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SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
 Quarterly Report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
 for the Quarterly Period Ended September 30, 2006,
 or
 Transition report pursuant to Section 13 or 15(d) Of the Exchange Act
 for the Transition Period from  to
 No. 000-25425
 (Commission
File Number)
 MERCER INSURANCE GROUP, INC.
  PENNSYLVANIA
    
    23-2934601(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)10 North Highway 31, P.O. Box 278, Pennington, NJ
    
    08534(Address of principal executive offices)
    
    (Zip Code)
  (Registrants telephone number, including area code)
 (Former name, former address and former fiscal year, if changed since last report)
 þ o
  o þ o
 o þ
  Number of Shares Outstanding as of November 8, 2006COMMON STOCK (No Par Value)
    
    6,550,720(Title of Class)
    
    (Outstanding Shares)




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##### 



TABLE OF CONTENTS
 PagePART I. FINANCIAL INFORMATION
    
    
    5Item 1. Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    18Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    34Item 4. Controls and Procedures
    
    
    34PART II. OTHER INFORMATION
    
    
    34Item 1. Legal Proceedings
    
    
    34Item 1A. Risk Factors
    
    
    34Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    34Item 3. Defaults Upon Senior Securities
    
    
    34Item 4. Submission of Matters to a Vote of Security Holders
    
    
    35Item 5. Other Information
    
    
    35Item 6. Exhibits
    
    
    35SIGNATURES
    
    
    36EMPLOYMENT AGREEMENTCertification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of Chief Executive Officer in accordance with Section 906Certification of Chief Financial Officer in accordance with Section 906
  Exhibits:
 Exhibit No.
    
    Title3.1
    
    Articles of Incorporation of Mercer Insurance Group, Inc. (incorporated by reference herein to the
Companys Pre-effective Amendment No. 3 on Form S-1, SEC File No. 333-104897.)3.2
    
    Bylaws of Mercer Insurance Group, Inc. (incorporated by reference herein to the Companys Annual Report
on Form 10-K, SEC File No. 000-25425, for the fiscal year ended December 31, 2003.10.2
    
    Employment Agreement, dated as of October 1, 2006, among BICUS Services Corporation, Mercer Insurance
Group, Inc., Mercer Insurance Company and Paul R. Corkery (filed herewith.)31.1
    
    Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002
 2




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Forward-looking Statements
                    3




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4




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Part I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
 MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
 CONSOLIDATED BALANCE SHEET
 September 30,
    
    
    December 31,2006
    
    
    2005(Dollars in thousands)(Unaudited)ASSETSInvestments:Fixed income securities, available-for-sale, at fair value (amortized cost of $276,245 and
$231,191, respectively)
    
    $
    274,966
    
    
    $
    229,129Equity securities, at fair value (cost of $10,679 and $8,599, respectively)
    
    
    16,145
    
    
    
    14,981Short-term investments, at cost, which approximates fair value
    
    
    1,799
    
    
    
    4,289Total investments
    
    
    292,910
    
    
    
    248,399Cash and cash equivalents
    
    
    11,070
    
    
    
    20,677Premiums receivable
    
    
    44,116
    
    
    
    37,497Reinsurance receivables
    
    
    86,860
    
    
    
    79,214Prepaid reinsurance premiums
    
    
    17,754
    
    
    
    21,554Deferred policy acquisition costs
    
    
    17,760
    
    
    
    10,789Accrued investment income
    
    
    2,784
    
    
    
    2,625Property and equipment, net
    
    
    11,808
    
    
    
    11,720Deferred income taxes
    
    
    8,122
    
    
    
    3,588Goodwill
    
    
    5,625
    
    
    
    5,633Other assets
    
    
    3,867
    
    
    
    5,002Total assets
    
    $
    502,676
    
    
    $
    446,698LIABILITIES AND STOCKHOLDERS EQUITYLiabilities:Losses and loss adjustment expenses
    
    $
    242,355
    
    
    $
    211,679Unearned premiums
    
    
    88,748
    
    
    
    78,982Accounts payable and accrued expenses
    
    
    14,342
    
    
    
    13,761Other reinsurance balances
    
    
    24,507
    
    
    
    18,574Trust preferred securities
    
    
    15,538
    
    
    
    15,525Advances under line of credit
    
    
    3,000
    
    
    
    3,000Other liabilities
    
    
    1,790
    
    
    
    1,778Total liabilities
    
    
    390,280
    
    
    
    343,299Stockholders Equity:Preferred stock, no par value, authorized 5,000,000 shares, no shares issued and outstanding
    
    
    
    
    
    
    Common stock, no par value, authorized 15,000,000 shares, issued 7,064,233 and 7,068,233
shares, outstanding 6,566,451 and 6,463,538 shares
    
    
    
    
    
    
    Additional paid-in capital
    
    
    67,878
    
    
    
    67,973Accumulated other comprehensive income:Unrealized gains in investments, net of deferred income taxes
    
    
    2,764
    
    
    
    2,851Retained earnings
    
    
    51,989
    
    
    
    44,896Unearned restricted stock compensation
    
    
    
    
    
    
    (1,654
    )Unearned ESOP shares
    
    
    (3,914
    )
    
    
    (4,383
    )Treasury stock, at cost, 503,513 and 501,563 shares
    
    
    (6,321
    )
    
    
    (6,284
    )Total stockholdersequity
    
    
    112,396
    
    
    
    103,399Total liabilities and stockholders equity
    
    $
    502,676
    
    
    $
    446,698
  5




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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF EARNINGS
Nine Months Ended September 30, 2006 and 2005
 2006
    
