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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549





FORM 10-Q







|x | Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | ---------------------------------------------------------------------------------------

for the Quarterly Period Ended September 30, 2008,

or



| ̈ | 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 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):



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈ |  | Accelerated filer         |  | x
|                        |  |   | 
|Non-accelerated filer   |  |  ̈ |  | Smaller reporting company |  |  ̈

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     |  | Number of Shares Outstanding as of November 4,
2008
|(No par Value)   |  | 9,533,279                                          
|(Title of Class) |  | (Outstanding Shares)                               









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##### Table of Contents

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 |  | 24  
|                               |  |                                                                                      
|Item 3.                        |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 40  
|                               |  |                                                                                      
|Item 4.                        |  | Controls and Procedures                                                               |  | 41  
|                               | 
|PART II - OTHER INFORMATION    |  | 41                                                                                   
|                               |  |                                                                                      
|Item 1.                        |  | Legal Proceedings                                                                     |  | 41  
|                               |  |                                                                                      
|Item 1A.                       |  | Risk Factors                                                                          |  | 41  
|                               |  |                                                                                      
|Item 2.                        |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 42  
|                               |  |                                                                                      
|Item 3.                        |  | Defaults Upon Senior Securities                                                       |  | 43  
|                               |  |                                                                                      
|Item 4.                        |  | Submission of Matters to Vote of Security Holders                                     |  | 43  
|                               |  |                                                                                      
|Item 5.                        |  | Other Information                                                                     |  | 43  
|                               |  |                                                                                      
|Item 6.                        |  | Exhibits                                                                              |  | 43  



2



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##### Table of Contents

PART IFINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

EASTERN INSURANCE
HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share data)



|                                                                                                                                         |  |                   |         |   |                  |   |         |  
|---------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                         |  | September 30,2008 |         |   | December 31,2007 |  
|ASSETS                                                                                                                                   |  |                   |         |   |                  |   |         |  
|Investments:                                                                                                                             |  |                   |         |   |                  |   |         |  
|Fixed income securities, at estimated fair value (amortized cost, $180,714; $202,039)                                                    |  | $                 | 179,961 |   |                  | $ | 205,785 |  
|Convertible bonds, at estimated fair value (amortized cost, $14,292; $14,232)                                                            |  |                   | 13,182  |   |                  |   | 15,478  |  
|Equity securities, at estimated fair value (cost, $27,623; $19,578)                                                                      |  |                   | 22,473  |   |                  |   | 20,541  |  
|Other long-term investments, at estimated fair value (cost, $10,637; $10,386)                                                            |  |                   | 11,524  |   |                  |   | 11,317  |  
|                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Total investments                                                                                                                        |  |                   | 227,140 |   |                  |   | 253,121 |  
|Cash and cash equivalents                                                                                                                |  |                   | 49,625  |   |                  |   | 45,940  |  
|Accrued investment income                                                                                                                |  |                   | 2,114   |   |                  |   | 2,290   |  
|Premiums receivable (net of allowance, $567; $558)                                                                                       |  |                   | 36,813  |   |                  |   | 26,846  |  
|Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses                                                           |  |                   | 28,490  |   |                  |   | 26,303  |  
|Deferred acquisition costs                                                                                                               |  |                   | 6,679   |   |                  |   | 6,257   |  
|Deferred income taxes, net                                                                                                               |  |                   | 6,694   |   |                  |   | 1,229   |  
|Federal income taxes recoverable                                                                                                         |  |                   | 1,979   |   |                  |   | 846     |  
|Intangible assets                                                                                                                        |  |                   | 9,568   |   |                  |   | 6,372   |  
|Goodwill                                                                                                                                 |  |                   | 10,908  |   |                  |   | 7,992   |  
|Other assets                                                                                                                             |  |                   | 10,587  |   |                  |   | 8,322   |  
|                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Total assets                                                                                                                             |  | $                 | 390,597 |   |                  | $ | 385,518 |  
|                                                                                                                                         |  |                   |         |   |                  |   |         |  
|LIABILITIES                                                                                                                              |  |                   |         |   |                  |   |         |  
|Reserves for unpaid losses and loss adjustment expenses                                                                                  |  | $                 | 146,530 |   |                  | $ | 129,788 |  
|Unearned premium reserves                                                                                                                |  |                   | 52,356  |   |                  |   | 39,826  |  
|Advance premium                                                                                                                          |  |                   | 1,348   |   |                  |   | 1,380   |  
|Accounts payable and accrued expenses                                                                                                    |  |                   | 11,823  |   |                  |   | 8,422   |  
|Ceded reinsurance balances payable                                                                                                       |  |                   | 6,303   |   |                  |   | 6,762   |  
|Benefit plan liabilities                                                                                                                 |  |                   | 315     |   |                  |   | 334     |  
|Segregated portfolio cell dividend payable                                                                                               |  |                   | 13,357  |   |                  |   | 13,168  |  
|Loan payable                                                                                                                             |  |                   | 2,427   |   |                  |   |        |  
|Junior subordinated debentures                                                                                                           |  |                   |        |   |                  |   | 8,007   |  
|                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Total liabilities                                                                                                                        |  | $                 | 234,459 |   |                  | $ | 207,687 |  
|                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Commitments and contingencies (Note 11)                                                                                                  |  |                   |         |   |                  |   |         |  
|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 - 11,597,723; outstanding  9,551,569 and 10,580,858, respectively |  |                   |        |   |                  |   |        |  
|Unearned ESOP compensation                                                                                                               |  |                   | (5,791  | ) |                  |   | (6,354  | )
|Additional paid in capital                                                                                                               |  |                   | 111,431 |   |                  |   | 110,166 |  
|Treasury stock, at cost (2,051,154 and 1,016,865 shares, respectively)                                                                   |  |                   | (32,308 | ) |                  |   | (15,589 | )
|Retained earnings                                                                                                                        |  |                   | 85,287  |   |                  |   | 86,363  |  
|Accumulated other comprehensive (loss) income, net                                                                                       |  |                   | (2,481  | ) |                  |   | 3,245   |  
|                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Total shareholders equity                                                                                                               |  |                   | 156,138 |   |                  |   | 177,831 |  
|                                                                                                                                         |  |                   |         |   |                  |   |         |  
|Total liabilities and shareholders equity                                                                                               |  | $                 | 390,597 |   |                  | $ | 385,518 |  
|                                                                                                                                         |  |                   |         |   |                  |   |         |  

See accompanying notes to unaudited consolidated financial statements.



3



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EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

AND COMPREHENSIVE INCOME

For the Three and Nine Months Ended September 30, 2008 and 2007

(Unaudited, in thousands, except per share data)



|                                                                                                                          |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------- | ------ | -------------------------------------- | ---- | - | ------ |  | - | ------- | - |  | - | ------- | -
|                                                                                                                          |  | For the Three MonthsEnded September 30, |        | For the Nine MonthsEnded September 30, |     
|                                                                                                                          |  | 2008                                    |        |                                        | 2007 |   | 2008   |  |   | 2007    |  
|REVENUE                                                                                                                   |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|Net premiums earned                                                                                                       |  | $                                       | 33,118 |                                        |      | $ | 34,264 |  | $ | 99,363  |   |  | $ | 95,226  |  
|Net investment income                                                                                                     |  |                                         | 755    |                                        |      |   | 3,108  |  |   | 5,442   |   |  |   | 9,326   |  
|Net realized investment (losses) gains                                                                                    |  |                                         | (4,518 | )                                      |      |   | 590    |  |   | (4,213  | ) |  |   | 2,321   |  
|Other revenue                                                                                                             |  |                                         | 167    |                                        |      |   | 179    |  |   | 522     |   |  |   | 517     |  
|                                                                                                                          |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|Total revenue                                                                                                             |  |                                         | 29,522 |                                        |      |   | 38,141 |  |   | 101,114 |   |  |   | 107,390 |  
|                                                                                                                          |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|EXPENSES                                                                                                                  |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|Losses and loss adjustment expenses incurred                                                                              |  |                                         | 22,517 |                                        |      |   | 21,459 |  |   | 62,930  |   |  |   | 57,968  |  
|Acquisition and other underwriting expenses                                                                               |  |                                         | 4,588  |                                        |      |   | 4,097  |  |   | 14,224  |   |  |   | 11,266  |  
|Other expenses                                                                                                            |  |                                         | 6,584  |                                        |      |   | 6,452  |  |   | 19,113  |   |  |   | 17,977  |  
|Amortization of intangibles                                                                                               |  |                                         | 328    |                                        |      |   | 434    |  |   | 984     |   |  |   | 1,303   |  
|Policyholder dividend expense                                                                                             |  |                                         | 325    |                                        |      |   | 95     |  |   | 253     |   |  |   | 349     |  
|Segregated portfolio dividend expense                                                                                     |  |                                         | 29     |                                        |      |   | 780    |  |   | 2,602   |   |  |   | 2,172   |  
|                                                                                                                          |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|Total expenses                                                                                                            |  |                                         | 34,371 |                                        |      |   | 33,317 |  |   | 100,106 |   |  |   | 91,035  |  
|                                                                                                                          |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|(Loss) income before income taxes                                                                                         |  |                                         | (4,849 | )                                      |      |   | 4,824  |  |   | 1,008   |   |  |   | 16,355  |  
|Income tax (benefit) expense                                                                                              |  |                                         | (1,760 | )                                      |      |   | 1,263  |  |   | 20      |   |  |   | 5,329   |  
|                                                                                                                          |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|Net (loss) income                                                                                                         |  | $                                       | (3,089 | )                                      |      | $ | 3,561  |  | $ | 988     |   |  | $ | 11,026  |  
|                                                                                                                          |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|Other comprehensive (loss) income                                                                                         |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|Unrealized holding (losses) gains arising during period, net of tax of $(2,197), $866, $(3,667) and $568                  |  |                                         | (4,080 | )                                      |      |   | 1,608  |  |   | (6,811  | ) |  |   | 1,054   |  
|Amortization of unrecognized benefit plan amounts, net of tax of $2, $3, $6, and $8                                       |  |                                         | 4      |                                        |      |   | 5      |  |   | 12      |   |  |   | 15      |  
|Less: Reclassification adjustment for (losses) gains included in net income, net of tax of $(893), $121, $(591), and $585 |  |                                         | (1,658 | )                                      |      |   | 224    |  |   | (1,097  | ) |  |   | 1,086   |  
|                                                                                                                          |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|Other comprehensive (loss) income                                                                                         |  |                                         | (2,426 | )                                      |      |   | 1,379  |  |   | (5,726  | ) |  |   | (47     | )
|                                                                                                                          |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  
|Comprehensive (loss) income                                                                                               |  | $                                       | (5,515 | )                                      |      | $ | 4,940  |  | $ | (4,738  | ) |  | $ | 10,979  |  
|                                                                                                                          |  |                                         |        |                                        |      |   |        |  |   |         |   |  |   |         |  



|                                 |  |                                |        |                               |      |   |       |  |      |      |  |   |       
|-------------------------------- |  | ------------------------------ | ------ | ----------------------------- | ---- | - | ----- |  | ---- | ---- |  | - | ------
|Earnings per share (See Note 4): |  | Three Months EndedSeptember 30 |        | Nine Months EndedSeptember 30
|                                 |  | 2008                           |        |                               | 2007 |   | 2008  |  | 2007
|Net (loss) income                |  | $                              | (3,089 | )                             |      | $ | 3,561 |  | $    | 988  |  | $ | 11,026
|Basic earnings per share         |  | $                              | (0.35  | )                             |      | $ | 0.35  |  | $    | 0.11 |  | $ | 1.06  
|Diluted earnings per share       |  | $                              | (0.35  | )                             |      | $ | 0.34  |  | $    | 0.11 |  | $ | 1.02  

See accompanying notes to unaudited consolidated financial statements.



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EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the Three and Nine Months Ended September 30, 2008

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2008



|                                     |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                                      |   |  |       |        |   |  |   |        |   |  |   |         |  
|------------------------------------ |  | ---------------------- |  | ------------------ | - |  | ------------------ | - | ------------------------ | - | ------ | ------------------------ |  | ------------- | ------- |  | ---------------- | ---------------------------------------------------- | - |  | ----- | ------ | - |  | - | ------ | - |  | - | ------- | -
|                                     |  | Outstanding Shares     |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  | AccumulatedOtherComprehensiveIncome (Loss)Net of Tax |   |  |       |       
|                                     |  | Series APreferredStock |  | CommonCapitalStock |   |  | CommonCapitalStock |   | UnearnedESOPCompensation |   |        | AdditionalPaid-InCapital |  | TreasuryStock |         |  | RetainedEarnings |                                                      |   |  | Total |       
|Balance, July 1, 2008                |  |                       |  | 9,588,946          |   |  | $                  |  |                          | $ | (5,978 | )                        |  | $             | 111,026 |  | $                | (31,661                                              | ) |  | $     | 89,044 |   |  | $ | (55    | ) |  | $ | 162,376 |  
|ESOP shares released                 |  |                       |  |                   |   |  |                    |  |                          |   | 187    |                          |  |               | 86      |  |                  |                                                     |   |  |       |       |   |  |   |       |   |  |   | 273     |  
|Stock compensation expense           |  |                       |  | 5,000              |   |  |                    |  |                          |   |       |                          |  |               | 319     |  |                  |                                                     |   |  |       |       |   |  |   |       |   |  |   | 319     |  
|Repurchase of common stock           |  |                       |  | (42,377            | ) |  |                    |  |                          |   |       |                          |  |               |        |  |                  | (647                                                 | ) |  |       |       |   |  |   |       |   |  |   | (647    | )
|Shareholder dividend                 |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                                     |   |  |       | (668   | ) |  |   |       |   |  |   | (668    | )
|Net loss                             |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                                     |   |  |       | (3,089 | ) |  |   |       |   |  |   | (3,089  | )
|Other comprehensive loss, net of tax |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                                     |   |  |       |       |   |  |   | (2,426 | ) |  |   | (2,426  | )
|                                     |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                                      |   |  |       |        |   |  |   |        |   |  |   |         |  
|Balance, September 30, 2008          |  |                       |  | 9,551,569          |   |  | $                  |  |                          | $ | (5,791 | )                        |  | $             | 111,431 |  | $                | (32,308                                              | ) |  | $     | 85,287 |   |  | $ | (2,481 | ) |  | $ | 156,138 |  
|                                     |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                                      |   |  |       |        |   |  |   |        |   |  |   |         |  

Nine Months Ended September 30, 2008



|                                                |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                                      |   |  |       |        |   |  |   |        |   |  |   |         |  
|----------------------------------------------- |  | ---------------------- |  | ------------------ | - |  | ------------------ | - | ------------------------ | - | ------ | ------------------------ |  | ------------- | ------- |  | ---------------- | ---------------------------------------------------- | - |  | ----- | ------ | - |  | - | ------ | - |  | - | ------- | -
|                                                |  | Outstanding Shares     |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  | AccumulatedOtherComprehensiveIncome (Loss)Net of Tax |   |  |       |       
|                                                |  | Series APreferredStock |  | CommonCapitalStock |   |  | CommonCapitalStock |   | UnearnedESOPCompensation |   |        | AdditionalPaid-InCapital |  | TreasuryStock |         |  | RetainedEarnings |                                                      |   |  | Total |       
|Balance, January 1, 2008                        |  |                       |  | 10,580,858         |   |  | $                  |  |                          | $ | (6,354 | )                        |  | $             | 110,166 |  | $                | (15,589                                              | ) |  | $     | 86,363 |   |  | $ | 3,245  |   |  | $ | 177,831 |  
|ESOP shares released                            |  |                       |  |                   |   |  |                    |  |                          |   | 563    |                          |  |               | 284     |  |                  |                                                     |   |  |       |       |   |  |   |       |   |  |   | 847     |  
|Stock compensation expense                      |  |                       |  | 5,000              |   |  |                    |  |                          |   |       |                          |  |               | 949     |  |                  |                                                     |   |  |       |       |   |  |   |       |   |  |   | 949     |  
|Excess tax benefit from vested restricted stock |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               | 32      |  |                  |                                                     |   |  |       |       |   |  |   |       |   |  |   | 32      |  
|Repurchase of common stock                      |  |                       |  | (1,034,289         | ) |  |                    |  |                          |   |       |                          |  |               |        |  |                  | (16,719                                              | ) |  |       |       |   |  |   |       |   |  |   | (16,719 | )
|Shareholder dividend                            |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                                     |   |  |       | (2,064 | ) |  |   |       |   |  |   | (2,064  | )
|Net income                                      |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                                     |   |  |       | 988    |   |  |   |       |   |  |   | 988     |  
|Other comprehensive loss, net of tax            |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                                     |   |  |       |       |   |  |   | (5,726 | ) |  |   | (5,726  | )
|                                                |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                                      |   |  |       |        |   |  |   |        |   |  |   |         |  
|Balance, September 30, 2008                     |  |                       |  | 9,551,569          |   |  | $                  |  |                          | $ | (5,791 | )                        |  | $             | 111,431 |  | $                | (32,308                                              | ) |  | $     | 85,287 |   |  | $ | (2,481 | ) |  | $ | 156,138 |  
|                                                |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                                      |   |  |       |        |   |  |   |        |   |  |   |         |  

See accompanying notes to unaudited consolidated financial statements



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EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

For the Three and Nine Months Ended September 30, 2007

(Unaudited, in thousands, except share data)

Three Months Ended September 30, 2007



|                                     |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                               |   |  |       |        |   |  |   |       |  |   |         |  
|------------------------------------ |  | ---------------------- |  | ------------------ | - |  | ------------------ | - | ------------------------ | - | ------ | ------------------------ |  | ------------- | ------- |  | ---------------- | --------------------------------------------- | - |  | ----- | ------ | - |  | - | ----- |  | - | ------- | -
|                                     |  | Outstanding Shares     |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  | AccumulatedOtherComprehensiveIncome Net ofTax |   |  |      
|                                     |  | Series APreferredStock |  | CommonCapitalStock |   |  | CommonCapitalStock |   | UnearnedESOPCompensation |   |        | AdditionalPaid-InCapital |  | TreasuryStock |         |  | RetainedEarnings |                                               |   |  | Total |       
|Balance, July 1, 2007                |  |                       |  | 11,320,340         |   |  | $                  |  |                          | $ | (6,728 | )                        |  | $             | 109,303 |  | $                | (4,156                                        | ) |  | $     | 76,773 |   |  | $ | 1,029 |  | $ | 176,221 |  
|ESOP shares released                 |  |                       |  |                   |   |  |                    |  |                          |   | 189    |                          |  |               | 107     |  |                  |                                              |   |  |       |       |   |  |   |      |  |   | 296     |  
|Issuance of stock awards             |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               | 317     |  |                  |                                              |   |  |       |       |   |  |   |      |  |   | 317     |  
|Repurchase of common stock           |  |                       |  | (591,918           | ) |  |                    |  |                          |   |       |                          |  |               |        |  |                  | (9,070                                        | ) |  |       |       |   |  |   |      |  |   | (9,070  | )
|Shareholder dividend                 |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                              |   |  |       | (580   | ) |  |   |      |  |   | (580    | )
|Net income                           |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                              |   |  |       | 3,561  |   |  |   |      |  |   | 3,561   |  
|Other comprehensive loss, net of tax |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                              |   |  |       |       |   |  |   | 1,379 |  |   | 1,379   |  
|                                     |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                               |   |  |       |        |   |  |   |       |  |   |         |  
|Balance, September 30, 2007          |  |                       |  | 10,728,422         |   |  | $                  |  |                          | $ | (6,539 | )                        |  | $             | 109,727 |  | $                | (13,226                                       | ) |  | $     | 79,754 |   |  | $ | 2,408 |  | $ | 172,124 |  
|                                     |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                               |   |  |       |        |   |  |   |       |  |   |         |  

