Back to GetFilings.com

Table of Contents

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

Commission File Number 1-14094

Meadowbrook Insurance Group, Inc.

26600 Telegraph Road, Southfield, Michigan 48034

(248) 358-1100

     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 Rule 12b-2 of the Exchange Act). Yes þ          No o

     The aggregate number of shares of the Registrant’s Common Stock, $.01 par value, outstanding on August 8, 2003 was 29,022,394.

Table of Contents

TABLE OF CONTENTS

1

Table of Contents

MEADOWBROOK INSURANCE GROUP, INC.

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

2

Table of Contents

MEADOWBROOK INSURANCE GROUP, INC.

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

3

Table of Contents

MEADOWBROOK INSURANCE GROUP, INC.

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

4

Table of Contents

MEADOWBROOK INSURANCE GROUP, INC.

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

5

Table of Contents

MEADOWBROOK INSURANCE GROUP, INC.

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

6

Table of Contents

MEADOWBROOK INSURANCE GROUP, INC.

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

7

Table of Contents

Note 1 — Summary of Significant Accounting Policies

     Basis of Presentation

      The consolidated financial statements include accounts, after elimination of intercompany accounts and transactions, of Meadowbrook Insurance Group, Inc. (the “Company”), its wholly owned subsidiary Star Insurance Company (“Star”), and Star’s wholly owned subsidiaries, Savers Property and Casualty Insurance Company, Williamsburg National Insurance Company, and Ameritrust Insurance Corporation (which collectively are referred to as the “Insurance Company Subsidiaries”), and American Indemnity Insurance Company, Ltd. and Preferred Insurance Company, Ltd. The consolidated financial statements also include Meadowbrook, Inc. and its subsidiaries, and Crest Financial Corporation and its subsidiaries.

      These financial statements and the notes thereto should be read in conjunction with the Company’s audited financial statements and accompanying notes included in its Annual Report on Form 10-K for the year ended December 31, 2002.

      The consolidated financial statements reflect all normal recurring adjustments, which were, in the opinion of management, necessary to present a fair statement of the results for the interim period. The results of operations for the six months ended June 30, 2003, are not necessarily indicative of the results expected for the full year.

     Revenue Recognition Policy

      Premiums written are recognized as earned on a pro rata basis over the life of the policy term. Unearned premiums represent the portion of premiums written that are applicable to the unexpired terms of policies in force. Provisions for unearned premiums on reinsurance assumed from others are made on the basis of ceding reports when received. Certain premiums are subject to retrospective premium adjustments. The estimated ultimate premium is recognized over the term of the insurance contract.

      Commission income, which includes reinsurance brokerage, is recorded on the latter of the effective date or the billing date of the policies on which they were earned. Commission income is reported net of sub-broker commission expense. Commission and other adjustments are recorded when they occur and the Company maintains an allowance for estimated policy cancellations and commission returns.

      Fee income, which includes risk management consulting, loss control, and claims services, is recognized in the period the services are provided. The claims processing fees are recognized as revenue over the estimated life of the claims. For those contracts that provide services beyond the contractually defined termination date of the related contracts, fees are deferred in an amount equal to management’s estimate of the Company’s obligation to continue to provide services.

      The Company reviews, on an ongoing basis, the collectibility of its receivables and establishes an allowance for estimated uncollectible accounts.

      Realized gains or losses on sale or maturity of investments are determined on the basis of specific costs of the investments. Dividend and interest income are recognized when earned. Discount or premium on debt securities purchased at other than par value is amortized using the constant yield method. Investments with other than temporary declines in fair value are written down to estimated fair value and the related realized losses recognized in income.

     Earnings Per Share

      Basic earnings per share are based on the weighted average number of common shares outstanding during the period, while diluted earnings per share includes the weighted average number of common shares and potential dilution from shares issuable pursuant to stock options using the treasury stock method.