    
    2005(Dollars in thousands, except pershare data)(Unaudited)Revenue:Net premiums earned
    
    $
    102,172
    
    
    $
    45,378Investment income, net of expenses
    
    
    7,057
    
    
    
    2,254Net realized investment gains
    
    
    100
    
    
    
    1,273Other revenue
    
    
    1,605
    
    
    
    256Total revenue
    
    
    110,934
    
    
    
    49,161Expenses:Losses and loss adjustment expenses
    
    
    64,519
    
    
    
    21,596Amortization of deferred policy
acquisition costs (related party
amounts of $916 and $947,
respectively)
    
    
    24,187
    
    
    
    11,936Other expense
    
    
    10,208
    
    
    
    9,725Interest expense
    
    
    913
    
    
    
    Total expenses
    
    
    99,827
    
    
    
    43,257Income before income taxes
    
    
    11,107
    
    
    
    5,904Income taxes
    
    
    3,368
    
    
    
    1,785Net income
    
    $
    7,739
    
    
    $
    4,119Earnings per common share:Basic
    
    $
    1.29
    
    
    $
    0.69Diluted
    
    $
    1.25
    
    
    $
    0.67Weighted average shares:Basic
    
    
    6,006,693
    
    
    
    5,939,436Diluted
    
    
    6,192,731
    
    
    
    6,155,328
  6




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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF EARNINGS
Three Months Ended September 30, 2006 and 2005
 2006
    
    
    2005(Dollars in thousands, except pershare data)(Unaudited)Revenue:Net premiums earned
    
    $
    35,004
    
    
    $
    15,404Investment income, net of expenses
    
    
    2,597
    
    
    
    770Net realized investment (losses) gains
    
    
    (505
    )
    
    
    1,175Other revenue
    
    
    527
    
    
    
    84Total revenue
    
    
    37,623
    
    
    
    17,433Expenses:Losses and loss adjustment expenses
    
    
    22,324
    
    
    
    6,562Amortization of deferred policy
acquisition costs (related party
amounts of $302 and $313,
respectively)
    
    
    9,047
    
    
    
    4,135Other expense
    
    
    2,721
    
    
    
    3,704Interest expense
    
    
    312
    
    
    
    Total expenses
    
    
    34,404
    
    
    
    14,401Income before income taxes
    
    
    3,219
    
    
    
    3,032Income taxes
    
    
    1,025
    
    
    
    971Net income
    
    $
    2,194
    
    
    $
    2,061Earnings per common share:Basic
    
    $
    0.36
    
    
    $
    0.35Diluted
    
    $
    0.35
    
    
    $
    0.34Weighted average shares:Basic
    
    
    6,055,132
    
    
    
    5,938,388Diluted
    
    
    6,265,888
    
    
    
    6,120,774
  7




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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY
Nine months ended September 30, 2006
(Unaudited, dollars in thousands)
 Accumulated
    
    
    
    
    
    
    UnearnedAdditional
    
    
    other
    
    
    
    
    
    
    restricted
    
    
    UnearnedPreferred
    
    
    Common
    
    
    paid-in
    
    
    comprehensive
    
    
    Retained
    
    
    stock
    
    
    ESOP
    
    
    Treasurystock
    
    
    stock
    
    
    capital
    
    
    income
    
    
    Earnings
    
    
    compensation
    
    
    shares
    
    
    stock
    
    
    TotalBalance,
December 31, 2005
    
    $
    
    
    
    
    
    
    
    
    67,973
    
    
    
    2,851
    
    
    
    44,896
    
    
    
    (1,654
    )
    
    
    (4,383
    )
    
    
    (6,284
    )
    
    $
    103,399Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,739
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,739Unrealized losses
on securities:Unrealized
holding losses
arising during
period, net of
related income
tax benefit of
$39
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (76
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (76
    )Less
reclassification
adjustment for
gains included
in net income,
net of related
income tax
expense of $5
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (11
    )Other
comprehensive
loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (87
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,652Reclassification of
unearned restricted
stock compensation
    
    
    
    
    
    
    
    
    
    
    (1,654
    )
    
    
    
    
    
    
    
    
    
    
    1,654
    
    
    
    
    
    
    
    
    
    
    
    Stock compensation
plan amortization
    
    
    
    
    
    
    
    
    
    
    995
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    995Tax benefit from
stock compensation
plan
    
    
    
    
    
    
    
    
    
    
    129
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    129ESOP shares
committed
    
    
    
    
    
    
    
    
    
    
    435
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    469
    
    
    
    
    
    
    
    904Treasury stock
purchased
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (37
    )
    
    
    (37
    )Dividends to
shareholders
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (646
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (646
    )Balance, September
30, 2006
    
    $
    
    
    
    
    
    
    
    
    67,878
    
    
    
    2,764
    
    
    
    51,989
    
    
    
    
    
    
    
    (3,914
    )
    
    
    (6,321
    )
    
    $
    112,396
  8




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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
 CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2006 and 2005
 2006
    
    
    2005(Dollars in thousands)(Unaudited)Cash flows from operating activities:Net income
    
    $
    7,739
    
    
    $
    4,119Adjustments to reconcile net income to net cash provided by operating activities:Depreciation and amortization of fixed assets
    
    
    1,834
    
    
    
    1,325Net amortization of premium
    
    
    758
    
    
    
    402Amortization of stock compensation
    
    
    995
    
    
    
    517ESOP share commitment
    
    
    904
    
    
    
    610Net realized investment gains
    
    
    (100
    )
    
    
    (1,273
    )Deferred income tax
    
    
    (4,490
    )
    