Nine Months Ended September 30, 2007



|                                     |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                               |   |  |       |        |   |  |   |       |   |  |   |         |  
|------------------------------------ |  | ---------------------- |  | ------------------ | - |  | ------------------ | - | ------------------------ | - | ------ | ------------------------ |  | ------------- | ------- |  | ---------------- | --------------------------------------------- | - |  | ----- | ------ | - |  | - | ----- | - |  | - | ------- | -
|                                     |  | Outstanding Shares     |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  | AccumulatedOtherComprehensiveIncome Net ofTax |   |  |       |       
|                                     |  | Series APreferredStock |  | CommonCapitalStock |   |  | CommonCapitalStock |   | UnearnedESOPCompensation |   |        | AdditionalPaid-InCapital |  | TreasuryStock |         |  | RetainedEarnings |                                               |   |  | Total |       
|Balance, January 1, 2007             |  |                       |  | 11,351,048         |   |  | $                  |  |                          | $ | (7,101 | )                        |  | $             | 108,502 |  | $                |                                              |   |  | $     | 69,483 |   |  | $ | 2,860 |   |  | $ | 173,744 |  
|Adoption of SFAS 155                 |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                              |   |  |       | 405    |   |  |   | (405  | ) |  |   |        |  
|ESOP shares released                 |  |                       |  |                   |   |  |                    |  |                          |   | 562    |                          |  |               | 298     |  |                  |                                              |   |  |       |       |   |  |   |      |   |  |   | 860     |  
|Issuance of stock awards             |  |                       |  | 246,675            |   |  |                    |  |                          |   |       |                          |  |               | 927     |  |                  |                                              |   |  |       |       |   |  |   |      |   |  |   | 927     |  
|Repurchase of common stock           |  |                       |  | (869,301           | ) |  |                    |  |                          |   |       |                          |  |               |        |  |                  | (13,226                                       | ) |  |       |       |   |  |   |      |   |  |   | (13,226 | )
|Shareholder dividend                 |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                              |   |  |       | (1,160 | ) |  |   |      |   |  |   | (1,160  | )
|Net income                           |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                              |   |  |       | 11,026 |   |  |   |      |   |  |   | 11,026  |  
|Other comprehensive loss, net of tax |  |                       |  |                   |   |  |                    |  |                          |   |       |                          |  |               |        |  |                  |                                              |   |  |       |       |   |  |   | (47   | ) |  |   | (47     | )
|                                     |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                               |   |  |       |        |   |  |   |       |   |  |   |         |  
|Balance, September 30, 2007          |  |                       |  | 10,728,422         |   |  | $                  |  |                          | $ | (6,539 | )                        |  | $             | 109,727 |  | $                | (13,226                                       | ) |  | $     | 79,754 |   |  | $ | 2,408 |   |  | $ | 172,124 |  
|                                     |  |                        |  |                    |   |  |                    |   |                          |   |        |                          |  |               |         |  |                  |                                               |   |  |       |        |   |  |   |       |   |  |   |         |  

See accompanying notes to unaudited consolidated financial statements



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EASTERN INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Nine Months Ended September 30, 2008 and 2007

(Unaudited, in thousands)



|                                                                                  |  |      |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | 2008 |         |   | 2007 |  
|Cash flows from operating activities:                                             |  |      |         |   |      |   |         |  
|Net income                                                                        |  | $    | 988     |   |      | $ | 11,026  |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |      |         |   |      |   |         |  
|Depreciation and amortization                                                     |  |      | 390     |   |      |   | 280     |  
|Net amortization of bond premium/discount                                         |  |      | 326     |   |      |   | 736     |  
|Net realized investment losses (gains)                                            |  |      | 4,212   |   |      |   | (2,321  | )
|Equity in loss (income) of limited partnerships                                   |  |      | 1,965   |   |      |   | (413    | )
|Deferred tax benefit                                                              |  |      | (3,437  | ) |      |   | (1,323  | )
|Stock compensation                                                                |  |      | 1,828   |   |      |   | 1,786   |  
|Intangible asset amortization                                                     |  |      | 984     |   |      |   | 1,303   |  
|Changes in assets and liabilities:                                                |  |      |         |   |      |   |         |  
|Accrued investment income                                                         |  |      | 340     |   |      |   | (63     | )
|Premiums receivable                                                               |  |      | (6,797  | ) |      |   | (11,727 | )
|Reinsurance recoverable on paid and unpaid losses and loss adjustment expenses    |  |      | (125    | ) |      |   | 130     |  
|Deferred acquisition costs                                                        |  |      | (421    | ) |      |   | (2,956  | )
|Other assets                                                                      |  |      | (259    | ) |      |   | (1,805  | )
|Reserves for unpaid losses and loss adjustment expenses                           |  |      | 7,153   |   |      |   | 7,443   |  
|Unearned and advance premium                                                      |  |      | 9,356   |   |      |   | 14,999  |  
|Ceded reinsurance balances payable                                                |  |      | (459    | ) |      |   | 1,403   |  
|Accounts payable and accrued expenses                                             |  |      | 2,489   |   |      |   | 1,615   |  
|Segregated portfolio cell dividend payable                                        |  |      | 189     |   |      |   | 2,731   |  
|Benefit plan liabilities                                                          |  |      | (36     | ) |      |   | (57     | )
|Federal income taxes recoverable/payable                                          |  |      | (1,483  | ) |      |   | (3,050  | )
|                                                                                  |  |      |         |   |      |   |         |  
|Net cash provided by operating activities                                         |  |      | 17,203  |   |      |   | 19,737  |  
|                                                                                  |  |      |         |   |      |   |         |  
|Cash flows from investing activities:                                             |  |      |         |   |      |   |         |  
|Purchase of fixed income securities                                               |  |      | (34,171 | ) |      |   | (96,167 | )
|Purchase of equity securities                                                     |  |      | (11,070 | ) |      |   | (11,299 | )
|Purchase of other long-term investments                                           |  |      | (3,000  | ) |      |   | (500    | )
|Proceeds from sale of fixed income securities                                     |  |      | 39,907  |   |      |   | 30,990  |  
|Proceeds from maturities/calls of fixed income securities                         |  |      | 25,701  |   |      |   | 49,417  |  
|Proceeds from equity securities                                                   |  |      | 4,263   |   |      |   | 10,907  |  
|Proceeds from other long-term investments                                         |  |      | 820     |   |      |   | 1,876   |  
|Change in unsettled investment purchases and sales                                |  |      |        |   |      |   | 230     |  
|Acquisition of Employers Security Holding Company, net of cash received           |  |      | (8,025  | ) |      |   |        |  
|Principal payments received on mortgage loans                                     |  |      | 7       |   |      |   | 10      |  
|Purchase of equipment, net                                                        |  |      | (1,192  | ) |      |   | (222    | )
|                                                                                  |  |      |         |   |      |   |         |  
|Net cash provided by (used in) investing activities                               |  |      | 13,377  |   |      |   | (14,758 | )
|                                                                                  |  |      |         |   |      |   |         |  
|Cash flows from financing activities:                                             |  |      |         |   |      |   |         |  
|Repurchase of common stock                                                        |  |      | (16,719 | ) |      |   | (13,226 | )
|Repayment of junior subordinated debentures                                       |  |      | (8,007  | ) |      |   |        |  
|Shareholder dividend                                                              |  |      | (2,064  | ) |      |   | (1,160  | )
|Excess tax benefit from vested restricted stock                                   |  |      | 32      |   |      |   |        |  
|                                                                                  |  |      |         |   |      |   |         |  
|Net cash used in financing activities                                             |  |      | (26,758 | ) |      |   | (14,386 | )
|                                                                                  |  |      |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                              |  |      | 3,685   |   |      |   | (9,407  | )
|Cash and cash equivalents, beginning of period                                    |  |      | 45,940  |   |      |   | 50,703  |  
|                                                                                  |  |      |         |   |      |   |         |  
|Cash and cash equivalents, end of period                                          |  | $    | 49,625  |   |      | $ | 41,296  |  
|                                                                                  |  |      |         |   |      |   |         |  
|Supplemental disclosure of cash flow information:                                 |  |      |         |   |      |   |         |  
|Cash paid for income taxes                                                        |  | $    | 4,875   |   |      | $ | 9,300   |  
|Cash paid for interest                                                            |  | $    | 468     |   |      | $ | 455     |  

See accompanying notes to unaudited consolidated financial statements.



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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 group benefits insurance
products and reinsurance products through its direct and indirect wholly-owned subsidiaries, Eastern Holding Company, Ltd. (EHC), Eastern Services Corporation (Eastern Services), Global Alliance Holdings, Ltd. (Global
Alliance), Global Alliance Statutory Trust I (Trust I), Eastern Alliance Insurance Company (Eastern Alliance), Allied Eastern Indemnity Company (Allied Eastern), Eastern Advantage Assurance Company
(Eastern Advantage), Eastern Re Ltd., S.P.C. (Eastern Re), Eastern Life and Health Insurance Company (ELH), and Employers Alliance, Inc. (Employers Alliance), collectively referred to as the Company.

On September 29, 2008, EIHI acquired all of the outstanding stock of Employers Security Holding Company (ESHC) and its wholly-owned
subsidiaries, Employers Security Insurance Company and Affinity Management Services (Note 3). Employers Security Insurance Company (ESIC) is an Indiana-domiciled, mono-line workers compensation insurance company licensed to
write business in Indiana, Illinois and Missouri.

The Company operates in five segments: workers compensation insurance, segregated portfolio cell
reinsurance, group benefits insurance, specialty reinsurance, and corporate/other. See Note 10 for a description of each segment.

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, 2007 included in the Companys Annual Report on Form 10-K, which was filed with the U.S. Securities and Exchange Commission on March 14, 2008.

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. Net investment income and segregated portfolio dividend expense for the three and nine months ended September 30, 2007 were reduced
by $774 to reflect the elimination of an inter-company transaction between the corporate/other and segregated portfolio cell reinsurance segments.

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.

Cash and Cash
Equivalents

The Company considers all investments with original maturity dates of three months or less to be cash equivalents for purposes of the
consolidated statements of cash flows. The carrying amount of cash equivalents approximates their fair value.

Investments

Fixed Income Securities

The Companys investments in
fixed income securities are classified as available-for-sale and are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss), net of tax. Fixed income securities include publicly
traded and private placement bonds. The estimated fair value of publicly traded bonds is determined based on quoted market



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prices or, in the absence of quoted market prices, dealer quotes or matrix pricing, all of which are based on observable market-based inputs when available.
Adverse credit market conditions have caused some markets to become relatively illiquid, thus reducing the availability of certain data used by the independent pricing services and dealers. The estimated fair value of private placement bonds is
determined using valuation models, taking into consideration the securities coupon rate, maturity date, and other pertinent features.

Premiums or
discounts are amortized using the effective interest method. Realized gains or losses are based on amortized cost and are computed using the specific identification method. The Company monitors its fixed income securities for unrealized losses that
appear to be other-than-temporary. The Company performs a detailed review of these securities to determine the underlying cause of the unrealized loss and whether the security is impaired. When a security is determined to be other-than-temporarily
impaired, the Company reduces the book value of the security to the current estimated fair value at the balance sheet date and records a realized loss in the consolidated statements of operations and comprehensive income (loss). Any subsequent
increase in the securitys estimated fair value would be reported as an unrealized gain.

Convertible Bond Securities

The Company adopted Statement of Financial Accounting Standards No. 155 (SFAS 155), Accounting for Certain Hybrid Financial Instruments, an
amendment of FASB Statements No. 133 and 140, on January 1, 2007. Under SFAS 155, the change in fair value of the Companys convertible bond securities, which meet the definition of a hybrid financial instrument under SFAS 155,
is reported as a realized gain or loss in the consolidated statements of operations and comprehensive income (loss). The adoption of SFAS 155 was reported as a cumulative effect adjustment to shareholders equity, as of January 1, 2007,
and resulted in a reclassification between retained earnings and accumulated other comprehensive income of $405. The carrying value of the Companys convertible bond securities did not change as a result of adopting SFAS 155.

Equity Securities

The Companys investments in equity
securities, which consist primarily of index and exchange-traded mutual funds, are classified as available-for-sale and are carried at estimated fair value, with unrealized gains and losses reported in accumulated other comprehensive income (loss),
net of tax. The estimated fair value of equity securities is determined based on quoted market prices or independent broker quotes.

Realized gains or
losses are based on cost and are computed using the specific identification method. The Company monitors its equity securities for unrealized losses that appear to be other-than-temporary. The Company performs a detailed review of these securities
to determine the underlying cause of the unrealized loss and whether the security is impaired. When a security is determined to be other-than-temporarily impaired, the Company reduces the cost of the security to the current estimated fair value at
the balance sheet date and records a realized loss in the consolidated statements of operations and comprehensive income (loss). Any subsequent increase in the securitys estimated fair value would be reported as an unrealized gain.

Other Long-Term Investments

Other long-term investments
consist primarily of investments in limited partnerships. Investments in limited partnerships are reported in the consolidated financial statements using the equity method. Changes in the value of the Companys proportionate share of its
limited partnership investments are included in net investment income in the consolidated statements of operations and comprehensive income (loss). The Company reports changes in the value of its limited partnership investments on a month lag
(quarter lag for one investment) as a result of the timing of statements being received from the limited partnership. The Company monitors its limited partnership investments for declines in value that may be other-than-temporary. When a limited
partnership interest is determined to be other-than-temporarily impaired, the Company reduces its interest in the limited partnership to its current estimated fair value at the balance sheet date. The impairment is recorded as a reduction to net
investment income in the consolidated statements of operations and comprehensive income (loss).

Premiums

Premiums generated by the Companys workers compensation insurance segment, including estimates of additional premiums resulting from audits of insureds
records, are generally recognized as written upon inception of the policy. Premiums written are primarily earned on a daily pro rata basis over the terms of the policies to which they relate. Accordingly, unearned premiums represent the portion of
premiums written which is applicable to the unexpired portion of the policies in force. 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 in net premiums earned is an estimate for earned but unbilled final audit premiums.
The Company estimates earned but unbilled premiums by tracking, by policy, how much additional premium is billed in final audit invoices as a percentage of payroll exposure to estimate the probable additional amount that it has earned, but not yet
billed, as of the balance sheet date. Earned but unbilled premiums accrued as of September 30, 2008 and December 31, 2007 and included in net premiums earned, totaled $1,200 and $1,500, respectively.



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Premiums generated by the Companys group benefits insurance segment are generally billed on a monthly basis with
premiums being earned in the month in which the coverage is provided. Unearned premiums represent those premiums that have been received but for which the coverage period has not expired. Advance premiums represent those premiums that have been
received in advance of the coverage period. Premiums receivable represent only those premiums that have been billed to policyholders for coverage periods through the balance sheet date.

Reinsurance premiums assumed by the Companys specialty reinsurance segment are estimated based on information provided by the ceding company. The information used in establishing these estimates is reviewed and
subsequent adjustments are recorded in the period in which they are reported. These premiums are earned over the terms of the related reinsurance contracts.

Other Revenue

Other revenue primarily consists of service revenue related to claims adjusting and risk management services. Claims
adjusting and risk management service revenue is earned over the term of the related contracts in proportion to the actual services rendered.

Losses
and Loss Adjustment Expenses

A liability is established for the estimated unpaid losses and LAE of the Companys workers compensation
insurance segment under the terms of, and with respect to, its policies and agreements and includes amounts determined on the basis of claims adjusters evaluations and an amount based on past experience for losses incurred but not reported
(IBNR).

The Company discounts its reserves for unpaid losses and LAE for workers compensation claims on a non-tabular basis, using a
discount rate of 3%, based upon regulatory guidelines. The reserves for unpaid losses and LAE have been reduced for the effects of discounting by approximately $4,044 and $3,474 as of September 30, 2008 and December 31, 2007, respectively.

A liability is established for the estimated unpaid losses and LAE of the Companys group benefits insurance segment as follows:



| |  |  | The liability for reported but unpaid long-term disability claims is calculated using the 1987 Commissioners Group Disability Table. The long-term disability
reserves are discounted based on the expected rate of return of ELHs fixed income portfolio in the year that the claim was incurred. The discount rate for claims incurred in 2008 and 2007 is 3.85% and 5.25%, respectively. The liability for
IBNR claims is estimated on a policy-by-policy basis, taking into consideration average monthly premium, policy elimination periods, and an expected loss ratio.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The liability for reported but unpaid and IBNR dental and short-term disability claims is estimated using statistical claim development models, taking into
consideration historical claim severity and frequency patterns and changes in benefit structures that may impact the amount at which claims are ultimately settled. For the most recent incurral months, which usually consist of the last three months,
the liability is estimated by applying an expected loss ratio to net premiums earned, less claim payments through the balance sheet date.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The liability for reported but unpaid term life claims represent those claims reported to the Company as of the balance sheet date for which payment has not yet
been made. Term life IBNR claims are estimated based on historical patterns of claims incurred as a percent of in-force premium as of the balance sheet date.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The liability for life premium waiver reserves represents the present value of future life insurance benefits under those term life insurance policies for which
premium has been waived due to the insureds disability. The liability for life premium waiver reserves is calculated using the 2005 Group Term Life Waiver Reserve Table for claims reported on or after October 1, 2007 and the 1970
Intercompany Group Life Disability Table for claims reported prior to October 1, 2007.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

A liability is established for the estimated
unpaid losses and LAE of the Companys specialty reinsurance segment based on information provided by the ceding company. Premium and reported claim data provided by the ceding company is utilized by management to estimate the ultimate losses
and LAE, including an amount for IBNR claims. As a result of a lag in receiving quarterly premium and reported claim data from the ceding company, the estimated unpaid losses and LAE are based on claim data one quarter in arrears.

The methods used to estimate the reserves for unpaid losses and LAE are reviewed periodically and any adjustments resulting therefrom are reflected in current
operations.

Management believes that its reserves for unpaid losses and LAE are adequate as of September 30, 2008. However, estimating the ultimate
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 the Companys ultimate losses, net of reinsurance, prove to
differ substantially from the amounts recorded as of September 30, 2008, the related adjustments could have a material adverse effect on the Companys financial condition, results of operations or liquidity.



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##### Table of Contents

Reinsurance

In the
ordinary course of business, the Company assumes and cedes reinsurance with other insurance companies. These arrangements provide greater diversification of business and minimize the net loss potential arising from large claims. Ceded reinsurance
contracts do not relieve the Company of its obligation to its insureds. Premiums and claims under the Companys reinsurance contracts are accounted for on a basis consistent with those used in accounting for the underlying policies reinsured
and the terms of the reinsurance contracts. The Company has certain reinsurance contracts that provide for return premium based on the actual loss experience of the written and reinsured business. The Company estimates the amounts to be recorded for
return premium based on the terms set forth in the reinsurance agreements and the expected loss experience.

The reinsurance recoverable for unpaid losses
and LAE includes the balances due from reinsurance companies for unpaid losses and LAE that are expected to be recovered from reinsurers, based on contracts in force.

Policy Acquisition Costs

Policy acquisition costs consist primarily of commissions and premium taxes that vary with
and are primarily related to the production of premium. Acquisition costs are deferred and amortized over the period in which the related premiums are earned. Deferred acquisition costs are limited to the estimated amounts recoverable after
providing for losses and LAE that are expected to be incurred based upon historical and current experience. Anticipated investment income is considered in determining recoverability.

The Companys group benefits insurance policies are cancelable and are not guaranteed renewable. In addition, the group benefits insurance policies provide coverage on a month-to-month basis with most
policies coverage effective on the first of each month. As a result, most of the Companys group benefits insurance premiums are earned as of the balance sheet date. Based on the nature of the Companys group benefits insurance
policies, costs related to the acquisition of new and renewal business are expensed as incurred.

Amortization of policy acquisition costs, before the
impact of purchase accounting, totaled $1,380 and $(136) for the three months ended September 30, 2008 and 2007, respectively, and $5,093 and $3,410 for the nine months ended September 30, 2008 and 2007, respectively.

Income Taxes

Deferred tax assets and liabilities are determined
based on differences between the financial reporting and tax basis of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the difference is reversed. A valuation allowance is recorded
against gross deferred tax assets if it is more likely than not that all or some portion of the benefits related to the deferred tax assets will not be realized.

Eastern Alliance, Allied Eastern, Eastern Advantage and ELH are generally not subject to state income taxes; rather, they are subject to state premium tax in the jurisdictions in which they write business. Employers Alliance and Eastern
Services are subject to Pennsylvania state income tax.

Eastern Re is an exempt entity under the Companies Law of the Cayman Islands; however, Eastern
Res earnings and profits are subject to federal income tax subsequent to June 16, 2006.

The Company includes income tax-related interest and
penalties as a component of income tax expense. The Company did not incur any income tax-related interest or penalties during 2008 or 2007.

The
Companys federal income tax returns for tax years subsequent to December 31, 2003 are subject to examination by the Internal Revenue Service.

Policyholder Dividends

The Company issues certain workers compensation insurance policies with dividend payment features. These
policyholders share in the operating results of their respective policies in the form of dividends. Dividends to policyholders are accrued during the period in which the related premiums are earned and are determined based on the terms of the
individual policies. As of September 30, 2008 and December 31, 2007, the Company accrued dividends payable of $1,052 and $989, respectively, which are included in accounts payable and accrued expenses on the consolidated balance sheets.

