##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  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, 2004 OR [   ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the Transition
Period Fromto 000-50511
Commission File Number UNITED NATIONAL GROUP, LTD.  Cayman Islands
(State or other jurisdiction
of incorporation or organization)
    
    98-0417107
(I.R.S. Employer Identification No.)
 WALKER HOUSE, 87 MARY STREET
P.O. BOX 908GT
GEORGE TOWN, GRAND CAYMAN
CAYMAN ISLANDS
(Address of principal executive office including zip code) (345) 949-0100
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO
[   ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES [   ] NO
[X] As of November 11, 2004, the registrant had outstanding 15,584,090 Class A
Common Shares and 12,687,500 Class B Common Shares.




---



TABLE OF CONTENTS PagePART I  FINANCIAL INFORMATIONItem 1. Financial Statements:Consolidated Balance Sheets
    
    
    3Consolidated Statements of Operations
Three Months Ended September 30, 2004 and 2003
    
    
    4Consolidated Statements of Operations
Nine Months Ended September 30, 2004 and 2003
    
    
    5Consolidated Statements of Comprehensive Income
Three Months Ended September 30, 2004 and 2003
    
    
    6Consolidated Statements of Comprehensive Income
Nine Months Ended September 30, 2004 and 2003
    
    
    7Consolidated Statements of Changes in Shareholders Equity
    
    
    8Consolidated Statements of Cash Flows
    
    
    9Notes to Consolidated Financial Statements
    
    
    10Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    37Item 4. Controls and Procedures
    
    
    38PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    39Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    39Item 3. Defaults Upon Senior Securities
    
    
    39Item 4. Submission of Matters to a Vote of Security Holders
    
    
    39Item 5.
Other Information
    
    
    39Item 6.Exhibits
    
    
    40Signatures
    
    
    41CertificationsExhibit Index
  As used in this quarterly report, unless the context requires otherwise, (1)
United National Group refers to United National Group, Ltd., an exempted
company incorporated with limited liability under the laws of the Cayman
Islands; (2) we, us and our refer to United National Group and its
subsidiaries as a whole; (3) our U.S. Operations refers to the insurance and
related operations conducted by American Insurance Service, Inc. and its
subsidiaries, including American Insurance Adjustment Agency, Inc., Diamond
State Insurance Company, J.H. Ferguson & Associates, LLC, United National
Casualty Insurance Company, United National Insurance Company and United
National Specialty Insurance Company; (4) our U.S. Insurance Subsidiaries
refers to United National Insurance Company, Diamond State Insurance Company,
United National Specialty Insurance Company and United National Casualty
Insurance Company; (5) U.N. Barbados refers to Wind River Insurance Company
(Barbados) Ltd.; (6) U.N. Bermuda refers to Wind River Insurance Company,
Ltd.; (7) our Non-U.S. Operations refers to the insurance and reinsurance and
related operations of U.N. Barbados and U.N. Bermuda; (8) Fox Paine & Company
refers to Fox Paine & Company, LLC and affiliated investment funds; and (9) $
or dollars refers to U.S. dollars. 2




---



##### Table of Contents



PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements UNITED NATIONAL GROUP, LTD. 
 Consolidated Balance Sheets
(Dollars in thousands, except share amounts) (Unaudited)Successor
    
    Successoras of
    
    as ofSeptember 30, 2004
    
    December 31, 2003ASSETSBonds:Available for sale securities, at fair value
(amortized cost: $611,639 and $540,543)
    
    $
    621,636
    
    
    $
    549,966Preferred shares:Available for sale securities, at fair value
(cost: $4,838 and $4,372)
    
    
    4,877
    
    
    
    4,894Common shares:Available for sale securities, at fair value
(cost: $31,502 and $30,762)
    
    
    34,163
    
    
    
    33,219Other invested assets
    
    
    51,013
    
    
    
    45,434Total investments
    
    
    711,689
    
    
    
    633,513Cash and cash equivalents
    
    
    189,069
    
    
    
    214,796Agents balances, net
    
    
    51,185
    
    
    
    62,374Reinsurance receivables, net
    
    
    1,650,957
    
    
    
    1,762,988Accrued investment income
    
    
    7,753
    
    
    
    5,909Federal income taxes receivable
    
    
    9,078
    
    
    
    4,898Deferred federal income taxes, net
    
    
    25,024
    
    
    
    25,323Deferred acquisition costs, net
    
    
    26,074
    
    
    
    8,581Prepaid reinsurance premiums
    
    
    59,546
    
    
    
    117,936Other assets
    
    
    12,162
    
    
    
    12,443Total assets
    
    $
    2,742,537
    
    
    $
    2,848,761LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Unpaid losses and loss adjustment expenses
    
    $
    1,965,015
    
    
    $
    2,059,760Unearned premiums
    
    
    158,311
    
    
    
    177,408Amounts held for the account of others
    
    
    15,350
    
    
    
    20,201Ceded balances payable
    
    
    29,792
    
    
    
    59,876Payable for securities
    
    
    20,060
    
    
    
    Contingent commissions
    
    
    5,236
    
    
    
    5,178Senior notes payable to related party
    
    
    72,848
    
    
    
    72,848Junior subordinated debentures
    
    
    30,929
    
    
    
    30,929Other liabilities
    
    
    28,491
    
    
    
    41,769Total liabilities
    
    
    2,326,032
    
    
    
    2,467,969Commitments and contingencies (Note 6)
    
    
    
    
    
    
    Shareholders equity:Common shares, $0.0001 par value, 900,000,000 common
shares authorized, 15,584,090 and 15,105,503 Class A
common shares issued and outstanding and 12,687,500
Class B common shares issued and outstanding
    
    
    3
    
    
    
    3Preferred shares, $0.0001 par value, 100,000,000
shares authorized, none issued and outstanding
    
    
    
    
    
    
    Additional paid-in capital
    
    
    356,488
    
    
    
    347,487Accumulated other comprehensive income
    
    
    13,517
    
    
    
    10,031Retained earnings
    
    
    46,497
    
    
    
    23,271Total shareholders equity
    
    
    416,505
    
    
    
    380,792Total liabilities and shareholders equity
    
    $
    2,742,537
    
    
    $
    2,848,761
 See accompanying notes to consolidated financial statements. 3




---



##### Table of Contents



UNITED NATIONAL GROUP, LTD. 
 Consolidated Statements of Operations
(Dollars in thousands, except per share data) (Unaudited)
    
    (Unaudited)(Unaudited)
    
    Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    July 1, 2003Three Months Ended
    
    through
    
    throughSeptember 30, 2004
    
    September 30, 2003
    
    September 5, 2003Revenues:Gross premiums written
    
    $
    108,657
    
    
    $
    33,190
    
    
    $
    147,670Net premiums written
    
    $
    78,243
    
    
    $
    9,692
    
    
    $
    39,655Net premiums earned
    
    $
    60,933
    
    
    $
    10,687
    
    
    $
    33,857Net investment income
    
    
    5,010
    
    
    
    792
    
    
    
    3,960Net realized investment gains (losses)
    
    
    (1,080
    )
    
    
    (718
    )
    
    
    2,473Total revenues
    
    
    64,863
    
    
    
    10,761
    
    
    
    40,290Losses and Expenses:Net losses and loss adjustment expenses
    
    
    34,616
    
    
    
    7,360
    
    
    
    23,040Acquisition costs and other underwriting expenses
    
    
    23,783
    
    
    
    4,576
    
    
    
    9,706Other operating expenses
    
    
    314
    
    
    
    124
    
    
    
    11Interest expense
    
    
    1,378
    
    
    
    249
    
    
    
    34Income (loss) before income taxes
    
    
    4,772
    
    
    
    (1,548
    )
    
    
    7,499Income tax (benefit) expense
    
    
    (1,425
    )
    
    
    (1,106
    )
    
    
    1,851Net income (loss) before equity in net
earnings of partnerships
    
    
    6,197
    
    
    
    (442
    )
    
    
    5,648Equity in net earnings of partnerships
    
    
    309
    
    
    
    258
    
    
    
    347Net income (loss) before extraordinary gain
    
    
    6,506
    
    
    
    (184
    )
    
    
    5,995Extraordinary gain
    
    
    1,195
    
    
    
    46,424
    
    
    
    Net income
    
    $
    7,701
    
    
    $
    46,240
    
    
    $
    5,995Per share data:Net income (loss) available to common
shareholders before extraordinary gain:Basic
    
    $
    0.23
    
    
    $
    (1.04
    )
    
    $
    59,950Diluted
    
    $
    0.23
    
    
    $
    (1.04
    )
    
    $
    59,950Extraordinary gain:Basic
    
    $
    0.04
    
    
    $
    3.63
    
    
    $
    Diluted
    
    $
    0.04
    
    
    $
    3.63
    
    
    $
    Net income:Basic
    
    $
    0.27
    
    
    $
    2.59
    
    
    $
    59,950Diluted
    
    $
    0.27
    
    
    $
    2.59
    
    
    $
    59,950Weighted-average number of shares outstanding:Basic
    
    
    28,268,716
    
    
    
    12,806,250
    
    
    
    100Diluted
    
    
    28,771,120
    
    
    
    12,806,250
    
    
    
    100
 See accompanying notes to consolidated financial statements. 4




---



##### Table of Contents



UNITED NATIONAL GROUP, LTD. 
 Consolidated Statements of Operations
(Dollars in thousands, except per share data) (Unaudited)
    
    (Unaudited)(Unaudited)
    
    Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    January 1, 2003Nine Months Ended
    
    through
    
    throughSeptember 30, 2004
    
    September 30, 2003
    
    September 5, 2003Revenues:Gross premiums written
    
    $
    314,733
    
    
    $
    33,190
    
    
    $
    510,623Net premiums written
    
    $
    205,043
    
    
    $
    9,692
    
    
    $
    139,116Net premiums earned
    
    $
    165,751
    
    
    $
    10,687
    
    
    $
    128,254Net investment income
    
    
    13,637
    
    
    
    792
    
    
    
    13,289Net realized investment gains (losses)
    
    
    (687
    )
    
    
    (718
    )
    
    
    5,589Total revenues
    
    
    178,701
    
    
    
    10,761
    
    
    
    147,132Losses and Expenses:Net losses and loss adjustment expenses
    
    
    98,395
    
    
    
    7,360
    
    
    
    85,178Acquisition costs and other underwriting expenses
    
    
    56,658
    
    
    
    4,576
    
    
    
    30,147Provision for doubtful reinsurance receivables
    
    
    
    
    
    
    
    
    
    
    1,750Other operating expenses
    
    
    1,007
    
    
    
    124
    
    
    
    377Interest expense
    
    
    4,087
    
    
    
    249
    
    
    
    46Income (loss) before income taxes
    
    
    18,554
    
    
    
    (1,548
    )
    
    
    29,634Income tax (benefit) expense
    
    
    (2,551
    )
    
    
    (1,106
    )
    
    
    6,864Net income (loss) before equity in net earnings
of partnerships
    
    
    21,105
    
    
    
    (442
    )
    
    
    22,770Equity in net earnings of partnerships, net of taxes
    
    
    926
    
    
    
    258
    
    
    
    1,834Net income (loss) before extraordinary gain
    
    
    22,031
    
    
    
    (184
    )
    
    
    24,604Extraordinary gain
    
    
    1,195
    
    
    
    46,424
    
    
    
    Net income
    
    $
    23,226
    
    
    $
    46,240
    
    
    $
    24,604Per share data:Net income (loss) available to common shareholders
before extraordinary gain:Basic
    
    $
    0.78
    
    
    $
    (1.04
    )
    
    $
    246,040Diluted
    
    $
    0.77
    
    
    $
    (1.04
    )
    
    $
    246,040Extraordinary gain:Basic
    
    $
    0.04
    
    
    $
    3.63
    
    
    $
    Diluted
    
    $
    0.04
    
    
    $
    3.63
    
    
    $
    Net income:Basic
    
    $
    0.82
    
    
    $
    2.59
    
    
    $
    246,040Diluted
    
    $
    0.81
    
    
    $
    2.59
    
    
    $
    246,040Weighted-average number of shares outstanding:Basic
    
    
    28,254,998
    
    
    
    12,806,250
    
    
    
    100Diluted
    
    
    28,829,597
    
    
    
    12,806,250
    
    
    
    100
 See accompanying notes to consolidated financial statements. 5




---



##### Table of Contents



UNITED NATIONAL GROUP, LTD. 
 Consolidated Statements of Comprehensive Income
(Dollars in thousands) (Unaudited)
    