    
    (120
    )Change in assets and liabilities:Premiums receivable
    
    
    (6,619
    )
    
    
    1,535Reinsurance receivables
    
    
    (7,646
    )
    
    
    (1,189
    )Prepaid reinsurance premiums
    
    
    3,800
    
    
    
    155Deferred policy acquisition costs
    
    
    (6,971
    )
    
    
    2Other assets
    
    
    1,079
    
    
    
    (1,098
    )Losses and loss adjustment expenses
    
    
    30,676
    
    
    
    (246
    )Unearned premiums
    
    
    9,766
    
    
    
    (1,422
    )Other
    
    
    6,527
    
    
    
    (422
    )Net cash provided by operating activities
    
    
    38,252
    
    
    
    2,895Cash flows from investing activities:Purchase of fixed income securities, available-for-sale
    
    
    (163,045
    )
    
    
    (17,814
    )Purchase of equity securities
    
    
    (4,468
    )
    
    
    (1,020
    )Sale and maturity of fixed income securities, available-for-sale
    
    
    116,848
    
    
    
    44,718Sale of equity securities
    
    
    2,792
    
    
    
    9,701Sale (purchase) of short-term investments, net
    
    
    2,490
    
    
    
    (2,496
    )Purchase of property and equipment, net
    
    
    (1,922
    )
    
    
    (1,194
    )Net cash (used) provided by investing activities
    
    
    (47,305
    )
    
    
    31,895Cash flows from financing activities:Purchase of treasury stock
    
    
    (37
    )
    
    
    (3,230
    )Tax benefit from stock compensation plans
    
    
    129
    
    
    
    Dividends to shareholders
    
    
    (646
    )
    
    
    Net cash used by financing activities
    
    
    (554
    )
    
    
    (3,230
    )Net (decrease) increase in cash and cash equivalents
    
    
    (9,607
    )
    
    
    31,560Cash and cash equivalents at beginning of period
    
    
    20,677
    
    
    
    16,289Cash and cash equivalents at end of period
    
    $
    11,070
    
    
    $
    47,849Cash paid during the period for:Interest
    
    $
    988
    
    
    $
    28Income taxes
    
    $
    3,400
    
    
    $
    1,650
  9




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MERCER INSURANCE GROUP, INC. AND SUBSIDIARIES
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share amounts)
(Unaudited)
 Basis of Presentation
      Share-based compensation
    10




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Nine monthsendedSeptember 30, 2005(In thousands,except pershare data)Net income, as reported
    
    $
    4,119Plus: Share-based compensation expense included in reported net income, net of related tax effects
    
    
    334Less: Total share-based compensation expense determined under fair value based method for all
awards, net of related tax effects
    
    
    (708
    )Pro forma net income
    
    $
    3,745Basic earnings per share:As reported
    
    $
    0.69Pro forma
    
    $
    0.63Diluted earnings per share:As reported
    
    $
    0.67Pro forma
    
    $
    0.61
 Three monthsendedSeptember 30, 2005(In thousands,except pershare data)Net income, as reported
    
    $
    2,061Plus: Share-based compensation expense included in reported net income, net of related tax effects
    
    
    116Less: Total share-based compensation expense determined under fair value based method for all
awards, net of related tax effects
    
    
    (247
    )Pro forma net income
    
    $
    1,930Basic earnings per share:As reported
    
    $
    0.35Pro forma
    
    $
    0.33Diluted earnings per share:As reported
    
    $
    0.34Pro forma
    
    $
    0.32
 11




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Recent Accounting Pronouncements
      12




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Segment Information
     Nine Months Ended September 302006
    
    
    2005(In thousands)Revenue:Net premiums earned:Commercial lines
    
    $
    85,263
    
    
    $
    28,517Personal lines
    
    
    16,909
    
    
    
    16,861Total net premiums earned
    
    
    102,172
    
    
    
    45,378Net investment income
    
    
    7,057
    
    
    
    2,254Realized investment gains
    
    
    100
    
    
    
    1,273Other
    
    
    1,605
    
    
    
    256Total revenue
    
    
    110,934
    
    
    
    49,161Income before income taxes:Underwriting income (loss):Commercial lines
    
    
    4,468
    
    
    
    3,242Personal lines
    
    
    (1,210
    )
    
    
    (1,121
    )Total underwriting income
    
    
    3,258
    
    
    
    2,121Net investment income
    
    
    7,057
    
    
    
    2,254Realized investment gains
    
    
    100
    
    
    
    1,273Other
    
    
    692
    
    
    
    256Income before income taxes
    
    $
    11,107
    
    
    $
    5,904
 Three Months Ended September 302006
    
    
    2005(In thousands)Revenue:Net premiums earned:Commercial lines
    
    $
    29,336
    
    
    $
    9,860Personal lines
    
    
    5,668
    
    
    
    5,544Total net premiums earned
    
    
    35,004
    
    
    
    15,404Net investment income
    
    
    2,597
    
    
    
    770Realized investment (losses) gains
    
    
    (505
    )
    
    
    1,175
 13




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Three Months Ended September 302006
    
    
    2005(In thousands)Other
    
    
    527
    
    
    
    84Total revenue
    
    
    37,623
    
    
    
    17,433Income before income taxes:Underwriting income (loss):Commercial lines
    
    
    1,254
    
    
    
    1,599Personal lines
    
    
    (342
    )
    
    
    (596
    )Total underwriting income
    
    
    912
    
    
    
    1,003Net investment income
    
    
    2,597
    
    
    
    770Realized investment (losses) gains
    
    
    (505
    )
    
    
    1,175Other
    
    
    215
    
    
    
