Eastern Insurance Holdings, Inc. - FORM 10-Q

Eastern Insurance Holdings, Inc. - FORM 10-Q - November 3, 2011

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Eastern Insurance Holdings, Inc. Reports

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EX-31.1 - SECTION 302 CEO CERTIFICATION - Eastern Insurance Holdings, Inc.	d249279dex311.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - Eastern Insurance Holdings, Inc.	d249279dex312.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - Eastern Insurance Holdings, Inc.	d249279dex321.htm
EX-32.2 - SECTION 906 CFO CERTIFICATION - Eastern Insurance Holdings, Inc.	d249279dex322.htm
EXCEL - IDEA: XBRL DOCUMENT - Eastern Insurance Holdings, Inc.	Financial_Report.xls

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

Quarterly Report pursuant to Section 13 or 15(d) of the

Securities Exchange Act of 1934

for the Quarterly Period Ended September 30, 2011,

Transition report pursuant to Section 13 or 15(d) Of the Exchange Act

for the Transition Period from to

No. 001-32899

(Commission File Number)

EASTERN INSURANCE HOLDINGS, INC.

(Exact name of Registrant as specified in its charter)


PENNSYLVANIA		20-2653793
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

25 Race Avenue, Lancaster, Pennsylvania		17603
(Address of principal executive offices)		(Zip Code)

(717) 396-7095

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

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 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 x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark if the Registrant is a shell company (as defined in Rule 12b-2 of the 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.

COMMON STOCK (No Par Value)

Number of Shares Outstanding as of November 2, 2011

7,948,631

(Title of Class)

(Outstanding Shares)

TABLE OF CONTENTS


		Page
PART I -FINANCIAL INFORMATION			3

Item 1.	Financial Statements (Unaudited)		3

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		20

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		31

Item 4.	Controls and Procedures		31

PART II -OTHER INFORMATION			32

Item 1.	Legal Proceedings		32

Item 1A.	Risk Factors		32

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		32

Item 3.	Defaults Upon Senior Securities		33

Item 4.	Submission of Matters to Vote of Security Holders		33

Item 5.	Other Information		33

Item 6.	Exhibits		33

PART I – FINANCIAL INFORMATION

Item 1.

Financial Statements

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share data)


	September 30 2011			December 31 2010
ASSETS
Investments:
Fixed income securities, at estimated fair value (amortized cost, $117,323; $124,201)	$	122,227		$	127,474
Convertible bonds, at estimated fair value (amortized cost, $16,972; $16,481)		17,271			18,140
Equity securities, at estimated fair value (cost, $23,740; $17,002)		23,205			20,880
Other long-term investments, at estimated fair value (cost, $10,228; $10,271)		11,726			11,435

Total investments		174,429			177,929

Cash and cash equivalents		50,126			45,855
Accrued investment income		1,110			1,195
Premiums receivable (net of allowance, $225; $225)		60,221			46,402
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		13,145			12,285
Deferred acquisition costs		9,691			7,721
Deferred income taxes, net		1,844			721
Federal income taxes recoverable		216			918
Intangible assets		5,401			6,163
Goodwill		10,752			10,752
Other assets		15,005			12,723

Total assets	$	341,940		$	322,664


LIABILITIES
Reserves for unpaid losses and loss adjustment expenses	$	104,751		$	95,963
Unearned premium reserves		69,103			53,485
Advance premium		89			482
Accounts payable and accrued expenses		16,315			15,707
Ceded reinsurance balances payable		9,674			7,371
Segregated portfolio cell dividend payable		14,648			13,355
Policyholder dividends payable		1,920			1,590

Total liabilities	$	216,500		$	187,953

Commitments and contingencies (Note 10)

SHAREHOLDERS’ EQUITY
Series A preferred stock, par value $0, auth. shares – 5,000,000; no shares issued and outstanding		—			—
Common capital stock, par value $0, auth. shares – 20,000,000; issued – 11,786,014 and 11,784,514; respectively; outstanding – 7,962,442 and 8,964,344, respectively		—			—
Unearned ESOP compensation		(3,552	)		(4,111	)
Additional paid in capital		115,715			114,472
Treasury stock, at cost (3,823,572 and 2,820,170 shares, respectively)		(53,751	)		(40,835	)
Retained earnings		64,580			61,364
Accumulated other comprehensive income, net		2,448			3,821

Total shareholders’ equity		125,440			134,711

Total liabilities and shareholders’ equity	$	341,940		$	322,664

See accompanying notes to unaudited consolidated financial statements.

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

For the Three and Nine Months Ended September 30, 2011 and 2010

(Unaudited, in thousands, except per share data)

		$96,002			$96,002		$96,002			$96,002
	For the Three Months Ended September 30,					For the Nine Months Ended September 30,
	2011			2010		2011			2010
REVENUE
Net premiums earned	$	33,917		$	28,774	$	96,002		$	80,040
Net investment income		1,013			869		2,947			2,517
Change in equity interest in limited partnerships		(354	)		266		291			520
Net realized investment (losses) gains		(1,306	)		1,513		500			1,592
Other revenue		86			143		348			434

Total revenue		33,356			31,565		100,088			85,103


EXPENSES
Losses and loss adjustment expenses incurred		21,051			19,916		61,216			55,440
Acquisition and other underwriting expenses		3,630			3,276		10,356			9,101
Other expenses		6,265			5,735		18,197			15,964
Amortization of intangibles		254			321		762			963
Policyholder dividend expense		204			333		823			732
Segregated portfolio dividend expense		1,007			84		2,196			(618	)

Total expenses		32,411			29,665		93,550			81,582

Income from continuing operations before income taxes		945			1,900		6,538			3,521
Income tax expense from continuing operations		289			732		2,011			1,129

Net income from continuing operations		656			1,168		4,527			2,392

Discontinued operations (Note 3):
Income from discontinued operations before income taxes		—			1,164		—			997
Income tax (benefit) expense		(368	)		154		(368	)		758

Net income from discontinued operations		368			1,010		368			239

Net income	$	1,024		$	2,178	$	4,895		$	2,631


Other comprehensive (loss) income
Unrealized holding (losses) gains arising during period, net of tax of $(891), $1,256, $(171) and $2,375		(1,655	)		2,333		(317	)		4,411
Amortization of unrecognized benefit plan amounts, net of tax of $123, $2, $126, and $5		229			4		234			10
Less: Reclassification adjustment for gains included in net income, net of tax of $97, $376, $694, and $1,608		181			697		1,290			2,986

Other comprehensive (loss) income		(1,607	)		1,640		(1,373	)		1,435

Comprehensive (loss) income	$	(583	)	$	3,818	$	3,522		$	4,066

		$96,002		$96,002		$96,002		$96,002
	Three Months Ended September 30				Nine Months Ended September 30
Earnings per share (See Note 4):	2011		2010		2011		2010
Basic earnings per share:
Income from continuing operations	$	0.08	$	0.13	$	0.56	$	0.27
Income from discontinued operations	$	0.05	$	0.12	$	0.05	$	0.03
Diluted earnings per share:
Income from continuing operations	$	0.08	$	0.13	$	0.56	$	0.27
Income from discontinued operations	$	0.05	$	0.12	$	0.04	$	0.03

See accompanying notes to unaudited consolidated financial statements.

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the Three and Nine Months Ended September 30, 2011

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2011


	Outstanding Shares																		Accumulated Other
	Series A Preferred Stock		Common Capital Stock			Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings			Comprehensive Income Net of Tax			Total
Balance, July 1, 2011		—		8,232,770			—	$	(3,741	)	$	115,263	$	(50,161	)	$	64,118		$	4,055		$	129,534
ESOP shares released		—		—			—		189			60		—			—			—			249
Equity awards		—		1,500			—		—			392		—			—			—			392
Repurchase of common stock		—		(271,828	)		—		—			—		(3,590	)		—			—			(3,590	)
Shareholder dividend		—		—			—		—			—		—			(562	)		—			(562	)
Net income		—		—			—		—			—		—			1,024			—			1,024
Other comprehensive loss, net of tax		—		—			—		—			—		—			—			(1,607	)		(1,607	)

Balance, September 30, 2011		—		7,962,442			—	$	(3,552	)	$	115,715	$	(53,751	)	$	64,580		$	2,448		$	125,440

Nine Months Ended September 30, 2011


	Outstanding Shares																		Accumulated Other
	Series A Preferred Stock		Common Capital Stock			Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings			Comprehensive Income Net of Tax			Total
Balance, January 1, 2011		—		8,964,344			—	$	(4,111	)	$	114,472	$	(40,835	)	$	61,364		$	3,821		$	134,711
ESOP shares released		—		—			—		559			139		—			—			—			698
Equity awards		—		1,500			—		—			1,104		—			—			—			1,104
Repurchase of common stock		—		(1,003,402	)		—		—			—		(12,916	)		—			—			(12,916	)
Shareholder dividend		—		—			—		—			—		—			(1,679	)		—			(1,679	)
Net income		—		—			—		—			—		—			4,895			—			4,895
Other comprehensive loss, net of tax		—		—			—		—			—		—			—			(1,373	)		(1,373	)

Balance, September 30, 2011		—		7,962,442			—	$	(3,552	)	$	115,715	$	(53,751	)	$	64,580		$	2,448		$	125,440

See accompanying notes to unaudited consolidated financial statements

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the Three and Nine Months Ended September 30, 2010

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2010


	Outstanding Shares																		Accumulated Other
	Series A Preferred Stock		Common Capital Stock			Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings			Comprehensive Income Net of Tax		Total
Balance, July 1, 2010		—		9,372,701			—	$	(4,488	)	$	113,771	$	(36,114	)	$	72,223		$	5,098	$	150,490
ESOP shares released		—		—			—		188			6		—			—			—		194
Equity awards		—		1,500			—		—			326		—			—			—		326
Repurchase of common stock		—		(163,939	)		—		—			—		(1,775	)		—			—		(1,775	)
Shareholder dividend		—		—			—		—			—		—			(645	)		—		(645	)
Net income		—		—			—		—			—		—			2,178			—		2,178
Other comprehensive income, net of tax		—		—			—		—			—		—			—			1,640		1,640

Balance, September 30, 2010		—		9,210,262			—	$	(4,300	)	$	114,103	$	(37,889	)	$	73,756		$	6,738	$	152,408

Nine Months Ended September 30, 2010


	Outstanding Shares																		Accumulated Other
	Series A Preferred Stock		Common Capital Stock			Common Capital Stock		Unearned ESOP Compensation			Additional Paid-In Capital		Treasury Stock			Retained Earnings			Comprehensive Income Net of Tax		Total
Balance, January 1, 2010		—		9,691,257			—	$	(4,859	)	$	113,049	$	(32,666	)	$	73,038		$	5,303	$	153,865
ESOP shares released		—		—			—		559			36		—			—			—		595
Equity awards		—		1,500			—		—			1,018		—			—			—		1,018
Repurchase of common stock		—		(482,495	)		—		—			—		(5,223	)		—			—		(5,223	)
Shareholder dividend		—		—			—		—			—		—			(1,913	)		—		(1,913	)
Net income		—		—			—		—			—		—			2,631			—		2,631
Other comprehensive income, net of tax		—		—			—		—			—		—			—			1,435		1,435