    (Unaudited)(Unaudited)
    
    Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    July 1, 2003Three Months Ended
    
    through
    
    throughSeptember 30, 2004
    
    September 30, 2003
    
    September 5, 2003Net income
    
    $
    7,701
    
    
    $
    46,240
    
    
    $
    5,995Other comprehensive income (loss) before tax:Unrealized gains (losses) on securities:Unrealized holding gains (losses) arising during period
    
    
    9,646
    
    
    
    13,538
    
    
    
    (1,625
    )Less:Reclassification adjustment for gains (losses)
included in net income
    
    
    (727
    )
    
    
    170
    
    
    
    8,482Other comprehensive income (loss), before tax
    
    
    10,373
    
    
    
    13,368
    
    
    
    (10,107
    )Income tax expense (benefit) related to items of other
comprehensive income
    
    
    3,305
    
    
    
    4,679
    
    
    
    (3,539
    )Other comprehensive income (loss), net of tax
    
    
    7,068
    
    
    
    8,689
    
    
    
    (6,568
    )Comprehensive income (loss), net of tax
    
    $
    14,769
    
    
    $
    54,929
    
    
    $
    (573
    )
 See accompanying notes to consolidated financial statements. 6




---



##### Table of Contents



UNITED NATIONAL GROUP, LTD. 
 Consolidated Statements of Comprehensive Income
(Dollars in thousands) (Unaudited)
    
    (Unaudited)(Unaudited)
    
    Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    January 1, 2003Nine Months Ended
    
    through
    
    throughSeptember 30, 2004
    
    September 30, 2003
    
    September 5, 2003Net income
    
    $
    23,226
    
    
    $
    46,240
    
    
    $
    24,604Other comprehensive income (loss) before tax:Unrealized gains (losses) on securities:Unrealized holding gains (losses) arising during period
    
    
    3,878
    
    
    
    13,538
    
    
    
    (2,450
    )Less:Reclassification adjustment for gains (losses)
included in net income
    
    
    (554
    )
    
    
    170
    
    
    
    568Other comprehensive income (loss), before tax
    
    
    4,432
    
    
    
    13,368
    
    
    
    (3,018
    )Income tax expense (benefit) related to items of other
comprehensive income
    
    
    946
    
    
    
    4,679
    
    
    
    (1,056
    )Other comprehensive income (loss), net of tax
    
    
    3,486
    
    
    
    8,689
    
    
    
    (1,962
    )Comprehensive income, net of tax
    
    $
    26,712
    
    
    $
    54,929
    
    
    $
    22,642
 See accompanying notes to consolidated financial statements. 7




---



##### Table of Contents



UNITED NATIONAL GROUP, LTD. 
 Consolidated Statements of Changes in Shareholders Equity
(Dollars in thousands) Successor
    
    Predecessor(Unaudited)
    
    September 6, 2003
    
    January 1, 2003Successor
    
    through
    
    throughSeptember 30, 2004
    
    December 31, 2003
    
    September 5, 2003Common shares:Number at beginning of period
    
    
    27,793,003
    
    
    
    10,000,000
    
    
    
    100Class A common shares issued in acquisition
    
    
    
    
    
    
    2,500,000
    
    
    
    Class A common shares issued under stock
purchase plan
    
    
    
    
    
    
    245,208
    
    
    
    Class A common shares issued in IPO
    
    
    462,500
    
    
    
    10,750,000Class A common shares issued in redemption of
Series A preferred shares
    
    
    
    
    
    
    1,610,295
    
    
    
    Class A common shares issued to directors
    
    
    3,681
    
    
    
    
    
    
    
    Class B common shares issued in exchange for Series
A preferred shares
    
    
    
    
    
    
    2,687,500
    
    
    
    Number at end of period
    
    
    28,259,184
    
    
    
    27,793,003
    
    
    
    100Common shares:Balance at beginning of period
    
    $
    3
    
    
    $
    1
    
    
    $
    Class A common shares issued in IPO
    
    
    
    
    
    
    2
    
    
    
    Balance at end of period
    
    $
    3
    
    
    $
    3
    
    
    $
    Preferred shares:Number at beginning of period
    
    
    
    
    
    
    14,000,000
    
    
    
    Preferred shares issued in acquisition
    
    
    
    
    
    
    3,500,000
    
    
    
    Preferred shares redeemed
    
    
    
    
    
    
    (15,000,000
    )
    
    
    Preferred shares exchanged for Class B common shares
    
    
    
    
    
    
    (2,500,000
    )
    
    
    Number at end of period
    
    
    
    
    
    
    
    
    
    
    Preferred shares:Balance at beginning of period
    
    $
    
    
    
    $
    2
    
    
    $
    Preferred shares redeemed
    
    
    
    
    
    
    (2
    )
    
    
    Preferred shares exchanged for Class B common shares
    
    
    
    
    
    
    
    
    
    
    Balance at end of period
    
    $
    
    
    
    $
    
    
    
    $
    Additional paid-in capital:Balance at beginning of period
    
    $
    347,487
    
    
    $
    239,997
    
    
    $
    81,186Preferred share dividends
    
    
    
    
    
    
    29,250Preferred shares redeemed
    
    
    
    
    
    
    (149,998
    )
    
    
    Contributed capital from preferred shares
    
    
    
    
    
    
    35,000
    
    
    
    Contributed capital from common shares
    
    
    7,312
    
    
    
    193,238
    
    
    
    5,638Other
    
    
    1,689
    
    
    
    
    
    
    
    Balance at end of period
    
    $
    356,488
    
    
    $
    347,487
    
    
    $
    86,824Accumulated other comprehensive income net of
deferred income tax:Balance at beginning of period
    
    $
    10,031
    
    
    $
    
    
    
    $
    7,329Other comprehensive income (loss)
    
    
    3,486
    
    
    
    10,031
    
    
    
    (1,962
    )Balance at end of period
    
    $
    13,517
    
    
    $
    10,031
    
    
    $
    5,367Retained earnings:Balance at beginning of period
    
    $
    23,271
    
    
    $
    
    
    
    $
    180,122Net income
    
    
    23,226
    
    
    
    52,521
    
    
    
    24,604Preferred share dividends
    
    
    
    
    
    
    (29,250
    )
    
    
    Balance at end of period
    
    $
    46,497
    
    
    $
    23,271
    
    
    $
    204,726Total shareholders equity
    
    $
    416,505
    
    
    $
    380,792
    
    
    $
    296,917
 See accompanying notes to consolidated financial statements. 8




---



##### Table of Contents



UNITED NATIONAL GROUP, LTD. 
 Consolidated Statements of Cash Flows
(Dollars in thousands) (Unaudited)
    
    (Unaudited)(Unaudited)
    
    Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    January 1, 2003Nine Months Ended
    
    through
    
    throughSeptember 30, 2004
    
    September 30, 2003
    
    September 5, 2003Cash flows from operating activities:Net income
    
    $
    23,226
    
    
    $
    46,240
    
    
    $
    24,604Adjustments to reconcile net income to net cash
(used for) provided by operating activities:Amortization of debt issuance costs
    
    
    135
    
    
    
    
    
    
    
    Restricted stock expense
    
    
    415
    
    
    
    
    
    
    
    Extraordinary gain
    
    
    (1,195
    )
    
    
    (46,424
    )
    
    
    Deferred federal income taxes
    
    
    2,572
    
    
    
    2,253
    
    
    
    39Amortization of bond premium and discount, net
    
    
    2,282
    
    
    
    266
    
    
    
    1,504Net realized investment gains
    
    
    687
    
    
    
    718
    
    
    
    2,994Equity in net earnings of partnerships
    
    
    (926
    )
    
    
    (258
    )
    
    
    (1,834
    )Unrealized loss on trading securities
    
    
    
    
    
    
    
    
    
    
    (8,583
    )Provision for doubtful reinsurance receivables
    
    
    
    
    
    
    
    
    
    
    1,750Proceeds from sale or maturity of trading securities
    
    
    
    
    
    
    
    
    
    
    9,827Purchase of trading securities
    
    
    
    
    
    
    
    
    
    
    (9,764
    )Changes in:Agents balances
    
    
    11,189
    
    
    
    13,906
    
    
    
    (32,077
    )Reinsurance receivables
    
    
    112,031
    
    
    
    9,049
    
    
    
    (102,611
    )Unpaid losses and loss adjustment expenses
    
    
    (94,745
    )
    
    
    14,469
    
    
    
    116,172Unearned premiums
    
    
    (19,097
    )
    
    
    (4,570
    )
    
    
    5,450Ceded balances payable
    
    
    (30,084
    )
    
    
    (8,886
    )
    
    
    25,691Other liabilities
    
    
    (12,004
    )
    
    
    (13,167
    )
    
    
    (24,170
    )Amounts held for the account of others
    
    
    (4,851
    )
    
    
    (5,917
    )
    
    
    5,070Contingent commissions
    
    
    58
    
    
    
    75
    
    
    
    1,718Federal income tax receivable
    
    
    (6,676
    )
    
    
    (6,858
    )
    
    
    31,099Prepaid reinsurance premiums
    
    
    58,390
    
    
    
    3,890
    
    
    
    5,100Deferred acquisition costs, net
    
    
    (17,493
    )
    
    
    
    
    
    
    Payable for securities
    
    
    
    
    
    
    (23
    )
    
    
    (6,227
    )Other  net
    
    
    (1,659
    )
    
    
    (20,113
    )
    
    
    1,489Net cash provided by (used for) operating activities
    
    
    22,255
    
    
    
    (15,350
    )
    
    
    47,241Cash flows from investing activities:Proceeds from sale of bonds and stocks
    
    
    187,958
    
    
    
    12,473
    
    
    
    70,629Proceeds from maturity of bonds
    
    
    
    
    
    
    
    
    
    
    3,525Proceeds from sale of other invested assets
    
    
    1,795
    
    
    
    125
    
    
    
    14,433Purchase of bonds and stocks
    
    
    (242,613
    )
    
    
    (1,151
    )
    
    
    (101,924
    )Proceeds from sale or repayment of mortgages
    
    
    
    
    
    
    
    
    
    
    8Proceeds from sale of mortgage
    
    
    
    
    
    
    
    
    
    
    1,166Purchase of other invested assets
    
    
    (2,434
    )
    
    
    (2,892
    )
    
    
    (8,663
    )Acquisition of business, net of cash acquired
    
    
    
    
    
    
    (10,837
    )
    
    
    Net cash used for investing activities
    
    
    (55,294
    )
    
    
    (2,282
    )
    
    
    (20,826
    )Cash flows from financing activities:Borrowing under credit facility
    
    
    
    
    
    
    
    
    
    
    4,650Repayments of credit facility
    
    
    
    
    
    
    
    
    
    
    (4,650
    )Capital contribution from Ball family trusts
    
    
    
    
    
    
    
    
    
    
    5,638Issuance of common shares under stock purchase plan
    
    
    
    
    
    
    1,988
    
    
    
    Issuance of trust preferred securities
    
    
    
    
    
    
    10,000
    
    
    
    Net proceeds from IPO of common shares
    
    
    7,312
    
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    7,312
    
    
    
    11,988
    
    
    
    5,638Net change in cash and cash equivalents
    
    
    (25,727
    )
    
    
    (5,644
    )
    
    
    32,053Cash and cash equivalents at beginning of period
    
    
    214,796
    
    
    
    240,000
    
    
    