    84Income before income taxes
    
    $
    3,219
    
    
    $
    3,032
 14




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Reinsurance
    Comprehensive Income
  Nine Months endedSeptember 302006
    
    
    2005(In thousands)Net income
    
    $
    7,739
    
    
    $
    4,119Other comprehensive loss, net of tax:Unrealized losses on securities:Unrealized
holding losses arising during period, net of related income tax
benefit of $39 and $503
    
    
    (76
    )
    
    
    (975
    )Less reclassification adjustment for gains included in net income, net of related income tax expense
of $5 and $433
    
    
    (11
    )
    
    
    (840
    )(87
    )
    
    
    (1,815
    )Comprehensive income
    
    $
    7,652
    
    
    $
    2,304
 Three Months endedSeptember 302006
    
    
    2005(In thousands)Net income
    
    $
    2,194
    
    
    $
    2,061Other comprehensive income, net of tax:Unrealized gains on securities:Unrealized holding gains and (losses)
arising during period, net of related
income tax (expense) benefit of $(1,685)
and $22
    
    
    3,271
    
    
    
    (41
    )Less reclassification adjustment for gains included in net income, net of related
income tax expense of $4 and
$400
    
    
    (7
    )
    
    
    (776
    )3,264
    
    
    
    (817
    )Comprehensive income
    
    $
    5,855
    
    
    $
    1,244
 Share-based Compensation
  15




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Weighted AverageNumber
    
    
    Exercise Priceof shares
    
    
    Per ShareOptions outstanding at December 31, 2005
    
    
    659,200
    
    
    $
    12.42Granted  2006
    
    
    0
    
    
    
    Exercised  2006
    
    
    0
    
    
    
    Forfeited  2006
    
    
    (62,500
    )
    
    
    13.04Options outstanding at September 30, 2006
    
    
    596,700
    
    
    $
    12.36Exercisable at:September 30, 2006
    
    
    322,533
    
    
    $
    12.22Weighted-average remaining contractual life
    
    
    
    
    
    7.9  yearsCompensation remaining to be recognized for unvested stock options at September 30, 2006
    
    
    
    
    
    $
    917,000Weighted-average remaining amortization period
    
    
    
    
    
    2.0 yearsAggregate
Intrinsic Value of outstanding options, September 30, 2006 (millions)
    
    
    
    
    
    $
    8.1Aggregate
Intrinsic Value of exercisable options, September 30, 2006
(millions)
    
    
    
    
    
    $
    4.4
   Weighted AverageNumber
    
    
    Fair valueof shares
    
    
    Per ShareUnvested restricted stock at December 31, 2005
    
    
    166,417
    
    
    $
    12.29Granted  2006
    
    
    10,000
    
    
    
    26.87Vested  2006
    
    
    (56,083
    )
    
    
    12.22Forfeited  2006
    
    
    (14,000
    )
    
    
    13.08Unvested restricted stock at September 30, 2006
    
    
    106,334
    
    
    $
    13.61Compensation remaining to be recognized for
unvested restricted stock at September 30, 2006
(millions):
    
    
    
    
    
    $
    1.2Weighted-average remaining amortization period
    
    
    
    
    
    2.2 years
 Earnings per Share
  16




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##### Table of Contents



Nine months endedSeptember 30,2006
    
    
    2005(Dollars in thousands,except per share data)Numerator for basic and diluted earnings per share:Net income
    
    $
    7,739
    
    
    $
    4,119Denominator
for basic earnings per share  weighted-average shares outstanding
    
    
    6,006,693
    
    
    
    5,939,436Effect of stock incentive plans
    
    
    186,038
    
    
    
    215,892Denominator for diluted earnings per share
    
    
    6,192,731
    
    
    
    6,155,328Basic earnings per share
    
    $
    1.29
    
    
    $
    0.69Diluted earnings per share
    
    $
    1.25
    
    
    $
    0.67
 Three months endedSeptember 30,2006
    
    
    2005(Dollars in thousands,except per share data)Numerator for basic and diluted earnings per share:Net income
    
    $
    2,194
    
    
    $
    2,061Denominator
for basic earnings per share  weighted-average shares outstanding
    
    
    6,055,132
    
    
    
    5,938,388Effect of stock incentive plans
    
    
    210,756
    
    
    
    182,386Denominator for diluted earnings per share
    
    
    6,265,888
    
    
    
    6,120,774Basic earnings per share
    
    $
    0.36
    
    
    $
    0.35Diluted earnings per share
    
    $
    0.35
    
    
    $
    0.34
 Contingency
    17




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
  Overview
  
    
    Mercer Insurance Company, a Pennsylvania property and casualty stock insurance company
offering insurance coverages to businesses and individuals in New Jersey and Pennsylvania,
    
    Mercer Insurance Company of New Jersey, Inc., a New Jersey property and casualty stock
insurance company offering insurance coverages to businesses and individuals located in New
Jersey,
    
    Franklin Insurance Company, a Pennsylvania property and casualty stock insurance company
offering private passenger automobile and homeowners insurances to individuals located in
Pennsylvania, and
    
    Financial Pacific Insurance Company, a California property and casualty stock insurance
company offering insurance and surety products to small and medium sized commercial
businesses in California, Arizona, Nevada and Oregon, and direct mail surety products to
commercial businesses in various other states.
      18




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##### Table of Contents



Critical Accounting Policies
 General.
 Liabilities for Loss and Loss Adjustment Expenses.
   19




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##### Table of Contents



AdjustmentChange in Loss and
    
    Adjusted Loss and
    
    
    
    
    