Assessments

The Company is subject to state guaranty
fund assessments in the Commonwealth of Pennsylvania, which provide for the payment of covered claims or to meet other insurance obligations from insurance company insolvencies. The Companys assessments consist primarily of charges from the
Workers Compensation Security Fund of Pennsylvania (Security Fund). The Security Fund serves as a guaranty fund to provide claim payments for those workers entitled to workers compensation benefits when the insurance company
originally providing the benefits was placed into liquidation by a court. Security Fund assessments are established on an actuarial basis



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to provide an amount sufficient to pay the outstanding and anticipated claims in a timely manner, to meet the costs of the Pennsylvania Insurance Department
(the Insurance Department) to administer the fund and to maintain a minimum balance in the fund of $500 million. If the Security Fund determines that the balance in the Security Fund is less than $500 million based on the actuarial
study, then an assessment equal to one percent of direct premiums written is made to all companies licensed to write workers compensation in Pennsylvania. The Company recognizes a liability and the related expense for the assessments when
premiums covered under the Security Fund are written; when an assessment from the Security Fund has been imposed or it is probable that an assessment will be imposed; and the amount of the assessment is reasonably estimable. As of September 30,
2008 and December 31, 2007, the Company accrued $881 and $0 related to the Security Fund assessment.

Goodwill and Intangible Assets

Goodwill represents the excess of cost over the fair value of net assets of businesses acquired. Goodwill and other intangible assets acquired in a
purchase business combination and determined to have an indefinite useful life are not amortized, but are instead tested for impairment at least annually. Intangible assets with estimable useful lives are amortized over their respective estimated
useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived Assets.

Treasury Stock

The Company records the repurchase of shares of its common stock using the cost method. Under the
cost method, treasury stock is recorded based on the actual cost of the shares repurchased.

Stock-Based Compensation

The Company adopted the Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan on December 18, 2006. Under the terms of the Plan, stock awards may be made in the
form of incentive stock options, non-qualified stock options or restricted stock. The Company accounts for stock-based compensation in accordance with SFAS 123R, Share-Based Payment. In accordance with SFAS 123R, the Company records
compensation expense based on the fair value of the stock award on the grant date using the straight-line attribution method.

Employee Stock Ownership
Plan

The Company recognizes compensation expense related to its employee stock ownership plan (ESOP) equal to the product of the number of
shares earned, or committed to be released, during the period, and the average price of the Companys common stock during the period. The estimated fair value of unearned ESOP shares is calculated based on the average price of the
Companys common stock for the period. For purposes of calculating earnings per share, the Company includes the weighted average of ESOP shares committed to be released for the period.

Suspense shares, allocated shares, shares committed to be released, average price per share and stock compensation expense as of and for the three and nine months ended
September 30, 2008 and 2007 were as follows (unaudited, in thousands, except share data):



|                                |  |                                                   |         |                                                  |   |         |  |      |         |  |   |        
|------------------------------- |  | ------------------------------------------------- | ------- | ------------------------------------------------ | - | ------- |  | ---- | ------- |  | - | -------
|                                |  | As of and for the Three MonthsEnded September 30, |         | As of and for the Nine MonthsEnded September 30,
|                                |  | 2008                                              |         | 2007                                             |   | 2008    |  | 2007
|Suspense shares                 |  |                                                   | 635,375 |                                                  |   | 710,125 |  |      | 635,375 |  |   | 710,125
|Allocated shares                |  |                                                   | 112,125 |                                                  |   | 37,375  |  |      | 112,125 |  |   | 37,375 
|Shares committed to be released |  |                                                   | 18,841  |                                                  |   | 18,841  |  |      | 56,318  |  |   | 56,216 
|Average price per share         |  | $                                                 | 14.49   |                                                  | $ | 15.68   |  | $    | 15.04   |  | $ | 15.30  
|Stock compensation expense      |  | $                                                 | 273     |                                                  | $ | 296     |  | $    | 847     |  | $ | 860    

As of September 30, 2008 and December 31, 2007, the estimated fair value of unearned ESOP shares was
$8,709 and $10,477, respectively.

Recent Accounting Pronouncements

SFAS 159

In February 2007, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards (SFAS) No. 159 (SFAS 159), The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115. SFAS 159 permits entities
to elect to measure certain financial instruments at fair value with changes in fair value being reported in earnings. SFAS 159 can be applied on an instrument-by-instrument basis and is effective for all eligible financial instruments as of the
beginning of an entitys first fiscal year that begins after November 15, 2007. Retrospective application to prior years financial statements is not permitted. For eligible financial instruments existing at the effective date, and
for which an



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entity elects the fair value option, the first remeasurement to fair value must be recorded as a cumulative effect adjustment to beginning retained earnings.
The Company adopted SFAS 159 effective January 1, 2008; however, no election was made to measure the Companys financial instruments at fair value. The adoption of SFAS 159 had no effect on the Companys consolidated financial
condition and results of operations.

SFAS 141R

In December 2007, the FASB issued Statement No. 141R, Business Combinations (SFAS 141R), which revises the accounting for business combination transactions previously accounted for under SFAS No. 141,
Business Combinations (SFAS 141), and broadens the scope of transactions which should be accounted for under this standard. SFAS 141R retains the fundamental requirements of SFAS 141 in that the acquisition method of
accounting is still used, and an acquirer must be identified in all business combinations. SFAS 141R applies prospectively to business combinations for which the acquisition date is on or after the beginning of the first annual reporting period
beginning on or after December 15, 2008. An entity is prohibited from applying SFAS 141R prior to that date. The Company is currently in the process of evaluating the impact of SFAS 141R.

SFAS 160

In December 2007, the FASB issued Statement
No. 160, Noncontrolling Interests in Consolidated Financial Statements  an amendment of ARB No. 51 (SFAS 160), which establishes accounting and reporting standards for the non-controlling interests in a
subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires that the ownership interests and the net income of the non-controlling interest be equally identified from that of the parent on the face of the financial statements. SFAS 160
also provides consistent accounting principles for changes in a parent controlling ownership interest in a subsidiary, and that any retained non-controlling financial interests in a deconsolidated subsidiary be measured initially at fair value. SFAS
160 applies to fiscal years beginning on or after December 15, 2008, and is applied prospectively, except for presentation and disclosure requirements, which are applied retrospectively for all periods presented. The Company is currently in the
process of evaluating the impact of SFAS 160.

SFAS 161

In March 2008, the FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161). SFAS 161 amends and expands the disclosure requirements of SFAS 133, Accounting
for Derivative Instruments and Hedging Activities. SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments
and disclosures about credit-risk-related contingent features in derivative agreements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2008. The adoption of SFAS 161 will not affect the
Companys consolidated financial condition or results of operations, but may require additional disclosures if the Company enters into derivative and hedging activities.

SFAS 163

In May 2008, the FASB issued Statement No. 163, Accounting for Financial Guarantee
Insurance Contracts, an interpretation of FASB Statement No. 60 (SFAS 163). SFAS 163 clarifies how FASB Statement No. 60 applies to the recognition and measurement of premium revenue and claim liabilities under financial
guarantee insurance contracts and requires expanded disclosures about financial guarantee insurance contracts. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods
within those fiscal years, except for certain disclosures about an entitys risk management activities. The Company does not currently write financial guarantee insurance contracts; therefore, the adoption of SFAS 163 will not affect the
Companys consolidated financial condition or results of operations.

3. Acquisition of ESHC

On September 29, 2008, EIHI acquired all of the outstanding stock of ESHC in a transaction valued at $14,820, including the assumption of $2,650 in debt. The
acquisition of ESHC resulted in the recognition of certain intangible assets totaling $4,180 (Note 4) and goodwill totaling $2,917. ESHC reported total assets and total liabilities of $25,856 and $19,203, respectively, on the date of the
transaction. ESHCs shareholders equity of $6,653 on the date of the transaction was reduced by $10 as a result of purchase accounting adjustments to reflect the fair value of certain acquired assets and liabilities. The most
significant purchase accounting adjustments related to the elimination of deferred acquisition costs, an increase to reserves for losses and LAE, and a decrease to unearned premiums. Direct costs related to the acquisition totaling $107 were
capitalized and included in goodwill.



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4. Intangible Assets

The Companys intangible assets consisted of the following as of September 30, 2008 and December 31, 2007(unaudited, in thousands):



|                                                   |  |                    |        |                         |   |              |  |                         |       |  |   |      
|-------------------------------------------------- |  | ------------------ | ------ | ----------------------- | - | ------------ |  | ----------------------- | ----- |  | - | -----
|                                                   |  | September 30, 2008 |        | December 31, 2007      
|Intangible Assets with Finite Life                 |  | GrossBalance       |        | AccumulatedAmortization |   | GrossBalance |  | AccumulatedAmortization
|Agency relationships (15 year amortization period) |  | $                  | 3,564  |                         | $ | 625          |  | $                       | 1,750 |  | $ | 447  
|Renewal rights (15 year amortization period)       |  |                    | 8,238  |                         |   | 3,184        |  |                         | 6,397 |  |   | 2,378
|                                                   |  |                    |        |                         |   |              |  |                         |       |  |   |      
|                                                   |  | $                  | 11,802 |                         | $ | 3,809        |  | $                       | 8,147 |  | $ | 2,825
|                                                   |  |                    |        |                         |   |              |  |                         |       |  |   |      
|                                                   |  |                    |        |                        
|Intangible Assets with Indefinite Life             |  |                    |        |                         |   |              |  |                        
|State insurance licenses                           |  |                    | 1,575  |                         |   |             |  |                         | 1,050 |  |   |     
|                                                   |  |                    |        |                         |   |              |  |                         |       |  |   |      
|Total intangible assets                            |  | $                  | 13,377 |                         | $ | 3,809        |  | $                       | 9,197 |  | $ | 2,825
|                                                   |  |                    |        |                         |   |              |  |                         |       |  |   |      

The acquisition of ESHC resulted in the recognition of certain intangible assets, including renewal rights of
$1,841, agency relationships of $1,814, and state insurance licenses of $525. The renewal rights and agency relationships will be amortized over their estimated useful lives of 15 years. The state insurance licenses are considered to have
an infinite life and will not be amortized.

Amortization expense totaled $328 and $434 for the three months ended September 30, 2008 and 2007,
respectively, and $984 and $1,303 for the nine months ended September 30, 2008 and 2007, respectively.

5. Earnings Per Share

Basic earnings per share are computed by dividing net income for the period by the weighted average number of shares outstanding for the respective period. Diluted
earnings per share are computed by dividing net income for the period by the weighted average number of shares outstanding for the period, including dilutive potential common shares outstanding for the period. For the three months ended
September 30, 2007, stock warrants of 306,099 and restricted stock awards of 30,187 have been included as dilutive potential common shares outstanding. For the nine months ended September 30, 2008 and 2007, stock warrants of 306,099 and
restricted stock awards of 47,944 and 23,528, respectively, have been included as dilutive potential common shares outstanding. For the three months ended September 30, 2008 and 2007, there were 1,203,038 and 846,752 stock options and
restricted stock 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 nine months ended September 30, 2008 and 2007, there were 848,995 and
853,411 stock options and restricted stock 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, 2008 and 2007 were as follows (unaudited, in thousands, except share and per share data):



|                           |  |                                 |           |                                |      |   |            |  |      |           |  |   |           
|-------------------------- |  | ------------------------------- | --------- | ------------------------------ | ---- | - | ---------- |  | ---- | --------- |  | - | ----------
|                           |  | Three Months EndedSeptember 30, |           | Nine Months EndedSeptember 30,
|                           |  | 2008                            |           |                                | 2007 |   | 2008       |  | 2007
|Consolidated net income    |  | $                               | (3,089    | )                              |      | $ | 3,561      |  | $    | 988       |  | $ | 11,026    
|Basic shares outstanding   |  |                                 | 8,776,743 |                                |      |   | 10,105,204 |  |      | 9,017,853 |  |   | 10,435,468
|Diluted shares outstanding |  |                                 | 8,776,743 |                                |      |   | 10,441,490 |  |      | 9,371,896 |  |   | 10,765,095
|Basic earnings per share   |  | $                               | (0.35     | )                              |      | $ | 0.35       |  | $    | 0.11      |  | $ | 1.06      
|Diluted earnings per share |  | $                               | (0.35     | )                              |      | $ | 0.34       |  | $    | 0.11      |  | $ | 1.02      
|Cash dividends per share   |  | $                               | 0.07      |                                |      | $ | 0.05       |  | $    | 0.21      |  | $ | 0.10      

6. Share Repurchase

During 2007, the Companys Board of Directors authorized the repurchase of up to 2,046,500 shares of the Companys issued and outstanding shares of common stock. The share repurchases are held as treasury stock and are available
for issuance in connection with the Companys 2006 Stock Incentive Plan. On March 24, 2008, the Company received approval from the Insurance Department to repurchase up to $10,000 of the Companys issued and outstanding common stock,
which is in addition to the 2,046,500 shares authorized in 2007. The Company repurchased 42,377 and 591,918 shares, at a cost of $647 and $9,070, for the three months ended September 30, 2008 and 2007, respectively. The Company repurchased
1,034,289 and 869,301 shares, at a cost of $16,719 and $13,226 for the nine months ended September 30, 2008 and 2007, respectively. The Company purchased an additional 18,290 shares, at a cost of $179, through November 4, 2008.



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7. Fair Value Measurements

The Company adopted Statement No. 157, Fair Value Measurements (SFAS 157) effective January 1, 2008. SFAS 157 clarifies the definition of fair value for purposes of financial reporting, specifies the
methods to be used to measure fair value, and requires expanded disclosures related to fair value and financial instruments measured at fair value. The adoption of SFAS 157 had no impact on the Companys consolidated financial condition or
results of operation.

On February 12, 2008, SFAS 157 was amended by FASB Staff Position No. FAS 157-2 (FSP FAS 157-2). FSP FAS 157-2
delayed the effective date of SFAS 157 for non-financial assets and non-financial liabilities which are measured at fair value on a nonrecurring basis. Non-financial assets and non-financial liabilities which are measured at fair value on a
recurring basis (i.e. at least annually) are not subject to this deferral. This deferral is effective until fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. At that time, provisions of SFAS 157 will
apply to non-financial assets and non-financial liabilities which are measured at fair value on a non-recurring basis.

As of September 30, 2008, the
Company has no non-financial assets or non-financial liabilities that are measured at fair value on a recurring basis. The Company is currently evaluating the impact of measuring non-financial assets and non-financial liabilities on a non-recurring
basis.

SFAS 157 requires assets and liabilities measured at fair value on a recurring basis to be 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, 2008:

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 fail 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 Company considers its limited partnership investments as Level 3 assets.

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, 2008, excluding the segregated
portfolio cell segment (unaudited, in thousands):



|                                             |  |         |         |                                                |   |         |  |         |         |  |   |  
|-------------------------------------------- |  | ------- | ------- | ---------------------------------------------- | - | ------- |  | ------- | ------- |  | - | -
|                                             |  |         |         | Fair Value Measurements at ReportingDate Using
|                                             |  | 9/30/08 |         | Level 1                                        |   | Level 2 |  | Level 3
|Fixed income securities - available for sale |  | $       | 155,543 |                                                | $ | 10,635  |  | $       | 144,908 |  | $ | 
|Convertible bonds                            |  |         | 13,182  |                                                |   |        |  |         | 13,182  |  |   | 
|Equity securities - available for sale       |  |         | 18,385  |                                                |   | 18,385  |  |         |        |  |   | 
|                                             |  |         |         |                                                |   |         |  |         |         |  |   |  
|Total                                        |  | $       | 187,110 |                                                | $ | 29,020  |  | $       | 158,090 |  | $ | 
|                                             |  |         |         |                                                |   |         |  |         |         |  |   |  



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The Companys investments in fixed income securities, convertible bonds, and equity securities are valued through
the use of a nationally recognized pricing service. The Company believes the scope of work performed when using data from outside parties is sufficient to validate the prices such that it does not rely upon these independent pricing services as
experts, nor would it seek indemnification from them in the event the prices provided were deemed inappropriate. Where independent pricing services provide fair values, the Company has obtained an understanding of the methods, models and inputs used
in pricing, 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 methodologies used by outside parties as well as
other techniques and assumptions to calculate fair value and 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.

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 municipal bond based limited partnership, an open-ended investment fund and a real
estate limited partnership. The Company records its investment in the limited partnerships using the equity method. 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, 2008 and December 31, 2007, the estimated fair values of the Companys limited partnership investments, by investment strategy, were
as follows (unaudited, in thousands):



|                                    |  |         |        |          |   |       
|----------------------------------- |  | ------- | ------ | -------- | - | ------
|                                    |  | 9/30/08 |        | 12/31/07
|Multi-strategy fund of funds        |  | $       | 5,617  |          | $ | 5,809 
|Natural resources                   |  |         | 2,855  |          |   | 3,312 
|Structured finance opportunity fund |  |         | 1,991  |          |   |      
|Municipal bond arbitrage            |  |         | 466    |          |   | 1,484 
|Open-ended investment fund          |  |         | 520    |          |   | 622   
|Real estate                         |  |         | 67     |          |   | 73    
|                                    |  |         |        |          |   |       
|Total                               |  | $       | 11,516 |          | $ | 11,300
|                                    |  |         |        |          |   |       

The activity in the Companys limited partnership investments for the three and nine months ended
September 30, 2008 and 2007 was as follows (unaudited, in thousands):



|                              |  |                                  |        |                                 |      |   |        |  |   |        |   |  |   |        |  
|----------------------------- |  | -------------------------------- | ------ | ------------------------------- | ---- | - | ------ |  | - | ------ | - |  | - | ------ | -
|                              |  | Three Months Ended September 30, |        | Nine Months Ended September 30, |     
|                              |  | 2008                             |        |                                 | 2007 |   | 2008   |  |   | 2007   |  
|Balance, beginning of period  |  | $                                | 11,999 |                                 |      | $ | 10,394 |  | $ | 11,300 |   |  | $ | 11,572 |  
|Contributions                 |  |                                  | 2,000  |                                 |      |   | 500    |  |   | 3,000  |   |  |   | 500    |  
|Withdrawals                   |  |                                  | (820   | )                               |      |   |       |  |   | (820   | ) |  |   | (1,876 | )
|Unrealized change in interest |  |                                  | (1,663 | )                               |      |   | 60     |  |   | (1,964 | ) |  |   | 758    |  
|                              |  |                                  |        |                                 |      |   |        |  |   |        |   |  |   |        |  
|Balance, end of period        |  | $                                | 11,516 |                                 |      | $ | 10,954 |  | $ | 11,516 |   |  | $ | 10,954 |  
|                              |  |                                  |        |                                 |      |   |        |  |   |        |   |  |   |        |  

The change in interest in the Companys limited partnership investments is included in net investment income
in the consolidated statements of operations and comprehensive income (loss). As a result of the current credit market conditions, the municipal bond arbitrage fund experienced a permanent decline in value during the third quarter of 2008 and will
be dissolved. The estimated fair value of the Companys interest in the limited partnership as of September 30, 2008 reflects managements best estimate of the proceeds the Company is expected to receive upon dissolution of the fund.
As a result of these events, the Company recorded an impairment write-down of $1,397 as of and for the three and nine months ended September 30, 2008.