Balance, September 30, 2010		—		9,210,262			—	$	(4,300	)	$	114,103	$	(37,889	)	$	73,756		$	6,738	$	152,408

See accompanying notes to unaudited consolidated financial statements

EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2011 and 2010

(Unaudited, in thousands)


	2011			2010
Cash flows from operating activities:
Net income from continuing operations	$	4,527		$	2,392
Adjustments to reconcile net income from continuing operations to net cash provided by operating activities:
Depreciation and amortization		547			520
Amortization of bond premium/discount		505			746
Net realized investment gains		(613	)		(1,592	)
Change in equity interest in limited partnerships		(291	)		(520	)
Deferred tax (benefit) expense		(536	)		397
Stock compensation		1,825			1,582
Intangible asset amortization		762			963
Changes in assets and liabilities:
Accrued investment income		84			(79	)
Premiums receivable		(13,818	)		(7,628	)
Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses		(860	)		(646	)
Deferred acquisition costs		(1,970	)		(1,612	)
Other assets		(2,127	)		(329	)
Reserves for unpaid losses and loss adjustment expenses		8,788			4,930
Unearned and advance premium		15,225			12,428
Ceded reinsurance balances payable		2,303			(1,963	)
Accounts payable and accrued expenses		967			(115	)
Segregated portfolio cell dividend payable		1,944			(2,940	)
Policyholder dividends payable		330			144
Federal income taxes recoverable/payable		1,070			154

Net cash provided by operating activities – continuing operations		18,662			6,832
Net cash used in operating activities – discontinued operations		—			(2,689	)

Net cash provided by operating activities		18,662			4,143

Cash flows from investing activities:
Purchase of fixed income securities		(34,903	)		(69,507	)
Purchase of equity securities		(9,646	)		(2,963	)
Purchase of other long-term investments		—			(2,186	)
Proceeds from sale of fixed income securities		30,711			28,543
Proceeds from maturities/calls of fixed income securities		10,858			17,329
Proceeds from sale of equity securities		3,908			2,530
Proceeds from sale of Eastern Life and Health Insurance Company		—			534
Purchase of equipment, net		(701	)		(445	)

Net cash provided by (used in) investing activities – continuing operations		227			(26,165	)
Net cash provided by investing activities – discontinued operations		—			26,411

Net cash provided by investing activities		227			246

Cash flows from financing activities:
Repurchase of common stock		(12,916	)		(5,223	)
Shareholder dividend		(1,679	)		(1,913	)
Repayment of loan principal		—			(500	)
Income taxes related to equity awards		(23	)		31

Net cash used in financing activities		(14,618	)		(7,605	)

Net increase (decrease) in cash and cash equivalents		4,271			(3,216	)
Cash and cash equivalents, beginning of period		45,855			50,437
Reclassification to discontinued operations		—			404

Cash and cash equivalents, end of period	$	50,126		$	47,625


Non-cash investing activity:
Issuance of promissory note	$	—			1,750

See accompanying notes to unaudited consolidated financial statements.

Eastern Insurance Holdings, Inc. and Subsidiaries

Condensed Notes to Consolidated Financial Statements

(Unaudited, dollars in thousands except share and per share data)

1. Background and Nature of Operations

Eastern Insurance Holdings, Inc. (“EIHI”) is an insurance holding company offering workers’ compensation and reinsurance products through its direct and indirect wholly-owned subsidiaries, Global Alliance Holdings, Ltd. (“Global Alliance”), Eastern Alliance Insurance Company (“Eastern Alliance”), Allied Eastern Indemnity Company (“Allied Eastern”), Eastern Advantage Assurance Company (“Eastern Advantage”), Employers Security Insurance Company (“Employers Security”), Employers Alliance, Inc. (“Employers Alliance”), Eastern Re Ltd., S.P.C. (“Eastern Re”), and Eastern Services Corporation (“Eastern Services), collectively referred to as the Company.

The Company currently operates in three segments: workers’ compensation insurance, segregated portfolio cell reinsurance, and corporate/other.

2. Significant Accounting Policies

Basis of Presentation

The accompanying unaudited interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities and Exchange Act of 1934, as amended. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, all adjustments, being normal, recurring adjustments, necessary for a fair statement of the financial position and results of operations of the Company for the periods presented have been included. The results of operations for an interim period are not necessarily indicative of the results for an entire year. These financial statements should be read in conjunction with the Company’s audited financial statements and notes thereto as of and for the year ended December 31, 2010 included in the Company’s Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission on March 4, 2011.

All inter-company transactions and related account balances have been eliminated in consolidation.

Certain amounts in the prior year consolidated financial statements have been reclassified to conform to the current year presentation.

Use of Estimates

The preparation of the unaudited interim consolidated financial statements requires management to make estimates and assumptions that affect the amount of reported assets and liabilities and disclosures of contingent assets and liabilities as of the date of the unaudited interim consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. The most significant estimates in the unaudited interim consolidated financial statements include reserves for unpaid losses and loss adjustment expenses (“LAE”), earned but unbilled premium, deferred acquisition costs, return premiums under reinsurance contracts, and current and deferred income taxes. Actual results could differ from these estimates.

Recent Accounting Pronouncements

Testing Goodwill for Impairment

In September 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2011-08 (“ASU 2011-08”), Testing Goodwill for Impairment. ASU 2011-08 provides an entity the option to first assess qualitative factors in determining whether the existence of certain events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If an entity determines that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, the performance of the two-step impairment test is unnecessary. If, however, an entity determines that is it more likely than not that the fair value is less than the carrying amount, the first step of the impairment test (calculation of the reporting unit’s fair value) is required. ASU 2011-08 provides examples of events and circumstances that an entity should consider in evaluating whether the fair value of a reporting unit is less than its carrying amount, but other relevant events or circumstances should be considered as necessary. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The Company performs its annual goodwill impairment test as of September 30 and has elected to early adopt the provisions of ASU 2011-08.

Presentation of Comprehensive Income

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 requires entities to present net income and comprehensive income in either a single continuous statement or in two separate, but consecutive, statements of net income and other comprehensive income. The option to present items of other comprehensive income in the statement of changes in equity is eliminated. ASU 2011-05 is effective for public entities as of the beginning of a fiscal year that begins after December 15, 2011 (including interim periods) and for nonpublic entities for fiscal years ending after December 15, 2012 and interim and annual periods thereafter. Early adoption is permitted and retrospective application is required. The Company currently presents comprehensive income in the consolidated statement of operations and comprehensive income. Management does not expect the adoption of ASU 2011-05 to have a significant impact on the Company’s current presentation of comprehensive income.

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

In October 2010, the FASB issued ASU 2010-26, “Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” (“ASU 2010-26”). ASU 2010-26 provides specific types of costs that should be capitalized in connection with the acquisition or renewal of insurance contracts. Those costs include incremental direct costs of contract acquisition incurred in connection with independent third parties and certain costs related to activities performed by the insurer for the contract, including underwriting, policy issuance and processing, medical and inspection, and sales force contract selling. Under ASU 2010-26, costs incurred by an entity related to unsuccessful acquisition or renewal efforts must be charged to expense as incurred. ASU 2010-26 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011 and is to be applied prospectively. Retrospective application to all prior periods upon the date of adoption is permitted, but not required. Early adoption is permitted but only at the beginning of an entity’s annual reporting period. The Company currently capitalizes and defers commissions and related expenses, premium taxes and certain underwriting personnel salaries. The Company expects to adopt ASU 2010-26 effective January 1, 2012 and apply it prospectively. Upon adoption, the Company expects to reduce the amount of acquisition costs capitalized related to certain underwriting personnel salaries to give effect to unsuccessful acquisition or renewal activities. Management does not expect the adoption of ASU 2010-26 to have a material effect on the Company’s financial condition or results of operations.

3. Discontinued Operations

On December 9, 2010, EIHI completed the sale of Eastern Atlantic RE (“Atlantic RE”). Atlantic RE was a Cayman Islands reinsurance company formed for the purpose of transferring certain assets and liabilities related to EIHI’s run-off specialty reinsurance segment as part of the sale. As a result of the sale, the results of operations for the portion of the run-off specialty reinsurance segment that was transferred to Atlantic RE have been reflected as discontinued operations for the three and nine months ended September 30, 2010. The portion of the run-off specialty reinsurance segment that was not sold has been reclassified to the corporate/other segment. For the three and nine months ended September 30, 2010, the run-off specialty reinsurance segment reported net premiums earned and revenue of $3 and $1,280 and $1 and $2,154, respectively. The run-off specialty reinsurance segment reported income before income taxes of $1,129 and a loss before income taxes of $(441) for the three and nine months ended September 30, 2010, respectively.

The Company recognized an estimated contingent profit commission of $3,018 related to the sale of Atlantic RE, which is based on the adequacy of the run-off specialty reinsurance segment’s reserves for losses and LAE as of September 30, 2010, compared to a predetermined targeted reserve for losses and LAE. The estimated contingent profit commission is included in other assets and any decrease in the estimated amount would be recorded as a loss from discontinued operations. As of September 30, 2011, management believes that the estimated contingent profit commission is realizable; however, due to the inherent uncertainty in the run-off specialty reinsurance segment’s reserves for losses and LAE, the estimated realizable amount could decrease in the future.

On June 21, 2010, EIHI completed the sale of Eastern Life and Health Insurance Company (“Eastern Life”). As a result of the sale, Eastern Life’s operations, which were reported as the group benefits insurance segment, have been reflected as discontinued operations for the three and nine months ended September 30, 2010. For the three and nine months ended September 30, 2010, the group benefits insurance segment reported net premiums earned and revenue of $0 and $0 and $18,262 and $20,563, respectively. The group benefits insurance segment reported income before income taxes of $0 and $952 for the three and nine months ended September 30, 2010, respectively.

During the third quarter of 2011, the Company filed its 2010 corporate federal income tax return. The Company’s tax liability related to Eastern Life’s operations for the period from January 1, 2010 to June 21, 2010 and the related sale of Eastern Life was less than the estimated tax liability recorded on the Company’s balance sheet as of December 31, 2010. As a result, the Company recorded a prior year tax return adjustment of $368, which was recorded as an income tax benefit in discontinued operations for the three and nine months ended September 30, 2011.

4. Earnings Per Share

Basic earnings per share are computed by dividing net (loss) income by the weighted average number of shares outstanding for the respective period. Diluted earnings per share are computed by dividing net (loss) income by the weighted average number of shares outstanding for the period, including dilutive potential common shares outstanding for the period. For the three and nine months ended September 30, 2011, there were 936,717 and 939,272 equity awards, respectively, that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive. For the three and nine months ended September 30, 2010, there were 784,125 and 794,255 equity awards, respectively, that were not included in the Company’s earnings per share calculation because to do so would have been anti-dilutive.