    Adjusted Loss and Loss
    
    Percentage ChangeLoss Adjustment
    
    Loss Reserves Net of
    
    Percentage Change in
    
    Adjustment Reserves Net
    
    in StockholdersReserves Net of
    
    Reinsurance as of
    
    Stockholders Equity as
    
    of Reinsurance as of
    
    Equity as ofReinsurance
    
    September 30, 2006
    
    of September 30, 2006 (1)
    
    December 31, 2005
    
    December 31, 2005 (1)(Dollars in thousands)(10.0)%
    
    $
    142,250
    
    
    
    9.3
    %
    
    $
    119,640
    
    
    
    8.5
    %(7.5)%
    
    
    146,202
    
    
    
    7.0
    %
    
    
    122,964
    
    
    
    6.4
    %(5.0)%
    
    
    150,153
    
    
    
    4.6
    %
    
    
    126,287
    
    
    
    4.2
    %(2.5)%
    
    
    154,105
    
    
    
    2.3
    %
    
    
    129,610
    
    
    
    2.1
    %Base
    
    
    158,056
    
    
    
    
    
    
    
    132,934
    
    
    
    2.5%
    
    
    162,007
    
    
    
    -2.3
    %
    
    
    136,257
    
    
    
    -2.1
    %5.0%
    
    
    165,959
    
    
    
    -4.6
    %
    
    
    139,581
    
    
    
    -4.2
    %7.5%
    
    
    169,910
    
    
    
    -7.0
    %
    
    
    142,904
    
    
    
    -6.4
    %10.0%
    
    $
    173,862
    
    
    
    -9.3
    %
    
    $
    146,227
    
    
    
    -8.5
    %
 
 (1)
    
    Net of tax   September 30, 2006
    
    
    December 31, 2005(Dollars in thousands)Commercial lines:Commercial multi-peril
    
    $
    173,462
    
    
    $
    147,041Commercial automobile
    
    
    35,198
    
    
    
    32,581Other liability
    
    
    10,000
    
    
    
    9,632Workers compensation
    
    
    7,300
    
    
    
    6,058Surety
    
    
    5,387
    
    
    
    5,304Fire, allied, inland marine
    
    
    334
    
    
    
    318231,681
    
    
    
    200,934Personal lines:Homeowners
    
    
    7,223
    
    
    
    7,595Personal automobile
    
    
    2,046
    
    
    
    1,840Other liability
    
    
    1,022
    
    
    
    900Fire, allied, inland marine
    
    
    343
    
    
    
    344Workers compensation
    
    
    40
    
    
    
    6610,674
    
    
    
    10,745Total
    
    $
    242,355
    
    
    $
    211,679
 Investments.
 20




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##### Table of Contents



Policy Acquisition Costs.
 Reinsurance.
    Income Taxes.
 21




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##### Table of Contents



Results of Operations
     Nine and three month periods ended September 30, 2006 compared to nine and three month periods
ended September 30, 2005
  Nine months ended September 30,2006 vs. 2005 Income(Dollars in thousands)
    
    2006
    
    2005
    
    Change
    
    % ChangeCommercial lines underwriting income
    
    $
    4,468
    
    
    $
    3,242
    
    
    $
    1,226
    
    
    
    37.8
    %Personal lines underwriting loss
    
    
    (1,210
    )
    
    
    (1,121
    )
    
    
    (89
    )
    
    
    (7.9
    %)Total underwriting income
    
    
    3,258
    
    
    
    2,121
    
    
    
    1,137
    
    
    
    53.6
    %Net investment income
    
    
    7,057
    
    
    
    2,254
    
    
    
    4,803
    
    
    
    213.1
    %Net realized investment gains
    
    
    100
    
    
    
    1,273
    
    
    
    (1,173
    )
    
    
    (92.1
    %)Other revenue
    
    
    1,605
    
    
    
    256
    
    
    
    1,349
    
    
    
    527.0
    %Interest expense
    
    
    (913
    )
    
    
    
    
    
    
    (913
    )
    
    
    N/MIncome before income taxes
    
    
    11,107
    
    
    
    5,904
    
    
    
    5,203
    
    
    
    88.1
    %Income taxes
    
    
    3,368
    
    
    
    1,785
    
    
    
    1,583
    
    
    
    88.7
    %Net income
    
    $
    7,739
    
    
    $
    4,119
    
    
    $
    3,620
    
    
    
    87.9
    %Loss / LAE ratio (GAAP)
    
    
    63.1
    %
    
    
    47.6
    %
    
    
    15.5
    %Underwriting expense ratio (GAAP)
    
    
    33.7
    %
    
    
    47.7
    %
    
    
    (14.0
    )%Combined ratio (GAAP)
    
    
    96.8
    %
    
    
    95.3
    %
    
    
    1.5
    %Loss / LAE ratio (Statutory)
    
    
    60.3
    %
    
    
    47.6
    %
    
    
    12.7
    %Underwriting expense ratio (Statutory)
    
    
    34.0
    %
    
    
    47.1
    %
    
    
    (13.1
    )%Combined ratio (Statutory)
    
    
    94.3
    %
    
    
    94.7
    %
    
    
    (0.4
    )%
 22




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Three months ended September 30,2006 vs. 2005 Income(Dollars in thousands)
    
    2006
    
    2005
    
    Change
    
    % ChangeCommercial lines underwriting income
    
    $
    1,254
    
    
    $
    1,599
    
    
    $
    (345
    )
    
    
    (21.6
    %)Personal lines underwriting loss
    
    
    (342
    )
    
    
    (596
    )
    
    
    254
    
    
    