8

Table of Contents

      Outstanding options of 2,092,149 and 2,764,244 for the six months ended June 30, 2003 and 2002, respectively, have been excluded from the diluted earnings per share as they were anti-dilutive. Shares issuable pursuant to stock options included in diluted earnings per share were 30,834 for the six months ended June 30, 2003. There were no shares issuable pursuant to stock options included in diluted earnings per share for the six months ended June 30, 2002. In addition, outstanding warrants of 300,000 for the six months ended June 30, 2003 and 2002, have been excluded from the diluted earnings per share as they were anti-dilutive.

      Outstanding options of 2,092,149 and 2,337,744 for the quarters ended June 30, 2003 and 2002, respectively, have been excluded from the diluted earnings per share as they were anti-dilutive. Shares issuable pursuant to stock options included in diluted earnings per share were 46,556 and 2,048 for the quarters ended June 30, 2003 and 2002, respectively. In addition, shares issuable pursuant to outstanding warrants included in diluted earnings per share were 468 for the quarter ended June 30, 2002. Outstanding warrants of 300,000 for the quarter ended June 30, 2003 have been excluded from the diluted earnings per share as they were anti-dilutive.

     New Accounting Pronouncements

      The Financial Accounting Standards Board (“FASB”) has issued Statement of Financial Accounting Standards (“SFAS”) No. 148 “Accounting for Stock-Based Compensation — Transition and Disclosure- an amendment of FASB Statement No. 123”, for periods starting after December 15, 2003, or thereafter. SFAS No. 148 provides three optional transition methods for entities that voluntarily adopt the fair value recognition principles of SFAS No 123, “Accounting for Stock-Based Compensation”, and modifies the disclosure requirements of that Statement. Under the prospective method, stock-based compensation expense is recognized for awards granted after the beginning of the fiscal year in which the change is made. The modified prospective method recognizes stock-based compensation expense related to new and unvested awards in the year of change equal to that which would have been recognized had SFAS No. 123 been adopted as of its effective date, fiscal years beginning after December 15, 1994. The retrospective restatement method recognizes stock compensation costs for the year of change and restates financial statements for all prior periods presented as though the fair value recognition provisions of SFAS No. 123 had been adopted as of its effective date.

      The Company, through its 1995 and 2002 Stock Option Plans (the “Plans”), may grant options to key executives and other members of management of the Company and its subsidiaries in amounts not to exceed 2,000,000 shares of the Company’s common stock allocated for each plan. The plans are administered by the Compensation Committee (the “Committee”) of the Board of Directors. Option shares may be exercised subject to the terms of the Plans and the terms prescribed by the Committee at the time of grant. Currently, the Plans’ options have either five or ten-year terms and are exercisable and vest in equal increments over the option term.

      As of January 1, 2003, the Company adopted the requirements of SFAS No. 148 utilizing the prospective method. Under the prospective method, stock-based compensation expense is recognized for awards granted after the beginning of the fiscal year in which the change is made. If compensation cost for stock option grants

9

Table of Contents

had been determined based on a fair value method, net income and earnings per share on a pro forma basis for the periods ending June 30, 2003 and 2002 would be as follows (in thousands):

      The Black-Scholes valuation model utilized the following annualized assumptions for all applicable years: Risk-free interest rate of 2.90% and 4.46% for 2003 and 2002, respectively. No dividends were declared in periods ended June 30, 2003 and 2002. The volatility factor for the expected market price of the Company’s common stock of 0.586 and 0.562 in 2003 and 2002, respectively. The weighted average expected life of options is 5.0 for the 2003 and 2002 grants.

      Compensation expense of $120,000 has been recorded for stock options granted in the six months ended June 30, 2003 under SFAS. 148. No compensation cost has been recorded for stock option grants issued during 2002 as the market value equaled the exercise price at the date of grant.

Note 2 — Reinsurance

      The Insurance Company Subsidiaries cede insurance to other insurers under pro-rata and excess-of-loss contracts. These reinsurance arrangements diversify the Company’s business and minimize its exposure to large losses or from hazards of an unusual nature. The ceding of insurance does not discharge the original insurer from its primary liability to its policyholder. In the event that all or any of the reinsuring companies are unable to meet their obligations, the Insurance Company Subsidiaries would be liable for such defaulted

10

Table of Contents

amounts. Therefore, the Company is subject to a credit risk with respect to the obligations of its reinsurers. In order to minimize its exposure to significant losses from reinsurer insolvencies, the Company evaluates the financial condition of its reinsurers and monitors the economic characteristics of the reinsurers on an ongoing basis. The Company also assumes insurance from other insurers and reinsurers, both domestic and foreign, under pro-rata and excess-of-loss contracts.