Consolidated net income, basic shares outstanding, diluted shares outstanding, basic earnings per share, diluted earnings per share and cash dividends per share for the three and nine months ended September 30, 2011 and 2010 were as follows (unaudited, in thousands, except share and per share data):


	Three Months Ended September 30, 2011			Three Months Ended September 30, 2010			Nine Months Ended September 30, 2011			Nine Months Ended September 30, 2010
Net income for basic and diluted earnings per share	$	1,024		$	2,178		$	4,895		$	2,631

Less: Dividends declared – common and unvested restricted share units		(562	)		(645	)		(1,679	)		(1,913	)

Undistributed earnings		462			1,533			3,216			718

Percent allocated to common shareholders		99.3	%		98.8	%		99.3	%		98.8	%

		459			1,515			3,193			709

Add: Dividends declared – common shares		558			637			1,668			1,891

	$	1,017		$	2,152		$	4,861		$	2,600


Denominator for basic earnings per share		7,694,403			8,690,061			7,967,230			8,797,417

Effect of dilutive securities		115,679			67,293			113,124			57,163


Denominator for diluted earnings per common share		7,810,082			8,757,354			8,080,354			8,854,580


Basic earnings per share:
Income from continuing operations	$	0.08		$	0.13		$	0.56		$	0.27
Income from discontinued operations	$	0.05		$	0.12		$	0.05		$	0.03
Diluted earnings per share:
Income from continuing operations	$	0.08		$	0.13		$	0.56		$	0.27
Income from discontinued operations	$	0.05		$	0.12		$	0.04		$	0.03
Cash dividends per share	$	0.07		$	0.07		$	0.21		$	0.21

5. Goodwill

Goodwill is assigned to one or more reporting units at the date of acquisition. The Company has allocated 100% of the goodwill recorded on its consolidated balance sheet as of September 30, 2011 to its workers’ compensation insurance segment.

The Company performs its annual goodwill impairment test as of September 30. The Company adopted ASU 2011-08 effective September 30, 2011. Under ASU 2011-08, the Company assessed certain qualitative factors to determine if it was more likely than not that the fair value of the workers’ compensation insurance segment was less than its carrying amount. As a result of this assessment, it was determined that it was not more likely than not that fair value of the workers’ compensation insurance segment was less than its carrying amount; therefore, the performance of the two-step impairment test was not required.

The factors management considered in determining that it was not more likely than not that the fair value of the workers’ compensation insurance segment was less than its carrying amount included year over year premium growth, an increase in the renewal retention rate, and a reduction in the segment’s combined ratio. In addition, the Company continues to increase its agency base and has experienced growth in each of its regional offices. Management also considered the increase in the Company’s stock price, which closed at $13.15 on September 30, 2011, compared to $10.39 on September 30, 2010, an increase of 26.6%.

6. Fair Value Measurements

The Company’s assets and liabilities that are measured at fair value on a recurring basis are segregated between those assets and liabilities that are valued based on quoted prices (unadjusted) in active markets for identical assets or liabilities, which the reporting entity can access at the measurement date (Level 1), direct or indirect observable inputs other than Level 1 quoted prices (Level 2), or unobservable inputs to the extent that observable inputs are not available (Level 3).

The following is a description of the Company’s categorization of the inputs used in the recurring fair value measurements of its financial assets included in its consolidated balance sheet as of September 30, 2011:

Level 1 – Represents financial assets whose fair value is determined based upon observable unadjusted quoted market prices for identical financial assets in active markets that the Company has the ability to access. An example of a Level 1 input utilized to measure fair value includes the closing price of one share of common stock on an active exchange market. The Company considers U.S. Treasuries and equity securities as Level 1 assets.

Level 2 – Represents financial assets whose fair value is determined based upon: quoted market prices for similar assets in active markets; quoted market prices for identical assets in inactive markets; inputs other than quoted market prices that are observable for the asset such as interest rates or yield curves; or other inputs derived principally from or corroborated from other observable market information. An example of a Level 2 input utilized to measure fair value, specifically for the Company’s fixed income portfolio, is “matrix pricing.” “Matrix pricing” relies on observable inputs from active markets other than quoted market prices including, but not limited to, benchmark securities and yields, latest reported trades, quotes from brokers or dealers, issuer spreads, bids, offers, and other relevant reference data to determine fair value. “Matrix pricing” is used to measure the fair value of fixed income securities where obtaining individual quoted market prices is impractical. The Company considers U.S. Government agencies, municipal bonds, mortgage-backed securities, collateralized mortgage obligations, asset-backed securities, corporate bonds, and convertible bonds as Level 2 assets.

Level 3 – Represents financial assets whose fair value is determined based upon inputs that are unobservable, including the Company’s own determinations of the assumptions that a market participant would use in pricing the asset.

The following table provides a summary of the fair value measurements of the Company’s fixed income securities, convertible bonds, and equity securities, as of September 30, 2011 and December 31, 2010, excluding the segregated portfolio cell reinsurance segment (unaudited, in thousands):


			Fair Value Measurements at Reporting Date Using
	9/30/11		Level 1		Level 2		Level 3
Fixed income securities – available for sale:
U.S. Treasuries and government agencies	$	13,217	$	8,760	$	4,457	$	—
States, municipalities, and political subdivisions		30,752		—		30,752		—
Corporate securities		25,457		—		25,457		—
Residential mortgage-backed securities		24,129		—		24,129		—
Commercial mortgage-backed securities		214		—		214		—
Collateralized mortgage obligations		6,354		—		6,354		—
Other structured securities		1,027		—		1,027		—
Convertible bonds		17,271		—		17,271		—
Equity securities – available for sale		18,875		18,875		—		—

Total	$	137,296	$	27,635	$	109,661	$	—


			Fair Value Measurements at Reporting Date Using
	12/31/10		Level 1		Level 2		Level 3
Fixed income securities – available for sale:
U.S. Treasuries and government agencies	$	23,344	$	9,272	$	14,072	$	—
States, municipalities, and political subdivisions		32,621		—		32,621		—
Corporate securities		16,006		—		16,006		—
Residential mortgage-backed securities		25,759		—		25,759		—
Commercial mortgage-backed securities		289		—		289		—
Collateralized mortgage obligations		7,220		—		7,220		—
Other structured securities		773		—		773		—
Convertible bonds		18,140		—		18,140		—
Equity securities – available for sale		16,753		13,228		3,525		—

Total	$	140,905	$	22,500	$	118,405	$	—

There were no transfers between Level 1 and Level 2 securities for the three and nine months ended September 30, 2011.

The estimated fair values of the Company’s investments in fixed income securities, convertible bonds, and equity securities are based on prices provided by an independent, nationally recognized pricing service. Approximately 99.0% of the Company’s fixed income and equity security prices are obtained from the independent pricing service. The prices provided by the independent pricing service are based on quoted market prices, when available, non-binding broker quotes, or matrix pricing. The independent pricing service provides a single price or quote per security and the Company does not adjust security prices. The Company obtains an understanding of the methods, models and inputs, used by the independent pricing service, and has controls in place to validate that amounts provided represent current exit values. The Company’s controls include, but are not limited to, initial and ongoing evaluation of the methodologies used by the independent pricing service as well as comparing the fair value estimates to the Company’s knowledge of the current market. Fixed income securities include U.S. Treasuries, agencies backed by the U.S. Government, municipal bonds, mortgage-backed securities, collateralized mortgage obligations, asset-backed securities, and corporate bonds.

The Company’s fixed income securities and convertible bonds consist primarily of publicly traded securities for which there are observable inputs and/or broker quotes. Most fixed income security prices provided by the independent pricing service are based on observable inputs and, therefore, are classified as Level 2 securities. The Company does not hold any fixed income securities, for which pricing was based on significant unobservable inputs; therefore, the Company has not classified any of its fixed income securities as Level 3 securities.

The Company’s equity securities consist primarily of mutual fund instruments for which there is an active market and quoted market prices; therefore, the Company has classified its mutual fund investments as Level 1 securities. As of December 31, 2010, the Company held an investment in an international equity fund that was not traded on an active exchange market and, therefore, was considered a Level 2 security. Approximately 94.1% of the international equity fund’s underlying investments were considered Level 1 securities as of December 31, 2010, the most recent date for which the Company had audited financial statements of the fund. The Company sold its interest in the international equity fund in the second quarter of 2011.

Other long-term investments include the Company’s interest in various limited partnerships, including a low volatility multi-strategy fund of funds, two natural resource limited partnerships, a structured finance opportunity fund, an open-ended investment fund and a real estate limited partnership. The Company records its investment in the limited partnerships using the equity method. The carrying value of the Company’s limited partnership investments are based on the Company’s allocable share of the limited partnership’s net asset value. Changes in the Company’s investments are based on statements received directly from the limited partnership and/or the limited partnership’s administrator. The estimated fair values of the underlying investments in the limited partnerships may be based on Level 1, Level 2, or Level 3 inputs, or a combination thereof.

As of September 30, 2011 and December 31, 2010, the estimated fair values of the Company’s limited partnership investments, by investment strategy, were as follows (unaudited, in thousands):


	9/30/11		12/31/10
Multi-strategy fund of funds	$	5,613	$	5,351
Natural resources		2,647		2,515
Structured finance opportunity fund		2,881		2,892
Open-ended investment fund		585		629
Real estate		—		48

Total	$	11,726	$	11,435

The activity in the Company’s limited partnership investments for the three and nine months ended September 30, 2011 and 2010 was as follows (unaudited, in thousands):


	Three Months Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011		2010
Balance, beginning of period	$	12,080		$	10,637	$	11,435	$	8,197
Contributions		—			—		—		2,186
Withdrawals		—			—		—		—
Unrealized change in interest		(354	)		266		291		520

Balance, end of period	$	11,726		$	10,903	$	11,726	$	10,903

The change in interest in the Company’s limited partnership investments is included in the change in equity interest in limited partnerships in the consolidated statements of operations and comprehensive income.

7. Investments

The following tables provide the amortized cost and estimated fair value of the Company’s fixed income and equity securities as of September 30, 2011 and December 31, 2010 (unaudited, in thousands):


September 30, 2011	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U.S. Treasuries and government agencies	$	12,562	$	655	$	—		$	13,217
States, municipalities, and political subdivisions		28,695		2,059		(2	)		30,752
Corporate securities		45,446		1,132		(44	)		46,534
Residential mortgage-backed securities		23,207		922		—			24,129
Commercial mortgage-backed securities		198		16		—			214
Collateralized mortgage obligations		6,209		157		(12	)		6,354
Other structured securities		1,006		21		—			1,027

Total fixed income securities		117,323		4,962		(58	)		122,227
Equity securities		23,740		947		(1,482	)		23,205

Total fixed income and equity securities	$	141,063	$	5,909	$	(1,540	)	$	145,432


December 31, 2010	Cost or Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
U.S. Treasuries and government agencies	$	22,775	$	575	$	(6	)	$	23,344
States, municipalities, and political subdivisions		31,282		1,428		(89	)		32,621
Corporate securities		36,462		1,130		(124	)		37,468
Residential mortgage-backed securities		25,474		415		(130	)		25,759
Commercial mortgage-backed securities		272		17		—			289
Collateralized mortgage obligations		7,177		117		(74	)		7,220
Other structured securities		759		18		(4	)		773

Total fixed income securities		124,201		3,700		(427	)		127,474
Equity securities		17,002		3,906		(28	)		20,880

Total fixed income and equity securities	$	141,203	$	7,606	$	(455	)	$	148,354

Other structured securities include other asset-backed securities collateralized by home equity loans, credit card receivables and manufactured homes.