    72,942Cash and cash equivalents at end of period
    
    $
    189,069
    
    
    $
    234,356
    
    
    $
    104,995
 See accompanying notes to consolidated financial statements. 9




---



##### Table of Contents



UNITED NATIONAL GROUP, LTD. 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited) (1) Principles of Consolidation and Basis of Presentation The consolidated financial statements include the accounts of United National
Group, Ltd. and its direct and indirect wholly-owned subsidiaries (United
National Group or the Company): Wind River Insurance Company (Barbados)
Ltd. (U.N. Barbados), Wind River Insurance Company, Ltd. (U.N. Bermuda),
U.N. Holdings II, Inc., U.N. Holdings Inc., Wind River Investment Corporation,
American Insurance Service, Inc. (AIS), American Insurance Adjustment Agency,
Inc. (AIAA), International Underwriters, Inc. (IUI), Unity Risk Partners
Insurance Services, Inc. (URP), United National Insurance Company (UNIC),
Diamond State Insurance Company (Diamond State), United National Specialty
Insurance Company (United National Specialty), United National Casualty
Insurance Company (United National Casualty) and J.H. Ferguson & Associates,
LLC (J.H. Ferguson). All significant intercompany balances and transactions
have been eliminated in consolidation. The Company acquired all of the outstanding common stock of Wind River
Investment Corporation and its subsidiaries (Wind River or the Predecessor)
on September 5, 2003 (the Acquisition). As a result of the Acquisition, the
capital structure and basis of accounting of the Company differ from those of
Wind River prior to the Acquisition. Therefore, the financial data with
respect to periods prior to the Acquisition (Predecessor period) may not be
comparable to data for periods subsequent to the Acquisition (Successor
period). The consolidated financial statements as of September 30, 2004 and for the
quarter and nine months ended September 30, 2004 and 2003 are unaudited, but in
the opinion of management have been prepared in conformity with accounting
principles generally accepted in the United States of America (GAAP) and on
the same basis as the annual audited consolidated financial statements. The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the date
of the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates. The consolidated financial statements include all adjustments that are, in the
opinion of management, necessary for a fair statement of results for the
interim periods. Results of operations for the quarter and nine months ended
September 30, 2004 and 2003 are not necessarily indicative of the results of a
full year. The accompanying notes to the consolidated financial statements
should be read in conjunction with the notes to the consolidated financial
statements contained in the Companys 2003 Annual Report on Form 10-K. Certain prior period amounts have been reclassified to conform to current
period presentation. (2) Investments Assets of $458.3 million and $294.7 million as of September 30, 2004 and
December 31, 2003, respectively, were on deposit or included in trusts to meet
statutory and other regulatory requirements enacted by states or stipulated by
the insurance departments. Assets on deposit or subject to trusts included
cash of $65.7 million and $1.9 million and bonds with estimated fair values of
$392.6 million and $292.8 million as of September 30, 2004 and December 31,
2003, respectively. In addition, bonds with an estimated fair market value of
$5.4 million at September 30, 2004 and December 31, 2003 were held in a trust
fund to meet the regulatory requirements of U.N. Bermuda. The carrying amounts for the Companys investments approximate their estimated
fair value. The Company measures the fair value of investments in bonds and
stocks based upon quoted market prices. Other invested assets are comprised
primarily of limited liability partnership interests. Partnership interests of
3% ownership or greater are accounted for using the equity method. Partnership
interests of less than 3% ownership are carried at their fair value. The Companys investments are regularly evaluated to determine if declines in
market value below cost are other than temporary. If market value declines are
determined to be other than temporary, the securitys cost basis is adjusted to
the market value of the security, with the loss recognized in the current
period. The following table contains an analysis of the Companys securities with gross
unrealized losses, categorized by the period that the securities were in a
continuous loss position as of September 30, 2004: 10




---



##### Table of Contents



Gross Unrealized LossesBetweenSevenNumber of
    
    
    
    
    
    
    
    
    
    
    
    
    
    Six Months
    
    Months and
    
    Greater than(In thousands)
    
    Securities
    
    Fair Value
    
    Book Value
    
    Total
    
    or Less
    
    One Year
    
    One YearBonds
    
    
    58
    
    
    $
    131,540
    
    
    $
    132,485
    
    
    $
    945
    
    
    $
    546
    
    
    $
    312
    
    
    $
    87Preferred Stock
    
    
    2
    
    
    
    1,227
    
    
    
    1,273
    
    
    
    46
    
    
    
    1
    
    
    
    45
    
    
    
    Common Stock
    
    
    54
    
    
    
    7,733
    
    
    
    8,700
    
    
    
    967
    
    
    
    395
    
    
    
    451
    
    
    
    121$
    1,958
    
    
    $
    942
    
    
    $
    808
    
    
    $
    208
 During the three and nine months ended September 30, 2004, the Company recorded
other than temporary impairment losses of $0.2 million on its equity portfolio.
During the three and nine months ended September 30, 2003, the Company recorded
other than temporary losses of $0 and $1.9 million, respectively, on its bond
portfolio, and $0 and $0.7 million, respectively, on its investments in limited
partnerships. (3) Reinsurance The Company cedes insurance to unrelated insurers in the ordinary course of
business to limit its net loss exposure. In addition, there are excess of loss
contracts that protect against losses over stipulated amounts. Reinsurance
ceded arrangements do not discharge the Company of primary liability as the
originating insurer. As of September 30, 2004, the Company had total reinsurance receivables of
$1,651.0 million, including $53.6 million of reinsurance receivables related to
paid losses. The carrying value of the receivables is net of a $31.2 million
reduction, which is equal to an estimate of potentially uncollectible
reinsurance receivables. The Companys estimate of potentially uncollectible
receivables, which was $49.1 million at the date of the Acquisition, has been
reduced to $31.2 million as of September 30, 2004 primarily as a result of a
commutation agreement with Trenwick America Reinsurance Corp. on October 29,
2003. As of December 31, 2003, the Company had reinsurance receivables of
$1,763.0 million, net of a $33.7 million reduction related to potentially
uncollectible receivables. The U.S. Insurance Subsidiaries have entered into a quota share arrangement
with U.N. Barbados and U.N. Bermuda. This reinsurance arrangement resulted in
45% and 15% of our net retained insurance liability on new and renewal business
bound January 1, 2004 through April 30, 2004 being ceded to U.N. Barbados and
U.N. Bermuda, respectively. The agreement also stipulates that 60% of the U.S.
Insurance Subsidiaries December 31, 2003 net unearned premium be ceded to our
Non-U.S. Operations. This quota share arrangement was modified effective May 1, 2004. The new
arrangement stipulates that 60% of the U.S. Insurance Subsidiaries net
retained insurance liability on new and renewal business bound May 1, 2004 and
later be ceded to U.N. Bermuda. The modified arrangement also stipulates that
60% of the U.S. Insurance Subsidiaries April 30, 2004 unearned premium be
ceded to U.N. Bermuda. (4) Federal Income Taxes The following tables summarize the differences between the effective tax rate
for financial statement purposes and the U.S. federal statutory rate: Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    July 1, 2003Three Months Ended
    
    through
    
    throughSeptember 30, 2004
    
    September 30, 2003
    
    September 5, 2003% of Pre-
    
    
    
    
    
    % of Pre-
    
    
    
    
    
    % of Pre-(Dollars in thousands)
    
    Amount
    
    Tax Income
    
    Amount
    
    Tax Income
    
    Amount
    
    Tax IncomeExpected tax expense (benefit) at
the U. S. statutory rate
    
    $
    1,670
    
    
    
    35.0
    %
    
    $
    (542
    )
    
    
    (35.0
    )%
    
    $
    2,625
    
    
    
    35.0
    %Adjustments:Tax exempt interest
    
    
    (1,127
    )
    
    
    (23.6
    )
    
    
    (593
    )
    
    
    (38.3
    )
    
    
    (728
    )
    
    
    (9.7
    )Foreign income not expected
to be taxed in the U.S.
    
    
    (2,663
    )
    
    
    (55.8
    )
    
    
    51
    
    
    
    3.3
    
    
    
    (1
    )
    
    
    Dividend exclusion
    
    
    (35
    )
    
    
    (0.7
    )
    
    
    (11
    )
    
    
    (0.7
    )
    
    
    (24
    )
    
    
    (0.3
    )Non- resident withholding
    
    
    145
    
    
    
    3.0
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    585
    
    
    
    12.2
    
    
    
    (11
    )
    
    
    (0.7
    )
    
    
    (21
    )
    
    
    (0.3
    )Actual tax expense (benefit)
    
    $
    (1,425
    )
    
    
    (29.9
    )%
    
    $
    (1,106
    )
    
    
    (71.4
    )%
    
    $
    1,851
    
    
    
    24.7
    %
 11




---



##### Table of Contents



Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    January 1, 2003Nine Months Ended
    
    through
    
    throughSeptember 30, 2004
    
    September 30, 2003
    
    September 5, 2003% of Pre-
    
    
    
    
    
    % of Pre-
    
    
    
    
    
    % of Pre-(Dollars in thousands)
    
    Amount
    
    Tax Income
    
    Amount
    
    Tax Income
    
    Amount
    
    Tax IncomeExpected tax expense (benefit) at
the U. S. statutory rate
    
    $
    6,494
    
    
    
    35.0
    %
    
    $
    (542
    )
    
    
    (35.0
    )%
    
    $
    10,372
    
    
    
    35.0
    %Adjustments:Tax exempt interest
    
    
    (3,465
    )
    
    
    (18.7
    )
    
    
    (593
    )
    
    
    (38.3
    )
    
    
    (3,404
    )
    
    
    (11.5
    )Foreign income not expected
to be taxed in the U.S.
    
    
    (6,728
    )
    
    
    (36.3
    )
    
    
    51
    
    
    
    3.3
    
    
    
    (1
    )
    
    
    Dividend exclusion
    
    
    (103
    )
    
    
    (0.6
    )
    
    
    (11
    )
    
    
    (0.7
    )
    
    
    (95
    )
    
    
    (0.3
    )Non- resident withholding
    
    
    437
    
    
    
    2.4
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    814
    
    
    
    4.4
    
    
    
    (11
    )
    
    
    (0.7
    )
    
    
    (8
    )
    
    
    Actual tax expense (benefit)
    
    $
    (2,551
    )
    
    
    (13.8
    )%
    
    $
    (1,106
    )
    
    
    (71.4
    )%
    
    $
    6,864
    
    
    
    23.2
    %
 In the quarter and nine months ended September 30, 2004 the Company recognized
an extraordinary gain of $1.2 million for tax benefits derived from acquisition
costs included as a reduction in equity as a result of the Acquisition, that
have been or will be deducted in the future from income for federal tax
purposes. The Company has managed its business in a manner designed to reduce the risk
that U.N. Barbados will be treated as engaged in a U.S. trade or business for
U.S. federal income tax purposes. On July 14, 2004 a protocol was signed by
the U.S. Treasury Secretary and the Barbados Minister of Industry and
International Business to amend the U.S.  Barbados Convention for the
Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect
to Taxes on Income Signed on December 31, 1984, as amended. The protocol was
ratified by the U.S. Senate on October 10, 2004. The treaty amendment is
awaiting ratification by the Barbados government. Provisions of the proposed
amended treaty would be effective the first day of the second month following
ratification with respect to tax withheld by the payor on amounts of interest
not subject to a portfolio exemption and on dividends or royalties paid or
credited, and would be effective for taxable years beginning on or after the
first day of January following ratification for other taxes. Under the
protocol, U.N. Barbados investment income on an intercompany note payable to
U.N. Barbados on or after the effective dates of the amendment would be subject
to U.S. withholding tax of 30 percent, an increase from the existing rate of 5
percent. The investment income subject to this tax was $2.9 million and $8.7
million for the quarter and nine months ended September 30, 2004, respectively.
The Company has identified an alternative that it believes will mitigate the
impact of the protocol on its overall effective tax rate. The Company has
begun to implement this plan and expects to have it in place before year-end
2004. (5) Liability for Unpaid Losses and Loss Adjustment Expenses The liability for unpaid losses and loss adjustment expenses reflects the
Companys best estimate for future amounts needed to pay losses and related
settlement expenses and the impact of the Companys reinsurance coverages with
respect to insured events. Estimating the ultimate claims liability of the
Company is necessarily a complex and judgmental process, inasmuch as the
amounts are based on managements informed estimates and judgments using data
currently available. In some cases, significant periods of time, up to several
years or more, may elapse between the occurrence of an insured loss and the
reporting of such to the Company. The method for determining the Companys
liability for unpaid losses and loss adjustment expenses includes, but is not
limited to, reviewing past loss experience and considering other factors such
as legal, social, and economic developments. As additional experience and data
become available, the Companys estimate for the liability for unpaid losses
and loss adjustment expenses is revised accordingly. If the Companys ultimate
losses, net of reinsurance, prove to differ substantially from the amounts
recorded with respect to unpaid losses and loss adjustment expenses at
September 30, 2004, the related adjustments could have a material impact on the
Companys results of operations. During the three months ended September 30, 2004, the Company experienced
catastrophe losses attributable to Hurricanes Charley, Frances, Ivan, and
Jeanne. The Company has estimated the gross and net aggregate loss and loss
adjustment expenses from the hurricanes to be $10.7 million and $1.7 million,
respectively. The net loss and loss adjustment expense of $1.7 million
included in the incurred loss and loss adjustment expense for the quarter and
nine month periods ending September 30, 2004 is reflective of the Companys
historically small property book and particularly the small exposure to wind
related losses in the state of Florida. (6) Commitments and Contingencies Various lawsuits against the Company have arisen in the ordinary course of the
Companys business, including defending coverage claims brought against the
Company by its policyholders or others. The Companys litigation, including
coverage claims matters, is subject to many uncertainties, and given their
complexity and scope, the outcomes cannot be predicted with certainty. It is
possible that the results of operations in a particular quarterly or annual
period could be materially affected by an ultimate unfavorable outcome of
litigation and/or coverage claim matters. 12