      At June 30, 2003, the Company had reinsurance recoverables for paid and unpaid losses of $201.1 million. The Company customarily collateralizes reinsurance balances due from non-admitted reinsurers through funds withheld trusts or letters of credit. The largest unsecured reinsurance recoverable is due from an admitted reinsurer with an “A” A.M. Best rating and accounts for 39.0% of the total recoverable for paid and unpaid losses.

      The Company maintains an excess-of-loss reinsurance program designed to protect against large or unusual loss and loss adjustment expense activity. The Company determines the appropriate amount of reinsurance based on the Company’s evaluation of the risks accepted and analysis prepared by consultants and reinsurers and on market conditions including the availability and pricing of reinsurance. To date, there have been no material disputes with the Company’s excess-of-loss reinsurers. No assurance can be given, however, regarding the future ability of any of the Company’s excess-of-loss reinsurers to meet their obligations.

      Under the workers’ compensation reinsurance program, the Company reinsures each loss in excess of $300,000 up to a limit of $50.0 million, under separate treaties. The first treaty reinsures losses in excess of $300,000 up to a maximum of $1.0 million. The second treaty reinsures losses in excess of $1.0 million up to a maximum of $2.0 million. The third treaty reinsures losses in excess of $2.0 million up to a maximum coverage including the Company’s retention of $5.0 million. The fourth treaty reinsures losses in excess of $5.0 million up to a maximum of $10.0 million. The fifth treaty reinsures losses in excess of $10.0 million up to a maximum of $20.0 million. The sixth treaty reinsures losses in excess of $20.0 million for coverage up to a maximum of $50.0 million.

      Under the liability reinsurance treaty, the reinsurers are responsible for 100% of the amount of each loss in excess of $350,000 up to a maximum of $2.0 million per occurrence. A clash layer reinsures losses in excess of $2.0 million up to a maximum coverage with the Company’s retention of $5.0 million. Clash coverage protects the Company against two casualty policies responding to the same occurrence or coverage to claims settled above stated policy limits.

      Under the property reinsurance treaty, the reinsurers are responsible for 100% of the amount of each loss in excess of $250,000 up to a maximum of $5.0 million per location for an occurrence. In addition, the reinsurers are responsible for 100% of the excess of $750,000 up to a maximum of $20.0 million for a multi-location loss due to a catastrophe. Additional capacity for individual risks may be acquired through facultative reinsurance sources.

      In its risk-sharing programs, the Company is also subject to credit risk with respect to the payment of claims by its clients’ captive, rent-a-captive, large deductible programs, indemnification agreements, and on the portion of risk exposure either ceded to the captives, or retained by the clients. The capitalization and credit worthiness of prospective risk-sharing partners is one of the factors considered by the Company in entering into and renewing risk-sharing programs. The Company collateralizes balances due from its risk-sharing partners through funds withheld trusts or letters of credit. At June 30, 2003, the Company had risk exposure in excess of collateral in the amount of $12.7 million, on these programs, for which the Company has an allowance of $7.6 million, related to these exposures. The Company has historically maintained an allowance for the potential uncollectibility of certain reinsurance balances due from some risk-sharing partners. At the end of each quarter, an analysis of these exposures is conducted to determine the potential exposure to uncollectibility. As of June 30, 2003, management believes that this allowance is adequate. To date, the Company has not, in the aggregate, experienced material difficulties in collecting balances from its risk-sharing partners. No assurance can be given, however, regarding the future ability of any of the

11

Table of Contents

Company’s risk-sharing partners to meet their obligations. At June 30, 2003, the exposure amount in litigation with former risk-sharing partners which is not reserved or collateralized is $2.1 million.