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8. Investments

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 available-for-sale by category and length of time an individual
security has been in a continuous unrealized position as of September 30, 2008 and December 31, 2007 are as follows (unaudited, in thousands):



|                                                   |  |                     |        |                       |                   |        |                    |       |                       |       |  |                    |      |                       |  |   |        |  |   |        |  
|-------------------------------------------------- |  | ------------------- | ------ | --------------------- | ----------------- | ------ | ------------------ | ----- | --------------------- | ----- |  | ------------------ | ---- | --------------------- |  | - | ------ |  | - | ------ | -
|                                                   |  | Less Than 12 Months |        |                       | 12 Months or More |        |                    | Total |                      
|September 30, 2008                                 |  | EstimatedFairValue  |        | GrossUnrealizedLosses |                   |        | EstimatedFairValue |       | GrossUnrealizedLosses |       |  | EstimatedFairValue |      | GrossUnrealizedLosses | 
|U.S. Treasuries and government agencies            |  | $                   | 8,195  |                       | $                 | (77    | )                  |       | $                     | 501   |  | $                  | (7   | )                     |  | $ | 8,696  |  | $ | (84    | )
|States, municipalities, and political subdivisions |  |                     | 20,476 |                       |                   | (545   | )                  |       |                       | 235   |  |                    | (26  | )                     |  |   | 20,711 |  |   | (571   | )
|Corporate securities                               |  |                     | 9,585  |                       |                   | (1,021 | )                  |       |                       | 1,908 |  |                    | (136 | )                     |  |   | 11,493 |  |   | (1,157 | )
|Mortgage-backed securities                         |  |                     | 383    |                       |                   | (1     | )                  |       |                       |      |  |                    |     |                       |  |   | 383    |  |   | (1     | )
|Other structured securities                        |  |                     | 17,633 |                       |                   | (726   | )                  |       |                       | 4,400 |  |                    | (603 | )                     |  |   | 22,033 |  |   | (1,329 | )
|                                                   |  |                     |        |                       |                   |        |                    |       |                       |       |  |                    |      |                       |  |   |        |  |   |        |  
|Total fixed income securities                      |  |                     | 56,272 |                       |                   | (2,370 | )                  |       |                       | 7,044 |  |                    | (772 | )                     |  |   | 63,316 |  |   | (3,142 | )
|Equity securities                                  |  |                     | 17,276 |                       |                   | (4,428 | )                  |       |                       | 18    |  |                    | (5   | )                     |  |   | 17,294 |  |   | (4,443 | )
|                                                   |  |                     |        |                       |                   |        |                    |       |                       |       |  |                    |      |                       |  |   |        |  |   |        |  
|Total fixed income and equity securities           |  | $                   | 73,548 |                       | $                 | (6,798 | )                  |       | $                     | 7,062 |  | $                  | (777 | )                     |  | $ | 80,610 |  | $ | (7,575 | )
|                                                   |  |                     |        |                       |                   |        |                    |       |                       |       |  |                    |      |                       |  |   |        |  |   |        |  
|                                                   |  |                     |       
|                                                   |  | Less Than 12 Months |        |                       | 12 Months or More |        |                    | Total |                      
|December 31, 2007                                  |  | EstimatedFairValue  |        | GrossUnrealizedLosses |                   |        | EstimatedFairValue |       | GrossUnrealizedLosses |       |  | EstimatedFairValue |      | GrossUnrealizedLosses | 
|U.S. Treasuries and government agencies            |  | $                   |       |                       | $                 |       |                    |       | $                     | 1,045 |  | $                  | (7   | )                     |  | $ | 1,045  |  | $ | (7     | )
|Corporate securities                               |  |                     | 4,658  |                       |                   | (85    | )                  |       |                       | 2,958 |  |                    | (31  | )                     |  |   | 7,616  |  |   | (116   | )
|Mortgage-backed securities                         |  |                     | 437    |                       |                   | (2     | )                  |       |                       |      |  |                    |     |                       |  |   | 437    |  |   | (2     | )
|Other structured securities                        |  |                     | 14,409 |                       |                   | (354   | )                  |       |                       | 1,758 |  |                    | (20  | )                     |  |   | 16,167 |  |   | (374   | )
|                                                   |  |                     |        |                       |                   |        |                    |       |                       |       |  |                    |      |                       |  |   |        |  |   |        |  
|Total fixed income securities                      |  |                     | 19,504 |                       |                   | (441   | )                  |       |                       | 5,761 |  |                    | (58  | )                     |  |   | 25,265 |  |   | (499   | )
|Equity securities                                  |  |                     | 5,972  |                       |                   | (132   | )                  |       |                       |      |  |                    |     |                       |  |   | 5,972  |  |   | (132   | )
|                                                   |  |                     |        |                       |                   |        |                    |       |                       |       |  |                    |      |                       |  |   |        |  |   |        |  
|Total fixed income and equity securities           |  | $                   | 25,476 |                       | $                 | (573   | )                  |       | $                     | 5,761 |  | $                  | (58  | )                     |  | $ | 31,237 |  | $ | (631   | )
|                                                   |  |                     |        |                       |                   |        |                    |       |                       |       |  |                    |      |                       |  |   |        |  |   |        |  

As of September 30, 2008, the Company held 148 fixed income securities with gross unrealized losses of
$3,142. Management has evaluated the gross unrealized losses related to the fixed income securities and determined that the decline in the market value primarily reflects the current credit and liquidity issues in the fixed income markets and not
the underlying credit quality of the issuer of the securities. Management has concluded that the carrying value of its fixed income securities in a gross unrealized loss position will be realized and that the Company has the ability and intent to
hold them until that time.

As of September 30, 2008, the Company held 41 equity securities with gross unrealized losses of $4,443. The equity
securities consist primarily of mutual fund instruments. Management has determined that the decline in market value is due to the broad decline in the equity securities markets.

As a result of the current adverse conditions in the credit markets, as well as the bankruptcy of Lehman Brothers Holdings, Inc. (Lehman Brothers), the Company recorded other-than-temporary investment
impairments totaling $2,768 related to 8 fixed income securities as of and for the three and nine months ended September 30, 2008. The Company held 4 Lehman Brothers fixed income securities, which comprises $1,126 of the total impairment
write-downs. The other impairment write-downs related primarily to collateralized mortgage obligations that had experienced a significant and prolonged decline in value as a result of the illiquidity in the credit markets. These securities continue
to remain current on principal and interest payments; however, due to the significant and prolonged decline in value and the continued uncertainty surrounding the credit markets, management has determined that an impairment write-down is
appropriate.



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##### Table of Contents

9. 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, excluding term life premium waiver reserves, for the
three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):



|                                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|----------------------------------------------------------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                  |  | Three Months EndedSeptember 30, |         |   | Nine Months EndedSeptember 30, |  
|                                                                  |  | 2008                            |         |   | 2007                           |   |         | 2008 |  |   | 2007    |  
|Balance, beginning of period                                      |  | $                               | 129,599 |   |                                | $ | 125,650 |      |  | $ | 125,249 |   |  | $ | 121,397 |  
|Reinsurance recoverables on unpaid losses and LAE                 |  |                                 | 24,260  |   |                                |   | 24,663  |      |  |   | 23,429  |   |  |   | 24,236  |  
|                                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net balance, beginning of period                                  |  |                                 | 105,339 |   |                                |   | 100,987 |      |  |   | 101,820 |   |  |   | 97,161  |  
|                                                                  |  |                                 |         |  
|Net reserves acquired as a result of ESHC acquisition             |  |                                 | 9,591   |   |                                |   |        |      |  |   |        |   |  |   |        |  
|                                                                  |  |                                 |         |  
|Incurred related to:                                              |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Current year                                                      |  |                                 | 20,405  |   |                                |   | 20,791  |      |  |   | 62,868  |   |  |   | 60,834  |  
|Prior year                                                        |  |                                 | 2,362   |   |                                |   | 862     |      |  |   | 867     |   |  |   | (2,167  | )
|                                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total incurred before purchase accounting adjustments             |  |                                 | 22,767  |   |                                |   | 21,653  |      |  |   | 63,735  |   |  |   | 58,667  |  
|Purchase accounting adjustments                                   |  |                                 | (81     | ) |                                |   | (155    | )    |  |   | (391    | ) |  |   | (692    | )
|                                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total incurred                                                    |  |                                 | 22,686  |   |                                |   | 21,498  |      |  |   | 63,344  |   |  |   | 57,975  |  
|                                                                  |  |                                 |         |  
|Paid related to:                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Current year                                                      |  |                                 | 9,911   |   |                                |   | 10,180  |      |  |   | 24,851  |   |  |   | 24,519  |  
|Prior year                                                        |  |                                 | 9,229   |   |                                |   | 7,540   |      |  |   | 31,428  |   |  |   | 25,852  |  
|                                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total paid                                                        |  |                                 | 19,140  |   |                                |   | 17,720  |      |  |   | 56,279  |   |  |   | 50,371  |  
|                                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net balance, end of period                                        |  |                                 | 118,476 |   |                                |   | 104,765 |      |  |   | 118,476 |   |  |   | 104,765 |  
|Reinsurance recoverables on unpaid losses and LAE                 |  |                                 | 24,032  |   |                                |   | 24,261  |      |  |   | 24,032  |   |  |   | 24,261  |  
|                                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Balance, end of period                                            |  | $                               | 142,508 |   |                                | $ | 129,026 |      |  | $ | 142,508 |   |  | $ | 129,026 |  
|                                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total reserves for unpaid for losses and loss adjustment expenses |  | $                               | 146,530 |   |                                | $ | 133,910 |      |  | $ | 146,530 |   |  | $ | 133,910 |  
|Less: Term life premium waiver reserves                           |  |                                 | 3,980   |   |                                |   | 4,807   |      |  |   | 3,980   |   |  |   | 4,807   |  
|Less: Other                                                       |  |                                 | 42      |   |                                |   | 77      |      |  |   | 42      |   |  |   | 77      |  
|                                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Balance, end of period                                            |  | $                               | 142,508 |   |                                | $ | 129,026 |      |  | $ | 142,508 |   |  | $ | 129,026 |  
|                                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  

Incurred losses by segment were as follows for the three and nine months ended September 30, 2008 and 2007
(unaudited, in thousands):

Three Months Ended September 30, 2008



|                                                      |  |                                      |       |   |                                            |   |       |                               |  |   |                             |   |       |   |       |  |   |        |  
|----------------------------------------------------- |  | ------------------------------------ | ----- | - | ------------------------------------------ | - | ----- | ----------------------------- |  | - | --------------------------- | - | ----- | - | ----- |  | - | ------ | -
|                                                      |  | WorkersCompensationInsuranceSegment |       |   | SegregatedPortfolio CellReinsuranceSegment |   |       | GroupBenefitsInsuranceSegment |  |   | SpecialtyReinsuranceSegment |   | Total |  
|Incurred related to:                                  |  |                                      |       |   |                                            |   |       |                               |  |   |                             |   |       |   |       |  |   |        |  
|Current year, gross of discount                       |  | $                                    | 9,642 |   |                                            | $ | 3,803 |                               |  | $ | 6,159                       |   |       | $ | 1,189 |  | $ | 20,793 |  
|Current period discount                               |  |                                      | (285  | ) |                                            |   | (103  | )                             |  |   |                            |   |       |   |      |  |   | (388   | )
|Prior year, gross of discount                         |  |                                      |      |   |                                            |   | (77   | )                             |  |   | (54                         | ) |       |   | 2,271 |  |   | 2,140  |  
|Accretion of prior period discount                    |  |                                      | 148   |   |                                            |   | 74    |                               |  |   |                            |   |       |   |      |  |   | 222    |  
|                                                      |  |                                      |       |   |                                            |   |       |                               |  |   |                             |   |       |   |       |  |   |        |  
|Total incurred before purchase accounting adjustments |  |                                      | 9,505 |   |                                            |   | 3,697 |                               |  |   | 6,105                       |   |       |   | 3,460 |  |   | 22,767 |  
|Purchase accounting adjustments                       |  |                                      | (71   | ) |                                            |   | (14   | )                             |  |   |                            |   |       |   | 4     |  |   | (81    | )
|                                                      |  |                                      |       |   |                                            |   |       |                               |  |   |                             |   |       |   |       |  |   |        |  
|Total incurred                                        |  | $                                    | 9,434 |   |                                            | $ | 3,683 |                               |  | $ | 6,105                       |   |       | $ | 3,464 |  | $ | 22,686 |  
|                                                      |  |                                      |       |   |                                            |   |       |                               |  |   |                             |   |       |   |       |  |   |        |  



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##### Table of Contents

Three Months Ended September 30, 2007



|                                                      |  |                                      |        |   |                                            |   |        |                               |  |                             |       |       |   |       |  |   |        |  
|----------------------------------------------------- |  | ------------------------------------ | ------ | - | ------------------------------------------ | - | ------ | ----------------------------- |  | --------------------------- | ----- | ----- | - | ----- |  | - | ------ | -
|                                                      |  | WorkersCompensationInsuranceSegment |        |   | SegregatedPortfolio CellReinsuranceSegment |   |        | GroupBenefitsInsuranceSegment |  | SpecialtyReinsuranceSegment |       | Total |  
|Incurred related to:                                  |  |                                      |        |   |                                            |   |        |                               |  |                             |       |       |   |       |  |   |        |  
|Current year, gross of discount                       |  | $                                    | 8,641  |   |                                            | $ | 4,535  |                               |  | $                           | 6,000 |       | $ | 1,725 |  | $ | 20,901 |  
|Current period discount                               |  |                                      | (60    | ) |                                            |   | (50    | )                             |  |                             |      |       |   |      |  |   | (110   | )
|Prior year, gross of discount                         |  |                                      | (2,252 | ) |                                            |   | (1,133 | )                             |  |                             | 206   |       |   | 4,056 |  |   | 877    |  
|Accretion of prior period discount                    |  |                                      | (23    | ) |                                            |   | 8      |                               |  |                             |      |       |   |      |  |   | (15    | )
|                                                      |  |                                      |        |   |                                            |   |        |                               |  |                             |       |       |   |       |  |   |        |  
|Total incurred before purchase accounting adjustments |  |                                      | 6,306  |   |                                            |   | 3,360  |                               |  |                             | 6,206 |       |   | 5,781 |  |   | 21,653 |  
|Purchase accounting adjustments                       |  |                                      | (137   | ) |                                            |   | (26    | )                             |  |                             |      |       |   | 8     |  |   | (155   | )
|                                                      |  |                                      |        |   |                                            |   |        |                               |  |                             |       |       |   |       |  |   |        |  
|Total incurred                                        |  | $                                    | 6,169  |   |                                            | $ | 3,334  |                               |  | $                           | 6,206 |       | $ | 5,789 |  | $ | 21,498 |  
|                                                      |  |                                      |        |   |                                            |   |        |                               |  |                             |       |       |   |       |  |   |        |  

Nine Months Ended September 30, 2008



|                                                      |  |                                      |        |   |                                            |   |        |                               |  |   |                             |   |       |   |        |  |   |        |  
|----------------------------------------------------- |  | ------------------------------------ | ------ | - | ------------------------------------------ | - | ------ | ----------------------------- |  | - | --------------------------- | - | ----- | - | ------ |  | - | ------ | -
|                                                      |  | WorkersCompensationInsuranceSegment |        |   | SegregatedPortfolio CellReinsuranceSegment |   |        | GroupBenefitsInsuranceSegment |  |   | SpecialtyReinsuranceSegment |   | Total |  
|Incurred related to:                                  |  |                                      |        |   |                                            |   |        |                               |  |   |                             |   |       |   |        |  |   |        |  
|Current year, gross of discount                       |  | $                                    | 27,651 |   |                                            | $ | 11,842 |                               |  | $ | 19,769                      |   |       | $ | 5,042  |  | $ | 64,304 |  
|Current period discount                               |  |                                      | (981   | ) |                                            |   | (455   | )                             |  |   |                            |   |       |   |       |  |   | (1,436 | )
|Prior year, gross of discount                         |  |                                      | (2,500 | ) |                                            |   | (2,698 | )                             |  |   | (670                        | ) |       |   | 5,394  |  |   | (474   | )
|Accretion of prior period discount                    |  |                                      | 907    |   |                                            |   | 434    |                               |  |   |                            |   |       |   |       |  |   | 1,341  |  
|                                                      |  |                                      |        |   |                                            |   |        |                               |  |   |                             |   |       |   |        |  |   |        |  
|Total incurred before purchase accounting adjustments |  |                                      | 25,077 |   |                                            |   | 9,123  |                               |  |   | 19,099                      |   |       |   | 10,436 |  |   | 63,735 |  
|Purchase accounting adjustments                       |  |                                      | (345   | ) |                                            |   | (66    | )                             |  |   |                            |   |       |   | 20     |  |   | (391   | )
|                                                      |  |                                      |        |   |                                            |   |        |                               |  |   |                             |   |       |   |        |  |   |        |  
|Total incurred                                        |  | $                                    | 24,732 |   |                                            | $ | 9,057  |                               |  | $ | 19,099                      |   |       | $ | 10,456 |  | $ | 63,344 |  
|                                                      |  |                                      |        |   |                                            |   |        |                               |  |   |                             |   |       |   |        |  |   |        |  

Nine Months Ended September 30, 2007



|                                                      |  |                                      |        |   |                                            |   |        |                               |  |   |                             |   |       |   |        |  |   |        |  
|----------------------------------------------------- |  | ------------------------------------ | ------ | - | ------------------------------------------ | - | ------ | ----------------------------- |  | - | --------------------------- | - | ----- | - | ------ |  | - | ------ | -
|                                                      |  | WorkersCompensationInsuranceSegment |        |   | SegregatedPortfolio CellReinsuranceSegment |   |        | GroupBenefitsInsuranceSegment |  |   | SpecialtyReinsuranceSegment |   | Total |  
|Incurred related to:                                  |  |                                      |        |   |                                            |   |        |                               |  |   |                             |   |       |   |        |  |   |        |  
|Current year, gross of discount                       |  | $                                    | 25,449 |   |                                            | $ | 12,204 |                               |  | $ | 18,785                      |   |       | $ | 5,844  |  | $ | 62,282 |  
|Current period discount                               |  |                                      | (979   | ) |                                            |   | (469   | )                             |  |   |                            |   |       |   |       |  |   | (1,448 | )
|Prior year, gross of discount                         |  |                                      | (4,500 | ) |                                            |   | (2,158 | )                             |  |   | (1,091                      | ) |       |   | 4,418  |  |   | (3,331 | )
|Accretion of prior period discount                    |  |                                      | 787    |   |                                            |   | 377    |                               |  |   |                            |   |       |   |       |  |   | 1,164  |  
|                                                      |  |                                      |        |   |                                            |   |        |                               |  |   |                             |   |       |   |        |  |   |        |  
|Total incurred before purchase accounting adjustments |  |                                      | 20,757 |   |                                            |   | 9,954  |                               |  |   | 17,694                      |   |       |   | 10,262 |  |   | 58,667 |  
|Purchase accounting adjustments                       |  |                                      | (621   | ) |                                            |   | (106   | )                             |  |   |                            |   |       |   | 35     |  |   | (692   | )
|                                                      |  |                                      |        |   |                                            |   |        |                               |  |   |                             |   |       |   |        |  |   |        |  
|Total incurred                                        |  | $                                    | 20,136 |   |                                            | $ | 9,848  |                               |  | $ | 17,694                      |   |       | $ | 10,297 |  | $ | 57,975 |  
|                                                      |  |                                      |        |   |                                            |   |        |                               |  |   |                             |   |       |   |        |  |   |        |  

The Companys results of operations include (unfavorable) favorable development on prior year reserves of
$(2,140) and $474 for the three and nine months ended September 30, 2008, respectively, compared to (unfavorable) favorable development of $(877) and $3,331 for the same periods in 2007, respectively. The unfavorable development for the three
months ended September 30, 2008 and 2007 primarily reflects an increase in reported claims from the ceding company related to prior accident years in the specialty reinsurance segment.



19



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##### Table of Contents

10. Segment Information

The Companys current operations are organized into the five following business segments.

Workers Compensation Insurance

The Company offers workers compensation insurance coverage to employers, primarily in Pennsylvania, Indiana, Maryland, Delaware and North
Carolina. The Company offers a complete line of workers compensation products, including guaranteed cost and loss sensitive products.

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, specialty reinsurance, and corporate/other segments totaling approximately $910 and
$864 for the three months ended September 30, 2008 and 2007, respectively, and $3,437 for the nine months ended September 30, 2008 and 2007.