The gross unrealized losses and estimated fair value of fixed income and equity securities, excluding those securities in the segregated portfolio cell reinsurance segment, classified as a available-for-sale by category and length of time an individual security has been in a continuous unrealized position as of September 30, 2011 and December 31, 2010 are as follows (unaudited, in thousands):


	Less Than 12 Months					12 Months or More				Total
September 30, 2011	Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses		Estimated Fair Value		Gross Unrealized Losses
States, municipalities, and political subdivisions	$	371	$	(2	)	$	—	$	—	$	371	$	(2	)
Corporate securities		1,349		(11	)		—		—		1,349		(11	)
Residential mortgage-backed securities		253		(1	)		—		—		253		(1	)
Collateralized mortgage obligations		445		(12	)		—		—		445		(12	)

Total fixed income securities		2,418		(26	)		—		—		2,418		(26	)
Equity securities		9,858		(1,200	)		—		—		9,858		(1,200	)

Total fixed income and equity securities	$	12,276	$	(1,226	)	$	—	$	—	$	12,276	$	(1,226	)

Note: The Company has excluded the segregated portfolio cell reinsurance segment’s gross unrealized losses from the above table because changes in the estimated fair value of the segregated portfolio cell reinsurance segment’s fixed income and equity securities inures to the segregated portfolio cell dividend participant and, accordingly, is included in the segregated portfolio cell dividend payable and the related segregated portfolio dividend expense in the Company’s consolidated balance sheet and consolidated statement of operations, respectively. Management believes the exclusion of the segregated portfolio cell reinsurance segment from this disclosure provides a more transparent understanding of gross unrealized losses in the Company’s fixed income and equity security portfolios that could impact its consolidated financial position or results of operations.


	Less Than 12 Months					12 Months or More					Total
December 31, 2011	Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses			Estimated Fair Value		Gross Unrealized Losses
U.S. Treasuries and government agencies	$	860	$	(6	)	$	—	$	—		$	860	$	(6	)
States, municipalities, and political subdivisions		5,914		(89	)		—		—			5,914		(89	)
Corporate securities		2,508		(25	)		—		—			2,508		(25	)
Residential mortgage-backed securities		10,921		(130	)		—		—			10,921		(130	)
Collateralized mortgage obligations		1,700		(19	)		722		(55	)		2,422		(74	)
Other structured securities		446		(4	)		—		—			446		(4	)

Total fixed income securities	$	22,349	$	(273	)	$	722	$	(55	)	$	23,071	$	(328	)

As of September 30, 2011, the Company held 14 fixed income securities with gross unrealized losses totaling $26. Management has evaluated the unrealized losses related to those fixed income securities and determined that they are primarily due to a fluctuation in interest rates and not to credit issues of the issuer or the underlying assets in the case of asset-backed securities. The Company does not intend to sell the fixed income securities and it is not more likely than not that the Company will be required to sell the fixed income securities before recovery of their amortized cost bases, which may be maturity; therefore, management does not consider the fixed income securities to be other-than-temporarily impaired as of September 30, 2011.

As of September 30, 2011, the Company held 6 equity securities with gross unrealized losses totaling $1,200. All of these securities have been in an unrealized loss position for less than twelve months and are not considered other-than-temporarily impaired.

There were no other-than-temporary impairments recognized by the Company for the three and nine months ended September 30, 2011. The Company recognized other-than-temporary impairments of $0 and $6 for the three and nine months ended September 30, 2010.

The Company’s equity interest in limited partnerships (decreased) increased $(354) and $291 for the three and nine months ended September 30, 2011, respectively, compared to $266 and $520 for the three and nine months ended September 30, 2010,. The Company obtains audited financial statements of its limited partnership investments on an annual basis. The total assets, total liabilities and results of operations of the limited partnerships in which the Company invests as of and for the year ended December 31, 2010, based on the limited partnerships’ audited financial statements, were as follows (unaudited, in thousands):


	Total Assets		Total Liabilities		Results of Operations
Multi-strategy fund of funds	$	452,826	$	54,633	$	41,821
Natural resource funds	$	187,079	$	12,604	$	25,103
Structured finance opportunity fund	$	294,726	$	20,153	$	54,793
Open-ended investment fund	$	118,386	$	575	$	11,167
Real estate partnership	$	3,606	$	2,655	$	(190	)

8. Reserves for Unpaid Losses and Loss Adjustment Expenses

The following table provides a summary of the activity in the Company’s reserves for unpaid losses and LAE for the three and nine months ended September 30, 2011 and 2010 (unaudited, in thousands):


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Balance, beginning of period	$	100,637		$	89,764		$	95,963		$	89,509
Reinsurance recoverables on unpaid losses and LAE		8,484			8,273			7,864			8,512

Net balance, beginning of period		92,153			81,491			88,099			80,997

Incurred related to:
Current year		21,823			20,526			62,208			54,198
Prior year		(772	)		(610	)		(992	)		1,242

Total incurred		21,051			19,916			61,216			55,440
Paid related to:
Current year		8,906			7,325			19,465			18,742
Prior year		8,599			7,796			34,151			31,409

Total paid		17,505			15,121			53,616			50,151

Net balance, end of period		95,699			86,286			95,699			86,286
Reinsurance recoverables on unpaid losses and LAE		9,052			8,145			9,052			8,145

Balance, end of period	$	104,751		$	94,431		$	104,751		$	94,431

Incurred losses by segment were as follows for the three and nine months ended September 30, 2011 and 2010, respectively (unaudited, in thousands):

Three Months Ended September 30, 2011


September 30, 2011	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	17,000		$	5,467		$	22,467
Current period discount		(474	)		(170	)		(644	)
Prior year, gross of discount		—			(1,260	)		(1,260	)
Accretion of prior period discount		370			118			488

Total incurred	$	16,896		$	4,155		$	21,051

Three Months Ended September 30, 2010

		00000000			00000000			00000000
September 30, 2010	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	15,233		$	5,805		$	21,038
Current period discount		(337	)		(175	)		(512	)
Prior year, gross of discount		—			(854	)		(854	)
Accretion of prior period discount		190			54			244

Total incurred	$	15,086		$	4,830		$	19,916

Nine Months Ended September 30, 2011

		000000000			000000000			000000000
September 30, 2011	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	49,913		$	14,690		$	64,603
Current period discount		(1,819	)		(576	)		(2,395	)
Prior year, gross of discount		—			(2,691	)		(2,691	)
Accretion of prior period discount		1,159			540			1,699

Total incurred	$	49,253		$	11,963		$	61,216

Nine Months Ended September 30, 2010

		000000000			000000000			000000000
September 30, 2010	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Total
Incurred related to:
Current year, gross of discount	$	41,324		$	14,817		$	56,141
Current period discount		(1,373	)		(570	)		(1,943	)
Prior year, gross of discount		—			(873	)		(873	)
Accretion of prior period discount		1,264			851			2,115

Total incurred	$	41,215		$	14,225		$	55,440

The Company’s results of operations include favorable development in its segregated portfolio cell reinsurance segment of $1,260 and $2,691 for the three and nine months ended September 30, 2011, compared to favorable development of $854 and $873 for the same periods in 2010. The favorable development primarily reflects the impact of claim settlements for amounts at, or less than, previously established case and IBNR reserves. Prior period reserve development in the segregated portfolio cell reinsurance segment results in an increase or decrease in the segment’s losses and LAE incurred, and a corresponding decrease or increase in the segregated portfolio cell dividend expense.

There was no development in the workers’ compensation insurance segments in 2011 or 2010.

9. Segment Information

The Company currently operates in three business segments. Prior to the sale of Atlantic RE and Eastern Life, the Company’s operations included a run-off specialty reinsurance segment and a group benefits insurance segment. The components of the run-off specialty reinsurance segment that were not transferred to Atlantic RE have been included in the corporate/other segment for the three and nine months ended September 30, 2011 and 2010.

Workers’ Compensation Insurance

The Company offers traditional workers’ compensation insurance coverage to employers, primarily in the Mid-Atlantic, Southeast and Midwest regions of the continental United States. The Company’s workers’ compensation products include guaranteed cost policies, policyholder dividend policies, retrospectively-rated policies and large deductible policies.

Segregated Portfolio Cell Reinsurance

The Company offers alternative market workers’ compensation solutions to individual companies, groups and associations (referred to as “segregated portfolio cell dividend participants”) through the creation of segregated portfolio cells. The segregated portfolio cells are segregated pools of assets that function as insurance companies within an insurance company. The pool of assets and associated liabilities of each segregated portfolio cell are solely for the benefit of the segregated portfolio cell dividend participants, and the pool of assets of one segregated portfolio cell are statutorily protected from the creditors of the others. This permits the Company to provide customers with a turn-key alternative markets solution that includes program design, fronting, claims administration, risk management, segregated portfolio cell rental, investment and segregated portfolio management services. The segregated portfolio cell structure provides dividend participants the opportunity to share in both underwriting profit and investment income derived from their respective segregated portfolio cell’s financial results. The segregated portfolio cell reinsurance segment generated fee revenue to the Company’s workers’ compensation and corporate/other segments totaling $1,383 and $1,134 for the three months ended September 30, 2011 and 2010, respectively and $4,261 and $3,507 for the nine months ended September 30, 2011 and 2010, respectively.

The Company is a preferred shareholder in certain of the segregated portfolio cells. For those segregated portfolio cells in which the Company participates, the Company shares in the operating and investment results of those cells and recognizes its share of the segregated portfolio dividend in the consolidated statements of operations and comprehensive income (loss). The Company’s share of the segregated portfolio dividend is included in the corporate/other segment.

Corporate/Other

The corporate/other segment primarily includes the expenses of the holding company, the third party administration activities of the Company, and the results of operations of Eastern Re, as well as certain eliminations necessary to reconcile the segment information to the consolidated statements of operations and comprehensive income (loss). The Company cancelled the remaining reinsurance contracts at Eastern Re in 1999 on a run-off basis and continues to have exposure for outstanding claims as of September 30, 2011. The corporate/other segment also includes the Company’s 10% interest in a segregated portfolio cell with an unaffiliated primary carrier that writes insurance coverage for sprinkler contractors. The Company non-renewed the contract for its 10% interest in the segregated portfolio cell on a run-off basis effective April 1, 2009.