Note 3 — Debt

      The Company has a credit agreement which includes a term loan and a revolving line of credit. This credit agreement consists of a $20.0 million term loan and a revolving line of credit for up to $8.0 million. The Company uses the revolving line of credit to meet short-term working capital needs. At June 30, 2003, the Company’s term loan had an outstanding balance of $16.5 million. The Company had no outstanding balance on the revolving line of credit at June 30, 2003. At December 31, 2002, the outstanding balance on the term loan and revolving line of credit was $18.8 million and $5.3 million, respectively. The term loan calls for quarterly amortization through July 1, 2006, at which time the term loan will be paid in full. The quarterly amortization requires payments of $1.0 million on April 1, 2003 and July 1, 2003; $1.5 million on October 1, 2003; and $1.2 million for the remaining quarterly amortization payments in 2004, 2005, and 2006, with a final payment of $1.5 million on July 1, 2006. The revolving line of credit will expire on July 1, 2004, and is thereafter renewable on an annual basis.

      The Company made principal payments of $1.2 million on January 1, 2003, and $1.0 million on April 1, 2003 and July 1, 2003, on the term loan.

      Both the term loan and revolving line of credit provide for interest at a variable rate based, at the Company’s option, upon either the prime rate or eurocurrency rate. The applicable margin, which ranges from 200 to 300 basis points above eurocurrency rates, is determined by the level of the fixed charge coverage ratio. Of all the covenants, the most restrictive covenant is the fixed charge coverage ratio. The fixed charge coverage ratio, as defined by the credit facility, is the ratio of the non-regulated earnings before interest and taxes for the four preceding fiscal quarters to the sum of fixed charges which include interest expense, principal payments payable, stock repurchases, and dividends declared during the period. Any unused portion of the revolving credit as of the date of determination reduces the sum of these fixed charges. At June 30, 2003, this ratio was 3.3 to 1.0, compared to the covenant minimum of 1.2 to 1.0.

      As of June 30, 2003, the Company was in compliance with all debt covenants.

      In addition, a non-insurance premium finance subsidiary of the Company maintains a line of credit with a bank, which permits borrowings up to 80% of the accounts receivable, which collateralize the line of credit. At June 30, 2003, this line of credit had an outstanding balance of $4.3 million.

      On January 14, 2003, the Company paid in full a $3.5 million subordinated promissory note, due June 30, 2003.

Note 4 — Shareholders’ Equity

      At June 30, 2003, shareholders’ equity was $153.4 million, or $5.29 per common share, compared to $147.4 million, or $4.98 per common share, at December 31, 2002.

      On September 17, 2002, the Company’s Board of Directors authorized management to repurchase up to 1,000,000 shares of the Company’s common stock in market transactions for a period not to exceed twenty-four months. On August 6, 2003, the Company’s Board of Directors authorized management to repurchase up to an additional 1,000,000 shares of the Company’s common stock under the existing share repurchase plan. As of June 30, 2003, the Company repurchased and retired 764,800 shares of common stock for a total cost of approximately $2.0 million. For the quarter ended June 30, 2003, the Company repurchased and retired 341,300 shares of common stock for a total cost of approximately $1.0 million. As of August 8, 2003, the Company repurchased and retired 764,800 shares of common stock for a total cost of approximately $2.0 million.

12

Table of Contents

Note 5 — Regulatory Matters and Rating Agencies

      A significant portion of the Company’s consolidated assets represent assets of the Insurance Company Subsidiaries that at this time, without prior approval of the Michigan Office of Financial and Insurance Services (“OFIS”), cannot be transferred to the holding company in the form of dividends, loans or advances. The restriction on the transferability to the holding company from its Insurance Company Subsidiaries is dictated by Michigan insurance regulatory guidelines which, in general, are as follows: the maximum discretionary dividend that may be declared, based on data from the preceding calendar year, is the greater of each insurance company’s net income (excluding realized capital gains) or ten percent of the insurance company’s surplus (excluding unrealized gains). These dividends are further limited by a clause in the Michigan law that prohibits an insurer from declaring dividends, except from surplus earnings of the company. Earned surplus balances are calculated on a quarterly basis. Since Star is the parent insurance company, its maximum dividend calculation represents the combined Insurance Company Subsidiaries’ surplus. Based upon the 2002 statutory financial statements, Star may only pay dividends to the Company during 2003 with the prior approval of OFIS. Star’s earned surplus position at December 31, 2002 was negative $24.3 million. At June 30, 2003, earned surplus was negative $27.4 million. No statutory dividends were paid from Star in 2002.