---



##### Table of Contents



On January 22, 2004, Diamond State elected to enter into a settlement with Bank
of America, N.A. and Platinum Indemnity Limited
relative to litigation pending in the United States District Court for the
Southern District of New York. Under the terms of the settlement, Diamond State
paid $17.8 million to Bank of America and provided other non-financial
consideration to Bank of America and Platinum in exchange for a full and final
release by Bank of America and Platinum, and other consideration, relative to
their claims of approximately $29.0 million, plus interest in excess of $10.0
million and fees and costs, related to facultative reinsurance policies
issued by Worldwide Weather Insurance Agency, and its principal Harold Mollin,
purportedly on behalf of Diamond State. As a result of the settlement, Diamond State is proceeding with an arbitration
against Partner Reinsurance Company, Ltd. and Partner Reinsurance Company of
the U.S. seeking recovery under a reinsurance agreement covering business
produced by Worldwide Weather Insurance Agency on a 100% basis with regard to
the type of risk involved. In that connection, Diamond State holds a letter of
credit dated March 31, 2004 from Partner Reinsurance Company, Ltd. in the
amount of $17.8 million. In addition, Diamond State is seeking indemnification
and contribution from Partner Reinsurance Company of the U.S. because of its
role in the appointment of Mr. Mollin and Worldwide Weather Insurance Agency.
The arbitration hearing commenced on November 8, 2004. On October 5, 2004, UNIC agreed in principle to settle, in consideration of a
payment by Gulf Underwriters Insurance Company (Gulf) to UNIC in the amount
of $1.8 million, a lawsuit instituted by Gulf pending in the Superior Court of
Fulton County, Georgia. The lawsuit had sought to rescind a facultative
reinsurance certificate issued by Gulf to UNIC with regard to an individual
insurance policy written by UNIC and ceded to Gulf. The facultative
reinsurance certificate provided 100% reinsurance to UNIC for loss and loss
adjustment expenses paid under the insurance policy. The lawsuit had followed
UNICs billing to Gulf for reimbursement of a loss in the amount of $3.1
million that UNIC had paid under that insurance policy and for which UNIC filed
a counterclaim against Gulf. The settlement of this matter had no material
effect on the financial condition or results of operations of the Company. Recently, state and federal
regulators, including the New York State Attorney General and others,
have instituted investigations, legal actions, and general inquiries
concerning alleged anti-competitive conduct within the insurance
industry. These allegations reference improper sales practices and
other non-competitive conduct. In light of this industry-wide regulatory scrutiny,
the Company has proactively initiated its own internal review with the assistance of
outside counsel. Management believes that the ultimate outcome of all litigation, arbitration,
reinsurance recoverable, and coverage claim matters, after consideration of
applicable reserves, should not have a material adverse effect on the Companys
financial condition. (7) Shareholders Equity In January 2004, the Company issued 462,500 Class A common shares at a price of
$17.00 per share in connection with the exercise by the underwriters of the
remaining overallotment option related to the Companys initial public
offering, which was consummated in December 2003. Proceeds to the Company, net
of underwriting discounts of $0.5 million, were $7.3 million. (8) Earnings Per Share Basic earnings per share is computed using the weighted average number of
common shares outstanding during the period. Diluted earning per share is
computed using the weighted average number of common shares outstanding during
the period, as well as the weighted average number of common share equivalents
outstanding during the period. The following tables set forth the computation
of basic and diluted earnings per share: 13




---



##### Table of Contents



Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    July 1, 2003Three Months Ended
    
    through
    
    through(Dollars in thousands, except per share data)
    
    September 30, 2004
    
    September 30, 2003
    
    September 5, 2003Net income (loss) before extraordinary gain
    
    $
    6,506
    
    
    $
    (184
    )
    
    $
    5,995Less: Preferred stock dividends
    
    
    
    
    
    
    (13,125
    )
    
    
    Net income (loss) available to common shareholders
before extraordinary gain
    
    
    6,506
    
    
    
    (13,309
    )
    
    
    5,995Extraordinary gain
    
    
    1,195
    
    
    
    46,424
    
    
    
    Net income
    
    $
    7,701
    
    
    $
    33,115
    
    
    $
    5,995Weighted average shares for basic earnings per share
    
    
    28,268,716
    
    
    
    12,806,250
    
    
    
    100Basic earnings (loss) per share:Net income (loss) available to common shareholders
before extraordinary gain
    
    $
    0.23
    
    
    $
    (1.04
    )
    
    $
    59,950Extraordinary gain
    
    
    0.04
    
    
    
    3.63
    
    
    
    Net income
    
    $
    0.27
    
    
    $
    2.59
    
    
    $
    59,950Weighted average shares for diluted earnings per share
    
    
    28,771,120
    
    
    
    12,806,250
    
    
    
    100Diluted earnings (loss) per share:Net income (loss) available to common shareholders
before extraordinary gain
    
    $
    0.23
    
    
    $
    (1.04
    )
    
    $
    59,950Extraordinary gain
    
    
    0.04
    
    
    
    3.63
    
    
    
    Net income
    
    $
    0.27
    
    
    $
    2.59
    
    
    $
    59,950
 Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    January 1, 2003Nine Months Ended
    
    through
    
    through(Dollars in thousands, except per share data)
    
    September 30, 2004
    
    September 30, 2003
    
    September 5, 2003Net income (loss) before extraordinary gain
    
    $
    22,031
    
    
    $
    (184
    )
    
    $
    24,604Less: Preferred stock dividends
    
    
    
    
    
    
    (13,125
    )
    
    
    Net income (loss) available to common shareholders
before extraordinary gain
    
    
    22,031
    
    
    
    (13,309
    )
    
    
    24,604Extraordinary gain
    
    
    1,195
    
    
    
    46,424
    
    
    
    Net income
    
    $
    23,226
    
    
    $
    33,115
    
    
    $
    24,604Weighted average shares for basic earnings per share
    
    
    28,254,998
    
    
    
    12,806,250
    
    
    
    100Basic earnings (loss) per share:Net income (loss) available to common shareholders
before extraordinary gain
    
    $
    0.78
    
    
    $
    (1.04
    )
    
    $
    246,040Extraordinary gain
    
    $
    0.04
    
    
    
    3.63
    
    
    
    Net income
    
    $
    0.82
    
    
    $
    2.59
    
    
    $
    246,040Weighted average shares for diluted earnings per share
    
    
    28,829,597
    
    
    
    12,806,250
    
    
    
    100Diluted earnings (loss) per share:Net income (loss) available to common shareholders
before extraordinary gain
    
    $
    0.77
    
    
    $
    (1.04
    )
    
    $
    246,040Extraordinary gain
    
    $
    0.04
    
    
    
    3.63
    
    
    
    Net income
    
    $
    0.81
    
    
    $
    2.59
    
    
    $
    246,040
 (9) Segment Information The Companys operations are classified into two reportable business segments
that are organized around its two underwriting divisions: excess and surplus
(E&S) lines and specialty admitted. The segments follow the same accounting
policies used for the Companys consolidated financial statements as described
in the summary of significant accounting policies in the Companys Annual
Report on Form 10-K for the year ended December 31, 2003. Management evaluates
a segments performance based upon premium production and the associated losses
and loss adjustment expense experience. Investments and investment performance,
acquisition costs and other underwriting expenses, including commissions,
premium taxes and other acquisition costs, and other operating expenses are
managed at a corporate level and are included in the Corporate segment. 14




---



##### Table of Contents



Gross premiums written by product class are as follows: Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    July 1, 2003Quarter Ended
    
    through
    
    through(Dollars in thousands)
    
    September 30, 2004
    
    September 30, 2003
    
    September 5, 2003Specific specialty
    
    $
    16,067
    
    
    $
    14,962
    
    
    $
    85,558Umbrella and excess
    
    
    10,363
    
    
    
    8,230
    
    
    
    19,291Property and general liability
    
    
    52,447
    
    
    
    5,916
    
    
    
    23,040Non-medical professional liability
    
    
    29,780
    
    
    
    4,082
    
    
    
    19,781$
    108,657
    
    
    $
    33,190
    
    
    $
    147,670
 Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    January 1, 2003Nine Months Ended
    
    through
    
    through(Dollars in thousands)
    
    September 30, 2004
    
    September 30, 2003
    
    September 5, 2003Specific specialty
    
    $
    77,265
    
    
    $
    14,962
    
    
    $
    230,183Umbrella and excess
    
    
    30,920
    
    
    
    8,230
    
    
    
    126,617Property and general liability
    
    
    135,722
    
    
    
    5,916
    
    
    
    91,022Non-medical professional liability
    
    
    70,826
    
    
    
    4,082
    
    
    
    62,801$
    314,733
    
    
    $
    33,190
    
    
    $
    510,623
 Following is a tabulation of business segment information. Corporate
information is included to reconcile segment data to the consolidated financial
statements. Successor
Quarter Ended September 30, 2004:
(Dollars in thousands) E&S
    
    SpecialtyLines
    
    Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    68,486
    
    
    $
    40,171
    
    
    $
    
    
    
    $
    108,657Net premiums written
    
    $
    42,888
    
    
    $
    35,355
    
    
    $
    
    
    
    $
    78,243Net premiums earned
    
    $
    34,529
    
    
    $
    26,404
    
    
    $
    
    
    
    $
    60,933Net investment income
    
    
    
    
    
    
    
    
    
    
    5,010
    
    
    
    5,010Net realized investment gains
    
    
    
    
    
    
    
    
    
    
    (1,080
    )
    
    
    (1,080
    )Total revenues
    
    
    34,529
    
    
    
    26,404
    
    
    
    3,930
    
    
    
    64,863Losses and Expenses:Net losses and loss adjustment expenses
    
    
    17,886
    
    
    
    16,730
    
    
    
    
    
    
    
    34,616Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    23,783
    
    
    
    23,783Other operating expenses
    
    
    
    
    
    
    
    
    
    
    314
    
    
    
    314Interest expense
    
    
    
    
    
    
    
    
    
    
    1,378
    
    
    
    1,378Income (loss) before income taxes
    
    
    16,643
    
    
    
    9,674
    
    
    
    (21,545
    )
    
    
    4,772Income tax benefit
    
    
    
    
    
    
    
    
    
    
    (1,425
    )
    
    
    (1,425
    )Net income (loss) before equity in net
earnings of partnerships
    
    
    16,643
    
    
    
    9,674
    
    
    
    (20,120
    )
    
    
    6,197Equity in net earnings of partnerships
    
    
    
    
    
    
    
    
    
    
    309
    
    
    
    309Net income (loss) before extraordinary gain
    
    
    16,643
    
    
    
    9,674
    
    
    
    (19,811
    )
    
    
    6,506Extraordinary gain
    
    
    
    
    
    
    
    
    
    
    1,195
    
    
    
    1,195Net income (loss)
    
    $
    16,643
    
    
    $
    9,674
    
    
    $
    (18,616
    )
    
    $
    7,701
 15




---



##### Table of Contents



Successor
September 6, 2003 through September 30, 2003
(Dollars in thousands) E&S
    
    SpecialtyLines
    
    Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    23,230
    
    
    $
    9,960
    
    
    $
    
    
    
    $
    33,190Net premiums written
    
    $
    5,785
    
    
    $
    3,907
    
    
    $
    
    
    
    $
    9,692Net premiums earned
    
    $
    6,495
    
    
    $
    4,192
    
    
    $
    
    
    
    $
    10,687Net investment income
    
    
    
    
    
    
    
    
    
    
    792
    
    
    
    792Net realized investment losses
    
    
    
    
    
    
    
    
    
    
    (718
    )
    
    
    (718
    )Total revenues
    
    
    6,495
    
    
    
    4,192
    
    
    
    74
    
    
    
    10,761Losses and Expenses:Net losses and loss adjustment expenses
    
    
    4,543
    
    
    
    2,817
    
    
    
    
    
    
    
    7,360Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    4,576
    
    
    
    4,576Other operating expenses
    
    
    
    
    
    
    
    
    
    
    124
    
    
    
    124Interest expense
    
    
    
    
    
    
    
    
    
    
    249
    
    
    
    249Income (loss) before income taxes
    
    
    1,952
    
    
    
    1,375
    
    
    
    (4,875
    )
    
