

     Management determines the loss reserves included in the Company’s financial statements based upon an actuarially derived point estimate. The Company uses a variety of actuarial techniques and methods to derive the actuarial point estimate. These methods include paid loss development, incurred loss development, paid and incurred Bornhuetter-Ferguson methods and frequency and severity methods. This actuarial data is analyzed by line of business, coverage, and accident or policy year, as appropriate, for each operating unit. Industry loss experience is also used to supplement the Company’s own data in selecting “tail factors” and in areas where the Company’s own data is limited.

     The establishment of loss reserves includes consideration of qualitative factors that may affect the ultimate losses. These qualitative considerations include, among others, the impact of re-underwriting initiatives, changes in the mix of business, changes in distribution sources and changes in policy terms and conditions. Examples of changes in terms and conditions that can have a significant impact on reserve levels are the use of aggregate policy limits, the expansion of coverage exclusions, whether or not defense costs are within policy limits and changes in deductibles and attachment points.

     Following is a summary of the Company’s reserves for losses and loss expenses by business segment as of September 30, 2004 and December 31, 2003:

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     Following is a summary of the Company’s reserves for losses and loss expenses by major line of business as of September 30, 2004 and December 31, 2003:

     Following is a summary of the Company’s major components of the Company’s reserves for losses and loss expenses as of September 30, 2004 and December 31, 2003:

     For the nine months ended September 30, 2004, the Company reported losses and loss expenses of $1.9 billion, of which $200 million represented an increase in estimates for claims occurring in prior years. The increases in estimates for claims occurring in prior years by segment were $80 million for reinsurance, $62 million for specialty, $33 million for regional, $23 million for alternative markets and $2 million for international. The estimate for claims occurring in accident years prior to accident year 2003 increased by $232 million and the estimate for claims occurring in accident year 2003 decreased by $32 million. The overall increase in prior year reserves was primarily related to the reinsurance, general liability and workers’ compensation lines of business, which increased $80 million, $87 million and $31 million, respectively.

     The increase in prior year reserves for reinsurance business was primarily a result of higher than expected claims reported by ceding companies. The Company sets its initial loss estimates based principally upon information obtained during the underwriting process and adjusts these estimates as additional information becomes available. As certain reinsurance contracts have matured, the Company has adjusted its estimates of ultimate losses to reflect a higher level of known losses as well as a pattern of delayed loss reporting by some ceding companies.

     The increase in prior year reserves for general liability is generally due to higher than expected legal expenses incurred in the defense of claims in certain classes of business. Prior year ultimate loss ratios were also adjusted upwards to recognize that claim costs for certain classes of business are emerging over a longer period of time and at a higher level than expected.

     The increase in prior year reserves for workers’ compensation was generally due to higher than expected medical cost inflation. This resulted principally from increased utilization of the health care system by injured workers and more expensive and higher usage of prescription drugs.

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Results of Operations for the First Nine Months of 2004 Compared with the First Nine Months of 2003

     Following is a summary of gross premiums written, net premiums written, premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of premiums earned), expense ratios (underwriting expenses expressed as a percentage of premiums earned) and combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the nine months ended September 30, 2004 and 2003 (dollars in thousands):

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Results of Operations

     The following table presents the Company’s net income and net income per share for the nine months ended September 30, 2004 and 2003 (amounts in thousands, except per share data).

     The increase in net income in 2004 compared with 2003 reflects higher profits from underwriting activity as well as higher investment income. The improvement in underwriting results reflects higher insurance prices, improved terms and conditions and growth in more profitable lines of business. The improved underwriting results were partially offset by losses of $32 million attributable to Hurricanes Charley, Frances, Ivan and Jeanne.

Gross Premiums Written. Gross premiums written were $3.5 billion in 2004, up 11% from 2003. The increase in gross premiums written in 2004 was a result of higher prices as well as new business. Although prices generally increased during the first nine months of 2004, the Company is experiencing an increased level of price competition. A summary of gross premiums written in 2004 compared with 2003 by business segment follows:

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Specialty gross premiums increased by 13% to $1.2 billion in 2004, compared with $1.1 billion in 2003, due to higher prices and new business. The increases in specialty gross premiums by major business line were 7% for premises operations, 18% for professional liability, 23% for automobile and 50% for products liability. The increase in products liability included approximately $22 million related to a renewal rights transaction completed in July 2004. Specialty property lines gross premiums decreased by 1%.

•

Regional gross premiums increased by 13% to $989 million in 2004, compared with $872 million in 2003. The increase generally reflects higher prices and new business. The increases in regional gross premiums by major business line were 12% for commercial multiple peril, 14% for automobile and 17% for workers’ compensation. Gross premiums from assigned risk plans decreased by 10%.

•

Alternative markets gross premiums increased by 30% to $557 million in 2004, compared with $429 million in 2003, due to higher prices and new business. The increases in alternative markets gross premiums by major business line were 20% for excess workers’ compensation, 29% for primary workers’ compensation and 131% for assigned risk plans. Assigned risk premiums, which are written on behalf of state-owned assigned risk plans managed by the Company, are 100% reinsured by the respective state-owned assigned risk pools.

•

Reinsurance premiums decreased by 6% to $721 million in 2004 compared with $768 million in 2003. Reinsurance written through Lloyd’s decreased 13% to $161 million due to a planned reduction in that business. Reinsurance written in the U.S. decreased 4% to $560 million. The decrease in business written in the U.S. is primarily the result of the discontinuance of all facultative business written with a particular ceding company.

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International premiums increased by 11% to $60 million in 2004 from $54 million in 2003.