      Insurance operations are subject to various leverage tests (e.g. premium to statutory surplus ratios), which are evaluated by regulators and rating agencies. The Company’s targets for gross and net written premium to statutory surplus are 3.0 to 1 and 2.0 to 1, respectively. As of June 30, 2003, on a statutory consolidated basis, gross and net premium leverage ratios were 2.3 to 1.0 and 1.7 to 1.0, respectively.

      The National Association of Insurance Commissioners (“NAIC”) has adopted a risk-based capital (“RBC”) formula to be applied to all property and casualty insurance companies. The formula measures required capital and surplus based on an insurance company’s products and investment portfolio and is used as a tool to evaluate the capital of regulated companies. The RBC formula is used by state insurance regulators to monitor trends in statutory capital and surplus for the purpose of initiating regulatory action. In general, an insurance company must submit a calculation of its RBC formula to the insurance department of its state of domicile as of the end of the previous calendar year. These laws require increasing degrees of regulatory oversight and intervention as an insurance company’s RBC declines. The level of regulatory oversight ranges from requiring the insurance company to inform and obtain approval from the domiciliary insurance commissioner of a comprehensive financial plan for increasing its RBC to mandatory regulatory intervention requiring an insurance company to be placed under regulatory control in a rehabilitation or liquidation proceeding.

      At December 31, 2002, all of the Insurance Company Subsidiaries were in compliance with RBC requirements. Star reported statutory surplus of $93.8 million at December 31, 2002, compared to the threshold requiring the minimum regulatory involvement of $49.7 million in 2002. At June 30, 2003, Star’s statutory surplus was $90.8 million.

      The Insurance Company Subsidiaries’ A.M. Best financial strength rating is a “B+” (Very Good) with a positive outlook. A positive outlook is placed on a company’s rating if its financial and market trends are favorable, relative to its current rating level.

Note 6 — Commitments and Contingencies

      The Company is involved in litigation arising in the ordinary course of operations. The Company vigorously defends such litigation. While the results of litigation cannot be predicted with certainty, management is of the opinion, after reviewing these matters with legal counsel, that the final outcome of such litigation will not have a material effect upon the Company’s financial statements.

13

Table of Contents

Note 7 — Segment Information

      The Company defines its operations as specialty risk management operations and agency operations based upon differences in products and services. The separate financial information of these segments is consistent with the way results are regularly evaluated by management in deciding how to allocate resources and in assessing performance. Intersegment revenue is eliminated in consolidation.

     Specialty Risk Management Operations

      The specialty risk management operations segment focuses on specialty or niche insurance business in which it provides services and coverages that are tailored to meet the specific requirements of defined client groups and their members. This includes providing services, such as risk management consulting, claims handling, loss control, and reinsurance brokering, along with various types of property and casualty insurance coverage, including workers’ compensation, general liability and commercial multiple peril.

     Agency Operations

      The agency operations segment was formed in 1955 as a retail insurance agency. The agency operations have grown to be one of the largest agencies in Michigan and, with acquisitions, have expanded into California. The agency operations produces primarily commercial insurance, as well as personal property, casualty, life, and accident and health insurance, with more than fifty insurance carriers from which it earns commission income.

      The following table sets forth the segment results (in thousands):

*	Excluding the allocation of corporate overhead.

14

Table of Contents

*	Excluding the allocation of corporate overhead.

      The reconciling item included in the revenue relates to interest income in the holding company. The following table sets forth the pre-tax income reconciling items:

Note 8 — Reclassifications

      Certain amounts in the notes and consolidated financial statements have been reclassified to conform to the 2003 presentation.

15

Table of Contents

PART I — FINANCIAL INFORMATION

      In the opinion of management, the financial statements reflect all adjustments of a normal recurring nature necessary for a fair presentation of the interim periods. Preparation of financial statements under GAAP requires management to make estimates. Actual results could differ from those estimates. Interim results are not necessarily indicative of results expected for the entire year. These financial statements should be read in conjunction with the Company’s 2002 Annual Report on Form 10-K, as filed with the Securities and Exchange Commission.