    42.6
    %Total underwriting income
    
    
    912
    
    
    
    1,003
    
    
    
    (91
    )
    
    
    (9.1
    %)Net investment income
    
    
    2,597
    
    
    
    770
    
    
    
    1,827
    
    
    
    237.3
    %Net realized investment gains
    
    
    (505
    )
    
    
    1,175
    
    
    
    (1,680
    )
    
    
    (143.0
    %)Other revenue
    
    
    527
    
    
    
    84
    
    
    
    443
    
    
    
    527.4
    %Interest expense
    
    
    (312
    )
    
    
    
    
    
    
    (312
    )
    
    
    N/MIncome before income taxes
    
    
    3,219
    
    
    
    3,032
    
    
    
    187
    
    
    
    6.2
    %Income taxes
    
    
    1,025
    
    
    
    971
    
    
    
    54
    
    
    
    5.6
    %Net income
    
    $
    2,194
    
    
    $
    2,061
    
    
    $
    133
    
    
    
    6.5
    %Loss / LAE ratio (GAAP)
    
    
    63.8
    %
    
    
    42.6
    %
    
    
    21.2
    %Underwriting expense ratio (GAAP)
    
    
    33.6
    %
    
    
    50.9
    %
    
    
    (17.3
    )%Combined ratio (GAAP)
    
    
    97.4
    %
    
    
    93.5
    %
    
    
    3.9
    %Loss / LAE ratio (Statutory)
    
    
    62.8
    %
    
    
    42.6
    %
    
    
    15.2
    %Underwriting expense ratio (Statutory)
    
    
    33.2
    %
    
    
    51.4
    %
    
    
    (13.9
    )%Combined ratio (Statutory)
    
    
    96.0
    %
    
    
    94.0
    %
    
    
    1.3
    %
 
 N/M means Not Meaningful 23




---



##### Table of Contents



Nine months ended September 30,2006 vs. 2005 Revenue(Dollars in thousands)
    
    2006
    
    2005
    
    Change
    
    % ChangeDirect premiums written
    
    $
    146,470
    
    
    $
    48,004
    
    
    $
    98,466
    
    
    
    205.1
    %Net premiums written
    
    
    115,738
    
    
    
    44,112
    
    
    
    71,626
    
    
    
    162.4
    %Net premiums earned
    
    
    102,172
    
    
    
    45,378
    
    
    
    56,794
    
    
    
    125.2
    %Net investment income
    
    
    7,057
    
    
    
    2,254
    
    
    
    4,803
    
    
    
    213.1
    %Realized investment gains
    
    
    100
    
    
    
    1,273
    
    
    
    (1,173)
    
    
    
    (92.1
    )%Other revenue
    
    
    1,605
    
    
    
    256
    
    
    
    1,349
    
    
    
    527.0
    %Total Revenue
    
    $
    110,934
    
    
    $
    49,161
    
    
    $
    61,773
    
    
    
    125.7
    %
 Three months ended September 30,2006 vs. 2005 Revenue(Dollars in thousands)
    
    2006
    
    2005
    
    Change
    
    % ChangeDirect premiums written
    
    $
    45,749
    
    
    $
    15,270
    
    
    $
    30,479
    
    
    
    199.6
    %Net premiums written
    
    
    34,809
    
    
    
    14,171
    
    
    
    20,638
    
    
    
    145.6
    %Net premiums earned
    
    
    35,004
    
    
    
    15,404
    
    
    
    19,600
    
    
    
    127.2
    %Net investment income
    
    
    2,597
    
    
    
    770
    
    
    
    1,827
    
    
    
    237.3
    %Realized investment (losses) gains
    
    
    (505
    )
    
    
    1,175
    
    
    
    (1,680)
    
    
    
    (143.0
    )%Other revenue
    
    
    527
    
    
    
    84
    
    
    
    443
    
    
    
    527.4
    %Total Revenue
    
    $
    37,623
    
    
    $
    17,433
    
    
    $
    20,190
    
    
    
    115.8
    %
 
 N/M
    
    means Not Meaningful 24




---



##### Table of Contents



25




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##### Table of Contents



Net
Investment Income
 Nine months ended September 30,2006 vs. 2005 Investment income andrealized gains(Dollars in thousands)
    
    2006
    
    2005
    
    Change
    
    % ChangeFixed income securities
    
    $
    7,961
    
    
    $
    2,651
    
    
    $
    5,310
    
    
    
    200.3
    %Dividends
    
    
    213
    
    
    
    303
    
    
    
    (90
    )
    
    
    (29.7
    )%Cash, cash equivalents & other
    
    
    710
    
    
    
    582
    
    
    
    128
    
    
    
    22.0
    %Gross investment income
    
    
    8,884
    
    
    
    3,536
    
    
    
    5,348
    
    
    
    151.2
    %Investment expenses
    
    
    (1,827
    )
    
    
    (1,282
    )
    
    
    (545
    )
    
    
    42.5
    %Net investment income
    
    $
    7,057
    
    
    $
    2,254
    
    
    $
    4,803
    
    
    
    213.1
    %Realized losses on fixed income
    
    $
    (385
    )
    
    $
    (498
    )
    
    $
    113
    
    
    
    N/MRealized gains on equities
    
    
    401
    
    
    
    1,771
    
    
    
    (1,370
    )
    
    
    N/MRealized gains  other
    
    
    84
    
    
    
    
    
    
    
    84
    
    
    
    N/MNet realized gains
    
    $
    100
    
    
    $
    1,273
    
    
    $
    (1,173
    )
    
    
    N/M
 Three months ended September 30,2006 vs. 2005 Investment income andrealized gains (losses)(Dollars in thousands)
    