    
    (1,548
    )Income tax benefit
    
    
    
    
    
    
    
    
    
    
    (1,106
    )
    
    
    (1,106
    )Net income (loss) before equity in net
earnings of partnerships
    
    
    1,952
    
    
    
    1,375
    
    
    
    (3,769
    )
    
    
    (442
    )Equity in net earnings of partnerships
    
    
    
    
    
    
    
    
    
    
    258
    
    
    
    258Net income (loss) before extraordinary gain
    
    
    1,952
    
    
    
    1,375
    
    
    
    (3,511
    )
    
    
    (184
    )Extraordinary gain
    
    
    
    
    
    
    
    
    
    
    46,424
    
    
    
    46,424Net income
    
    $
    1,952
    
    
    $
    1,375
    
    
    $
    42,913
    
    
    $
    46,240
 Predecessor
July 1, 2003 through September 5, 2003
(Dollars in thousands) E&S
    
    SpecialtyLines
    
    Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    115,442
    
    
    $
    32,228
    
    
    $
    
    
    
    $
    147,670Net premiums written
    
    $
    25,554
    
    
    $
    14,101
    
    
    $
    
    
    
    $
    39,655Net premiums earned
    
    $
    21,702
    
    
    $
    12,155
    
    
    $
    
    
    
    $
    33,857Net investment income
    
    
    
    
    
    
    
    
    
    
    3,960
    
    
    
    3,960Net realized investment gains
    
    
    
    
    
    
    
    
    
    
    2,473
    
    
    
    2,473Total revenues
    
    
    21,702
    
    
    
    12,155
    
    
    
    6,433
    
    
    
    40,290Losses and Expenses:Net losses and loss adjustment expenses
    
    
    12,866
    
    
    
    10,174
    
    
    
    
    
    
    
    23,040Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    9,706
    
    
    
    9,706Other operating expenses
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    11Interest expense
    
    
    
    
    
    
    
    
    
    
    34
    
    
    
    34Income (loss) before income taxes
    
    
    8,836
    
    
    
    1,981
    
    
    
    (3,318
    )
    
    
    7,499Income tax expense
    
    
    
    
    
    
    
    
    
    
    1,851
    
    
    
    1,851Net income (loss) before equity in net
earnings of partnerships
    
    
    8,836
    
    
    
    1,981
    
    
    
    (5,169
    )
    
    
    5,648Equity in net earnings of partnerships
    
    
    
    
    
    
    
    
    
    
    347
    
    
    
    347Net income (loss)
    
    $
    8,836
    
    
    $
    1,981
    
    
    $
    (4,822
    )
    
    $
    5,995
 16




---



##### Table of Contents



Successor
Nine Months Ended September 30, 2004:
(Dollars in thousands) E&S
    
    SpecialtyLines
    
    Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    206,237
    
    
    $
    108,496
    
    
    $
    
    
    
    $
    314,733Net premiums written
    
    $
    117,803
    
    
    $
    87,240
    
    
    $
    
    
    
    $
    205,043Net premiums earned
    
    $
    95,392
    
    
    $
    70,359
    
    
    $
    
    
    
    $
    165,751Net investment income
    
    
    
    
    
    
    
    
    
    
    13,637
    
    
    
    13,637Net realized investment losses
    
    
    
    
    
    
    
    
    
    
    (687
    )
    
    
    (687
    )Total revenues
    
    
    95,392
    
    
    
    70,359
    
    
    
    12,950
    
    
    
    178,701Losses and Expenses:Net losses and loss adjustment expenses
    
    
    54,758
    
    
    
    43,637
    
    
    
    
    
    
    
    98,395Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    56,658
    
    
    
    56,658Other operating expenses
    
    
    
    
    
    
    
    
    
    
    1,007
    
    
    
    1,007Interest expense
    
    
    
    
    
    
    
    
    
    
    4,087
    
    
    
    4,087Income (loss) before income taxes
    
    
    40,634
    
    
    
    26,722
    
    
    
    (48,802
    )
    
    
    18,554Income tax benefit
    
    
    
    
    
    
    
    
    
    
    (2,551
    )
    
    
    (2,551
    )Net income (loss) before equity in net
earnings of partnerships
    
    
    40,634
    
    
    
    26,722
    
    
    
    (46,251
    )
    
    
    21,105Equity in net earnings of partnerships
    
    
    
    
    
    
    
    
    
    
    926
    
    
    
    926Net income (loss) before extraordinary gain
    
    
    40,634
    
    
    
    26,722
    
    
    
    (45,325
    )
    
    
    22,031Extraordinary gain
    
    
    
    
    
    
    
    
    
    
    1,195
    
    
    
    1,195Net income (loss)
    
    $
    40,634
    
    
    $
    26,722
    
    
    $
    (44,130
    )
    
    $
    23,226
 Successor
September 6, 2003 through September 30, 2003
(Dollars in thousands) E&S
    
    SpecialtyLines
    
    Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    23,230
    
    
    $
    9,960
    
    
    $
    
    
    
    $
    33,190Net premiums written
    
    $
    5,785
    
    
    $
    3,907
    
    
    $
    
    
    
    $
    9,692Net premiums earned
    
    $
    6,495
    
    
    $
    4,192
    
    
    $
    
    
    
    $
    10,687Net investment income
    
    
    
    
    
    
    
    
    
    
    792
    
    
    
    792Net realized investment losses
    
    
    
    
    
    
    
    
    
    
    (718
    )
    
    
    (718
    )Total revenues
    
    
    6,495
    
    
    
    4,192
    
    
    
    74
    
    
    
    10,761Losses and Expenses:Net losses and loss adjustment expenses
    
    
    4,543
    
    
    
    2,817
    
    
    
    
    
    
    
    7,360Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    4,576
    
    
    
    4,576Other operating expenses
    
    
    
    
    
    
    
    
    
    
    124
    
    
    
    124Interest expense
    
    
    
    
    
    
    
    
    
    
    249
    
    
    
    249Income (loss) before income taxes
    
    
    1,952
    
    
    
    1,375
    
    
    
    (4,875
    )
    
    
    (1,548
    )Income tax benefit
    
    
    
    
    
    
    
    
    
    
    (1,106
    )
    
    
    (1,106
    )Net income (loss) before equity in net
earnings of partnerships
    
    
    1,952
    
    
    
    1,375
    
    
    
    (3,769
    )
    
    
    (442
    )Equity in net earnings of partnerships
    
    
    
    
    
    
    
    
    
    
    258
    
    
    
    258Net income (loss) before extraordinary gain
    
    
    1,952
    
    
    
    1,375
    
    
    
    (3,511
    )
    
    
    (184
    )Extraordinary gain
    
    
    
    
    
    
    
    
    
    
    46,424
    
    
    
    46,424Net income
    
    $
    1,952
    
    
    $
    1,375
    
    
    $
    42,913
    
    
    $
    46,240
 17




---



##### Table of Contents



Predecessor
January 1, 2003 through September 5, 2003
(Dollars in thousands) E&S
    
    SpecialtyLines
    
    Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    357,394
    
    
    $
    153,229
    
    
    $
    
    
    
    $
    510,623Net premiums written
    
    $
    83,046
    
    
    $
    56,070
    
    
    $
    
    
    
    $
    139,116Net premiums earned
    
    $
    77,942
    
    
    $
    50,312
    
    
    $
    
    
    
    $
    128,254Net investment income
    
    
    
    
    
    
    
    
    
    
    13,289
    
    
    
    13,289Net realized investment gains
    
    
    
    
    
    
    
    
    
    
    5,589
    
    
    
    5,589Total revenues
    
    
    77,942
    
    
    
    50,312
    
    
    
    18,878
    
    
    
    147,132Losses and Expenses:Net losses and loss adjustment expenses
    
    
    51,166
    
    
    
    34,012
    
    
    
    
    
    
    
    85,178Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    30,147
    
    
    
    30,147Provision for doubtful reinsurance
    
    
    
    
    
    
    
    
    
    
    1,750
    
    
    
    1,750Other operating expenses
    
    
    
    
    
    
    
    
    
    
    377
    
    
    
    377Interest expense
    
    
    
    
    
    
    
    
    
    
    46
    
    
    
    46Income (loss) before income taxes
    
    
    26,776
    
    
    
    16,300
    
    
    
    (13,442
    )
    
    
    29,634Income tax expense
    
    
    
    
    
    
    
    
    
    
    6,864
    
    
    
    6,864Net income (loss) before equity in net
earnings of partnerships
    
    
    26,776
    
    
    
    16,300
    
    
    
    (20,306
    )
    
    
    22,770Equity in net earnings of partnerships
    
    
    
    
    
    
    
    
    
    
    1,834
    
    
    
    1,834Net income (loss)
    
    $
    26,776
    
    
    $
    16,300
    
    
    $
    (18,472
    )
    
    $
    24,604
 (10) Supplemental Cash Flow Information Taxes and Interest Paid Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    July 1, 2003Three Months Ended
    
    through
    
    through(Dollars in thousands)
    
    September 30, 2004
    
    September 30, 2003
    
    September 5, 2003Net federal income taxes paid (refunded)
    
    $
    (3
    )
    
    $
    3,500
    
    
    $
    (20,180
    )Interest paid
    
    
    410
    
    
    
    
    
    
    
    
 Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    January 1, 2003Nine Months Ended
    
    through
    
    through(Dollars in thousands)
    
    September 30, 2004
    
    September 30, 2003
    
    September 5, 2003Net federal income taxes paid (refunded)
    
    $
    1,113
    
    
    $
    3,500
    
    
    $
    (24,346
    )Interest paid
    
    
    1,203
    
    
    
    
    
    
    
    
 (11) Subsequent Events: United National Insurance Companys agreement to purchase Penn Independent
Corporation Pursuant to a stock purchase agreement entered into by United National Group,
UNIC, Penn Independent Corporation and the shareholders of Penn Independent
Corporation on October 14, 2004 (Stock Purchase Agreement), prior to the
closing of a proposed merger of a subsidiary of United National Group and Penn-America Group,
Inc. (Merger), UNIC will purchase all of the common stock of Penn Independent
Corporation for approximately $96.8 million, subject to adjustment in
accordance with the Stock Purchase Agreement. Penn Independent Corporation, a
privately held corporation located in Hatboro, Pennsylvania, is a leading U.S.
wholesale broker of commercial insurance for small and middle market
businesses, public entities and associations. Penn Independent Corporation also
owns 4,631,250 shares of Penn-America Group, Inc. (Penn-America) common
stock, which represents approximately 31.4% of the outstanding common stock of
Penn-America. Penn Independent Corporation is comprised of five major
businesses, including: Delaware Valley Underwriting Agency, Inc., a wholesale
agency primarily providing insurance polices on an excess and surplus lines
basis; Apex Insurance Agency, Inc., a specialty and reinsurance broker for
municipalities and government agencies; Stratus Insurance Services, Inc., a
niche association-based broker; Summit Risk Services, Inc., a third party
claims administrator; and Penn Independent Financial Services, Inc., a premium
finance company. Pursuant to the Stock Purchase Agreement, Penn Independent
Corporation has also agreed to vote its shares of Penn-America common stock in
favor of the adoption of the Agreement and Plan of Merger (the
Merger Agreement), dated October 14, 2004 by and
among Penn-America, United National Group, U.N. Holdings II,
Inc. and Cheltenham Acquisition Corp., which contemplates, among other things, the Merger, at a Penn-America special meeting
of shareholders. The Penn Independent Corporation transaction is expected to close in the first quarter of
2005. 18