The following table represents the segment results for the three months ended September 30, 2011 (unaudited, in thousands):


	Workers’ Compensation Insurance			Segregated Portfolio Cell Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	26,388		$	7,529		$	—		$	33,917
Net investment income		808			99			106			1,013
Change in equity interest in limited partnerships		(269	)		—			(85	)		(354	)
Net realized investment (losses) gains		(1,436	)		(22	)		152			(1,306	)
Other revenue		—			—			86			86

Total revenue		25,491			7,606			259			33,356


Expenses:
Losses and LAE incurred		16,896			4,155			—			21,051
Acquisition and other underwriting expenses		1,903			2,270			(543	)		3,630
Other expenses		4,106			56			2,103			6,265
Amortization of intangibles		—			—			254			254
Policyholder dividend expense		196			8			—			204
Segregated portfolio dividend expense		—			1,117			(110	)		1,007

Total expenses		23,101			7,606			1,704			32,411

Income (loss) from continuing operations before income taxes		2,390			—			(1,445	)		945
Income tax expense (benefit) from continuing operations		875			—			(586	)		289

Net income (loss) from continuing operations	$	1,515		$	—		$	(859	)	$	656

Total assets	$	301,443		$	61,225		$	(20,728	)	$	341,940

The following table represents the segment results for the three months ended September 30, 2010 (unaudited, in thousands):


	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	22,409	$	6,365		$	—		$	28,774
Net investment income		598		124			147			869
Change in equity interest in limited partnerships		214		—			52			266
Net realized investment gains		1,191		232			90			1,513
Other revenue		—		—			143			143

Total revenue		24,412		6,721			432			31,565


Expenses:
Losses and LAE incurred		15,085		4,831			—			19,916
Acquisition and other underwriting expenses		1,790		1,908			(422	)		3,276
Other expenses		4,110		50			1,575			5,735
Amortization of intangibles		—		—			321			321
Policyholder dividend expense		333		—			—			333
Segregated portfolio dividend expense		—		(68	)		152			84

Total expenses		21,318		6,721			1,626			29,665

Income (loss) from continuing operations before income taxes		3,094		—			(1,194	)		1,900
Income tax expense (benefit) from continuing operations		1,094		—			(362	)		732

Net income (loss) from continuing operations	$	2,000	$	—		$	(832	)	$	1,168

Total assets	$	270,739	$	58,673		$	40		$	329,452

The following table represents the segment results for the nine months ended September 30, 2011 (unaudited, in thousands):


	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance		Corporate/ Other			Total
Revenue:
Net premiums earned	$	75,089	$	20,913	$	—		$	96,002
Net investment income		2,568		351		28			2,947
Change in equity interest in limited partnerships		273		—		18			291
Net realized investment gains		204		45		251			500
Other revenue		—		—		348			348

Total revenue		78,134		21,309		645			100,088


Expenses:
Losses and LAE incurred		49,252		11,964		—			61,216
Acquisition and other underwriting expenses		5,678		6,275		(1,597	)		10,356
Other expenses		11,839		205		6,153			18,197
Amortization of intangibles		—		—		762			762
Policyholder dividend expense		802		21		—			823
Segregated portfolio dividend expense		—		2,844		(648	)		2,196

Total expenses		67,571		21,309		4,670			93,550

Income (loss) from continuing operations before income taxes		10,563		—		(4,025	)		6,538
Income tax expense (benefit) from continuing operations		3,520		—		(1,509	)		2,011

Net income (loss) from continuing operations	$	7,043	$	—	$	(2,516	)	$	4,527

Total assets	$	301,443	$	61,225	$	(20,728	)	$	341,940

The following table represents the segment results for the nine months ended September 30, 2010 (unaudited, in thousands):


	Workers’ Compensation Insurance		Segregated Portfolio Cell Reinsurance			Corporate/ Other			Total
Revenue:
Net premiums earned	$	62,025	$	18,015		$	—		$	80,040
Net investment income		1,812		433			272			2,517
Change in equity interest in limited partnerships		445		—			75			520
Net realized investment gains (losses)		1,062		774			(244	)		1,592
Other revenue		—		—			434			434

Total revenue		65,344		19,222			537			85,103


Expenses:
Losses and LAE incurred		41,214		14,226			—			55,440
Acquisition and other underwriting expenses		4,860		5,488			(1,247	)		9,101
Other expenses		11,087		189			4,678			15,954
Amortization of intangibles		—		—			963			963
Policyholder dividend expense		732		10			—			742
Segregated portfolio dividend expense		—		(691	)		73			(618	)

Total expenses		57,893		19,222			4,467			81,582

Income (loss) from continuing operations before income taxes		7,451		—			(3,930	)		3,521
Income tax expense (benefit) from continuing operations		2,351		—			(1,222	)		1,129

Net income (loss) from continuing operations	$	5,100	$	—		$	(2,708	)	$	2,392

Total assets	$	270,739	$	58,673		$	40		$	329,452

10. Commitments and Contingencies

Legal Proceedings

The Company is subject to legal proceedings and claims that arise in the ordinary course of its business and have not been finally adjudicated. Although there can be no assurance as to the ultimate disposition of these matters, it is the opinion of the Company’s management, based upon the information available at this time, that the expected outcome of these matters, individually or in the aggregate, will not have a material adverse effect on the Company’s results of operations or financial condition.

11. Subsequent Events

Management performed an evaluation of subsequent events and determined there were no recognized or unrecognized subsequent events that would require an adjustment and/or additional disclosure in the consolidated financial statements as of September 30, 2011.

Item 2.

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

The following discussion and analysis of financial condition and results of operations should be read in conjunction with the unaudited interim consolidated financial statements of Eastern Insurance Holdings, Inc. (the “Company”) and the related notes thereto included in Item 1 of this Part 1. The information contained in this quarterly report is not a complete description of the Company’s business or the risks associated with an investment in the Company’s common stock. You should carefully review and consider the various disclosures made by the Company in this quarterly report and in the Company’s Annual Report on Form 10-K filed with the U.S. Securities and Exchange Commission on March 8, 2011.

Forward-looking Statements

The Company may from time to time make written or oral “forward-looking statements,” including statements contained in the Company’s filings with the U.S. Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the exhibits hereto), in its reports to shareholders and in other communications by the Company, which are made in good faith by the Company pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.

These forward-looking statements include statements with respect to the Company’s beliefs, plans, objectives, goals, expectations, anticipations, estimates and intentions, that are subject to significant risks and uncertainties, and are subject to change based on various factors (some of which are beyond the Company’s control). The words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan” and similar expressions are intended to identify forward-looking statements. The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements:

•

the ability to carry out our business plans;

•

future economic conditions in the regional and national markets in which we compete that are less favorable than expected;

•

the effect of legislative, judicial, economic, demographic and regulatory events in the states in which we do business;

•

the ability to obtain licenses and enter new markets successfully and capitalize on growth opportunities either through mergers or the expansion of our producer network;

•

financial market conditions, including, but not limited to, changes in interest rates and the credit and equity markets causing a reduction of investment income or investment gains, an acceleration of the amortization of deferred policy acquisition costs, reduction in the value of our investment portfolio or a reduction in the demand for our products;

•

the impact of acts of terrorism and acts of war;

•

the effects of terrorist related insurance legislation and laws;

•

changes in general economic conditions, including inflation, unemployment, interest rates and other factors;

•

the cost, availability and collectibility of reinsurance;

•

estimates and adequacy of loss reserves and trends in losses and LAE;

•

heightened competition, including specifically the intensification of price competition, increased underwriting capacity and the entry of new competitors and the development of new products by new and existing competitors;

•

the effects of mergers, acquisitions and dispositions;

•

changes in the coverage terms selected by insurance customers, including higher deductibles and lower limits;

•

changes in the underwriting criteria that we use resulting from competitive pressures;

•

our inability to obtain regulatory approval of, or to implement, premium rate increases;

•

the potential impact on our reported earnings that could result from the adoption of future accounting standards issued by the FASB or other standard setting bodies;

•

our inability to carry out marketing and sales plans, including, among others, development of new products or changes to existing products and acceptance of the new or revised products in the market;

•

unanticipated changes in industry trends and ratings assigned by nationally recognized rating organizations;

•

adverse litigation or arbitration results; and

•

adverse changes in applicable laws, regulations or rules governing insurance holding companies and insurance companies, and tax or accounting matters including limitations on premium levels, increases in minimum capital and reserves, and other financial viability requirements, and changes that affect the cost of, or demand for our products.

The Company cautions that the foregoing list of important factors is not exclusive. Readers are also cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this report. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

Overview

The Company reported net income from continuing operations of $656,000 and $4.5 million for the three and nine months ended September 30, 2011, respectively, compared to $1.2 million and $2.4 million for the same periods in 2010.

The improvement in the Company’s operating results reflects continued growth of the workers’ compensation business and the impact of audit premium from customers, which reflects an improvement in insured payrolls. The workers’ compensation insurance segment reported a combined ratio of 87.5% and 90.0% for the three and nine months ended September 30, 2011, respectively, compared to a combined ratio of 95.1% and 93.3% for the same periods in 2010.

The decline in the investment markets during the third quarter of 2011 had an adverse impact on the Company’s results of operations. During the third quarter, the Company’s equity interest in limited partnerships declined $354,000 and the estimated fair value of the Company’s convertible bond portfolio decreased $1.5 million, which is reflected in net realized investment (losses) gains.

Principal Revenue and Expense Items

The Company derives its revenue primarily from net premiums earned, including assumed premiums earned, net investment income and net realized investment gains.

Direct and net premiums written. Direct premiums written is the sum of both direct premiums and assumed premiums before the effect of ceded reinsurance. Direct premiums written include all premiums billed during a specific policy period. Net premiums written is the difference between direct premiums written and premiums ceded or paid to reinsurers (ceded premiums written). In the segregated portfolio cell reinsurance segment, assumed premiums are derived from insurance contracts written by the Company and ceded to the segregated portfolio cells. In the run-off specialty reinsurance segment, assumed premiums are premiums that are received from a third party under a reinsurance agreement, which are reported to the Company directly from the broker one quarter in arrears.

Net premiums earned. Net premiums earned are the earned portion of the Company’s net premiums written. Premiums are earned over the term of the related policies. At the end of each accounting period, the portion of the premiums that are not yet earned are included in unearned premiums and are realized as revenue in subsequent periods over the remaining term of the policy. The Company’s workers’ compensation policies typically have a term of twelve months. Thus, for example, for a policy that is written on July 1, 2011, one-half of the premiums would be earned in 2011 and the other half would be earned in 2012. Workers’ compensation premiums are determined based upon the payroll of the insured, the applicable premium rates and, where applicable, an experience based modification factor. An audit of the policyholders’ records is conducted after policy expiration, to make a final determination of applicable premiums. Included with net premiums earned is an estimate for earned but unbilled final audit premiums. The Company can estimate earned but unbilled premiums because it keeps track, by policy, of how much additional premium is billed (or returned to insureds as a result of payroll reductions) in final audit invoices as a percentage to estimate the probable additional amount that it has earned but not yet billed as of the balance sheet date.

Net investment income and realized gains and losses on investments. The Company invests its surplus and the funds supporting its insurance liabilities (including unearned premiums and unpaid losses and loss adjustment expenses) in cash, cash equivalents, fixed income securities, convertible bonds, equity securities, and other long-term investments. Investment income includes interest earned on invested assets, including the impact of premium amortization and discount accretion. Realized gains and losses on invested assets are reported separately from net investment income. The Company recognizes realized gains when invested assets are sold for an

amount greater than their cost or amortized cost (in the case of fixed income securities) and recognizes realized losses when investment securities are written down as a result of an other than temporary impairment or sold for an amount less than their cost or amortized cost. Realized gains and losses also include the change in fair value of convertible bonds.

Other revenue. Other revenue includes claim administration, risk management, and cell rental fees earned. There are other revenue items that the Company recognizes on a segmental basis that are eliminated in consolidation. Such items consist primarily of fees paid by the segregated portfolio cells to other entities within the consolidated group. The segregated portfolio cells recognize an expense for such items (included as part of its ceding commission) and a corresponding revenue item is recognized by the affiliate providing the service. For segment reporting purposes, such revenue items primarily include claims administration, risk management, and cell rental fees. Fronting fees are included in acquisition and other underwriting expenses as an offset to the direct costs incurred. For segment reporting purposes, such fees are recognized ratably over the period in which the service is provided, which generally corresponds to the earned portion of net premiums written for the underlying policies.