    2006
    
    2005
    
    Change
    
    % ChangeFixed income securities
    
    $
    2,818
    
    
    $
    806
    
    
    $
    2,012
    
    
    
    249.6
    %Dividends
    
    
    68
    
    
    
    94
    
    
    
    (26
    )
    
    
    (27.7
    )%Cash, cash equivalents & other
    
    
    307
    
    
    
    322
    
    
    
    (15
    )
    
    
    (4.7
    )%Gross investment income
    
    
    3,193
    
    
    
    1,222
    
    
    
    1,971
    
    
    
    161.3
    %Investment expenses
    
    
    (596
    )
    
    
    (452
    )
    
    
    (144
    )
    
    
    31.9
    %Net investment income
    
    $
    2,597
    
    
    $
    770
    
    
    $
    1,827
    
    
    
    237.3
    %Realized losses on fixed income
    
    $
    
    
    
    $
    (89
    )
    
    $
    89
    
    
    
    N/MRealized gains on equities
    
    
    11
    
    
    
    1,264
    
    
    
    (1,253
    )
    
    
    N/MRealized losses  other
    
    
    (516
    )
    
    
    
    
    
    
    (516
    )
    
    
    N/MNet realized
(losses) gains
    
    $
    (505
    )
    
    $
    1,175
    
    
    $
    (1,680
    )
    
    
    N/M
 
 (N/M means not meaningful)     26




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##### Table of Contents



Length of Unrealized LossSeptember 30, 2006
    
    Fair
    
    
    Unrealized
    
    
    Less than
    
    
    6 to 12
    
    
    Over 12(in thousands)
    
    Value
    
    
    Losses
    
    
    6 months
    
    
    Months
    
    
    MonthsEquity securities:Preferred stocks
    
    $
    463
    
    
    
    12
    
    
    
    
    
    
    
    12
    
    
    $
    Common stocks
    
    
    1,758
    
    
    
    179
    
    
    
    179
    
    
    
    
    
    
    
    Total equities
    
    $
    2,221
    
    
    
    191
    
    
    
    179
    
    
    
    12
    
    
    $
    
  Less than 12 Months
    
    
    12 Months or Longer
    
    
    TotalEstimated
    
    
    Unrealized
    
    
    Estimated
    
    
    Unrealized
    
    
    Estimated
    
    
    UnrealizedSeptember 30, 2006
    
    Fair Value
    
    
    Losses
    
    
    Fair Value
    
    
    Losses
    
    
    Fair Value
    
    
    LossesU.S. Treasury
securities and
obligations of U.S.
government corporations
and agencies
    
    $
    4,446
    
    
    $
    33
    
    
    $
    50,527
    
    
    $
    869
    
    
    $
    54,973
    
    
    $
    902Obligations of states and
political subdivisions
    
    
    4,722
    
    
    
    22
    
    
    
    47,911
    
    
    
    463
    
    
    
    52,633
    
    
    
    485Corporate securities
    
    
    7,234
    
    
    
    45
    
    
    
    42,768
    
    
    
    778
    
    
    
    50,002
    
    
    
    823Mortgage-backed securities
    
    
    1,991
    
    
    
    9
    
    
    
    13,707
    
    
    
    161
    
    
    
    15,698
    
    
    
    170Total fixed maturities
    
    
    18,393
    
    
    
    109
    
    
    
    154,913
    
    
    
    2,271
    
    
    
    173,306
    
    
    
    2,380Total equity securities
    
    
    2,221
    
    
    
    191
    
    
    
    
    
    
    
    
    
    
    
    2,221
    
    
    
    191Total securities in a
temporary unrealized loss
position
    
    $
    20,614
    
    
    $
    300
    
    
    $
    154,913
    
    
    $
    2,271
    
    
    $
    175,527
    
    
    $
    2,571
    27




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##### Table of Contents



Nine months ended September 30,2006 vs. 2005 Commercial lines (CL)(Dollars in thousands)
    
    2006
    
    2005
    
    Change
    
    % ChangeCL Direct premiums written
    
    $
    128,170
    
    
    $
    30,832
    
    
    $
    97,338
    
    
    
    315.7
    %CL Net premiums written
    
    $
    98,842
    
    
    $
    28,005
    
    
    $
    70,837
    
    
    
    252.9
    %CL Net premiums earned
    
    $
    85,263
    
    
    $
    28,517
    
    
    $
    56,746
    
    
    
    199.0
    %CL Loss / LAE expense ratio (GAAP)
    
    
    62.2
    %
    
    
    39.1
    %
    
    
    23.1
    %CL Expense ratio (GAAP)
    
    
    32.6
    %
    
    
    49.5
    %
    
    
    (16.9
    )%CL Combined ratio (GAAP)
    
    
    94.8
    %
    
    
    88.6
    %
    
    
    6.2
    %
 Three months ended September 30,2006 vs. 2005 Commercial lines (CL)(Dollars in thousands)
    
    2006
    
    2005
    
    Change
    
    % ChangeCL Direct premiums written
    
    $
    39,332
    
    
    $
    9,104
    
    
    $
    30,228
    
    
    
    332.0
    %CL Net premiums written
    
    $
    28,879
    
    
    $
    8,393
    
    
    $
    20,486
    
    
    
    244.1
    %CL Net premiums earned
    
    $
    29,336
    
    
    $
    9,860
    
    
    $
    19,476
    
    
    
    197.5
    %CL Loss / LAE expense ratio (GAAP)
    
    
    63.1
    %
    
    
    33.0
    %
    
    
    30.1
    %CL Expense ratio (GAAP)
    