---



##### Table of Contents



Proposed Merger of United National Group and Penn-America In a transaction separate from the Stock Purchase Agreement, on October 14,
2004 the board of directors of United National Group and the board of directors
of Penn-America agreed to a strategic combination of United National Group and
Penn-America under the terms of the Merger Agreement. Penn-America, a publicly
traded company, located in Hatboro, Pennsylvania, is a specialty property and
casualty insurance holding company, which markets and underwrites general
liability, commercial property and multi-peril insurance for small businesses
that are located in small towns and suburban and rural areas nationwide.
Penn-America distributes its products through a network of about 65 wholesale
general agents who serve the needs of more than 30,000 retail insurance
brokers. Subject to the terms and conditions of the Merger Agreement and in accordance
with Pennsylvania law, at the effective time of the Merger,
Cheltenham Acquisition Corp., a wholly-owned
subsidiary of U.N. Holdings II, Inc., that was formed for the purposes of the
Merger, will be merged with and into Penn-America. Penn-America will survive
the Merger as an
indirect, wholly-owned subsidiary of United National Group. The transaction is
expected to close in the first quarter of 2005. Each share of Penn-America common stock outstanding immediately prior to the
effective time of the Merger (other than shares held by United National Group,
Penn Independent Corporation or any of their subsidiaries) will be converted
into the right to receive (A) an amount of United National Group Class A common
shares equal to the result obtained by dividing $13.875 by the volume weighted
average sales price of a United National Group Class A common share during the
20 consecutive trading days ending on and including the trading day immediately
preceding the date of the effective time of the Merger and (B) cash equal to
$1.50, issuable and payable, without interest, upon surrender of the
certificate that formerly evidenced such share of Penn-America common stock. The Merger Agreement may be terminated at any time prior to the effective time
of the Merger by the mutual written consent of United National Group and
Penn-America. In addition, the Merger Agreement may be terminated by either
United National Group or Penn-America if the Merger has not been consummated as
of March 31, 2005, subject to certain limitations, and under other
circumstances described in the Merger Agreement. The transaction is expected to
close in the first quarter of 2005. The closing of the sale of the Penn Independent Corporation common stock is not
a condition to the closing of the Merger and the closing of the Merger is not a
condition to the sale of the Penn Independent Corporation common stock. Subject to the approval of the United National Group shareholders, United
National Group intends to changes its name to United America Indemnity, Ltd.
upon the close of the Merger. 19




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the consolidated financial
statements and accompanying notes of United National Group and Wind River
Investment Corporation included elsewhere in this report. Some of the
information contained in this discussion and analysis or set forth elsewhere in
this report, including information with respect to our plans and strategy,
constitutes forward-looking statements that involve risks and uncertainties.
Please see Cautionary Note Regarding Forward-Looking Statements for a
discussion of important factors that could cause actual results to differ
materially from the results described in or implied by the forward-looking
statements contained herein. For more information regarding our business and
operations, please see our Annual Report on Form 10-K for the year ended
December 31, 2003. Overview We acquired all of the outstanding common stock of Wind River Investment
Corporation and its subsidiaries (Wind River or the Predecessor) on
September 5, 2003 (the Acquisition). As a result of the Acquisition, the
capital structure and basis of accounting of United National Group differ from
those of Wind River prior to the Acquisition. Therefore, the financial data
with respect to periods prior to the Acquisition (Predecessor period) may not
be comparable to data for periods subsequent to the Acquisition (Successor
period). We operate our business principally through two business segments: excess and
surplus lines (E&S) and specialty admitted. Our E&S segment focuses on
writing insurance for hard-to-place risks and risks that standard admitted
insurers specifically choose not to write. Our specialty admitted segment
focuses on writing insurance for risks that are unique and hard to place in the
standard market for insureds that are required, for marketing and regulatory
reasons, to purchase insurance from an admitted insurance company. We offer four general classes of insurance products across both our E&S and
specialty admitted business segments. These four classes of products are
specific specialty insurance products, umbrella and excess insurance products,
property and general liability insurance products, and non-medical professional
liability insurance products. Our insurance products target very specific, defined, homogenous groups of
insureds with customized coverages to meet their needs. Our products include
customized underwriting guidelines, rates, and forms tailored to our risk and
underwriting philosophy. We distribute the insurance products of our U.S. Operations through our
wholly-owned subsidiary, J.H. Ferguson, as well as through a group of 67
professional general agencies that have limited quoting and binding authority. We derive our revenues primarily from premiums paid on insurance policies that
we write and from income generated by our investment portfolio, net of fees
paid for investment management and investment accounting services. The amount
of insurance premiums that we receive is a function of the amount and type of
policies we write, as well as of prevailing market prices. Our expenses include losses and loss adjustment expenses, acquisition costs and
other underwriting expenses, other operating expenses, and interest and other
investment expenses. Losses and loss adjustment expenses are estimated by
management and reflect our best estimate of ultimate losses and costs arising
during the reporting period and revisions of prior period estimates. We record
losses and loss adjustment expenses based on an actuarial analysis of the
estimated losses we expect to be reported on insurance policies written. The
ultimate losses and loss adjustment expenses will depend on the actual costs to
resolve claims. Acquisition expenses consist principally of commissions that
are typically a percentage of the premiums on insurance policies written, net
of ceding commissions earned from reinsurers. Other underwriting expenses
consist primarily of personnel expenses and general operating expenses. Other
operating expenses are comprised primarily of management fees paid to
affiliates. Interest expense consists of interest paid on funds held on behalf
of others, senior notes payable to related parties and junior subordinated
debentures. In managing the business and evaluating performance, our management focuses on
measures such as loss ratio, expense ratio, combined ratio and net operating
income, which we define as net income excluding after-tax realized investment
gains (losses) and extraordinary items that do not reflect overall operating
trends. Our management focuses on net operating income as a useful measure of
the profitability attributable to the ongoing operations of the business. Net
operating income is not a substitute for the net income determined in
accordance with GAAP, and investors should not place undue reliance on this
measure. During the nine months ended September 30, 2004, we realized additional
insurance policy rate increases at levels less than those levels realized
during the nine months ended September 30, 2003. These increases have resulted
primarily from a number of industry wide factors, including a reduction in
underwriting capacity, ratings downgrades, the exit or insolvency of several
insurers and the industry wide recording of reserve charges resulting from
reserve deficiencies. Recently, state and federal regulators, including the
New York State Attorney General and others, have instituted investigations, legal actions, and
general inquiries concerning alleged anti-competitive conduct within the insurance industry.
These allegations reference improper sales practices and other non-competitive conduct.
In light of this industry-wide regulatory scrutiny, we have proactively initiated our own
internal review with the assistance of outside counsel. 20




---



##### Table of Contents



United National Insurance Companys agreement to purchase Penn Independent
Corporation Pursuant to a stock purchase agreement entered into by United National Group,
United National Insurance Company, Penn Independent Corporation and the
shareholders of Penn Independent Corporation on October 14, 2004 (Stock
Purchase Agreement), prior to the closing of a proposed merger
of a subsidiary of United
National Group and Penn-America Group, Inc. (Merger), United National
Insurance Company will purchase all of the common stock of Penn Independent
Corporation from Penn Independent Corporations shareholders for approximately
$96.8 million, subject to adjustment in accordance with the Stock Purchase
Agreement. Penn Independent Corporation, a privately held corporation located
in Hatboro, Pennsylvania, is a leading U.S. wholesale broker of commercial
insurance for small and middle market businesses, public entities and
associations. Penn Independent Corporation also owns 4,631,250 shares of
Penn-America Group, Inc. (Penn-America) common stock, which represents
approximately 31.4% of the outstanding common stock of Penn-America. Penn
Independent Corporation is comprised of five major businesses, including:
Delaware Valley Underwriting Agency, Inc., a wholesale agency primarily
providing insurance polices on an excess and surplus lines basis; Apex
Insurance Agency, Inc., a specialty and reinsurance broker for municipalities
and government agencies; Stratus Insurance Services, Inc., a niche
association-based broker; Summit Risk Services, Inc., a third party claims
administrator; and Penn Independent Financial Services, Inc., a premium finance
company. Pursuant to the Stock Purchase Agreement, Penn Independent Corporation
has also agreed to vote its shares of Penn-America common stock in favor of the
adoption of the Agreement and Plan of Merger (the Merger
Agreement), dated October 14, 2004 by and among
Penn-America, United National Group, U.N. Holdings II, Inc. and
Cheltenham Acquisition Corp., which contemplates, among other things,
the Merger, at a Penn-America special meeting of
shareholders. The Penn Independent Corporation transaction is expected to close in the first quarter of
2005. Proposed Merger of United National Group and Penn-America In a transaction separate from the Stock Purchase Agreement, on October 14,
2004 the board of directors of United National Group and the board of directors
of Penn-America agreed to a strategic combination of United National Group and
Penn-America under the terms of the Merger Agreement. Penn-America, a publicly
traded company, located in Hatboro, Pennsylvania, is a specialty property and
casualty insurance holding company, which markets and underwrites general
liability, commercial property and multi-peril insurance for small businesses
that are located in small towns and suburban and rural areas nationwide.
Penn-America distributes its products through a network of about 65 wholesale
general agents who serve the needs of more than 30,000 retail insurance
brokers. Subject to the terms and conditions of the Merger Agreement and in accordance
with Pennsylvania law, at the effective time of the Merger,
Cheltenham Acquisition Corp., a wholly-owned
subsidiary of U.N. Holdings II, Inc. that was formed for the purposes of the Merger,
will be merged with and into Penn-America. Penn-America will survive the
Merger as an indirect,
wholly-owned subsidiary of United National Group. The transaction is expected
to close in the first quarter of 2005. Each share of Penn-America common stock outstanding immediately prior to the
effective time (other than shares held by United National Group, Penn
Independent Corporation or any of their subsidiaries) will be converted into
the right to receive (A) an amount of United National Group Class A common
shares equal to the result obtained by dividing $13.875 by the volume weighted
average sales price of a United National Group Class A common share, as
reported on the Nasdaq Stock Market by The Wall Street Journal during the 20
consecutive trading days ending on and including the trading day immediately
preceding the date of the effective time of the Merger and (B) an amount in
cash equal to $1.50, issuable and payable, without interest, upon surrender of
the certificate that formerly evidenced such share of Penn-America common
stock. Penn-America shareholders will receive cash for any fractional shares they
would otherwise receive in the Merger. The amount of cash for any fractional
shares Penn-America shareholders will receive will be equal to the product of
(A) the fractional share interest of a United National Group Class A common
share to which such holder otherwise would be entitled (after taking into
account all shares of Penn-America common stock held at the effective time by
such holder) multiplied by (B) the volume weighted average sales price of a
United National Group Class A common share during the 20 consecutive trading
days ending on and including the trading day immediately preceding the date of
the effective time. The Merger Agreement may be terminated at any time prior to the effective time
of the Merger by the mutual written consent of United National Group and
Penn-America. In addition, the Merger Agreement may be terminated by either
United National Group or Penn-America if the Merger has not been consummated as
of March 31, 2005, subject to certain limitations, and under other
circumstances described in the Merger Agreement. The transaction is expected to
close in the first quarter of 2005. The closing of the sale of the Penn Independent Corporation common stock is not
a condition to the closing of the Merger and the Closing of the Merger is not a
condition to the sale of the Penn Independent Corporation common stock. 21




---



##### Table of Contents



Subject to the approval of the United National Group shareholders, United
National Group intends to changes its name to United America Indemnity, Ltd.
upon the close of the Merger. Critical Accounting Policies and Estimates Investments Fair values The carrying amount for our investments approximates their estimated fair
value. We measure the fair value of investments in our fixed income and equity
portfolios based upon quoted market prices. We also hold other invested assets,
including investments in several limited partnerships, which were valued at
$51.0 million as of September 30, 2004. Several of the limited partnerships
invest solely in securities that are publicly traded and are valued at the net
asset value as reported by the investment manager. As of September 30, 2004,
our other invested assets portfolio included $20.2 million in securities for
which there is no readily available independent market price. The estimated
fair value of such securities is determined by the general partner of each
limited partnership based on comparisons to transactions involving similar
investments. Material assumptions and factors utilized in pricing these
securities include future cash flows, default rates, recovery rates and any
market clearing activity that may have occurred since the prior month-end
pricing period. Classification of Investments Prior to the Acquisition, our equity portfolio and our convertible bond
portfolio were treated as trading securities and, as such, any change in market
value was recorded on our income statement. Subsequent to the date of the
Acquisition, all securities have been designated as available for sale, and any
change in market value will be included in other comprehensive income in our
shareholders equity and, accordingly, have no effect on net income except for
investment market declines deemed to be other than temporary. Other Than Temporary Impairment We regularly perform various analytical procedures with respect to our
investments, including identifying any security the fair value of which is
below its cost. Upon identification of such securities, we perform a detailed
review of all such securities meeting predetermined thresholds, to determine
whether such decline is other than temporary. If we determine a decline in
value to be other than temporary based upon this detailed review, or if a
decline in value for an investment has persisted for 12 continuous months, or
if the value of the investment has been 20% or more below cost for six
continuous months or more, or significantly declines in value for shorter
periods of time, we evaluate the security to determine whether the cost basis
of the security should be written down to its fair value. The factors we
consider in reaching the conclusion that a decline below cost is other than
temporary include, among others, whether the issuer is in financial distress,
the investment is secured, a significant credit rating action occurred,
scheduled interest payments were delayed or missed and changes in laws or
regulations have affected an issuer or industry. We include the amount of any
write-down in earnings as a realized loss in the period in which the impairment
arose. At September 30, 2004, we had two equity securities whose decline in value had
persisted for 12 continuous months and two equity securities whose decline in
value had been more than 20% for six continuous months. These four securities
were written down to their fair value at September 30, 2004, and we recorded an
impairment charge of $0.2 million, which was included in net realized
investment gains (losses) for the quarter and nine months ended on September
30, 2004. Liability for Unpaid Losses and Loss Adjustment Expenses The liability for unpaid losses and loss adjustment expenses reflects our best
estimate for future amounts needed to pay losses and related adjustment
expenses and the impact of our reinsurance coverages with respect to insured
events. The process of establishing the liability for property and casualty
unpaid losses and loss adjustment expenses is a complex process, requiring the
use of informed estimates and judgments. This liability includes an amount
determined on the basis of claim adjusters evaluations with respect to insured
events that occurred and an amount for losses incurred that have not been
reported to us. In some cases, significant periods of time, up to several years
or more, may elapse between the occurrence of an insured loss and the reporting
of the loss to us. The method for determining our liability for unpaid losses and loss adjustment
expenses includes, among other things, reviewing past loss experience and
considering other factors such as legal, social and economic developments. We
regularly review and update the methods of making such estimates and
establishing the resulting liabilities and we make any resulting adjustment in
the accounting period in which the adjustment arose. 22