The Company’s expenses consist primarily of losses and LAE, acquisition and other underwriting expenses, policyholder dividends, other expenses, and income taxes:

Losses and LAE. Losses and LAE represent the largest expense item and include: (1) claim payments made, (2) estimates for future claim payments and changes in those estimates from prior periods, and (3) costs associated with investigating, defending and adjusting claims.

Acquisition and other underwriting expenses. In the workers’ compensation insurance segment, expenses incurred to underwrite risks are referred to as acquisition and other underwriting expenses, which consist of commissions, premium taxes and fees and other underwriting expenses incurred in acquiring, writing and administering the Company’s business. In the segregated portfolio cell reinsurance and run-off specialty reinsurance segments, acquisition and other underwriting expenses consist of ceding commissions earned under the respective reinsurance agreements. Ceding commissions received are netted against acquisition and other underwriting expenses.

Other expenses. Other expenses consist of general administrative expenses such as salaries, rent, office supplies, depreciation and all other operating expenses not otherwise classified separately. Other expenses also include interest expense related primarily to the Company’s loan payable.

Policyholder dividend expense. Policyholder dividends represent the amount of dividends incurred during the period that are expected to be returned to policyholders. The dividend expense is based on the loss experience of the underlying workers’ compensation insurance policy.

Income tax expense. EIHI and certain of its subsidiaries pay federal, state and local income taxes. Income tax expense includes an amount for both current and deferred income taxes. Current income tax expense includes an amount for the Company’s current year federal income tax liability and any adjustments related to differences between the prior year federal income tax estimate and the actual income tax expense reported in the tax return. Deferred tax expense represents the change in the Company’s net deferred tax asset, exclusive of the tax effect related to changes in unrealized gains and losses in the Company’s investment portfolio and changes in the unrecognized amounts related to the Company’s benefit plan liabilities.

Key Financial Measures

The Company evaluates its insurance operations by monitoring certain key measures of growth and profitability. The Company measures growth by monitoring changes in direct premiums written and net premiums written. The Company measures underwriting profitability by examining loss, expense and combined ratios. On a segmental basis, the Company measures a segment’s operating results by examining net income, diluted earnings per share, and return on average equity.

Loss ratio. The loss ratio is the ratio (expressed as a percentage) of losses and LAE incurred to net premiums earned and measures the underwriting profitability of a company’s insurance business. The Company measures the loss ratio on an accident year and calendar year loss basis to measure underwriting profitability. An accident year loss ratio measures losses and LAE for insured events occurring in a particular year, regardless of when they are reported, as a percentage of net premiums earned during that year. A calendar year loss ratio measures losses and LAE for insured events occurring during a particular year and the change in loss reserves from prior accident years as a percentage of net premiums earned during that year.

Expense ratio. The expense ratio is the ratio (expressed as a percentage) of the sum of the acquisition and other underwriting expenses and other expenses to net premiums earned and measures the Company’s operational efficiency in producing, underwriting and administering its insurance business.

Policyholder dividend expense ratio. The policyholder dividend expense ratio is the ratio (expressed as a percentage) of policyholder dividend expense to net premiums earned and measures the impact of the Company’s policyholder dividend policies on its workers’ compensation insurance segment.

Combined ratio. The combined ratio is the sum of the loss ratio and the expense ratio and measures the Company’s overall underwriting profit. If the combined ratio is below 100%, the Company is making an underwriting profit. If the Company’s combined ratio is at or above 100%, the Company is not profitable without investment income and may not be profitable if investment income is insufficient.

Net income, diluted earnings per share, and return on average equity. The Company uses net income and diluted earnings per share to measure its profits and return on average equity to measure its effectiveness in utilizing shareholders’ equity to generate net income. In determining return on average equity for a given year, net income is divided by the average of the beginning and ending shareholders’ equity for that year.

Critical Accounting Policies and Estimates

The preparation of financial statements in accordance with U.S. GAAP requires both the use of estimates and judgment relative to the application of appropriate accounting policies. The Company is required to make estimates and assumptions in certain circumstances that affect amounts reported in the consolidated financial statements and related footnotes. The Company evaluates these estimates and assumptions on an on-going basis based on historical developments, market conditions, industry trends and other information that is believed to be reasonable under the circumstances. There can be no assurance that actual results will conform to the estimates and assumptions and that reported results of operations will not be materially adversely affected by the need to make accounting adjustments to reflect changes in these estimates and assumptions from time to time. The Company believes the following policies are the most sensitive to estimates and judgments.

Reserves for Unpaid Losses and LAE

The Company establishes reserves for unpaid losses and LAE for its workers’ compensation insurance, segregated portfolio cell reinsurance and run-off specialty reinsurance products, which are estimates of future payments of reported and unreported claims for losses and related expenses. The adequacy of the Company’s reserves for unpaid losses and LAE are inherently uncertain because the ultimate amount that the Company may pay under many of the claims incurred as of the balance sheet date will not be known for many years. Establishing reserves continues to be a complex and imprecise process, requiring the use of informed estimates and judgments. The Company’s estimates and judgments may be revised as additional experience and other data becomes available and are reviewed, as new or improved methodologies are developed, or as current laws change. Any such revisions could result in future changes in estimates of losses or reinsurance recoverable and would be reflected in the Company’s results of operations in the period in which the estimates are changed. Estimating the ultimate claims liability is necessarily a complex and judgmental process inasmuch as the amounts are based on management’s informed estimates and judgments using data currently available. If ultimate losses, net of reinsurance, prove to be substantially higher than the amounts recorded as of September 30, 2011, the related adjustments could have a material adverse effect on the Company’s financial condition, results of operations or liquidity.

The Company discounts its workers’ compensation reserves, using a discount rate of approximately 3.0%. As of September 30, 2011 and December 31, 2010, the Company’s reserves for unpaid losses and LAE were reduced by $5.3 million and $4.6 million, respectively, related to the effects of discounting.

The Company’s reserves for unpaid losses and LAE in its workers’ compensation insurance, segregated portfolio cell reinsurance and corporate/other segments as of September 30, 2011 (unaudited) and December 31, 2010 are summarized below (in thousands):


September 30, 2011	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Corporate/Other		Total
Case / tabular reserves	$	41,398		$	10,270		$	—	$	51,668
Case incurred development, IBNR, and unallocated LAE reserves		34,873			13,939			527		49,339
Amount of discount		(4,095	)		(1,213	)		—		(5,308	)

Net reserves		72,176			22,996			527		95,699
Reinsurance recoverables on unpaid losses and LAE		5,761			3,291			—		9,052

Reserves for unpaid losses and LAE	$	77,937		$	26,287		$	527	$	104,751


December 31, 2010	Workers’ Compensation Insurance Segment			Segregated Portfolio Cell Reinsurance Segment			Corporate/Other		Total
Case reserves	$	35,758		$	11,618		$	—	$	47,376
Case incurred development, IBNR, and unallocated LAE reserves		32,124			12,369			862		45,355
Amount of discount		(3,435	)		(1,198	)		—		(4,633	)

Net reserves		64,447			22,789			862		88,098
Reinsurance recoverables on unpaid losses and LAE		4,464			3,401			—		7,865

Reserves for unpaid losses and LAE	$	68,911		$	26,190		$	862	$	95,963

“Other Than Temporary” Investment Impairments

Unrealized investment gains or losses on investments carried at fair value, net of applicable income taxes, are reflected directly in shareholders’ equity as a component of comprehensive income (loss) and, accordingly, have no effect on net income. When, in the opinion of management, a decline in the fair value of an investment below its cost or amortized cost is considered to be “other-than-temporary,” such investment is written down to its fair value. The amount written down is recorded in earnings as a net realized investment loss. Generally, the determination of other-than-temporary impairment includes, in addition to other relevant factors, a presumption that if the market value is below cost by a significant amount for a period of time, a write down is necessary. Notwithstanding this presumption, the determination of other-than-temporary impairment requires judgment about future prospects for an investment and is therefore a matter of inherent uncertainty. There were no other-than-temporary impairments recognized by the Company for the three and nine months ended September 30, 2011. For the three and nine months ended September 30, 2010, the Company recognized other-than-temporary impairments, excluding impairments in the segregated portfolio cell reinsurance segment, of $0 and $6,000, respectively. As of September 30, 2011, the Company held securities with gross unrealized losses of $1.2 million, excluding those securities in the segregated portfolio cell reinsurance segment, of which none were in an unrealized loss position for more than 12 months. Adverse investment market conditions, poor operating results of underlying investments, or the passage of time with respect to equity securities in an unrealized loss position, could result in impairment charges in the future. The Company generally applies the following standards in determining whether the decline in fair value of an investment is other-than-temporary:

Equity securities. An equity security is considered impaired when one of the following conditions exist: 1) an equity security’s market value is less than 80.0% of its cost for a continuous period of six months, 2) an equity’s security’s market value is less than 50.0% of its cost, regardless of the amount of time the security’s market value has been below cost, and 3) an equity security’s market value has been less than cost for a continuous period of 12 months, regardless of the magnitude of the decline in market value. Equity securities that are in an unrealized loss position, but do not meet the above quantitative thresholds, are evaluated to determine if the decline in market value is other than temporary.

The Company did not recognize any other-than-temporary impairments related to its equity securities for the three and nine months ended September 30, 2011.

Fixed income securities. A fixed income security is considered to be other-than-temporarily impaired when the security’s fair value is less than its amortized cost basis and 1) the Company intends to sell the security, 2) it is more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, or 3) the Company believes it will be unable to recover the entire amortized cost basis of the security (i.e., a credit loss has occurred). When the Company determines a credit loss has been incurred, but the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery of the security’s amortized cost basis, the portion of the other-than-temporary impairment that is credit related is recorded as a realized loss in the consolidated statements of operations and comprehensive income, and the portion of the other-than-temporary impairment that is not credit related is included in other comprehensive income. A fixed income security is reviewed for potential credit loss if any of the following situations occur:

•

A review of the financial condition and prospects of the issuer indicates that the security should be evaluated;

•

Moody’s or Standard & Poor’s rate the security below investment grade; or

•

The security has a market value below 80% of amortized cost due to deterioration in credit quality.

The Company did not recognize any other-than-temporary impairments related to its fixed income securities for the three and nine months ended September 30, 2011.

Limited partnerships. A limited partnership investment is generally written down if the Company is unable to hold or otherwise intends to sell its interest in the limited partnership at a loss, or if management has received information that suggests the Company

will be unable to recover its original investment in the limited partnership. The amount written down is recorded in the change in equity interest in limited partnerships in the consolidated statement of operations and comprehensive income. There were no other-than-temporary impairments related to the Company’s limited partnership interests for the three and nine months ended September 30, 2011 or 2010.

Goodwill

In accordance with the requirements of ASC 350, Intangibles – Goodwill and Other, goodwill is not amortized but is tested for impairment at the reporting unit level, which is at the operating segment level or one level below an operating segment. Impairment is the condition that exists when the carrying amount of goodwill exceeds its implied fair value. Goodwill is required to be tested for impairment annually and between annual tests if events or circumstances change, such as adverse changes in the business climate, that would more likely than not reduce the fair value of the reporting unit below its carrying value.