    
    32.6
    %
    
    
    50.8
    %
    
    
    (18.2
    )%CL Combined ratio (GAAP)
    
    
    95.7
    %
    
    
    83.8
    %
    
    
    11.9
    %
        28




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##### Table of Contents



Nine months ended September 30,2006 vs. 2005 Personal lines (PL)(Dollars in thousands)
    
    2006
    
    2005
    
    Change
    
    % ChangePL Direct premiums written
    
    $
    18,300
    
    
    $
    17,172
    
    
    $
    1,128
    
    
    
    6.6
    %PL Net premiums written
    
    $
    16,896
    
    
    $
    16,107
    
    
    $
    789
    
    
    
    4.9
    %PL Net premiums earned
    
    $
    16,909
    
    
    $
    16,861
    
    
    $
    48
    
    
    
    0.3
    %PL Loss / LAE expense ratio (GAAP)
    
    
    68.1
    %
    
    
    61.9
    %
    
    
    6.2
    %PL Expense ratio (GAAP)
    
    
    39.1
    %
    
    
    44.7
    %
    
    
    (5.6
    )%PL Combined ratio (GAAP)
    
    
    107.2
    %
    
    
    106.6
    %
    
    
    0.6
    %
 Three months ended September 30,2006 vs. 2005 Personal lines (PL)(Dollars in thousands)
    
    2006
    
    2005
    
    Change
    
    % ChangePL Direct premiums written
    
    $
    6,417
    
    
    $
    6,166
    
    
    $
    251
    
    
    
    4.1
    %PL Net premiums written
    
    $
    5,930
    
    
    $
    5,778
    
    
    $
    152
    
    
    
    2.6
    %PL Net premiums earned
    
    $
    5,668
    
    
    $
    5,544
    
    
    $
    124
    
    
    
    2.2
    %PL Loss / LAE expense ratio (GAAP)
    
    
    67.1
    %
    
    
    59.7
    %
    
    
    7.4
    %PL Expense ratio (GAAP)
    
    
    38.9
    %
    
    
    51.0
    %
    
    
    (12.1
    )%PL Combined ratio (GAAP)
    
    
    106.0
    %
    
    
    110.7
    %
    
    
    (4.7
    )%
      29




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##### Table of Contents



2006 vs. 2005 Expenses and expense ratio
    
    2006
    
    2005
    
    Change
    
    % ChangeAmortization of DAC
    
    $
    24,187
    
    
    $
    11,936
    
    
    $
    12,251
    
    
    
    102.6
    %As a % of net premiums earned
    
    
    23.7
    %
    
    
    26.3
    %
    
    
    (2.6
    )%Other underwriting expenses
    
    
    10,208
    
    
    
    9,725
    
    
    
    483
    
    
    
    5.0
    %Total expenses excluding losses/LAE and interest expense
    
    $
    34,395
    
    
    $
    21,661
    
    
    $
    12,734
    
    
    
    58.8
    %Underwriting expense ratio
    
    
    33.7
    %
    
    
    47.7
    %
    
    
    (14.0
    )%
    30




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##### Table of Contents



2006 vs. 2005 Income taxes
    
    2006
    
    2005
    
    Change
    
    % ChangeIncome before income taxes
    
    $
    11,107
    
    
    $
    5,904
    
    
    $
    5,203
    
    
    
    88.1
    %Income taxes
    
    
    3,368
    
    
    
    1,785
    
    
    
    1,583
    
    
    
    88.7
    %Net income
    
    $
    7,739
    
    
    $
    4,119
    
    
    $
    3,620
    
    
    
    87.9
    %Effective tax rate
    
    
    30.3
    %
    
    
    30.2
    %
    
    
    0.1
    %
  LIQUIDITY AND CAPITAL RESOURCES
        31




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##### Table of Contents



32




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##### Table of Contents



IMPACT OF INFLATION
   OFF BALANCE SHEET COMMITMENTS AND CONTRACTUAL OBLIGATIONS
   33




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk
 General.
 Interest Rate Risk.
 Credit Risk.
 Equity Risk.
  
 Item 4. Controls and Procedures
  
 Part II  OTHER INFORMATION
 
 Item 1. Legal Proceedings.
  
 Item 1A. Risk Factors.
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
  
 Item 3. Defaults Upon Senior Securities
  34




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##### Table of Contents



Item 4. Submission of Matters to Vote of Security Holders
  
 Item 5. Other Information
  
 Item 6. Exhibits
 Exhibits
 Exhibit No.
    
    Title3.1
    
    Articles of Incorporation of Mercer Insurance Group, Inc.
(incorporated by reference herein to the Companys
Pre-effective Amendment No. 3 on Form S-1, SEC File No.
333-104897.)3.2
    
    Bylaws of Mercer Insurance Group, Inc. (incorporated by
reference herein to the Companys Annual Report on Form
10-K, SEC File No. 000-25425, for the fiscal year ended
December 31, 2003.)10.2
    
    Employment Agreement, dated as of
October 1, 2006, among Bicus Services Corporation, Mercer
Insurance Group, Inc., Mercer Insurance Company and Paul R. Corkery (filed herewith)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)
 35




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##### Table of Contents



SIGNATURES
  MERCER
    
    INSURANCE GROUP, INC. (Registrant)Dated: November 9, 2006
    
    By:
    
    /s/ Andrew R. SpeakerAndrew R. Speaker,President and Chief Executive OfficerDated: November 9, 2006
    
    By:
    
    /s/ David B. MercleanDavid B. Merclean,Senior Vice President and Chief Financial Officer
 36