---



##### Table of Contents



Recoverability of Reinsurance Receivables We regularly review the collectibility of our reinsurance receivables, and we
include adjustments resulting from this review in earnings in the period in
which the adjustment arises. As of September 30, 2004, we had total reinsurance receivables of $1,651.0
million. The carrying value of these reinsurance receivables is net of a $31.2
million reduction, which is equal to our estimate of potentially uncollectible
reinsurance receivables. Our estimate of potentially uncollectible reinsurance
receivables, which was $49.1 million at the date of the Acquisition, has been
reduced to $31.2 million as of September 30, 2004 primarily as a result of the
commutation agreement with Trenwick America Reinsurance Corp. on October 29,
2003. As of December 31, 2003, the Company had net reinsurance receivables of
$1,763.0 million, net of a $33.7 million reduction related to potentially
uncollectible receivables. As of September 30, 2004, the amount of collateral securing individual
reinsurance receivables held by us aggregated $725.9 million, resulting in
reinsurance receivables net of collateral of $925.1 million. As of September 30, 2004, we also had total prepaid reinsurance premiums of
$59.5 million. Gross premiums written were $108.7 million and $314.7 million for the quarter
and nine months ended September 30, 2004, respectively, compared with $180.9
million and $543.8 million for the quarter and nine months ended September 30,
2003, respectively. Net premiums written were $78.2 million and $205.0 million
for the quarter and nine months ended September 30, 2004, respectively,
compared with $49.3 million and $148.8 million for the quarter and nine months
ended September 30, 2003, respectively. Net premiums written grew as a result
of increasing rates combined with increased retentions across our core book of
business as a result of purchasing less reinsurance. In addition, we have
recently converted select quota share reinsurance arrangements to excess of
loss reinsurance arrangements. Gross premiums written were lower as a result
of exiting from heavily reinsured products. The U.S. Insurance Subsidiaries have entered into a quota share arrangement
with U.N. Barbados and U.N. Bermuda. This reinsurance arrangement resulted in
45% and 15% of our net retained insurance liability on new and renewal business
bound January 1, 2004 through April 30, 2004 being ceded to U.N. Barbados and
U.N. Bermuda, respectively. The agreement also stipulates that 60% of the U.S.
Insurance Subsidiaries December 31, 2003 net unearned premium be ceded to our
Non-U.S. Operations. This quota share arrangement was modified as of May 1, 2004. The new
arrangement stipulates that 60% of the U.S. Insurance Subsidiaries net
retained insurance liability on new and renewal business bound May 1, 2004 and
later be ceded to U.N. Bermuda. The modified arrangement also stipulates that
60% of the U.S. Insurance Subsidiaries April 30, 2004 unearned premium be
ceded to U.N. Bermuda. Contingent Commissions Certain professional general agencies receive special incentives when certain
premium thresholds are met or when loss results of programs are more favorable
than predetermined thresholds. These costs are estimated and charged to other
underwriting expenses when incurred. The aggregate dollar amount of contingent
commission payments that we pay to brokers and agents represents only a small
portion of our total commissions paid. Income Tax We have managed our business in a manner designed to reduce the risk that U.N.
Barbados will be treated as engaged in a U.S. trade or business for U.S.
federal income tax purposes. On July 14, 2004 a protocol was signed by the
U.S. Treasury Secretary and the Barbados Minister of Industry and International
Business to amend the U.S.  Barbados Convention for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income
Signed on December 31, 1984, as amended. The treaty amendment is subject to
ratification by the U.S. and Barbados governments. On October 10, 2004 the
United States Senate approved the treaty amendment. In order to complete the
ratification process, the government of Barbados must approve the treaty
amendment and formally exchange ratification documents with the United States.
Provisions of the proposed amended treaty would be effective the first day of
the second month following ratification with respect to tax withheld by the
payor on amounts of interest not subject to a portfolio exemption and on
dividends or royalties paid or credited, and would be effective for taxable
years beginning on or after the first day of January following ratification for
other taxes. Under the protocol, U.N. Barbados investment income on an
intercompany note payable to U.N. Barbados on or after the effective dates of
the amendment would be subject to U.S. withholding tax of 30 percent, an
increase from the existing rate of 5 percent. The investment income subject to
this tax was $2.9 million and $8.7 million for the quarter and nine months
ended September 30, 2004, respectively. We have identified an alternative that
we believe will mitigate the impact of the protocol on our overall effective
tax rate. We have begun to implement this plan and expect to have it in place
before year-end 2004. 23




---



##### Table of Contents



Stock Based Compensation We account for stock-based compensation in accordance with SFAS No. 123,
Accounting for Stock-Based Compensation which establishes a fair value-based
method of accounting for stock-based compensation plans. Our Business Segments We have two reporting business segments: E&S and specialty admitted.  
    
    Our E&S segment focuses on writing insurance for hard-to-place risks
and risks that standard admitted insurers specifically choose not to
write.  
    
    Our specialty admitted segment focuses on writing insurance for risks
that are unique and hard to place in the standard market, but that for
marketing and regulatory reasons must remain with an admitted insurance
company. We evaluate segment performance based on gross and net premiums written, net
premiums earned and net losses and loss adjustment expenses. The following
tables set forth an analysis of financial data for our segments during the
periods indicated: For the Nine Months EndedSeptember 30,(Dollars in thousands)
    
    2004
    
    2003Gross premiums written:E&S
    
    $
    206,237
    
    
    $
    380,624Specialty admitted
    
    
    108,496
    
    
    
    163,189Gross premiums written
    
    $
    314,733
    
    
    $
    543,813Net premiums written:E&S
    
    $
    117,803
    
    
    $
    88,832Specialty admitted
    
    
    87,240
    
    
    
    59,976Net premiums written
    
    $
    205,043
    
    
    $
    148,808Net premiums earned:E&S
    
    $
    95,392
    
    
    $
    84,437Specialty admitted
    
    
    70,359
    
    
    
    54,504Net premiums earned
    
    $
    165,751
    
    
    $
    138,941Net losses and loss adjustment expenses:E&S
    
    $
    54,758
    
    
    $
    55,709Specialty admitted
    
    
    43,637
    
    
    
    36,829Net losses and loss adjustment expenses
    
    $
    98,395
    
    
    $
    92,538Net losses and loss adjustment expense ratio:E&S
    
    
    57.4
    %
    
    
    66.0
    %Specialty admitted
    
    
    62.0
    %
    
    
    67.6
    %Net losses and loss adjustment expense ratio
    
    
    59.4
    %
    
    
    66.6
    %
 24




---



##### Table of Contents



For the Quarter Ended September 30,(Dollars in thousands)
    
    2004
    
    2003Gross premiums written:E&S
    
    $
    68,486
    
    
    $
    138,672Specialty admitted
    
    
    40,171
    
    
    
    42,188Gross premiums written
    
    $
    108,657
    
    
    $
    180,860Net premiums written:E&S
    
    $
    42,888
    
    
    $
    31,339Specialty admitted
    
    
    35,355
    
    
    
    18,008Net premiums written
    
    $
    78,243
    
    
    $
    49,347Net premiums earned:E&S
    
    $
    34,529
    
    
    $
    28,197Specialty admitted
    
    
    26,404
    
    
    
    16,347Net premiums earned
    
    $
    60,933
    
    
    $
    44,544Net losses and loss adjustment expenses:E&S
    
    $
    17,886
    
    
    $
    17,409Specialty admitted
    
    
    16,730
    
    
    
    12,991Net losses and loss adjustment expenses
    
    $
    34,616
    
    
    $
    30,400Net losses and loss adjustment expense ratio:E&S
    
    
    51.8
    %
    
    
    61.7
    %Specialty admitted
    
    
    63.4
    %
    
    
    79.5
    %Net losses and loss adjustment expense ratio
    
    
    56.8
    %
    
    
    68.2
    %
 Results of Operations Nine Months Ended September 30, 2004 Compared with the Nine Months Ended September 30, 2003 The results of operations for the nine months ended September 30, 2004 reflect
the financial performance of United National Group. The results of operations
for the nine months ended September 30, 2003 reflect the combined financial
performance of United National Group and the Predecessor, Wind River Investment
Corporation. Premiums Gross premiums written, which represent the amount received or to be received
for insurance policies written without reduction for acquisition costs,
reinsurance costs or other deductions, were $314.7 million for the nine months
ended September 30, 2004, compared with $543.8 million for the nine months
ended September 30, 2003, a decrease of $229.1 million or 42.1%. The decrease
primarily resulted from the termination of 17 products within our four product
classes during 2003 and 13 products within our four product classes during
2002. Gross premiums written relative to those terminated products were $19.3
million for the nine months ended September 30, 2004, compared with $191.8
million for the nine months ended September 30, 2003. In addition, gross
premiums written decreased $63.4 million relative to our umbrella and excess
product class, exclusive of the terminated products. A further breakdown of
gross premiums written is as follows:  
    
    E&S gross premiums written were $206.2 million for the nine months
ended September 30, 2004, compared with $380.6 million for the nine
months ended September 30, 2003, a decrease of $174.4 million or 45.8%.
This decrease primarily resulted from the termination of 12 products
within our four product classes during 2003 and 11 products within our
four product classes during 2002, combined with a reduction in gross
premiums written of $36.9 million relative to our umbrella and excess
product class, exclusive of the terminated products, offset by renewal
rate increases of approximately 11% (as measured against expiring rates)
on other products. E&S gross premiums written relative to the terminated
products were $13.1 million for the nine months ended September 30,
2004, compared with $142.9 million for the nine months ended September
30, 2003.
    
    Specialty admitted gross premiums written were $108.5 million for the
nine months ended September 30, 2004, compared with $163.2 million for
the nine months ended September 30, 2003, a decrease of $54.7 million or
33.5%. The decrease in specialty admitted gross premiums written was
primarily the result of the termination of 5 products during 2003 and 2
products during 2002, combined with a reduction in gross premiums
written of $26.5 million relative to our umbrella and excess product
class, exclusive of the terminated products, offset by renewal rate
increases of approximately 9% on other products. Specialty admitted
gross premiums written relative to the terminated products were $6.2
million for the nine months ended September 30, 2004, compared with
$48.9 million for the nine months ended September 30, 2003. 25




---



##### Table of Contents



Net premiums written, which equal gross premiums written less ceded premiums
written, were $205.0 million for the nine months
ended September 30, 2004, compared with $148.8 million for the nine months
ended September 30, 2003, an increase of $56.2 million or 37.8%. The ratio of
net premiums written to gross premiums written increased to 65.1% for the nine
months ended September 30, 2004 from 27.4% for the nine months ended September
30, 2003. Net premiums written relative to terminated products were $2.5
million for the nine months ended September 30, 2004 compared with $18.5
million for the nine months ended September 30, 2003. A further breakdown of
net premiums written is as follows:  
    
    E&S net premiums written were $117.8 million for the nine months
ended September 30, 2004, compared with $88.8 million for the nine
months ended September 30, 2003, an increase of $29.0 million or 32.6%.
The ratio of net premiums written to gross premiums written was 57.1%
for the nine months ended September 30, 2004, compared with 23.3% for
the nine months ended September 30, 2003. The increase in net premiums
written was largely due to increasing our retention relative to
individual products and due to rate increases of approximately 12%.
These increases in net premiums written were partially offset by
decreases in net premiums written due to the termination of the products
previously mentioned. Net premiums written relative to the terminated
products were $1.5 million for the nine months ended September 30, 2004,
compared with $10.9 million for the nine months ended September 30,
2003.
    