Deferred Income Taxes

The temporary differences between the tax and book bases of assets and liabilities are recorded as deferred income taxes. Management evaluates the recoverability of the net deferred tax asset based on historical trends of generating taxable income or losses, as well as expectations of future taxable income or loss. As of September 30, 2011, the Company recorded a net deferred tax asset of $1.8 million. Management expects that the net deferred tax asset is fully recoverable. If this assumption were to change, any amount of the net deferred tax asset that the Company could not expect to recover would be provided for as an allowance and would be reflected as an increase in income tax expense in the period in which it was established.

As of September 30, 2011, the Company has not recognized any future tax benefit related to its foreign operations at Eastern Re. The unrecognized tax benefit, which represents the excess of the tax basis over the amount for financial reporting (i.e., outside basis difference) of Eastern Re, was $11.6 million as of September 30, 2011. The outside basis difference primarily arises from losses at Eastern Re recognized for financial statement purposes, which have not yet been recognized for tax purposes. Management presently believes that the Company will not be able to recognize these tax benefits in the foreseeable future and, therefore, has not recognized the future tax benefits as of September 30, 2011; however, to the extent Eastern Re generates earnings and profits, the Company will be able to record the tax benefit of the outside basis difference.

Reinsurance Recoverables

Amounts recoverable from the Company’s reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured policy. Amounts paid for reinsurance contracts are expensed over the contract period during which insured events are covered by the reinsurance contracts. Reinsurance balances recoverable on paid and unpaid loss and LAE are reported separately as assets, instead of being netted with the appropriate liabilities, because reinsurance does not relieve the Company of its legal liability to its policyholders. Reinsurance balances recoverable are subject to credit risk associated with the particular reinsurer. Additionally, the same uncertainties associated with estimating unpaid losses and LAE affect the estimates for the ceded portion of these liabilities. The Company continually monitors the financial condition of its reinsurers.

Recent Accounting Pronouncements

Testing Goodwill for Impairment

value of a reporting unit is less than its carrying amount, the performance of the two-step impairment test is unnecessary. If, however, an entity determines that is it more likely than not that the fair value is less than the carrying amount, the first step of the impairment test (calculation of the reporting unit’s fair value) is required. ASU 2011-08 provides examples of events and circumstances that an entity should consider in evaluating whether the fair value of a reporting unit is less than its carrying amount, but other relevant events or circumstances should be considered as necessary. ASU 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued or, for nonpublic entities, have not yet been made available for issuance. The Company performs its annual goodwill impairment test as of September 30 and has elected to early adopt the provisions of ASU 2011-08.

Presentation of Comprehensive Income

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

RESULTS OF OPERATIONS

The major components of consolidated revenue were as follows for the three and nine months ended September 30, 2011 and 2010 (unaudited, in thousands):


	Three Months Ended September 30,					Nine Months Ended September 30,
	2011			2010		2011		2010
Net premiums written	$	37,863		$	32,337	$	111,621	$	93,047


Net premiums earned		33,917			28,774		96,002		80,040
Net investment income		1,013			869		2,947		2,517
Change in equity interest in limited partnerships		(354	)		266		291		520
Net realized investment (losses) gains		(1,306	)		1,513		500		1,592
Other revenue		86			143		348		434


Consolidated revenue	$	33,356		$	31,565	$	100,088	$	85,103

The increase in consolidated revenue primarily reflects growth in the Company’s workers’ compensation book of business and the impact of audit premium from customers, partially offset by a decline in the fair value of the Company’s investment portfolio, which resulted in a decrease in the equity interest in limited partnerships and net realized investment losses related to the decrease in the fair value of the Company’s convertible bond portfolio during the third quarter of 2011. The decrease in other revenue primarily reflects the loss of a third party administration customer in the first quarter of 2011.

The components of consolidated net income from continuing operations, by segment, for the three and nine months ended September 30, 2011 and 2010 were as follows (unaudited, in thousands):


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Workers’ compensation insurance	$	1,515		$	2,000		$	7,043		$	5,100
Segregated portfolio cell reinsurance		—			—			—			—
Corporate / other		(859	)		(832	)		(2,516	)		(2,708	)

Consolidated net income from continuing operations	$	656		$	1,168		$	4,527		$	2,392

The increase in consolidated net income primarily reflects the improved combined ratio in the workers’ compensation insurance segment, partially offset by the aforementioned decline in the Company’s investment portfolio.

WORKERS’ COMPENSATION INSURANCE

The following table represents the operations of the workers’ compensation insurance segment for the three and nine months ended September 30, 2011 and 2010 (unaudited, in thousands):


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Revenue:
Direct premiums written	$	41,750		$	34,541		$	121,298		$	100,014
Reinsurance premiums assumed		457			401			1,608			1,159
Ceded premiums written		(11,473	)		(8,743	)		(35,331	)		(28,609	)

Net premiums written		30,734			26,199			87,575			72,564
Change in unearned premiums		(4,346	)		(3,790	)		(12,486	)		(10,539	)

Net premiums earned		26,388			22,409			75,089			62,025
Net investment income		808			598			2,568			1,812
Change in equity interest in limited partnerships		(269	)		214			273			445
Net realized investment (losses) gains		(1,436	)		1,191			204			1,062

Total revenue		25,491			24,412			78,134			65,344


Expenses:
Losses and LAE incurred		16,896			15,085			49,252			41,214
Acquisition and other underwriting expenses		1,903			1,790			5,678			4,860
Other expenses		4,106			4,110			11,839			11,087
Policyholder dividend expense		196			333			802			732

Total expenses		23,101			21,318			67,571			57,893


Income before income taxes		2,390			3,094			10,563			7,451
Income tax expense		875			1,094			3,520			2,351

Net income	$	1,515		$	2,000		$	7,043		$	5,100

The workers’ compensation insurance ratios were as follows for the three and nine months ended September 30, 2011 and 2010:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Loss and LAE ratio		64.0	%		67.3	%		65.6	%		66.4	%
Expense ratio		22.8	%		26.3	%		23.3	%		25.7	%
Policyholders’ dividend ratio		0.7	%		1.5	%		1.1	%		1.2	%


Combined ratio		87.5	%		95.1	%		90.0	%		93.3	%

Premiums

The increase in direct premiums written primarily reflects new business sales $25.5 million, an increase in audit premium, an increase in the renewal retention rate, and renewal rate increases of 0.9%. Audit premium from customers totaled $983,000 and $1.4 million for the three and nine months ended September 30, 2011, respectively, compared to audit premium from customers of $95,000 and audit premium returned to customers of $1.3 million for the same periods in 2010. The Company’s traditional book of business recognized audit premium from customers of $727,000 and $1.3 million for the three and nine months ended September 30, 2011, compared to audit premium from customers of $181,000 and audit premium returned to customers of $361,000 for the same periods in 2010, respectively. In addition to audit premium from customers, direct premiums written increased as a result of an adjustment of $350,000 to earned but unbilled premium for the three and nine months ended September 30, 2011, compared to an adjustment of $100,000 and $750,000 to earned but unbilled premium that decreased direct premiums written for the same periods in 2010. The renewal retention rate increased from 86.9% in 2010 to 88.4% in 2011.

Net Investment Income

The increase in net investment income primarily reflects an increase in invested assets, partially offset by a decrease in the average yield on the fixed income portfolio. The average yield on the fixed income portfolio was 3.33% as of September 30, 2011, compared to 3.66% as of September 30, 2010.

Net Realized Investment (Losses) Gains

Net realized investment losses for the three months ended September 30, 2011 primarily reflect a decrease in the fair value of the Company’s convertible bond portfolio. Net realized gains for the nine months ended September 30, 2011 primarily reflect gains on the sale of investments, including an international equity fund that experienced an other-than-temporary impairment prior to 2011, partially offset by the aforementioned decline in the fair value of the convertible bond portfolio. Net realized investment gains for the three and nine months ended September 30, 2010 primarily reflect an increase in the estimated fair value of the Company’s convertible bond portfolio.

Losses and LAE

The decrease in the calendar period loss and LAE ratio reflects a decrease in the accident period loss ratio from 2010 to 2011, partially offset by audit premium from customers in 2011, compared to audit premium returned to customers in 2010. The 2011 calendar period loss and LAE ratio was impacted by audit premium from customers for the three and nine months ended September 30, 2011, which decreased the loss and LAE ratio by 2.8 points and 1.5 points, respectively. The 2010 calendar period loss and LAE ratio was impacted by audit premium from customers for the three months ended September 30, 2010 and audit premium return to customers for the nine months ended September 30, 2010, which decreased the loss and LAE ratio by 0.3 points and increased the loss ratio by 1.1 points, respectively. There was no prior year reserve development recognized in 2011 or 2010.

Acquisition and Other Underwriting Expenses and Other Expenses

The acquisition and other underwriting expense ratio was 7.2% and 7.6% for the three and nine months ended September 30, 2011, respectively, compared to 8.0% and 7.8% for the same periods in 2010. The decrease in the ratio from 2010 to 2011 primarily reflects the impact of audit premium from customers.

The other expense ratio was 15.6% and 15.7% for the three and nine months ended September 30, 2011, respectively, compared to 18.3% and 17.9% for the same periods in 2010. The decrease in the expense ratio primarily reflects the impact of the increase in net premiums earned, including the impact of audit premium from customers.

Policyholder Dividends

The increase in the policyholder dividend expense primarily reflects the loss experience of dividend paying policies. For the nine months ended September 30, 2011 and 2010, 11.9% and 12.3%, respectively, of all policies were written on a dividend policy basis.

Tax Expense

The effective tax rate for the three and nine months ended September 30, 2011 was 36.6% and 33.3%, respectively, compared to an effective tax rate of 35.4% and 31.6% for the same periods in 2010. The primary difference between the statutory rate of 35.0% and the effective tax rate reflects a prior year tax return adjustment, partially offset by tax-exempt income on municipal bond securities. The increase in the effective tax rate from 2010 to 2011 primarily reflects the relationship of tax-exempt municipal bond income to pre-tax income.

SEGREGATED PORTFOLIO CELL REINSURANCE

The following table represents the operations of the segregated portfolio cell reinsurance segment for the three and nine months ended September 30, 2011 and 2010 (unaudited, in thousands):


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Revenue:
Reinsurance premiums assumed	$	8,149		$	7,003		$	26,909		$	22,895
Ceded premiums written		(1,020	)		(865	)		(2,863	)		(2,412	)

Net premiums written		7,129			6,138			24,046			20,483
Change in unearned premiums		400			227			(3,133	)		(2,468	)

Net premiums earned		7,529			6,365			20,913			18,015
Net investment income		99			124			351			433
Net realized investment (losses) gains		(22	)		232			45			774

Total revenue		7,606			6,721			21,309			19,222


Expenses:
Losses and LAE incurred		4,155			4,831			11,964			14,226
Acquisition and other underwriting expenses		2,270			1,908			6,275			5,488
Other expenses		56			50			205			189
Policyholder dividend expense		8			—			21			10
Segregated portfolio dividend expense (1)		1,117			(68	)		2,844			(691	)

Total expenses		7,606			6,721			21,309			19,222

Net income (1)	$	—		$	—		$	—		$	—

(1)

The workers’ compensation insurance, run-off specialty reinsurance and corporate/other segments provide services to the segregated portfolio cell reinsurance segment. The fees paid by the segregated portfolio cell reinsurance segment for these services are included in the revenue of the segment providing the service. The segregated portfolio cell reinsurance segment records the fees associated with these services as ceding expense, which is included in its underwriting expenses. The difference between total revenue for the segregated portfolio cell reinsurance segment for each period and the sum of losses and loss adjustment expenses, underwriting expenses, policyholder dividend expenses and other expenses is accrued as a segregated portfolio dividend expense. As a result, the segregated portfolio cell reinsurance segment has no net income for the period presented in this table.