      This quarterly report may provide information including certain statements which constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These include statements regarding the intent, belief, or current expectations of the Company’s management, including, but not limited to, those statements that use the words “believes”, “expects”, “anticipates”, “estimates”, or similar expressions. You are cautioned that any such forward-looking statements are not guarantees of future performance and involve a number of risks and uncertainties, and results could differ materially from those indicated by such forward-looking statements. Among the important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are: the frequency and severity of claims; uncertainties inherent in reserve estimates; catastrophic events; a change in the demand for, pricing of, availability or collectibility of reinsurance; increased rate pressure on premiums; obtainment of certain rate increases in current market conditions; investment rate of return; changes in and adherence to insurance regulation; actions taken by regulators, rating agencies or lenders; obtainment of certain processing efficiencies; changing rates of inflation; general economic conditions and other risks identified in the Company’s reports and registration statements filed with the Securities and Exchange Commission. The Company is not under any obligation to (and expressly disclaims any such obligation to) update or alter its forward-looking statements whether as a result of new information, future events or otherwise.

16

Table of Contents

      Meadowbrook Insurance Group, Inc. (the “Company”) is a publicly traded specialty risk management company, specializing in alternative market insurance and risk management solutions for agents, brokers, professional and trade associations, and insureds of all sizes. The alternative market includes a wide range of approaches to financing and managing risk exposures, such as captives, risk retention and risk purchasing groups, governmental pools and trusts, and self-insurance plans. The alternative market developed as a result of the historical volatility in the cost and availability of traditional commercial insurance coverages, and usually involves some form of self-insurance or risk-sharing on the part of the client. The Company develops and manages alternative risk management programs for defined groups and their members. The Company also operates as an insurance agency representing policyholders in placing their insurance coverages with unaffiliated insurance companies. Management defines its business segments as specialty risk management operations and agency operations.

Results of Operations for the Six Months Ended June 30, 2003 and 2002

     Overview

      Net income for the six months ended June 30, 2003 was $5.4 million, or $0.18 per dilutive share, compared to net income of $1.0 million, or $0.09 per dilutive share, for the six months ended June 30, 2002. This improvement reflects the addition of new fee-for-service agreements and the Company’s continued expense control initiatives. These initiatives have allowed the Company to leverage its fixed costs.

      Revenues for the six months ended June 30, 2003 decreased $12.7 million, or 11.7%, to $95.7 million from $108.4 million for the comparable period in 2002.

     Specialty Risk Management Operations

      The following table sets forth the revenues and results from specialty risk management operations (in thousands):

      Revenues from specialty risk management operations decreased $10.2 million, or 10.1%, to $90.7 million for the six months ended June 30, 2003, from $100.9 million for the comparable period in 2002. This decrease reflects a $19.4 million, or 23.3% decrease in net earned premiums to $63.6 million in the six months ended June 30, 2003, from $83.0 million in the comparable period in 2002. This decrease is the result of a reduction in earned premium of $27.4 million related to programs discontinued in 1999 and programs terminated for leverage ratio purposes. Offsetting the overall decrease in net earned premiums is a $6.9 million increase in

17

Table of Contents

      Management fees increased $3.6 million, or 54.8%, to $10.2 million for the six months ended June 30, 2003, from $6.6 million for the comparable period in 2002. Claim fees increased $4.6 million, or 129.9%, to $8.1 million from $3.5 million for the comparable period in 2002. The increase in management fees and claim fees reflects the previously mentioned addition of new fee-for-service agreements of $3.4 million and $5.3 million, respectively. This increase in management fees and claim fees is partially offset by a decrease in discontinued programs and the result of the conversion of an existing fee-based program into an insured program within the Company’s underwriting subsidiary. Loss control fees decreased $209,000, or 15.7%, to $1.1 million from $1.3 million for the comparable period in 2002. This decrease is mainly the result of the conversion of an existing fee-based program into an insured program.