Net Premiums Written. Net premiums written were $3.2 billion in 2004, up 17% from 2003. Net premiums grew more than gross premiums due to a reduction in the portion of gross premiums ceded to reinsurers. The decrease in premiums ceded to reinsurers was a result of the termination of an aggregate reinsurance agreement effective December 31, 2003 and to the planned reduction in reinsurance purchases. Premiums ceded under the aggregate reinsurance agreement were $110 million in the first nine months of 2003.

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Premiums Earned. Premiums earned increased 28% in 2004 compared with 2003. Insurance premiums are earned ratably over the policy term, and therefore premiums earned in 2004 are related to premiums written during both 2003 and 2004. The growth rate for 2004 earned premiums reflects the underlying growth in net premiums written of 35% for all of 2003 and 17% for the first nine months of 2004.

Net Investment Income. Following is a summary of net investment income for the nine months ended September 30, 2004 and 2003 (dollars in thousands):

     Net investment income increased 36% in 2004 compared with 2003. Average invested assets (including cash and cash equivalents) increased 37% to $7.0 billion in 2004 compared with $5.1 billion in 2003. The increase was a result of cash flow from operations and the proceeds from debt issued during 2004 and 2003. The average annualized gross yield on investments was 4.1% in 2004 compared with 4.7% in 2003. The lower yield in 2004 reflects the decrease in general interest rate levels, an increase in the portion of the portfolio invested in tax-exempt securities and a planned reduction in the portfolio duration. Interest on funds held under reinsurance treaties decreased by $24 million due to the termination of an aggregate reinsurance agreement effective December 31, 2003.

Realized Investment Gains and Losses. Realized investment gains and losses result from sales of securities and from provisions for other than temporary impairment in securities. Realized investment gains were $45 million in 2004 and $61 million in 2003. Realized gains in 2004 resulted primarily from the sale of common and preferred equity securities and the sale of high yield fixed income securities. Realized gains in 2003 resulted primarily from the sale of fixed income securities in order to decrease the duration of the portfolio and to increase the portion of the portfolio invested in state and municipal securities. There were no provisions for other than temporary impairment in the first nine months of 2004 or 2003.

Service Fees. The alternative markets segment offers fee-based services to help clients develop and administer self-insurance programs, primarily for workers’ compensation coverages. Service fees increased 9% in 2004 compared with 2003 primarily as a result of an increase in service fees for managing assigned risk plans.

Losses and Loss Expenses. Losses and loss expenses increased 28% in 2004 compared with 2003 primarily as a result of the increased premium volume and higher weather-related losses. Weather-related losses were $58 million compared to $35 million in the corresponding 2003 period. Weather-related losses in 2004 include losses of $32 million attributable to Hurricanes Charley, Frances, Ivan and Jeanne. The consolidated loss ratio decreased to 63.6% in 2004 from 63.7% in 2003. A summary of loss ratios in 2004 compared with 2003 by business segment follows:

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The specialty segment’s loss ratio decreased to 61.9% in 2004 from 63.1% in 2003 primarily as a result of higher prices and lower prior year reserve development ($62 million in 2004 compared with $76 million in 2003).

•

The regional loss ratio was 57.2% in 2004 compared with 56.7% in 2003 as improvement in the current accident year results were offset by higher prior year reserve development ($33 million in 2004 compared with $18 million in 2003). Weather-related losses for the regional segment were $28 million and $35 million in 2004 and 2003, respectively.

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•

The alternative market loss ratio increased to 70.4% in 2004 from 68.7% in 2003. The Company discounts its liabilities for excess workers’ compensation business because of the long period of time over which losses are paid. The increase in the loss ratio in 2004 reflects a lower discount rate for current year business and an increase in prior year reserves.

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The reinsurance loss ratio was 70.6% in 2004 compared with 70.8% in 2003. The decrease reflects improved results for the current accident year as a result of higher prices for both Lloyd’s and U.S. business. These improvements were partially offset by losses of $27 million attributable to Hurricanes Charley, Frances, Ivan and Jeanne and by higher prior year reserve development ($81 million in 2004 compared with $61 million in 2003).

•

The international loss ratio was 53.1% in 2004 compared with 52.2% in 2003.

Other Operating Costs and Expenses. Following is a summary of other operating costs and expenses for the nine months ended September 30, 2004 and 2003 (dollars in thousands):

     Underwriting expenses increased 23% in 2004 compared with 2003 as a result of higher premium volume. The consolidated expense ratio decreased to 27.1% in 2004 from 28.0% in 2003. The decrease is due to a 28% increase in earned premiums with no significant increase in underwriting expenses other than commissions and premium taxes.

     Service company expenses represent the costs associated with the alternative market’s fee-based business. The increase in service expenses of 5% compared with 2003 was commensurate with the increase in service fee revenues of 9%.

     Other costs and expenses represent primarily general and administrative expenses for the corporate office and costs associated with our foreign operations. Other costs and expenses increased to $38 million in 2004 from $33 million in 2003 due to higher compensation costs.

Interest Expense. Interest expense increased 23% to $48 million as a result of the issuance of $200 million of 5.875% senior notes in February 2003, $150 million of 5.125% senior notes in September 2003 and $150 million of 6.15% senior notes in August 2004.

Income taxes. The effective income tax rate was 31% in 2004 and 2003. The effective tax rate differs from the federal income tax rate of 35% primarily because of tax-exempt investment income and state income taxes.

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Results of Operations for the Third Quarter of 2004 Compared to the Third Quarter of 2003

     Following is a summary of gross premiums written, net premiums written, premiums earned, loss ratios (losses and loss expenses incurred expressed as a percentage of premiums earned), expense ratios (underwriting expenses expressed as a percentage of premiums earned) and combined ratios (sum of loss ratio and expense ratio) for each of our business segments for the three months ended September 30, 2004 and 2003 (dollars in thousands):