The segregated portfolio cell reinsurance ratios were as follows for the three and nine months ended September 30, 2011 and 2010:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Loss and LAE ratio		55.2	%		75.9	%		57.2	%		79.0	%
Expense ratio		31.0	%		30.8	%		31.1	%		31.5	%

Combined ratio		86.2	%		106.7	%		88.3	%		110.5	%

Reinsurance Premiums Assumed

The increase in reinsurance premiums assumed primarily reflects new business sales of $4.2 million, an increase in audit premium, and increase in the renewal retention rate, and renewal rate increases of 1.1%. Audit premium from customers totaled $256,000 and $114,000 for the three and nine months ended September 30, 2011, respectively, compared to audit premium returned to customers of $86,000 and $952,000 for the same periods in 2010. The renewal retention rate increased from 86.7% in 2010 to 90.8% in 2011.

Net Investment Income

The decrease in net investment income primarily reflects the impact of the current interest rate environment.

Net Realized Investment (Losses) Gains

Net realized investment (losses) gains primarily reflect investment sale activity in 2011 and 2010.

Losses and LAE

The decrease in the calendar period loss and LAE ratio reflects a decrease in the accident period loss ratio, an increase in favorable reserve development, and an improvement in audit premium from 2010 to 2011. The accident period loss ratio was 71.9% and 70.1% for the three and nine months ended September 30, 2011, respectively, compared to 89.3% and 83.8% for the same periods in 2010. The Company recorded favorable reserve development of $1.3 million and $2.7 million for the three and nine months ended September 30, 2011, respectively, compared to favorable reserve development of $854,000 and $873,000 for the same period in 2010. The favorable reserve development primarily reflects the impact of claim settlements for amounts at, or less than, previously established case and IBNR reserves. The 2011 calendar period loss and LAE ratio was impacted by audit premium from customers for the three and nine months ended September 30, 2011, which decreased the loss and LAE ratio by 1.9 points and 0.3 points, respectively. The 2010 calendar period loss and LAE ratio was impacted by audit premium returned to customers for the three and nine months ended September 30, 2010, which increased the loss and LAE ratio by 1.0 points and 4.0 points, respectively.

Acquisition and Other Underwriting Expenses

The expense ratios are consistent with the contractual ceding commissions for the three and nine months ended September 30, 2011 and 2010.

Segregated Portfolio Dividend Expense

The segregated portfolio dividend expense represents the amount of net income or loss in a specific period that may be payable to the segregated portfolio dividend participants.

CORPORATE/OTHER

The corporate/other segment reported a net loss of $859,000 and $2.5 million for the three and nine months ended September 30, 2011, respectively, compared to a net loss of $832,000 and $2.7 million for the same periods in 2010. The improvement in the corporate/other operating results primarily reflects an increase in the Company’s equity interest in certain segregated portfolio cells, an increase in fee revenue generated by the segregated portfolio cell reinsurance segment, and a decrease in intangible asset amortization, partially offset by a decrease in other revenue due to the loss of a third party administration customer and an increase in other expenses.

CONSOLIDATED FINANCIAL POSITION

Consolidated assets totaled $341.9 million at September 30, 2011, compared to $322.7 million at December 31, 2010. The increase primarily reflects growth in the workers’ compensation business, as premiums receivable, deferred acquisition costs and prepaid reinsurance (which is included in other assets) have all increased. Cash and cash equivalents has also increased as a result of positive cash flows from operations, partially offset by cash outflows for stock repurchases and shareholder dividends. The decrease in investments primarily reflects a decrease in fair value. The decrease in the fair value of the Company’s investments has contributed to the increase in the net deferred tax asset.

Consolidated liabilities totaled $216.5 million at September 30, 2011, compared to $188.0 million at December 31, 2010. The increase primarily reflects growth in the workers’ compensation business, as loss and LAE reserves, unearned premiums and ceded reinsurance balances payable have all increased. The increase in the segregated portfolio cell dividend payable reflects the segment’s results of operations for the period.

Consolidated equity totaled $125.4 million at September 30, 2011, compared to $134.7 million at December 31, 2010. The decrease reflects common stock repurchases, a decrease in the fair value of investments, and shareholder dividends, partially offset by 2011 net income.

LIQUIDITY AND CAPITAL RESOURCES

The Company’s principal sources of funds are premiums, investment income, and proceeds from sales and maturities of investments. The Company’s primary use of funds is to pay claims and operating expenses and to purchase investments.

The Company’s investment portfolio is structured so that investments mature periodically over time in reasonable relation to current expectations of future claim payments. Currently, claim payments are made from operating cash flows, with excess cash invested in investment securities. As securities mature, management intends to invest excess cash with appropriate durations to fund anticipated future claim payments. Management does not anticipate having to sell securities in its investment portfolios to fund claims or operating expenses. In the event the sale of securities becomes necessary, the Company may incur losses on those sales, which would adversely affect its results of operations and could reduce net investment income.

The Company has a $2.6 million line of credit available to provide additional liquidity if needed.

Our domestic insurance subsidiaries’ ability to pay dividends to EIHI is limited by the insurance laws and regulations of Pennsylvania and Indiana. The maximum annual dividends that the domestic insurance entities may pay without prior approval from the Pennsylvania Insurance Department and the Indiana Insurance Department is limited to the greater of 10.0% of statutory surplus or 100% of statutory net income for the most recently filed annual statement. Eastern Re must receive approval from the Cayman Islands Monetary Authority before it can pay any dividend to the Company.

CASH FLOWS

Cash flows from continuing operations for the nine months ended September 30, 2011 and 2010 were as follows (unaudited, in thousands):


	2011			2010
Cash flows provided by operating activities	$	18,662		$	6,832
Cash flows provided by investing activities		227			(26,165	)
Cash flows used in financing activities		(14,618	)		(7,605	)

Net increase (decrease) in cash and cash equivalents	$	4,271		$	(26,938	)

The increase in cash flows provided by operating activities primarily reflects the growth in the workers’ compensation business.

Cash flows from investing for the nine months ended September 30, 2011 primarily reflects the sale of investments to fund stock repurchases, partially offset by the purchase of fixed income and equity securities with cash from operations. Cash flows from investing for the nine months ended September 30, 2010 primarily reflects the purchase of investments with cash from the sale of Eastern Life.

The increase in cash used in financing activities primarily reflects common stock repurchases in 2011.

OFF-BALANCE SHEET ARRANGEMENTS

The Company has no off-balance sheet arrangements that have or are reasonably likely to have a current or, as of September 30, 2011, future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

The Company is subject to market risk with respect to its fixed income investment portfolio. The most significant components of market risk affecting the Company are credit risk and interest rate risk. The Company is also subject to equity risk with respect to its investment in equity securities.

There have been no material changes in the Company’s market risk since December 31, 2009. Additional disclosures related to the Company’s market risk are discussed under “Quantitative and Qualitative Disclosures About Market Risk” in Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 8, 2011.

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including the President, the Chief Executive Officer, the Chief Financial Officer and the Vice President of Finance, we have evaluated the effectiveness of our disclosure controls and procedures (as

such term is defined in Rules 13a – 15(e) and 15 d – 15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based on that evaluation, the President, the Chief Executive Officer, the Chief Financial Officer and the Vice President of Finance have concluded that, as of the end of such period, these disclosure controls and procedures are effective.

Changes in Internal Control Over Financial Reporting

There have not been any changes in our internal control over financial reporting (as such term is defined in Rules 13a – 15(f) and 15d – 15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1.

Legal Proceedings

None

Item 1A.

Risk Factors

There are no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010, SEC File No. 001-32899.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Issuer Purchases of Equity Securities

The following table presents information with respect to those purchases of our common stock made during the nine months ended September 30, 2011 and 2010. On August 23, 2011, the Company’s Board of Directors increased the repurchase authorization of its issued and outstanding shares of common stock by 1,000,000 shares.


Period	Total number of shares purchased		Average price paid per share		Total number of shares purchases as part of publicly announced plans or programs		Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs
January 1-31, 2011		129,110	$	12.34		129,110		987,855
February 1-28, 2011		31,976	$	13.02		31,976		955,879
March 1-31, 2011		360,832	$	12.57		360,832		595,047
April 1-30, 2011		72,948	$	12.86		72,948		522,099
May 1-31, 2011		111,984	$	13.24		111,984		410,115
June 1-30, 2011		26,405	$	13.21		26,405		383,710
July 1-31, 2011		70,063	$	13.24		70,063		313,647
August 1-31, 2011		123,012	$	13.10		123,012		1,190,635
September 1-30, 2011		78,913	$	13.14		78,913		1,111,722

Total		1,005,243	$	12.83		1,005,243


Period	Total number of shares purchased		Average price paid per share		Total number of shares purchases as part of publicly announced plans or programs		Maximum number (or approximate dollar value) of shares that may yet be purchased under the plans or programs
January 1-31, 2010		—	$	—		—	$	9,570,000
February 1-28, 2010		—	$	—		—	$	9,570,000
March 1-31, 2010		—	$	—		—	$	9,570,000
April 1-30, 2010		—	$	—		—	$	9,570,000
May 1-31, 2010		167,128	$	10.79		167,128	$	7,770,000
June 1-30, 2010		218,917	$	10.75		218,917	$	5,420,000
July 1-31, 2011		96,450	$	10.79		96,450	$	4,380,000
August 1-31, 2011		—	$	—		—	$	4,380,000
September 1-30, 2010		—	$	—		—	$	4,380,000

Total		482,495	$	10.77		482,495

Item 3.

Defaults Upon Senior Securities

None

Item 4.

Submission of Matters to a Vote of Security Holders

None

Item 5.

Other Information

None

Item 6.

Exhibits


Exhibit No.		Title

3.1		Articles of Incorporation of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.1 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)

3.2		Bylaws of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 3.2 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)

10.12		Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan (Incorporated by reference from Exhibit 4.1 to EIHI’s Registration Statement on Form S-8 filed on April 2, 2007)

21.1		Subsidiaries of Eastern Insurance Holdings, Inc. (Incorporated by reference from Exhibit 21 to the Eastern Insurance Holdings, Inc. Registration Statement No. 333-128913 on Form S-1)

31.1		Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)

31.2		Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002, (filed herewith)

32.1		Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

32.2		Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002, (filed herewith)

101		Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010, (ii) the Consolidated Statements of Operations and Comprehensive Income (Loss) for the three and nine months ended September 30, 2011 and 2010, (iii) the Consolidated Statements of Changes in Equity for the three and nine months ended September 30, 2011 and 2010, (iv) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2011 and 2010, and (v) the Condensed Notes to Consolidated Financial Statements, tagged as blocks of text.

SIGNATURES

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


	EASTERN INSURANCE HOLDINGS, INC. (Registrant)

Dated: November 3, 2011	By:	/s/ Michael L. Boguski
		Michael L. Boguski,
		President and Chief Executive Officer

Dated: November 3, 2011	By:	/s/ Kevin M. Shook
		Kevin M. Shook,
		Executive Vice President, Treasurer & Chief Financial Officer

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Smaller reporting company