      Net investment income increased $301,000, or 4.6%, to $6.9 million for the six months ended June 30, 2003, compared to $6.6 million for the comparable period in 2002. This increase reflects a $59.1 million, or 24.9% increase in average invested assets and cash and cash equivalents, to $296.8 million for the six months ended June 30, 2003, from $237.7 million for the comparable period in 2002. The increase in average invested assets and cash and cash equivalents, primarily reflects net assets invested of $37.5 million from the proceeds received from the Company’s public offering in June 2002. In addition, the increase in average invested assets and cash and cash equivalents, was the result of growth in premiums, collection of reinsurance recoverables, and the cancellation of the surplus relief treaty in 2002. The pre-tax yield for June 30, 2003 was 4.6%, compared to 5.6% for the comparable period in 2002.

      Specialty risk management operations generated pre-tax income of $5.5 million for the six months ended June 30, 2003, compared to pre-tax loss of $217,000 for the comparable period in 2002. This improvement reflects the favorable impact of the previously indicated fee-for-service agreements and improved underwriting results. The generally accepted accounting principles (“GAAP”) combined ratio was 106.0% for the six months ended June 30, 2003, compared to 107.0% for the same period in 2002.

      Net loss and loss adjustment expenses (“LAE”) decreased $13.8 million, or 25.1%, to $41.3 million for the six months ended June 30, 2003, from $55.1 million for the same period in 2002. The Company’s loss and LAE ratio for both periods in 2003 and 2002 was 70.2%. This ratio is the unconsolidated net loss and LAE in relation to net earned premium.

      The Company’s expense ratio improved 1.0 percentage point to 35.8% for the six months ended June 30, 2003, from 36.8% for the same period in 2002. This ratio is the unconsolidated policy acquisition and other underwriting expenses in relation to net earned premium. The improvement reflects the ability to leverage fixed costs and a reduction in gross commissions. This improvement is partially offset by an increase in insurance related assessments.

     Agency Operations

      The following table sets forth the revenues and results from agency operations (in thousands):

*	Excluding the allocation of corporate overhead

      Revenue from agency operations, which consists primarily of agency commission revenue, increased $208,000, or 2.7%, to $7.8 million for the six months ended June 30, 2003, from $7.6 million for the comparable period in 2002. This increase is primarily the result of rate increases, increases in contingent

18

Table of Contents

      Agency operations generated pre-tax income of $3.6 million for the six months ended June 30, 2003, compared to $3.4 million for the comparable period in 2002. The improvement in the pre-tax margin is primarily attributable to overall expense reductions.

Other Items

     Reserves

      At June 30, 2003, management’s best estimate for the ultimate liability for loss and LAE reserves, net of reinsurance recoverables, was $187.6 million. Management established a reasonable range of reserves of approximately $175.7 million to $200.0 million. This range was established primarily by considering the various indications derived from standard actuarial techniques and other appropriate reserve considerations. The following table sets forth this range by line of business.

(1)	Includes Residual Markets

      Reserves are reviewed by internal and/or independent actuaries for adequacy on a quarterly basis. When reviewing reserves, the Company analyzes historical data and estimates the impact of numerous factors such as (i) per claim information; (ii) Company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the imposition of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves, because the eventual deficiency or redundancy is affected by multiple factors.

      The key assumptions used in management’s selection of ultimate reserves included the underlying actuarial methodologies, a review of current pricing and underwriting initiatives, an evaluation of reinsurance costs and retention levels, and a detailed claims analysis with an emphasis on how aggressive claims handling may be impacting the paid and incurred loss data trends embedded in the traditional actuarial methods. With respect to the ultimate estimates for losses and LAE, the key assumptions remained consistent for the six months ended June 30, 2003 and the years ended December 31, 2002 and 2001.

      For the six months ended June 30, 2003, the Company reported an increase in net ultimate loss estimates for accident years 2002 and prior to be $2.3 million, or 1.2% of $193.1 million of net loss and LAE reserves at December 31, 2002. The increase in net ultimate loss estimates reflected revisions in the estimated reserves as a result of actual claims activity in calendar year 2003 that differed from the projected activity. There were no

19

Table of Contents