Group Benefits Insurance

The Companys group benefits insurance products include dental, short and long-term disability, and term life
insurance. The group benefits insurance products are marketed to employers, primarily in the Mid-Atlantic, Southeast, and Midwest regions of the United States. Net premiums earned, by product, for the three and nine months ended September 30,
2008 and 2007 were as follows (unaudited in thousands):



|                      |  |                                  |       |                                 |   |       |  |      |        |  |   |       
|--------------------- |  | -------------------------------- | ----- | ------------------------------- | - | ----- |  | ---- | ------ |  | - | ------
|                      |  | Three months ended September 30, |       | Nine months ended September 30,
|                      |  | 2008                             |       | 2007                            |   | 2008  |  | 2007
|Dental                |  | $                                | 5,669 |                                 | $ | 5,564 |  | $    | 17,002 |  | $ | 16,097
|Short-term disability |  |                                  | 1,625 |                                 |   | 1,657 |  |      | 4,932  |  |   | 4,962 
|Long-term disability  |  |                                  | 385   |                                 |   | 413   |  |      | 1,205  |  |   | 1,263 
|Term life             |  |                                  | 1,452 |                                 |   | 1,430 |  |      | 4,366  |  |   | 4,256 
|                      |  |                                  |       |                                 |   |       |  |      |        |  |   |       
|Total                 |  | $                                | 9,131 |                                 | $ | 9,064 |  | $    | 27,505 |  | $ | 26,578
|                      |  |                                  |       |                                 |   |       |  |      |        |  |   |       

Specialty Reinsurance

Prior to July 1, 2008, the Company assumed business through participation in reinsurance treaties with an unaffiliated insurance company related to an underground storage tank insurance program, referred to as EnviroGuard,
and a non-hazardous waste transportation product, referred to as EIA liability (EIA). The EnviroGuard program provides coverage to underground tank owners for third party off-site bodily injury and property damage claims as
well as clean-up coverage and first party on-site claims. The EIA program provides commercial automobile liability coverage for non-hazardous waste haulers. Effective July 1, 2008, the reinsurance treaties that comprise the specialty
reinsurance segment were terminated on a run-off basis. Net premiums earned, by program, for the three and nine months ended September 30, 2008 and 2007 were as follows (unaudited in thousands):



|                    |  |                                  |       |                                 |   |       |  |      |       |  |   |        |  
|------------------- |  | -------------------------------- | ----- | ------------------------------- | - | ----- |  | ---- | ----- |  | - | ------ | -
|                    |  | Three months ended September 30, |       | Nine months ended September 30, |  
|                    |  | 2008                             |       | 2007                            |   | 2008  |  | 2007 |      
|EnviroGuard         |  | $                                | 1,723 |                                 | $ | 3,582 |  | $    | 6,588 |  | $ | 8,772  |  
|EIA                 |  |                                  | 391   |                                 |   | 148   |  |      | 2,156 |  |   | 2,456  |  
|Other               |  |                                  |      |                                 |   | 175   |  |      | 6     |  |   | 383    |  
|Purchase accounting |  |                                  |      |                                 |   |      |  |      |      |  |   | (849   | )
|                    |  |                                  |       |                                 |   |       |  |      |       |  |   |        |  
|Total               |  | $                                | 2,114 |                                 | $ | 3,905 |  | $    | 8,750 |  | $ | 10,762 |  
|                    |  |                                  |       |                                 |   |       |  |      |       |  |   |        |  



20



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##### Table of Contents

Corporate/Other

The
corporate/other segment includes the holding company and third party administration activities of the Company, as well as certain eliminations necessary to reconcile the segment information to the consolidated statements of operations and
comprehensive income (loss). 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 following table represents the segment results for the three months ended September 30, 2008 (unaudited, in thousands):



|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|------------------------------------------- |  | ----------------------------- | ------- | - | ----------------------------------- | - | ------ | ---------------------- |  | - | -------------------- | - |  | --------------- | ------ | - | ----- | - | ------- | - |  | - | ------- | -
|                                            |  | WorkersCompensationInsurance |         |   | SegregatedPortfolio CellReinsurance |   |        | GroupBenefitsInsurance |  |   | SpecialtyReinsurance |   |  | Corporate/Other |        |   | Total |  
|Revenue:                                    |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Net premiums earned                         |  | $                             | 15,822  |   |                                     | $ | 6,051  |                        |  | $ | 9,131                |   |  | $               | 2,114  |   |       | $ |        |   |  | $ | 33,118  |  
|Net investment income                       |  |                               | (299    | ) |                                     |   | 291    |                        |  |   | 535                  |   |  |                 | 195    |   |       |   | 33      |   |  |   | 755     |  
|Net realized investment (losses) gains      |  |                               | (731    | ) |                                     |   | (706   | )                      |  |   | (2,883               | ) |  |                 | (263   | ) |       |   | 65      |   |  |   | (4,518  | )
|Other revenue                               |  |                               |        |   |                                     |   |       |                        |  |   |                     |   |  |                 | 361    |   |       |   | (194    | ) |  |   | 167     |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Total revenue                               |  |                               | 14,792  |   |                                     |   | 5,636  |                        |  |   | 6,783                |   |  |                 | 2,407  |   |       |   | (96     | ) |  |   | 29,522  |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Expenses:                                   |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Losses and LAE incurred                     |  |                               | 9,435   |   |                                     |   | 3,686  |                        |  |   | 5,932                |   |  |                 | 3,464  |   |       |   |        |   |  |   | 22,517  |  
|Acquisition and other underwriting expenses |  |                               | 1,322   |   |                                     |   | 1,872  |                        |  |   | 1,383                |   |  |                 | 635    |   |       |   | (624    | ) |  |   | 4,588   |  
|Other expenses                              |  |                               | 2,952   |   |                                     |   | 183    |                        |  |   | 1,420                |   |  |                 | 297    |   |       |   | 1,732   |   |  |   | 6,584   |  
|Amortization of intangibles                 |  |                               |        |   |                                     |   |       |                        |  |   |                     |   |  |                 |       |   |       |   | 328     |   |  |   | 328     |  
|Policyholder dividend expense               |  |                               | 325     |   |                                     |   |       |                        |  |   |                     |   |  |                 |       |   |       |   |        |   |  |   | 325     |  
|Segregated portfolio dividend expense       |  |                               |        |   |                                     |   | (105   | )                      |  |   |                     |   |  |                 |       |   |       |   | 134     |   |  |   | 29      |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Total expenses                              |  |                               | 14,034  |   |                                     |   | 5,636  |                        |  |   | 8,735                |   |  |                 | 4,396  |   |       |   | 1,570   |   |  |   | 34,371  |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Income (loss) before income taxes           |  |                               | 758     |   |                                     |   |       |                        |  |   | (1,952               | ) |  |                 | (1,989 | ) |       |   | (1,666  | ) |  |   | (4,849  | )
|Income tax expense (benefit)                |  |                               | 231     |   |                                     |   |       |                        |  |   | (814                 | ) |  |                 | (696   | ) |       |   | (481    | ) |  |   | (1,760  | )
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Net income (loss)                           |  | $                             | 527     |   |                                     | $ |       |                        |  | $ | (1,138               | ) |  | $               | (1,293 | ) |       | $ | (1,185  | ) |  | $ | (3,089  | )
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Total assets                                |  | $                             | 233,551 |   |                                     | $ | 54,171 |                        |  | $ | 82,484               |   |  | $               | 46,428 |   |       | $ | (26,037 | ) |  | $ | 390,597 |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  



21



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##### Table of Contents

The following table represents the segment results for the three months ended September 30, 2007 (unaudited, in
thousands):



|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|------------------------------------------- |  | ----------------------------- | ------- | ----------------------------------- | - | ---------------------- |  | -------------------- | ------- |  | --------------- | ------ | - | ----- | - | ------- | - |  | - | -------
|                                            |  | WorkersCompensationInsurance |         | SegregatedPortfolio CellReinsurance |   | GroupBenefitsInsurance |  | SpecialtyReinsurance |         |  | Corporate/Other |        |   | Total
|Revenue:                                    |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Net premiums earned                         |  | $                             | 15,217  |                                     | $ | 6,078                  |  | $                    | 9,064   |  | $               | 3,905  |   |       | $ |        |   |  | $ | 34,264 
|Net investment income                       |  |                               | 1,100   |                                     |   | 334                    |  |                      | 795     |  |                 | 379    |   |       |   | 500     |   |  |   | 3,108  
|Net realized investment gains               |  |                               | 133     |                                     |   | 22                     |  |                      | 422     |  |                 |       |   |       |   | 13      |   |  |   | 590    
|Other revenue                               |  |                               |        |                                     |   |                       |  |                      |        |  |                 | 121    |   |       |   | 58      |   |  |   | 179    
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Total revenue                               |  |                               | 16,450  |                                     |   | 6,434                  |  |                      | 10,281  |  |                 | 4,405  |   |       |   | 571     |   |  |   | 38,141 
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Expenses:                                   |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Losses and LAE incurred                     |  |                               | 6,160   |                                     |   | 3,336                  |  |                      | 6,174   |  |                 | 5,789  |   |       |   |        |   |  |   | 21,459 
|Acquisition and other underwriting expenses |  |                               | 1,107   |                                     |   | 1,924                  |  |                      | 1,389   |  |                 | 1,132  |   |       |   | (1,455  | ) |  |   | 4,097  
|Other expenses                              |  |                               | 2,271   |                                     |   | 187                    |  |                      | 1,197   |  |                 | 181    |   |       |   | 2,616   |   |  |   | 6,452  
|Amortization of intangibles                 |  |                               |        |                                     |   |                       |  |                      |        |  |                 |       |   |       |   | 434     |   |  |   | 434    
|Policyholder dividend expense               |  |                               | 95      |                                     |   |                       |  |                      |        |  |                 |       |   |       |   |        |   |  |   | 95     
|Segregated portfolio dividend expense       |  |                               |        |                                     |   | 987                    |  |                      |        |  |                 |       |   |       |   | (207    | ) |  |   | 780    
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Total expenses                              |  |                               | 9,633   |                                     |   | 6,434                  |  |                      | 8,760   |  |                 | 7,102  |   |       |   | 1,388   |   |  |   | 33,317 
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Income (loss) before income taxes           |  |                               | 6,817   |                                     |   |                       |  |                      | 1,521   |  |                 | (2,697 | ) |       |   | (817    | ) |  |   | 4,824  
|Income tax expense (benefit)                |  |                               | 1,938   |                                     |   |                       |  |                      | 291     |  |                 | (1,207 | ) |       |   | 241     |   |  |   | 1,263  
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Net income (loss)                           |  | $                             | 4,879   |                                     | $ |                       |  | $                    | 1,230   |  | $               | (1,490 | ) |       | $ | (1,058  | ) |  | $ | 3,561  
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Total assets                                |  | $                             | 204,981 |                                     | $ | 50,400                 |  | $                    | 111,000 |  | $               | 50,038 |   |       | $ | (23,257 | ) |  | $ | 393,162
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        

The following table represents the segment results for the nine months ended September 30, 2008 (unaudited,
in thousands):



|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|------------------------------------------- |  | ----------------------------- | ------- | - | ----------------------------------- | - | ------ | ---------------------- |  | - | -------------------- | - |  | --------------- | ------ | - | ----- | - | ------- | - |  | - | ------- | -
|                                            |  | WorkersCompensationInsurance |         |   | SegregatedPortfolio CellReinsurance |   |        | GroupBenefitsInsurance |  |   | SpecialtyReinsurance |   |  | Corporate/Other |        |   | Total |  
|Revenue:                                    |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Net premiums earned                         |  | $                             | 45,961  |   |                                     | $ | 17,147 |                        |  | $ | 27,505               |   |  | $               | 8,750  |   |       | $ |        |   |  | $ | 99,363  |  
|Net investment income                       |  |                               | 1,077   |   |                                     |   | 855    |                        |  |   | 2,161                |   |  |                 | 881    |   |       |   | 468     |   |  |   | 5,442   |  
|Net realized investment (losses) gains      |  |                               | (836    | ) |                                     |   | (445   | )                      |  |   | (3,212               | ) |  |                 | 33     |   |       |   | 247     |   |  |   | (4,213  | )
|Other revenue                               |  |                               |        |   |                                     |   |       |                        |  |   |                     |   |  |                 | 776    |   |       |   | (254    | ) |  |   | 522     |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Total revenue                               |  |                               | 46,202  |   |                                     |   | 17,557 |                        |  |   | 26,454               |   |  |                 | 10,440 |   |       |   | 461     |   |  |   | 101,114 |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Expenses:                                   |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Losses and LAE incurred                     |  |                               | 24,733  |   |                                     |   | 9,057  |                        |  |   | 18,684               |   |  |                 | 10,456 |   |       |   |        |   |  |   | 62,930  |  
|Acquisition and other underwriting expenses |  |                               | 3,546   |   |                                     |   | 5,306  |                        |  |   | 4,242                |   |  |                 | 2,624  |   |       |   | (1,494  | ) |  |   | 14,224  |  
|Other expenses                              |  |                               | 8,137   |   |                                     |   | 234    |                        |  |   | 4,179                |   |  |                 | 623    |   |       |   | 5,940   |   |  |   | 19,113  |  
|Amortization of intangibles                 |  |                               |        |   |                                     |   |       |                        |  |   |                     |   |  |                 |       |   |       |   | 984     |   |  |   | 984     |  
|Policyholder dividend expense               |  |                               | 253     |   |                                     |   |       |                        |  |   |                     |   |  |                 |       |   |       |   |        |   |  |   | 253     |  
|Segregated portfolio dividend expense       |  |                               |        |   |                                     |   | 2,960  |                        |  |   |                     |   |  |                 |       |   |       |   | (358    | ) |  |   | 2,602   |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Total expenses                              |  |                               | 36,669  |   |                                     |   | 17,557 |                        |  |   | 27,105               |   |  |                 | 13,703 |   |       |   | 5,072   |   |  |   | 100,106 |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Income (loss) before income taxes           |  |                               | 9,533   |   |                                     |   |       |                        |  |   | (651                 | ) |  |                 | (3,263 | ) |       |   | (4,611  | ) |  |   | 1,008   |  
|Income tax expense (benefit)                |  |                               | 3,060   |   |                                     |   |       |                        |  |   | (501                 | ) |  |                 | (1,142 | ) |       |   | (1,397  | ) |  |   | 20      |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Net income (loss)                           |  | $                             | 6,473   |   |                                     | $ |       |                        |  | $ | (150                 | ) |  | $               | (2,121 | ) |       | $ | (3,214  | ) |  | $ | 988     |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  
|Total assets                                |  | $                             | 233,551 |   |                                     | $ | 54,171 |                        |  | $ | 82,484               |   |  | $               | 46,428 |   |       | $ | (26,037 | ) |  | $ | 390,597 |  
|                                            |  |                               |         |   |                                     |   |        |                        |  |   |                      |   |  |                 |        |   |       |   |         |   |  |   |         |  



22



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##### Table of Contents

The following table represents the segment results for the nine months ended September, 2007 (unaudited, in thousands):



|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|------------------------------------------- |  | ----------------------------- | ------- | ----------------------------------- | - | ---------------------- |  | -------------------- | ------- |  | --------------- | ------ | - | ----- | - | ------- | - |  | - | -------
|                                            |  | WorkersCompensationInsurance |         | SegregatedPortfolio CellReinsurance |   | GroupBenefitsInsurance |  | SpecialtyReinsurance |         |  | Corporate/Other |        |   | Total
|Revenue:                                    |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Net premiums earned                         |  | $                             | 40,876  |                                     | $ | 17,010                 |  | $                    | 26,578  |  | $               | 10,762 |   |       | $ |        |   |  | $ | 95,226 
|Net investment income                       |  |                               | 3,475   |                                     |   | 967                    |  |                      | 2,365   |  |                 | 1,154  |   |       |   | 1,365   |   |  |   | 9,326  
|Net realized investment gains (losses)      |  |                               | 744     |                                     |   | 181                    |  |                      | 1,347   |  |                 | (5     | ) |       |   | 54      |   |  |   | 2,321  
|Other revenue                               |  |                               |        |                                     |   |                       |  |                      |        |  |                 | 525    |   |       |   | (8      | ) |  |   | 517    
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Total revenue                               |  |                               | 45,095  |                                     |   | 18,158                 |  |                      | 30,290  |  |                 | 12,436 |   |       |   | 1,411   |   |  |   | 107,390
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Expenses:                                   |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Losses and LAE incurred                     |  |                               | 20,125  |                                     |   | 9,850                  |  |                      | 17,696  |  |                 | 10,297 |   |       |   |        |   |  |   | 57,968 
|Acquisition and other underwriting expenses |  |                               | 2,683   |                                     |   | 5,093                  |  |                      | 4,159   |  |                 | 2,861  |   |       |   | (3,530  | ) |  |   | 11,266 
|Other expenses                              |  |                               | 5,867   |                                     |   | 395                    |  |                      | 3,969   |  |                 | 539    |   |       |   | 7,207   |   |  |   | 17,977 
|Amortization of intangibles                 |  |                               |        |                                     |   |                       |  |                      |        |  |                 |       |   |       |   | 1,303   |   |  |   | 1,303  
|Policyholder dividend expense               |  |                               | 349     |                                     |   |                       |  |                      |        |  |                 |       |   |       |   |        |   |  |   | 349    
|Segregated portfolio dividend expense       |  |                               |        |                                     |   | 2,820                  |  |                      |        |  |                 |       |   |       |   | (648    | ) |  |   | 2,172  
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Total expenses                              |  |                               | 29,024  |                                     |   | 18,158                 |  |                      | 25,824  |  |                 | 13,697 |   |       |   | 4,332   |   |  |   | 91,035 
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Income (loss) before income taxes           |  |                               | 16,071  |                                     |   |                       |  |                      | 4,466   |  |                 | (1,261 | ) |       |   | (2,921  | ) |  |   | 16,355 
|Income tax expense (benefit)                |  |                               | 4,836   |                                     |   |                       |  |                      | 1,309   |  |                 | (704   | ) |       |   | (112    | ) |  |   | 5,329  
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Net income (loss)                           |  | $                             | 11,235  |                                     | $ |                       |  | $                    | 3,157   |  | $               | (557   | ) |       | $ | (2,809  | ) |  | $ | 11,026 
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        
|Total assets                                |  | $                             | 204,981 |                                     | $ | 50,400                 |  | $                    | 111,000 |  | $               | 50,038 |   |       | $ | (23,257 | ) |  | $ | 393,162
|                                            |  |                               |         |                                     |   |                        |  |                      |         |  |                 |        |   |       |   |         |   |  |   |        

11. 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.

12. Junior Subordinated Debentures

On May 15, 2008, the Company called its junior subordinated debentures at
par. The Company paid $8,400 to satisfy its outstanding obligation related to the debentures, including accrued interest of $253.

13. Agency Stock
Purchase Plan

On June 17, 2008, the Company announced its 2008 Agency Stock Purchase Plan (the Stock Purchase Plan). The purpose of
the Stock Purchase Plan is to provide eligible insurance agencies of the Company with the opportunity to purchase the Companys common stock at a discount from fair market value and is designed to foster the common interests of the Company and
agencies in achieving long-term profitable growth for the Company. The Company has reserved 125,000 shares of its common stock for purchase under the Stock Purchase Plan for the five-year period ending June 30, 2013. Common stock issued under
the Stock Purchase Plan will be issued from treasury stock.



23



---

##### Table of Contents

|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 14, 2008.

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 business plans;
| | - |  | ----------------------------------------



| |  |  | future economic conditions in the regional and national markets in which we compete that are less favorable than expected, specifically in Pennsylvania, North
Carolina, and Indiana;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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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s results of operations for the three and nine months ended September 30, 2008, compared to the same periods in 2007 include the following:



| |  |  | A decrease in net premiums earned for the three months ended September 30, 2008, compared to the same period in 2007, primarily reflecting the impact of the
termination of the quota share reinsurance treaty in the specialty reinsurance segment effective July 1, 2008;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Other-than-temporary impairments totaling $4.2 million for the three and nine months ended September 30, 2008, compared to no impairments for the same periods
in 2007. The impairments include the write-down of an interest in a limited partnership totaling $1.4 million, which was reported as a reduction to net investment income in the workers compensation insurance segment;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Net realized investment losses related to the change in fair value of the Companys convertible bond portfolio totaling $1.3 million and $2.4 million for the
three and nine months ended September 30, 2008, compared to an increase of $208,000 and $28,000 for the same periods in 2007;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | An increase in the loss ratio from 2007 to 2008, primarily reflecting unfavorable loss reserve development in the specialty reinsurance segment and a reduction in
favorable loss reserve development from 2007 to 2008 in the workers compensation insurance segment;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | An increase in the expense ratio from 2007 to 2008, primarily reflecting costs associated with the opening of a regional office in North Carolina, state licensing
initiatives in the workers compensation segment, and integration activities related to the acquisition of ESHC. In addition, the specialty reinsurance segments expense ratio increased as a result of the reduction in and subsequent
termination of the quota share reinsurance treaty; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Purchase accounting adjustments that increased net income by $163,000 and $732,000 for three and nine months ended September 30, 2008, respectively, compared
to adjustments that increased net income by $208,000 and $146,000 for the same periods in 2007, respectively.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 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, 2007, one-half of the premiums would be earned in 2007 and the other half would be earned in 2008. 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 in 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 in final audit invoices as a percentage of
payroll exposure to estimate the probable additional amount that it has earned but not yet billed as of the balance sheet date. The majority of the Companys group benefits insurance policies are billed on a monthly basis with premiums being
earned in the month in which coverage is provided. As a result, there is minimal unearned premium related to the group benefits insurance policies 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 LAE) in
cash, cash equivalents, fixed income securities,



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convertible bonds, equity securities, and other long-term investments. Investment income includes interest earned on invested assets and the change in equity
interest of limited partnerships included in other long-term investments. 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 loss adjustment expenses.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 for prior periods, and (3) costs associated with investigating, defending and adjusting claims.

Acquisition and other underwriting expenses.In the workers compensation and group benefits insurance segments, 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 as well as required
payments to the Security Fund. In the segregated portfolio cell reinsurance and 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 junior
subordinated debt.

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 consolidated federal income 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.



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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 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 premiums written to statutory surplus ratio.The net premiums written to statutory surplus ratio represents the ratio of net premiums written
to statutory surplus. This ratio measures the Companys insurance subsidiaries exposure to pricing errors in its current book of business. The higher the ratio, the greater the impact on surplus should pricing prove inadequate.

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, group benefits insurance, and 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 recoverables 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, 2008, 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 3%, which is based on regulatory guidelines. As of September 30, 2008 and December 31, 2007, the Companys reserves for unpaid losses and LAE were reduced by $4.0 million
and $3.5 million, respectively, related to the effects of discounting.



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##### Table of Contents

The Companys reserves for unpaid losses and LAE in its workers compensation insurance, segregated portfolio
cell reinsurance, group benefits insurance, and specialty reinsurance segments as of September 30, 2008 (unaudited) and December 31, 2007 are summarized below (in thousands):



|                                                              |  |                               |        |   |                                     |   |        |                        |  |                      |        |  |       |        |   |  |   |         |  
|------------------------------------------------------------- |  | ----------------------------- | ------ | - | ----------------------------------- | - | ------ | ---------------------- |  | -------------------- | ------ |  | ----- | ------ | - |  | - | ------- | -
|September 30, 2008                                            |  | WorkersCompensationInsurance |        |   | SegregatedPortfolio CellReinsurance |   |        | GroupBenefitsInsurance |  | SpecialtyReinsurance |        |  | Total |       
|Case/tabular reserves                                         |  | $                             | 35,522 |   |                                     | $ | 11,208 |                        |  | $                    | 10,848 |  | $     | 15,002 |   |  | $ | 72,580  |  
|Case incurred development, IBNR, and unallocated LAE reserves |  |                               | 21,270 |   |                                     |   | 11,191 |                        |  |                      | 4,582  |  |       | 13,568 |   |  |   | 50,611  |  
|Amount of discount                                            |  |                               | (2,924 | ) |                                     |   | (1,120 | )                      |  |                      |       |  |       |       |   |  |   | (4,044  | )
|                                                              |  |                               |        |   |                                     |   |        |                        |  |                      |        |  |       |        |   |  |   |         |  
|Net reserves                                                  |  |                               | 53,868 |   |                                     |   | 21,279 |                        |  |                      | 15,430 |  |       | 28,570 |   |  |   | 119,147 |  
|Reinsurance recoverables on unpaid losses and LAE             |  |                               | 5,362  |   |                                     |   | 2,832  |                        |  |                      | 17,995 |  |       |       |   |  |   | 26,189  |  
|Purchase accounting adjustments                               |  |                               | 1,134  |   |                                     |   | 95     |                        |  |                      |       |  |       | (35    | ) |  |   | 1,194   |  
|                                                              |  |                               |        |   |                                     |   |        |                        |  |                      |        |  |       |        |   |  |   |         |  
|Reserves for unpaid losses and LAE                            |  | $                             | 60,364 |   |                                     | $ | 24,206 |                        |  | $                    | 33,425 |  | $     | 28,535 |   |  | $ | 146,530 |  
|                                                              |  |                               |        |   |                                     |   |        |                        |  |                      |        |  |       |        |   |  |   |         |  



|                                                              |  |                               |        |   |                                     |   |        |                        |  |                      |        |  |       |        |   |  |   |         |  
|------------------------------------------------------------- |  | ----------------------------- | ------ | - | ----------------------------------- | - | ------ | ---------------------- |  | -------------------- | ------ |  | ----- | ------ | - |  | - | ------- | -
|December 31, 2007                                             |  | WorkersCompensationInsurance |        |   | SegregatedPortfolio CellReinsurance |   |        | GroupBenefitsInsurance |  | SpecialtyReinsurance |        |  | Total |       
|Case/tabular reserves                                         |  | $                             | 19,915 |   |                                     | $ | 8,906  |                        |  | $                    | 12,131 |  | $     | 10,873 |   |  | $ | 51,825  |  
|Case incurred development, IBNR, and unallocated LAE reserves |  |                               | 25,295 |   |                                     |   | 13,083 |                        |  |                      | 4,251  |  |       | 14,117 |   |  |   | 56,746  |  
|Amount of discount                                            |  |                               | (2,375 | ) |                                     |   | (1,099 | )                      |  |                      |       |  |       |       |   |  |   | (3,474  | )
|                                                              |  |                               |        |   |                                     |   |        |                        |  |                      |        |  |       |        |   |  |   |         |  
|Net reserves                                                  |  |                               | 42,835 |   |                                     |   | 20,890 |                        |  |                      | 16,382 |  |       | 24,990 |   |  |   | 105,097 |  
|Reinsurance recoverables on unpaid losses and LAE             |  |                               | 2,709  |   |                                     |   | 2,033  |                        |  |                      | 18,900 |  |       |       |   |  |   | 23,642  |  
|Purchase accounting adjustments                               |  |                               | 941    |   |                                     |   | 161    |                        |  |                      |       |  |       | (53    | ) |  |   | 1,049   |  
|                                                              |  |                               |        |   |                                     |   |        |                        |  |                      |        |  |       |        |   |  |   |         |  
|Reserves for unpaid losses and LAE                            |  | $                             | 46,485 |   |                                     | $ | 23,084 |                        |  | $                    | 35,282 |  | $     | 24,937 |   |  | $ | 129,788 |  
|                                                              |  |                               |        |   |                                     |   |        |                        |  |                      |        |  |       |        |   |  |   |         |  

As a result of the economic uncertainty in the Companys primary geographic markets and the potential impact
on its insureds, management increased the absolute value of its workers compensation base case reserves during the third quarter of 2008. The increase in case reserves resulted in a reduction to the workers compensation IBNR reserves.
The workers compensation case and IBNR reserves also reflect the acquisition of ESHC, which reported case and IBNR reserves of $5,991 and $1,524, respectively, as of September 30, 2008.

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. For fixed
income and equity securities, the amount written down is recorded in earnings as a realized loss on investments. For limited partnership investments, the amount written down is included as a reduction to net investment income. 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. For the three and nine months ended September 30, 2008, the Company
recorded other-than-temporary investment impairments totaling $4.2 million. For the three and nine months ended September 30, 2007, the Company did not experience any declines in investment securities that were determined to be
other-than-temporary. As of September 30, 2008, the Company held securities with gross unrealized losses of $7.6 million, of which $777,000 were in an unrealized loss position for more than 12 months. Adverse investment market conditions, or
poor operating results of underlying investments, 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:

Equities. If an equity security has a market value below 80% of cost and remains below 80% of cost for more than three months, a review of the
financial condition and prospects of the company is performed to determine if the decline in market value is other-than-temporary. A specific determination is made for any such security. Equity securities in an unrealized loss position not meeting
these quantitative thresholds are evaluated considering, among other things, the magnitude and reasons for the decline and the prospects for the fair value of the securities to recover in the near term. If the decline in market value is judged to be
other-than-temporary, then the



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cost basis of the security is written down to realizable value. Equity securities whose market value has been below 80% of cost for more than six months are
deemed other-than-temporarily impaired and are written down to net realizable value. Realizable value is defined as the quoted market price of the security.

Fixed income securities. A fixed income security generally is written down if the Company is unable to hold or otherwise intends to sell a security with an unrealized loss, or if it is probable that it will be unable to collect all
amounts due according to the contracted terms of a debt security not impaired at acquisition. A fixed income security review for collectibility is done 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.
| | - |  | ---------------------------------------------------------------------------------------------------

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 it management has received information that suggests the Company will be unable to recover its original investment in the limited partnership.

Deferred Acquisition Costs

Certain direct policy acquisition costs consisting of commissions, premium taxes,
fronting fees and certain other direct underwriting costs are deferred and amortized as the underlying policy premiums are earned. As of September 30, 2008 (unaudited) and December 31, 2007, deferred policy acquisition costs and the
related unearned premium reserves were as follows (in thousands):



|                                               |  |                   |        |                  |   |       
|---------------------------------------------- |  | ----------------- | ------ | ---------------- | - | ------
|                                               |  | September 30,2008 |        | December 31,2007
|Workers compensation insurance segment:       |  |                   |        |                  |   |       
|Deferred policy acquisition costs              |  | $                 | 2,607  |                  | $ | 1,924 
|Unearned premium reserves                      |  | $                 | 37,583 |                  | $ | 24,707
|                                               |  |                  
|Segregated portfolio cell reinsurance segment: |  |                   |        |                  |   |       
|Deferred policy acquisition costs              |  | $                 | 3,333  |                  | $ | 2,137 
|Unearned premium reserves                      |  | $                 | 12,233 |                  | $ | 7,716 
|                                               |  |                  
|Group benefits insurance segment:              |  |                   |        |                  |   |       
|Deferred policy acquisition costs              |  | $                 |       |                  | $ |      
|Unearned premium reserves                      |  | $                 | 78     |                  | $ | 83    
|                                               |  |                  
|Specialty reinsurance segment:                 |  |                   |        |                  |   |       
|Deferred policy acquisition costs              |  | $                 | 739    |                  | $ | 2,196 
|Unearned premium reserves                      |  | $                 | 2,462  |                  | $ | 7,320 

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. The profits and losses of the Companys specialty reinsurance segment and investment income related to the Companys ownership
interests in certain segregated portfolio cells are subject to U.S. federal income tax under Subpart F of the Internal Revenue Code. However, a Subpart F taxable loss cannot be used to offset taxable income related to the Companys domestic
operations. As of September 30, 2008, the Companys federal income tax estimate includes a net taxable loss related to Subpart F. As of September 30, 2008, management expects the net deferred tax asset, including the net operating
loss related to Subpart F, to be 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.

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 losses 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.



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Recent Accounting Pronouncements

SFAS 159

In February 2007, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 159 (SFAS 159), The Fair Value Option for Financial Assets and Financial Liabilities Including an Amendment of FASB Statement No. 115. SFAS 159 permits entities to elect to measure
certain financial instruments at fair value with changes in fair value being reported in earnings. SFAS 159 can be applied on an instrument-by-instrument basis and is effective for all eligible financial instruments as of the beginning of an
entitys first fiscal year that begins after November 15, 2007. Retrospective application to prior years financial statements is not permitted. For eligible financial instruments existing at the effective date, and for which an
entity elects the fair value option, the first remeasurement to fair value must be recorded as a cumulative effect adjustment to beginning retained earnings. The Company adopted SFAS 159 effective January 1, 2008; however, no election was made
to measure the Companys financial instruments at fair value. The adoption of SFAS 159 had no effect on the Companys consolidated financial condition and results of operations.

SFAS 141R

In December 2007, the FASB issued Statement
No. 141R, Business Combinations (SFAS 141R), which revises the accounting for business combination transactions previously accounted for under SFAS No. 141, Business Combinations (SFAS 141),
and broadens the scope of transactions which should be accounted for under this standard. SFAS 141R retains the fundamental requirements of SFAS 141 in that the acquisition method of accounting is still used, and an acquirer must be identified in
all business combinations. SFAS 141R applies prospectively to business combinations which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. An entity is prohibited
from applying SFAS 141R prior to that date. The Company is currently in the process of evaluating the impact of SFAS 141R.

SFAS 160

In December 2007, the FASB issued Statement No. 160, Noncontrolling Interests in Consolidated Financial Statements  an amendment
of ARB No. 51 (SFAS 160), which establishes accounting and reporting standards for the non-controlling interests in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires that the ownership interests and
the net income of the non-controlling interest be equally identified from that of the parent on the face of the financial statements. SFAS 160 also provides consistent accounting principles for changes in a parent controlling ownership interest in a
subsidiary, and that any retained non-controlling financial interests in a deconsolidated subsidiary be measured initially at fair value. SFAS 160 applies to fiscal years beginning on or after December 15, 2008, and is applied prospectively,
except for presentation and disclosure requirements, which are applied retrospectively for all periods presented. The Company is currently in the process of evaluating the impact of SFAS 160.

SFAS 161

In March 2008, the FASB issued Statement
No. 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161). SFAS 161 amends and expands the disclosure requirements of SFAS 133, Accounting for Derivative Instruments and Hedging
Activities. SFAS 161 requires qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of gains and losses on derivative instruments and disclosures about
credit-risk-related contingent features in derivative agreements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2008. The adoption of SFAS 161 will not affect the Companys
consolidated financial condition or results of operations, but may require additional disclosures if the Company enters into derivative and hedging activities.

SFAS 163

In May 2008, the FASB issued Statement No. 163, Accounting for Financial Guarantee Insurance Contracts, an
interpretation of FASB Statement No. 60 (SFAS 163). SFAS 163 clarifies how FASB Statement No. 60 applies to the recognition and measurement of premium revenue and claim liabilities under financial guarantee insurance
contracts and requires expanded disclosures about financial guarantee insurance contracts. SFAS 163 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and all interim periods within those fiscal
years, except for certain disclosures about an entitys risk management activities. The Company does not currently write financial guarantee insurance contracts; therefore, the adoption of SFAS 163 will not affect the Companys
consolidated financial condition or results of operations.



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RESULTS OF OPERATIONS

The major components of consolidated revenue were as follows for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):



|                                       |  |                                  |        |                                 |      |   |        |  |   |         |   |  |   |        
|-------------------------------------- |  | -------------------------------- | ------ | ------------------------------- | ---- | - | ------ |  | - | ------- | - |  | - | -------
|                                       |  | Three Months Ended September 30, |        | Nine Months Ended September 30,
|                                       |  | 2008                             |        |                                 | 2007 |   | 2008   |  |   | 2007   
|Net premiums written                   |  | $                                | 33,314 |                                 |      | $ | 35,655 |  | $ | 108,752 |   |  | $ | 107,836
|                                       |  |                                  |        |                                 |      |   |        |  |   |         |   |  |   |        
|Net premiums earned                    |  | $                                | 33,118 |                                 |      | $ | 34,264 |  | $ | 99,363  |   |  | $ | 95,226 
|Net investment income                  |  |                                  | 755    |                                 |      |   | 3,108  |  |   | 5,442   |   |  |   | 9,326  
|Net realized investment (losses) gains |  |                                  | (4,518 | )                               |      |   | 590    |  |   | (4,213  | ) |  |   | 2,321  
|Other revenue                          |  |                                  | 167    |                                 |      |   | 179    |  |   | 522     |   |  |   | 517    
|                                       |  |                                  |        |                                 |      |   |        |  |   |         |   |  |   |        
|Consolidated revenue                   |  | $                                | 29,522 |                                 |      | $ | 38,141 |  | $ | 101,114 |   |  | $ | 107,390
|                                       |  |                                  |        |                                 |      |   |        |  |   |         |   |  |   |        

The decrease in consolidated revenue primarily reflects the aforementioned other-than-temporary investment
impairments and the termination of the quota share reinsurance treaty.

The components of consolidated net (loss) income, by segment, for the three and
nine months ended September 30, 2008 and 2007 were as follows (unaudited, in thousands):



|                                      |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                      |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                      |  | 2008                             |        |   | 2007                            |   |        | 2008 |  |   | 2007   |  
|Workers compensation insurance       |  | $                                | 527    |   |                                 | $ | 4,879  |      |  | $ | 6,473  |   |  | $ | 11,235 |  
|Segregated portfolio cell reinsurance |  |                                  |       |   |                                 |   |       |      |  |   |       |   |  |   |       |  
|Group benefits insurance              |  |                                  | (1,138 | ) |                                 |   | 1,230  |      |  |   | (150   | ) |  |   | 3,157  |  
|Specialty reinsurance                 |  |                                  | (1,293 | ) |                                 |   | (1,490 | )    |  |   | (2,121 | ) |  |   | (557   | )
|Corporate/other                       |  |                                  | (1,185 | ) |                                 |   | (1,058 | )    |  |   | (3,214 | ) |  |   | (2,809 | )
|                                      |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Consolidated net (loss) income        |  | $                                | (3,089 | ) |                                 | $ | 3,561  |      |  | $ | 988    |   |  | $ | 11,026 |  
|                                      |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  

The decrease in consolidated net income primarily reflects the impact of the aforementioned other-than-temporary
investment impairments and the increase in the loss and expense ratios as described earlier. The other-than-temporary impairments reduced net income in the workers compensation insurance, group benefits insurance, and specialty
reinsurance segments by $1.9 million, $2.0 million, and $260,000, respectively, for the three and nine months ended September 30, 2008.



31



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##### Table of Contents

WORKERS COMPENSATION INSURANCE

The following table represents the operations of the workers compensation insurance segment for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):



|                                            |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                            |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                            |  | 2008                             |        |   | 2007                            |   |        | 2008 |  |   | 2007    |  
|Revenue:                                    |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Direct premiums written                     |  | $                                | 26,416 |   |                                 | $ | 25,510 |      |  | $ | 83,067  |   |  | $ | 78,391  |  
|Reinsurance premiums assumed                |  |                                  | 128    |   |                                 |   | 293    |      |  |   | 535     |   |  |   | 1,078   |  
|Ceded premiums written                      |  |                                  | (7,287 | ) |                                 |   | (7,410 | )    |  |   | (27,908 | ) |  |   | (29,393 | )
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Net premiums written                        |  |                                  | 19,257 |   |                                 |   | 18,393 |      |  |   | 55,694  |   |  |   | 50,076  |  
|Change in unearned premiums                 |  |                                  | (3,435 | ) |                                 |   | (3,176 | )    |  |   | (9,733  | ) |  |   | (9,199  | )
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Net premiums earned                         |  |                                  | 15,822 |   |                                 |   | 15,271 |      |  |   | 45,961  |   |  |   | 40,876  |  
|Net investment income                       |  |                                  | (299   | ) |                                 |   | 1,100  |      |  |   | 1,077   |   |  |   | 3,475   |  
|Net realized investment (losses) gains      |  |                                  | (731   | ) |                                 |   | 133    |      |  |   | (836    | ) |  |   | 744     |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Total revenue                               |  | $                                | 14,792 |   |                                 | $ | 16,450 |      |  | $ | 46,202  |   |  | $ | 45,095  |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Expenses:                                   |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Losses and LAE incurred                     |  | $                                | 9,435  |   |                                 | $ | 6,160  |      |  | $ | 24,733  |   |  | $ | 20,125  |  
|Acquisition and other underwriting expenses |  |                                  | 1,322  |   |                                 |   | 1,107  |      |  |   | 3,546   |   |  |   | 2,683   |  
|Other expenses                              |  |                                  | 2,952  |   |                                 |   | 2,271  |      |  |   | 8,137   |   |  |   | 5,867   |  
|Policyholder dividend expense               |  |                                  | 325    |   |                                 |   | 95     |      |  |   | 253     |   |  |   | 349     |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Total expenses                              |  | $                                | 14,034 |   |                                 | $ | 9,633  |      |  | $ | 36,669  |   |  | $ | 29,024  |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Income before income taxes                  |  |                                  | 758    |   |                                 |   | 6,817  |      |  |   | 9,533   |   |  |   | 16,071  |  
|Income tax expense                          |  |                                  | 231    |   |                                 |   | 1,938  |      |  |   | 3,060   |   |  |   | 4,836   |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  
|Net income                                  |  | $                                | 527    |   |                                 | $ | 4,879  |      |  | $ | 6,473   |   |  | $ | 11,235  |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |         |   |  |   |         |  

Net Income

The decrease in net income primarily reflects an increase in the loss and expense ratios and the impact of other-than-temporary investment impairments. The decrease in net income for the nine months ended September 30, 2008 was
partially offset by the impact of purchase accounting adjustments, which increased net income by $224,000 in 2008, compared to a decrease in net income of $228,000 for the same period in 2007.

The workers compensation insurance ratios were as follows for the three and nine months ended September 30, 2008 and 2007:



|                              |  |                                  |   |  |                                 |   |  |      |   |  |      |  
|----------------------------- |  | -------------------------------- | - |  | ------------------------------- | - |  | ---- | - |  | ---- | -
|                              |  | Three Months Ended September 30, |   |  | Nine Months Ended September 30, |  
|                              |  | 2008                             |   |  | 2007                            |   |  | 2008 |   |  | 2007 |  
|Loss and LAE ratio            |  | 59.6                             | % |  | 40.5                            | % |  | 53.8 | % |  | 49.2 | %
|Expense ratio                 |  | 27.0                             | % |  | 22.2                            | % |  | 25.4 | % |  | 20.9 | %
|Policyholders dividend ratio |  | 2.1                              | % |  | 0.6                             | % |  | 0.6  | % |  | 0.9  | %
|                              |  |                                  |   |  |                                 |   |  |      |   |  |      |  
|Combined ratio                |  | 88.7                             | % |  | 63.3                            | % |  | 79.8 | % |  | 71.0 | %
|                              |  |                                  |   |  |                                 |   |  |      |   |  |      |  

Premiums

The
increase in direct premiums written primarily reflects an increase in new business production and a decrease in the impact of purchase accounting adjustments from 2007 to 2008, partially offset by a decrease in the premium renewal retention rate and
continued renewal rate decreases. Direct premiums written for traditional business and alternative markets were $20.4 million and $6.0 million, respectively, for the three months ended September 30, 2008 and $59.2 million and $23.9 million for
the nine months ended September 30, 2008, respectively. Direct premiums written in 2008 and 2007 include the impact of renewal rate decreases of 7.6%. Premium renewal retention rates were 87.9% and 90.0%, respectively, in 2008 and 2007. New
business production was $5.8 million and $17.5 million for the three and nine months ended September 30, 2008, respectively, compared to $3.7 million and $13.3 million for the same periods in 2007, respectively. Direct premiums written for the
nine months ended September 30, 2007 includes a reduction of $1.2 million related to the amortization of purchase accounting adjustments. There were no purchase accounting adjustments in 2008 or for the three months ended September 30,
2007.



32



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##### Table of Contents

Net Investment Income

The decrease in net investment income primarily reflects a decline in value of a limited partnership interest and a slight decrease in the portfolio yield. The decline in value of the limited partnership interest totaled $1.4 million and
$1.9 million for the three and nine months ended September 30, 2008, including an impairment write-down of $1.4 million. The average yield on the fixed income portfolio was 4.34% as of September 30, 2008, compared to 4.49% as of
September 30, 2007.

Net Realized Gains

Net
realized investment losses for the three and nine months ended September 30, 2008 primarily reflect the decline in fair value of the convertible bond portfolio from 2007 to 2008 and other-than-temporary investment impairments totaling $504,000
recognized in the third quarter of 2008. The fair value of the convertible bond portfolio declined $206,000 and $474,000 for the three and nine months ended September 30, 2008, respectively, compared to an increase of $16,000 and $101,000 for
the same periods in 2007, respectively. Net realized gains for the nine months ended September 30, 2007 also include gains recognized on the sale of an equity portfolio. There were no impairments recognized in 2007.

Losses and Loss Adjustment Expenses

The increase in the calendar
period loss and LAE ratios primarily reflects a decrease in favorable loss reserve development on prior accident periods. The accident period loss and LAE ratio was 60.0% for the three months ended September 30, 2008 and the nine months ended
September 30, 2008 and 2007. The accident period loss ratio was decreased from 62.0% to 60.0% during the third quarter of 2007, which further decreased the calendar period loss ratio for the three months ended September 30, 2007. Favorable
loss reserve development on prior accident periods of $2.5 million was recorded for the nine months ended September 30, 2008, compared to $2.3 million and $4.5 million for the three and nine months ended September 30, 2007, respectively,
which lowered loss ratios by 14.8 points for the three months ended September 30, 2007 and lowered loss ratios for the nine months ended September 30, 2008 and 2007 by 5.4 points and 10.7 points, respectively. There was no loss reserve
development on prior accident periods recorded for the three months ended September 30, 2008. The favorable reserve development relates primarily to a decrease in the prior accident period loss development factors used to estimate losses and
LAE. The decrease in prior accident period loss development factors relates primarily to significant prior year claim settlements during 2008 for amounts at, or less than, previously established case and IBNR reserves. This decrease had the effect
of lowering loss development factors as of September 30, 2008. For the nine months ended September 30, 2008, the Company closed 315, or 44.7% of the 570 open lost time claims as of December 31, 2007. In the aggregate, the claims were
closed at amounts lower than the provision established for IBNR claims. Management believes that the realization of the benefits of its return-to-work controls coupled with strong economies in its underwriting territories during 2006, 2007, and the
first half of 2008 enabled it to record losses and LAE that were lower than the amount reserved for claim settlements. For the three and nine months ended September 30, 2008, there was one claim that exceeded the Companys $500,000
reinsurance retention, compared to no reinsured claims for the same period in 2007.

Acquisition and Other Underwriting Expenses

The increase in acquisition and other underwriting expenses primarily reflects growth in net premiums earned and a decrease in fee based revenue from the segregated
portfolio reinsurance segment during 2008, which is netted against acquisition and other underwriting expenses.

Other Expenses

The increase in other expenses primarily reflects start-up costs incurred in conjunction with the Companys expansion into the Southeast, due diligence and
integration expenses associated with the acquisition of ESHC and other state licensing initiatives.

Policyholder Dividends

The increase in the policyholders dividend expense ratio is due to a decrease in the loss ratio of participating policies. Policyholder dividends represent payments
to customers who purchased participating policies that produced favorable loss ratios. In 2008 and 2007, 10.9% and 10.1%, 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, 2008 was 30.5% and 32.1%, respectively, and 28.4% and 30.1% for the three and nine months ended September 30 2007, respectively. The increase in the effective tax rate from 2007 to 2008 primarily reflects rehabilitation
tax credits recognized in 2007.



33



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##### Table of Contents

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, 2008 and 2007 (unaudited, in thousands):



|                                            |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   |        |  
|------------------------------------------- |  | -------------------------------- | ----- | - | ------------------------------- | - | ----- | ---- |  | - | ------ | - |  | - | ------ | -
|                                            |  | Three Months Ended September 30, |       |   | Nine Months Ended September 30, |  
|                                            |  | 2008                             |       |   | 2007                            |   |       | 2008 |  |   | 2007   |  
|Revenue:                                    |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   |        |  
|Reinsurance premiums assumed                |  | $                                | 6,008 |   |                                 | $ | 5,718 |      |  | $ | 23,873 |   |  | $ | 22,958 |  
|Ceded premiums written                      |  |                                  | (792  | ) |                                 |   | (786  | )    |  |   | (2,209 | ) |  |   | (1,912 | )
|                                            |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   |        |  
|Net premiums written                        |  |                                  | 5,216 |   |                                 |   | 4,933 |      |  |   | 21,664 |   |  |   | 21,047 |  
|Change in unearned premiums                 |  |                                  | 835   |   |                                 |   | 1,145 |      |  |   | (4,517 | ) |  |   | (4,037 | )
|                                            |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   |        |  
|Net premiums earned                         |  |                                  | 6,051 |   |                                 |   | 6,078 |      |  |   | 17,147 |   |  |   | 17,010 |  
|Net investment income                       |  |                                  | 291   |   |                                 |   | 334   |      |  |   | 855    |   |  |   | 967    |  
|Net realized investment (losses) gains      |  |                                  | (706  | ) |                                 |   | 22    |      |  |   | (445   | ) |  |   | 181    |  
|                                            |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   |        |  
|Total revenue                               |  | $                                | 5,636 |   |                                 | $ | 6,434 |      |  | $ | 17,557 |   |  | $ | 18,158 |  
|                                            |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   |        |  
|Expenses:                                   |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   |        |  
|Losses and LAE incurred                     |  | $                                | 3,686 |   |                                 | $ | 3,336 |      |  | $ | 9,057  |   |  | $ | 9,850  |  
|Acquisition and other underwriting expenses |  |                                  | 1,872 |   |                                 |   | 1,924 |      |  |   | 5,306  |   |  |   | 5,093  |  
|Other expenses                              |  |                                  | 183   |   |                                 |   | 187   |      |  |   | 234    |   |  |   | 395    |  
|Segregated portfolio dividend expense (1)   |  |                                  | (105  | ) |                                 |   | 987   |      |  |   | 2,960  |   |  |   | 2,820  |  
|                                            |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   |        |  
|Total expenses                              |  | $                                | 5,636 |   |                                 | $ | 6,434 |      |  | $ | 17,557 |   |  | $ | 18,158 |  
|                                            |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   |        |  
|Net income (1)                              |  | $                                |      |   |                                 | $ |      |      |  | $ |       |   |  | $ |       |  
|                                            |  |                                  |       |   |                                 |   |       |      |  |   |        |   |  |   |        |  



|(1) | The workers compensation insurance, 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, 2008 and 2007:



|                   |  |                                  |   |  |                                 |   |  |      |   |  |      |  
|------------------ |  | -------------------------------- | - |  | ------------------------------- | - |  | ---- | - |  | ---- | -
|                   |  | Three Months Ended September 30, |   |  | Nine Months Ended September 30, |  
|                   |  | 2008                             |   |  | 2007                            |   |  | 2008 |   |  | 2007 |  
|Loss and LAE ratio |  | 60.9                             | % |  | 54.9                            | % |  | 52.8 | % |  | 57.9 | %
|Expense ratio      |  | 34.0                             | % |  | 34.7                            | % |  | 32.3 | % |  | 32.3 | %
|                   |  |                                  |   |  |                                 |   |  |      |   |  |      |  
|Combined ratio     |  | 94.9                             | % |  | 89.6                            | % |  | 85.1 | % |  | 90.2 | %
|                   |  |                                  |   |  |                                 |   |  |      |   |  |      |  

Reinsurance Premiums Assumed

The increase in reinsurance premiums assumed primarily reflects an increase in new business production and a decrease in the impact of purchase accounting adjustments, partially offset by a decrease in audit premiums,
a decrease in premium renewal retention rates and continued renewal rate decreases. New business sales totaled $690,000 and $2.7 million for the three and nine months ended September 30, 2008, respectively, compared to $625,000 and $1.7 million
for the same periods in 2007, respectively. Reinsurance premiums assumed in 2008 and 2007 include the impact of renewal rate decreases of 4.0%. Premium renewal retention rates were 87.7% and 89.9%, respectively, in 2008 and 2007. The decrease in
audit premiums reflects additional premium to the Company of $122,000 for the three months ended September 30, 2008 and return premium to customers of $344,000 for the nine months ended September 30, 2008, compared to additional premium to
the Company of $413,000 and $572,000 for the three and nine months ended September 30, 2007, respectively. Reinsurance premiums assumed for the nine months ended September 30, 2007 includes a reduction of $849,000 related to the
amortization of purchase accounting adjustments. There were no purchase accounting adjustments in 2008 or for the three months ended September 30, 2007.



34



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##### Table of Contents

Net Investment Income

The decrease in net investment income primarily reflects a reduction in short-term interest rates from 2007 to 2008.

Net Realized Investment
(Losses) Gains

Net realized investment losses for the three and nine months ended September 30, 2008 include other-than-temporary impairments of
$478,000. There were no impairments recorded in 2007.

Losses and Loss Adjustment Expenses

The increase in the calendar period loss and LAE ratios from 2007 to 2008 reflects a decrease in favorable loss reserve development recorded on prior accident periods of
$77,000 and $2.7 million for the three and nine months ended September 30, 2008, respectively, compared to $1.1 million and $2.2 million for the same periods in 2007, respectively, which lowered loss ratios for the three months ended
September 30, 2008 and 2007 by 1.3 points and 18.6 points, respectively, and lowered loss ratios for the nine months ended September 30, 2008 and 2007 by 15.7 points and 12.4 points, respectively. The favorable loss reserve development on
prior accident periods relates primarily to a decrease in the prior year loss development factors used to estimate losses and LAE. The decrease in accident period loss development factors relates primarily to significant prior year claim settlements
during 2008 for amounts at, or less than, previously established case and IBNR reserves. This decrease had the effect of lowering loss development factors as of September 30, 2008. The accident period loss ratios were 62.4% and 68.9% for the
three and nine months ended September 30, 2008, respectively, compared to 73.9% and 71.2% for the same periods in 2007, 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, 2008 and 2007.

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.

GROUP BENEFITS INSURANCE

The following table represents the
operations of the group benefits insurance segment for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):



|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                            |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                            |  | 2008                             |        |   | 2007                            |   |        | 2008 |  |   | 2007   |  
|Revenue:                                    |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Direct premiums written                     |  | $                                | 9,774  |   |                                 | $ | 9,737  |      |  | $ | 29,339 |   |  | $ | 28,607 |  
|Ceded premiums written                      |  |                                  | (643   | ) |                                 |   | (672   | )    |  |   | (1,838 | ) |  |   | (2,027 | )
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net premiums written                        |  |                                  | 9,131  |   |                                 |   | 9,065  |      |  |   | 27,501 |   |  |   | 26,580 |  
|Change in unearned premiums                 |  |                                  |       |   |                                 |   | (1     | )    |  |   | 4      |   |  |   | (2     | )
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net premiums earned                         |  |                                  | 9,131  |   |                                 |   | 9,064  |      |  |   | 27,505 |   |  |   | 26,578 |  
|Net investment income                       |  |                                  | 535    |   |                                 |   | 795    |      |  |   | 2,161  |   |  |   | 2,365  |  
|Net realized investment (losses) gains      |  |                                  | (2,883 | ) |                                 |   | 422    |      |  |   | (3,212 | ) |  |   | 1,347  |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total revenue                               |  | $                                | 6,783  |   |                                 | $ | 10,281 |      |  | $ | 26,454 |   |  | $ | 30,290 |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Expenses:                                   |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Losses and LAE incurred                     |  | $                                | 5,932  |   |                                 | $ | 6,174  |      |  | $ | 18,684 |   |  | $ | 17,696 |  
|Acquisition and other underwriting expenses |  |                                  | 1,383  |   |                                 |   | 1,389  |      |  |   | 4,242  |   |  |   | 4,159  |  
|Other expenses                              |  |                                  | 1,420  |   |                                 |   | 1,197  |      |  |   | 4,179  |   |  |   | 3,969  |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total expenses                              |  | $                                | 8,735  |   |                                 | $ | 8,760  |      |  | $ | 27,105 |   |  | $ | 25,824 |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|(Loss) income before income taxes           |  |                                  | (1,952 | ) |                                 |   | 1,521  |      |  |   | (651   | ) |  |   | 4,466  |  
|Income tax (benefit) expense                |  |                                  | (814   | ) |                                 |   | 291    |      |  |   | (501   | ) |  |   | 1,309  |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net (loss) income                           |  | $                                | (1,138 | ) |                                 | $ | 1,230  |      |  | $ | (150   | ) |  | $ | 3,157  |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  



35



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##### Table of Contents

Net (Loss) Income

The net loss in the group benefits insurance segment for the three months ended September 30, 2008 primarily reflects the impact of other-than-temporary investment impairments and the change in the fair value of the convertible bond
portfolio. Other-than-temporary investment impairments totaled $2.0 million and the fair value of the convertible bond portfolio decreased $1.1 million for the three months ended September 30, 2008. The combined ratio in the group
benefits insurance segment decreased 0.9 percentage points from 2007 to 2008, primarily reflecting a reduction in the disability and life loss ratios.

The
group benefits insurance ratios were as follows for the three and nine months ended September 30, 2008 and 2007:



|                   |  |                                  |   |  |                                 |   |  |      |   |  |      |  
|------------------ |  | -------------------------------- | - |  | ------------------------------- | - |  | ---- | - |  | ---- | -
|                   |  | Three Months Ended September 30, |   |  | Nine Months Ended September 30, |  
|                   |  | 2008                             |   |  | 2007                            |   |  | 2008 |   |  | 2007 |  
|Loss and LAE ratio |  | 65.0                             | % |  | 68.1                            | % |  | 67.9 | % |  | 66.6 | %
|Expense ratio      |  | 30.7                             | % |  | 28.5                            | % |  | 30.6 | % |  | 30.6 | %
|                   |  |                                  |   |  |                                 |   |  |      |   |  |      |  
|Combined ratio     |  | 95.7                             | % |  | 96.6                            | % |  | 98.5 | % |  | 97.2 | %
|                   |  |                                  |   |  |                                 |   |  |      |   |  |      |  

Premiums

Direct premiums written, by line of business, for the three and nine months ended September 30, 2008 and 2007 were as follows (unaudited, in thousands):



|                      |  |                                  |       |                                 |   |       |  |      |        |  |   |       
|--------------------- |  | -------------------------------- | ----- | ------------------------------- | - | ----- |  | ---- | ------ |  | - | ------
|                      |  | Three Months Ended September 30, |       | Nine Months Ended September 30,
|                      |  | 2008                             |       | 2007                            |   | 2008  |  | 2007
|Dental                |  | $                                | 5,674 |                                 | $ | 5,565 |  | $    | 17,007 |  | $ | 16,101
|Short-term disability |  |                                  | 1,625 |                                 |   | 1,657 |  |      | 4,928  |  |   | 4,963 
|Long-term disability  |  |                                  | 959   |                                 |   | 1,010 |  |      | 2,858  |  |   | 3,054 
|Term life             |  |                                  | 1,516 |                                 |   | 1,505 |  |      | 4,546  |  |   | 4,489 
|                      |  |                                  |       |                                 |   |       |  |      |        |  |   |       
|Total                 |  | $                                | 9,774 |                                 | $ | 9,737 |  | $    | 29,339 |  | $ | 28,607
|                      |  |                                  |       |                                 |   |       |  |      |        |  |   |       

Direct premiums written were relatively consistent for the three months ended September 30, 2008 and
2007. Year-to-date new business sales have decreased $2.6 million from 2007 to 2008 and the year-to-date renewal retention rate has decreased 3.3 percentage points.

Net Investment Income

The decrease in net investment income primarily reflects the decrease in invested
assets. The decrease in invested assets reflects the sale of investments to fund dividend payments to EIHI for the acquisition of ESHC and share repurchases. The average tax equivalent yield on the fixed income portfolio was 5.40% as of
September 30, 2008, compared to 5.24% as of September 30, 2007.

Net Realized Investment (Losses) Gains

The net realized investment losses for the three and nine months ended September 30, 2008 primarily reflect the aforementioned other-than temporary impairments and
decrease in the fair value of the convertible bond portfolio from 2007 to 2008. These realized losses were partially offset by gains recognized on the sale of investments to fund dividends paid to EIHI.

Losses and Loss Adjustment Expenses

The decrease in losses and LAE
from 2007 to 2008 for the three months ended September 30, 2008 primarily reflects favorable claim activity in the long-term disability line of business. Reported claim reserves decreased $305,000 for the three months ended
September 30, 2008, compared to $97,000 for the same period in 2007. The increase in losses and LAE from 2007 to 2008 for the nine months ended September 30, 2008 primarily reflects an increase in the dental accident year loss ratio
and unfavorable claim activity in the long-term disability line of business. The calendar period loss ratios, by line of business, for the three and nine months ended September 30, 2008 and 2007 were as follows:



|                      |  |                                  |    |  |                                 |   |  |      |   |  |      |  
|--------------------- |  | -------------------------------- | -- |  | ------------------------------- | - |  | ---- | - |  | ---- | -
|                      |  | Three Months Ended September 30, |    |  | Nine Months Ended September 30, |  
|                      |  | 2008                             |    |  | 2007                            |   |  | 2008 |   |  | 2007 |  
|Dental                |  | 73.5                             | %  |  | 68.7                            | % |  | 75.3 | % |  | 69.7 | %
|Short-term disability |  | 62.7                             | %  |  | 64.7                            | % |  | 63.9 | % |  | 70.2 | %
|Long-term disability  |  | (4.4                             | )% |  | 61.4                            | % |  | 39.7 | % |  | 14.1 | %
|Term life             |  | 51.2                             | %  |  | 70.2                            | % |  | 49.2 | % |  | 61.7 | %
|Total group benefits  |  | 65.0                             | %  |  | 68.1                            | % |  | 67.9 | % |  | 66.6 | %



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##### Table of Contents

Dental

The
increase in the dental calendar period loss ratio reflects an accident period loss ratio of 77.2% for the nine months ended September 30, 2008, compared to an accident period loss ratio of 71.8% for the same period in 2007. The increase in
the accident period loss ratio primarily reflects increased utilization and claim cost inflation. The calendar period loss ratio reflects favorable development on prior accident period reserves, which reduced the loss ratio by 1.9 and 2.1
percentage points in 2008 and 2007, respectively.

Short-term Disability

The decrease in the short-term disability calendar period loss ratio reflects an accident period loss ratio of 66.3% for the nine months ended September 30, 2008, compared to an accident period loss ratio of
73.4% for the same period in 2007. The decrease in the accident period loss ratio primarily reflects a decrease in claim frequency and severity. The calendar period loss ratio reflects favorable development on prior accident period
reserves, which reduced the loss ratio by 2.5 and 3.2 percentage points in 2008 and 2007, respectively.

Long-term Disability

The long-term disability loss ratio for the three months ended September 30, 2008 reflects the impact of prior period claim reserve terminations. Claim reserve
terminations totaled $251,000, compared to new reported claim reserves totaling $57,000. Claim terminations and other reserve adjustments reduced long-term disability claim reserves by $305,000 and $488,000 for the three and nine months ended
September 30, 2008, compared to a reduction in claim reserves of $97,000 and $805,000 for the same period in 2007. The were several claim terminations in excess of $100,000 in the first six months of 2007

Term Life

The decrease in the term life loss ratio reflects a
reduction in death claims from 2007 to 2008, as well as a decrease in premium waiver reserves.

Acquisition and Other Underwriting Expenses

Acquisition and other underwriting expenses as a percent of direct premiums written have remained consistent from 2007 to 2008.

Other Expenses

The increase in other expenses from 2007 to 2008
primarily reflects an increase in consulting costs related to outsourced actuarial services and costs associated with the acquisition of software.

Tax
(Benefit) Expense

The effective tax rate was 41.7% and 77.0% for the three and nine months ended September 30, 2008, compared to 19.1% and 29.3%
for the same periods in 2007. The effective tax rate in 2008 primarily reflects the impact of tax-exempt interest income in relation to the loss before income taxes. The effective tax rate for in 2007 primarily reflects the impact of a
prior year tax return adjustment and tax-exempt interest income.



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##### Table of Contents

SPECIALTY REINSURANCE

The following table represents the operations of the specialty reinsurance segment for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):



|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------------- |  | -------------------------------- | ------ | - | ------------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                            |  | Three Months Ended September 30, |        |   | Nine Months Ended September 30, |  
|                                            |  | 2008                             |        |   | 2007                            |   |        | 2008 |  |   | 2007   |  
|Revenue:                                    |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Reinsurance premiums assumed                |  | $                                | (290   | ) |                                 | $ | 3,263  |      |  | $ | 3,893  |   |  | $ | 10,133 |  
|Change in unearned premiums                 |  |                                  | 2,404  |   |                                 |   | 641    |      |  |   | 4,857  |   |  |   | 628    |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net premiums earned                         |  | $                                | 2,114  |   |                                 | $ | 3,905  |      |  | $ | 8,750  |   |  | $ | 10,762 |  
|Net investment income                       |  |                                  | 195    |   |                                 |   | 379    |      |  |   | 881    |   |  |   | 1,154  |  
|Net realized investment (losses) gains      |  |                                  | (263   | ) |                                 |   |       |      |  |   | 33     |   |  |   | (5     | )
|Other revenue                               |  |                                  | 361    |   |                                 |   | 121    |      |  |   | 776    |   |  |   | 525    |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total revenue                               |  | $                                | 2,407  |   |                                 | $ | 4,405  |      |  | $ | 10,440 |   |  | $ | 12,436 |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Expenses:                                   |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Losses and LAE incurred                     |  | $                                | 3,464  |   |                                 | $ | 5,789  |      |  | $ | 10,456 |   |  | $ | 10,297 |  
|Acquisition and other underwriting expenses |  |                                  | 635    |   |                                 |   | 1,132  |      |  |   | 2,624  |   |  |   | 2,861  |  
|Other expenses                              |  |                                  | 297    |   |                                 |   | 181    |      |  |   | 623    |   |  |   | 539    |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Total expenses                              |  | $                                | 4,396  |   |                                 | $ | 7,102  |      |  | $ | 13,703 |   |  | $ | 13,697 |  
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Loss before income taxes                    |  |                                  | (1,989 | ) |                                 |   | (2,697 | )    |  |   | (3,263 | ) |  |   | (1,261 | )
|Income tax benefit                          |  |                                  | (696   | ) |                                 |   | (1,207 | )    |  |   | (1,142 | ) |  |   | (704   | )
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  
|Net loss                                    |  | $                                | (1,293 | ) |                                 | $ | (1,490 | )    |  | $ | (2,121 | ) |  | $ | (557   | )
|                                            |  |                                  |        |   |                                 |   |        |      |  |   |        |   |  |   |        |  

Net Loss

The
decrease in the net loss for the three months ended September 30, 2008, compared to the same period in 2007, primarily reflects a decrease in loss and LAE expenses incurred, partially offset by a reduction in investment income, and an increase
in net realized investment losses. The increase in the net loss for the nine months ended September 30, 2008, compared to the same period in 2007, primarily reflects an increase in unfavorable loss reserve development on prior accident years
and the impact of purchase accounting adjustments. The net loss for the nine months ended September 30, 2007 was increased by $225,000 related to the amortization of purchase accounting adjustments. There were negligible purchase accounting
adjustments in 2008 and for the three months ended September 30, 2007.

The specialty reinsurance ratios were as follows for the three and nine months
ended September 30, 2008 and 2007:



|                   |  |                                  |   |  |                                 |   |  |       |   |  |       |  
|------------------ |  | -------------------------------- | - |  | ------------------------------- | - |  | ----- | - |  | ----- | -
|                   |  | Three Months Ended September 30, |   |  | Nine Months Ended September 30, |  
|                   |  | 2008                             |   |  | 2007                            |   |  | 2008  |   |  | 2007  |  
|Loss and LAE ratio |  | 163.9                            | % |  | 148.2                           | % |  | 119.5 | % |  | 95.7  | %
|Expense ratio      |  | 44.1                             | % |  | 33.6                            | % |  | 37.1  | % |  | 31.6  | %
|                   |  |                                  |   |  |                                 |   |  |       |   |  |       |  
|Combined ratio     |  | 207.9                            | % |  | 181.8                           | % |  | 156.6 | % |  | 127.3 | %
|                   |  |                                  |   |  |                                 |   |  |       |   |  |       |  

Reinsurance Premiums Assumed

Reinsurance premiums assumed, by line of business, were as follows for the three and nine months ended September 30, 2008 and 2007 (unaudited, in thousands):



|                                |  |                                  |      |   |                                 |   |       |      |  |      |       |  |   |        |  
|------------------------------- |  | -------------------------------- | ---- | - | ------------------------------- | - | ----- | ---- |  | ---- | ----- |  | - | ------ | -
|                                |  | Three Months Ended September 30, |      |   | Nine Months Ended September 30, |  
|                                |  | 2008                             |      |   | 2007                            |   |       | 2008 |  | 2007 |      
|EnviroGuard                     |  | $                                | (33  | ) |                                 | $ | 3,287 |      |  | $    | 2,887 |  | $ | 8,516  |  
|EIA liability                   |  |                                  | (257 | ) |                                 |   | (199  | )    |  |      | 1,000 |  |   | 2,083  |  
|Other                           |  |                                  |     |   |                                 |   | 175   |      |  |      | 6     |  |   | 383    |  
|Purchase accounting adjustments |  |                                  |     |   |                                 |   |      |      |  |      |      |  |   | (849   | )
|                                |  |                                  |      |   |                                 |   |       |      |  |      |       |  |   |        |  
|Total assumed premiums          |  | $                                | (290 | ) |                                 | $ | 3,263 |      |  | $    | 3,893 |  | $ | 10,133 |  
|                                |  |                                  |      |   |                                 |   |       |      |  |      |       |  |   |        |  



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##### Table of Contents

The decrease in reinsurance premiums assumed is due to the termination of the quota share reinsurance treaty in the
specialty reinsurance segment effective July 1, 2008, partially offset by a decrease in the impact of purchase accounting adjustments from 2007 to 2008. Reinsurance premiums assumed for the nine months ended September 30, 2007 includes a
reduction of $849,000 related to the amortization of purchase accounting adjustments. There were no purchase accounting adjustments in 2008 or for the three months ended September 30, 2007.

Net Investment Income

The decrease in net investment income
primarily reflects a decline in the value of limited partnership interests from 2007 to 2008 and a decrease in the portfolio yield. The average yield on the fixed income portfolio was 4.10% as of September 30, 2008, compared to 4.71% as of
September 30, 2007.

Net Realized Investment (Losses) Gains

Net realized investment losses for the three and nine months ended September 30, 2008 include other-than-temporary impairments of $260,000. There were no impairments recorded in 2007

Losses and Loss Adjustment Expenses

The increase in the calendar
period loss and LAE ratios reflects a decrease in net earned premium due to the termination of the quota share reinsurance treaty and unfavorable loss reserve development on prior accident years of $2.3 million and $5.4 million for the three and
nine months ended September 30, 2008, respectively, and $4.1 million and $4.4 million for the same periods in 2007, respectively, which increased the loss ratios for the three months ended September 30, 2008 and 2007 by 107.4 points and
103.9 points, respectively, and increased the loss ratios for the nine months ended September 30, 2008 and 2007 by 61.7 points and 38.1 points, respectively. The unfavorable loss reserve development in 2008 relates to an increase in reported
claims from the ceding company. The accident period loss ratios were 56.2% and 57.6% for the three and nine months ended September 30, 2008, respectively, compared to 44.2% and 54.3% for the same periods in 2007, respectively.

Acquisition and Other Underwriting Expenses

The increase in the
expense ratio is related to a decrease in net earned premium due to the termination of the quota share reinsurance treaty. As part of its previously in-force quota share reinsurance agreement with the primary insurer, the Company paid the primary
insurer a ceding commission of 30.0% based on assumed premiums

Tax Expense

The effective tax rate for the three and nine months ended September 30, 2008 was 35.0%, compared to 44.8% and 55.8% for the same periods in 2007. The 2007 effective tax rates reflect the impact of prior year tax
return adjustments that increased the income tax benefit.

CORPORATE/OTHER

The increase in the net loss in the corporate/other segment primarily reflects a decline in net investment income. The decrease in net investment income reflects the decline in short-term interest rates as well as the
decrease in cash related to the stock buyback program and the repayment of the junior subordinated debentures.

CONSOLIDATED FINANCIAL POSITION

Consolidated assets totaled $390.6 million as of September 30, 2008, compared to $385.5 million as of December 31, 2007. The acquisition of ESHC
resulted in an increase to consolidated assets of $25.9 million, including the recognition of goodwill and intangible assets of $2.9 million and $4.2 million, respectively. The increase in consolidated assets related to the acquisition of ESHC
was partially offset by a decrease in investments, which reflects the sale of investments to fund the acquisition of ESHC, share repurchases, and the repayment of the junior subordinated debentures, as well as the decrease in the fair value of the
Companys investment portfolio.

Consolidated liabilities totaled $234.5 million as of September 30, 2008, compared to $207.7 million as of
December 31, 2007. The acquisition of ESHC resulted in an increase to consolidated liabilities of $19.2 million. In addition to the acquired ESHC liabilities, loss and LAE reserves and unearned premiums increased. The increase in loss
and LAE reserves primarily reflects unfavorable reserve development in the specialty reinsurance segment and new business growth in the workers compensation insurance segment.



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##### Table of Contents

The increase in unearned premiums primarily reflects the workers compensation premium cycle. Unearned premiums in the workers compensation
insurance segment totaled $46.7 million as of September 30, 2008, compared to $42.9 million as of September 30, 2007.

Consolidated equity
totaled $156.1 million as of September 30, 2008, compared to $177.8 million as of December 31, 2007. The decrease primarily reflects the stock buyback program, shareholder dividends, and a decline in the market value of the Companys
investments, partially offset by net income for the nine months ended September 30, 2008.

LIQUIDITY AND CAPITAL RESOURCES

The Companys principal sources of funds are underwriting operations, investment income, and proceeds from the sale and maturity 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. Eastern Re has a $30.0 million letter of credit facility to secure
its obligations, if needed.

EIHIs domestic insurance subsidiaries ability to pay dividends to EIHI is limited by the insurance laws and
regulations of Pennsylvania. The maximum annual dividends that the domestic insurance entities may pay without prior approval from the Insurance Department is limited to the greater of 10% of statutory surplus or 100% of statutory net income for the
most recently filed annual statement. In addition, EIHI and its subsidiaries are prohibited from declaring or paying any dividends or other forms of distribution for the three years after June 16, 2006, the effective date of the
conversion/merger transaction, without the prior approval of the Pennsylvania Insurance Commissioner. Eastern Re must receive approval from the Cayman Islands Monetary Authority before it can pay any dividend to EIHI.

CASH FLOWS

Cash flows for the nine months ended September 30,
2008 and 2007 were as follows (unaudited, in thousands):



|                                                      |  |      |         |   |      |   |         |  
|----------------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                                      |  | 2008 |         |   | 2007 |  
|Cash flows provided by operating activities           |  | $    | 17,203  |   |      | $ | 19,737  |  
|Cash flows provided by (used in) investing activities |  |      | 13,240  |   |      |   | (14,758 | )
|Cash flows used in financing activities               |  |      | (26,758 | ) |      |   | (14,386 | )
|                                                      |  |      |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents  |  | $    | 3,685   |   |      | $ | (9,407  | )
|                                                      |  |      |         |   |      |   |         |  

The increase in cash flows from 2007 to 2008 primarily reflects proceeds from the sale of investments, offset by
the Companys stock buyback program and the repayment of the junior subordinated debentures. The decrease in cash flows from operations primarily reflects the reduction in net investment income and a reduction in assumed premiums in the
specialty reinsurance segment. The increase in proceeds from investments reflects the sale of investments to fund the acquisition of ESHC and the stock buyback program and the repayment of the junior subordinated debentures.

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, 2008, 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 investment portfolios. 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; however, since only a small percentage of the Companys invested assets are invested in equity securities (approximately 9.9% as of September 30, 2008), the Company does not believe that its exposure to
equity risk is significant.

There have been no material changes in the Companys market risk since December 31, 2007. 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 14, 2008.



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##### Table of Contents

|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
|-------- | ------------

With exception of the risk factor below, 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, 2007, SEC File No. 001-32899.

Our premium revenue in the group benefits insurance segment may be adversely affected as a result of the termination of our relationship with IBSi.

On September 2, 2008, we terminated our relationship with IBSi, a key general agent for our group benefits insurance segment in our Southeast market,
primarily North Carolina, South Carolina, and Georgia. Direct premiums written in North Carolina, South Carolina, and Georgia totaled approximately $11.6 million for the nine months ended September 30, 2008. The termination is effective for all
new and renewal business written on or after January 1, 2009; however, IBSiis still entitled to override payments related to renewals on existing business as of December 31, 2008 for a period of 24 months. As a result of the
termination, we will no longer rely on IBSi to manage producer relationships in the Southeast market. Those relationships will be handled directly by our internal sales personnel. The termination of our relationship with IBSirequires
our sales personnel to develop direct relationships with IBSis key producers. In the event we are unable to develop and maintain these relationships, we could experience a decrease in retention of this business upon renewal and/or our
ability to generate new sales in the Southeast territory could be adversely impacted, which could result in a decrease in premium revenue in the group benefits insurance segment.



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##### Table of Contents

|Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds
|------- | -----------------------------------------------------------

Issuer Purchases of Equity Securities

On February 15, 2007, the Companys Board of Directors authorized the repurchase of up to 5
percent of the Companys issued and outstanding shares of common stock for the purpose of funding the issuance of stock under the Eastern Insurance Holdings, Inc. 2006 Stock Incentive Plan. On August 2, 2007, the Companys Board of
Directors authorized the repurchase of additional shares of the Companys outstanding common stock up to an aggregate of 1,046,500 shares, which represents the total number of shares of common stock for which awards may be granted under the
Companys Stock Incentive Plan. On September 27, 2007, the Companys Board of Directors increased the share repurchase authorization to 2,046,500 shares.

The following table presents information with respect to those purchases of our common stock made during the nine months ended September 30, 2008 and 2007:



|                     |  |                                 |  |                             |       |                                                                              |           |                                                                                                       |         |    
|-------------------- |  | ------------------------------- |  | --------------------------- | ----- | ---------------------------------------------------------------------------- | --------- | ----------------------------------------------------------------------------------------------------- | ------- | ---
|Period               |  | Total number ofshares purchased |  | Average pricepaid per share |       | Total number ofshares purchasesas part of publiclyannounced plansor programs |           | Maximum number(or approximatedollar value)of shares thatmay yet bepurchasedunder the plansor programs |        
|January 1-31, 2008   |  | 113,757                         |  | $                           | 16.23 |                                                                              | 113,757   |                                                                                                       | 915,878 |    
|February 1-28, 2008  |  | 540,271                         |  | $                           | 16.50 |                                                                              | 540,271   |                                                                                                       | 375,607 |    
|March 1-31, 2008     |  | 156,193                         |  | $                           | 15.38 |                                                                              | 156,193   |                                                                                                       | 219,414 |    
|April 1-30, 2008     |  | 74,610                          |  | $                           | 15.76 |                                                                              | 74,610    |                                                                                                       | 144,804 |    
|May 1-31, 2008       |  | 81,800                          |  | $                           | 15.99 |                                                                              | 81,800    |                                                                                                       | 63,004  |    
|June 1-30, 2008      |  | 31,797                          |  | $                           | 15.82 |                                                                              | 31,797    |                                                                                                       | 31,207  | (a)
|July 1-31 2008       |  | 21,563                          |  | $                           | 15.05 |                                                                              | 21,563    |                                                                                                       | 9,644   | (a)
|August 1-31, 2008    |  | 10,826                          |  | $                           | 15.18 |                                                                              | 10,826    |                                                                                                       |        | (a)
|September 1-30, 2008 |  | 3,472                           |  | $                           | 15.16 |                                                                              | 3,472     |                                                                                                       |        | (a)
|                     |  |                                 |  |                             |       |                                                                              |           |                                                                                                       |         |    
|Total                |  | 1,034,289                       |  | $                           | 16.14 |                                                                              | 1,034,289 |                                                                                                       |         |    
|                     |  |                                 |  |                             |       |                                                                              |           |                                                                                                       |         |    



|(a) | The maximum number of remaining shares represents the difference between 2,046,500 authorized shares and the number of shares repurchased as of September 30, 2008. The approval
to repurchase an additional $10 million of the Companys common stock is not included in this amount.
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|                     |  |                                 |  |                             |       |                                                                              |         |                                                                                                       |          
|-------------------- |  | ------------------------------- |  | --------------------------- | ----- | ---------------------------------------------------------------------------- | ------- | ----------------------------------------------------------------------------------------------------- | ---------
|Period               |  | Total number ofshares purchased |  | Average pricepaid per share |       | Total number ofshares purchasesas part of publiclyannounced plansor programs |         | Maximum number(or approximatedollar value)of shares thatmay yet bepurchasedunder the plansor programs
|January 1-31, 2007   |  |                                |  | $                           | N/A   |                                                                              | N/A     |                                                                                                       | N/A      
|February 1-28, 2007  |  | 10,355                          |  | $                           | 14.40 |                                                                              | 10,355  |                                                                                                       | 557,197  
|March 1-31, 2007     |  | 61,868                          |  | $                           | 14.46 |                                                                              | 61,868  |                                                                                                       | 495,329  
|April 1-30, 2007     |  | 1,100                           |  | $                           | 15.00 |                                                                              | 1,100   |                                                                                                       | 494,229  
|May 1-31, 2007       |  | 29,319                          |  | $                           | 14.73 |                                                                              | 29,319  |                                                                                                       | 464,910  
|June 1-30, 2007      |  | 262,578                         |  | $                           | 15.22 |                                                                              | 262,578 |                                                                                                       | 202,332  
|July 1-31, 2007      |  | 128,088                         |  | $                           | 15.18 |                                                                              | 128,088 |                                                                                                       | 74,244   
|August 1-31, 2007    |  | 243,004                         |  | $                           | 15.18 |                                                                              | 243,004 |                                                                                                       | 310,188  
|September 1-30, 2007 |  | 135,689                         |  | $                           | 15.49 |                                                                              | 135,689 |                                                                                                       | 1,174,499
|                     |  |                                 |  |                             |       |                                                                              |         |                                                                                                       |          
|Total                |  | 872,001                         |  | $                           | 15.22 |                                                                              | 872,001 |                                                                                                       |          
|                     |  |                                 |  |                             |       |                                                                              |         |                                                                                                       |          



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##### Table of Contents

|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------

None



|Item 4. | Submission of Matters to Vote of Security Holders
|------- | -------------------------------------------------

None



|Item 5. | Other Information
|------- | -----------------

None



|Item 6. | Exhibits
|------- | --------

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)                                                                         



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##### Table of Contents

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 6, 2008 |  | By:                              |  | /s/ Bruce M. Eckert                  
|                        |  |                                  |  | Bruce M. Eckert,                     
|                        |  |                                  |  | Chief Executive Officer              
|                        |  |                                 
|Dated: November 6, 2008 |  | By:                              |  | /s/ Kevin M. Shook                   
|                        |  |                                  |  | Kevin M. Shook,                      
|                        |  |                                  |  | Treasurer and Chief Financial Officer



44