    Specialty admitted net premiums written were $87.2 million for the
nine months ended September 30, 2004, compared with $60.0 million for
the nine months ended September 30, 2003, an increase of $27.3 million
or 45.5%. The ratio of net premiums written to gross premiums written
was 80.4% for the nine months ended September 30, 2004, compared with
36.8% for the nine months ended September 30, 2003. The increase in net
premiums written was largely due to the increases in retentions and due
to rate increases of approximately 8%. The increases in net premiums
written were partially offset by decreases in net premiums written due
to the termination of the products previously mentioned. Net premiums
written relative to terminated products were $1.0 million for the nine
months ended September 30, 2004, compared with $7.6 million for the nine
months ended September 30, 2003. Net premiums earned were $165.8 million for the nine months ended September 30,
2004, compared with $138.9 million for the nine months ended September 30,
2003, an increase of $26.8 million or 19.3%. A further breakdown of net
premiums earned is as follows:  
    
    E&S net premiums earned were $95.4 million for the nine months ended
September 30, 2004, compared with $84.4 million for the nine months
ended September 30, 2003, an increase of $11.0 million or 13.0%. The
increase in net premiums earned was primarily due to the impact of the
previously mentioned retention increases and rate increases, partially
offset by a decrease due to the previously mentioned product
terminations.  
    
    Specialty admitted net premiums earned were $70.4 million for the
nine months ended September 30, 2004, compared with $54.5 million for
nine months ended September 30, 2003, an increase of $15.9 million or
29.1%. Net premiums earned increased primarily due to the impact of the
previously mentioned retention increases and rate increases, partially
offset by a decrease due to the impact of the previously mentioned
product terminations. Net Investment Income Gross investment income, excluding realized gains and losses, was $16.5 million
for the nine months ended September 30, 2004, compared with $17.1 million for
the nine months ended September 30, 2003, a decrease of $0.6 million or 3.4%.
The decrease in investment income is due to several factors. As a result of
the revaluation of our investment portfolio in connection with the Acquisition,
amortization of premiums on bonds reduced gross investment income by $0.9
million for the nine months ended September 30, 2004. Although the value of
cash and invested assets was $100.6 million higher at September 30, 2004
compared to September 30, 2003, our average bond portfolio, net of securities
that are short-term in nature, was only $23.3 million greater for the nine
months ended September 30, 2004 compared to the corresponding period in 2003. The average duration of our fixed income investments, excluding securities that
are short-term in nature, approximated 3.8 years as of September 30, 2004,
compared with 4.2 years as of December 31, 2003. Our book yield on our fixed
income investments was 3.2% for the nine months ended September 30, 2004,
compared with 4.2% for the nine months ended September 30, 2003. Investment expenses were $2.9 million for the nine months ended September 30,
2004, compared with $3.0 million for the nine months ended September 30, 2003,
a decrease of $0.1 million or 4.7%. Net Realized Investment Gains (Losses) Net realized investment losses were $0.7 million for the nine months ended
September 30, 2004, compared with net realized investment gains of $4.9 million
for the nine months ended September 30, 2003. The net realized investment
losses for the current period consists of net gains of $0.1 million relative to
our equity portfolio (net of a $0.2 impairment charge), net losses of $0.6
million relative to the market value of options, net losses of $0.1 million
relative to our fixed income investments, and net losses of $0.1 26




---



##### Table of Contents



million relative to our convertible bond and equity portfolios. The net realized
investment gains for the nine months ended September
30, 2003 consisted of net gains of $6.3 million relative to our equity
portfolio, net losses of $0.5 million relative to our fixed income investments,
and net losses of $0.9 million relative to other invested assets. Net Losses and Loss Adjustment Expenses Net losses and loss adjustment expenses were $98.4 million for the nine months
ended September 30, 2004, compared with $92.5 million for the nine months ended
September 30, 2003, a increase of $5.9 million or 6.3%. The loss ratio for the
nine months ended September 30, 2004 was 59.4% compared with 66.6% for the nine
months ended September 30, 2003. The loss ratio for the nine months ended
September 30, 2004 and 2003, excluding the impact of purchase accounting
adjustments, would have been 57.8% and 65.8%, respectively. The loss ratio is
calculated by dividing net losses and loss adjustment expenses by net premiums
earned. The improvement in the loss ratio was attributable to continuing rate
increases in 2004 and the termination of products that did not meet our
profitability targets in 2003. These improvements were offset by $1.7 million
of net losses related to Hurricanes Charley, Frances, Ivan, and Jeanne for the
nine months ended September 30, 2004, which had the impact of increasing our
loss ratio by 1.0 percentage points. A further breakdown of losses incurred is
as follows:  
    
    E&S net losses and loss adjustment expenses were $54.8 million for
the nine months ended September 30, 2004, compared with $55.7 million
for the nine months ended September 30, 2003. The loss ratio was 57.4%
for the nine months ended September 30, 2004, compared with 66.0% for
the nine months ended September 30, 2003. The improvement in the loss
ratio was attributable to continuing rate increases in 2004 and the
termination of products that did not meet our profitability targets in
2003. These improvements were offset by $1.7 million of net losses
related to hurricanes for the nine months ended September 30, 2004,
which had the impact of increasing our loss ratio by 1.7 percentage
points.  
    
    Specialty admitted net losses and loss adjustment expenses were $43.6
million for the nine months ended September 30, 2004, compared with
$36.8 million for the nine months ended September 30, 2003. The loss
ratio for the nine months ended September 30, 2004 was 62.0%, compared
with 67.6% for the nine months ended September 30, 2003. The improvement
in the loss ratio was attributable to continuing rate increases in 2004
and the termination of products that did not meet our profitability
targets in 2003. Acquisition Costs and Other Underwriting Expenses Acquisition costs and other underwriting expenses were $56.7 million for the
nine months ended September 30, 2004, compared with $34.7 million for the nine
months ended September 30, 2003, an increase of $21.9 million or 63.2%. This
increase can be attributed to a $24.1 million increase in acquisition costs and
a $2.2 million decrease in other underwriting expenses. The $24.1 million increase in acquisition costs was primarily the result of a
reduction in ceding commissions of $77.8 million partially offset by a decrease
in direct commission expense of $39.6 million. Contingent commission expense
decreased $1.5 million and the deferral of acquisition costs increased by $12.6
million. The reduction in ceding commission income was a result of a decrease
in ceded premiums written resulting from an increase in our level of retention
and reduction in heavily reinsured business. The reduction in direct commission
was consistent with the reduction in gross premiums written. While increased
retentions have the impact of increasing acquisition costs, our underwriting
profit margins nonetheless increased based upon an improvement in our loss
experience. The $2.2 million decrease in other underwriting expenses was primarily due to
reduced compensation and employee benefit costs which were $3.8 million lower
resulting from the termination of the stock appreciation plan in the nine
months ended September 30, 2003 offset by higher professional service costs
which increased by $1.5 million. Provision for Doubtful Reinsurance Receivables We recorded no charge for an allowance for doubtful reinsurance receivables for
the nine months ended September 30, 2004 as compared to a $1.8 million charge
for the nine months ended September 30, 2003. Expense and Combined Ratios Our expense ratio, which is calculated by dividing the sum of acquisition costs
and other underwriting expenses and provisions for doubtful reinsurance
receivables by premiums earned, was 34.2% for the nine months ended September
30, 2004, compared with 26.3% for the nine months ended September 30, 2003.
The expense ratio for the nine months ended September 30, 2004 and 2003,
excluding the impact of purchase accounting adjustments, would have been 33.8%
and 26.6%, respectively. The expense ratio for the nine months ended September
30, 2004 was principally impacted by the changes to commissions and other
underwriting expenses described above. Part of our strategy is to continue to
retain a higher percentage of our premiums, and increase our underwriting
profit through improved loss experience. To the extent that we are able to
accomplish a higher retention percentage, we expect this increase in expense
ratio to be more than offset by a decrease in our loss ratio. 27




---



##### Table of Contents



Our combined ratio was 93.5% for the nine months ended September 30, 2004,
compared with 92.9% for the nine months ended September 30, 2003. This
increase in the combined ratio was primarily due an increase of purchase
accounting adjustments of 1.3% compared to the same period in the prior year,
1.0% of catastrophe losses during the nine months ended September 30, 2004, and
a reduction in the amount of ceding commission income, net of direct
commission, related to terminated products, partially offset by an improvement
in the loss ratio as described above. Other Operating Expenses Other operating expenses were $1.0 million for the nine months ended September
30, 2004, compared with $0.5 million for the nine months ended September 30,
2003, an increase of $0.5 million. Interest Expense Interest expense was $4.1 million for the nine months ended September 30, 2004,
an increase of $3.8 million compared to the same period in the prior year.
Interest expense for the current period consists of interest related to our
senior notes payable to a related party and junior subordinated debentures. Income Tax (Benefit) Expense Income tax benefit was $2.6 million for the nine months ended September 30,
2004, compared with $5.8 million of tax expense for the nine months ended
September 30, 2003. Our effective tax benefit for the nine months ended
September 30, 2004 was 13.7%, compared with an effective tax rate of 20.5% for
the nine months ended September 30, 2003. The effective rates differed from
the 35.0% U.S. statutory rate due in part to investment in tax-exempt
securities and foreign income not expected to be taxed in the U.S. An
alternative minimum tax credit carryover of $9.3 million is available for 2004
and future years and does not expire. We are limited by Internal Revenue Code
sections 382 and 383 on the amount of our income that can be offset by an
alternative minimum tax carryover following the Acquisition. The section 382
limitation is an amount equal to the value of the purchase price of the
Acquisition less stock redemptions multiplied by the long-term tax-exempt rate.
The limitation applies until the carryforward is fully utilized. The income
limitation as a result of the Acquisition is $8.3 million per year. Equity in Net Earnings of Partnerships Equity in net earnings of partnerships was $0.9 million for the nine months
ended September 30, 2004, compared with $2.1 million for the nine months ended
September 30, 2003, a decrease of $1.2 million or 55.7%. The decrease is
primarily attributable to the performance of a limited partnership investment
which invests mainly in convertible bonds and equities. Extraordinary Gain The extraordinary gain of $1.2 million for the nine months ended September 30,
2004 represents the recognition of tax benefits derived from acquisition costs
incurred in connection with the Acquisition, which are currently considered to
be deductible for federal tax purposes. The extraordinary gain of $46.4 million
for the nine months ending September 30, 2003 represents the excess of the
estimated fair value of net assets acquired over purchase price from the
Acquisition. Net Income and Net Operating Income The factors described above resulted in net income of $23.2 million for the
nine months ended September 30, 2004, compared with $70.8 million for the nine
months ended September 30, 2003, a decrease of $47.6 million or 67.2%. Net
operating income was $22.5 million for the nine months ended September 30,
2004, compared with $21.3 million for the nine months ended September 30, 2003.
Net operating income for the nine months ended September 30, 2004 is equal to
the sum of the nine months ended September 30, 2004 net income and $0.5 million
of after-tax realized investment losses less the extraordinary gain of $1.2
million. Net operating income for the nine months ended September 30, 2003 is
equal to the nine months ended September 30, 2003 net income less $3.1 million
of after-tax realized investment gains and the extraordinary gain of $46.4
million. The Quarter Ended September 30, 2004 Compared with the Quarter Ended September
30, 2003 The results of operations for the quarter ended September 30, 2004 reflect the
financial performance of United National Group. The results of operations for
the quarter ended September 30, 2003 reflects the combined financial
performance of United National Group and the Predecessor, Wind River
Investment Corporation. 28




---



##### Table of Contents



Premiums Gross premiums written, which represent the amount received or to be received
for insurance policies written without reduction for acquisition costs,
reinsurance costs or other deductions, were $108.7 million for the quarter
ended September 30, 2004, compared with $180.9 million for the quarter ended
September 30, 2003, a decrease of $72.2 million or 39.9%. The decrease
primarily resulted from the termination of 17 products within our four product
classes during 2003 and 13 products within our four product classes during
2002. Gross premiums written relative to those terminated products were $0.8
million for the quarter ended September 30, 2004, compared with $61.2 million
for the quarter ended September 30, 2003. In addition, gross premiums written
decreased $10.7 million relative to our umbrella and excess product class,
exclusive of the terminated products. A further breakdown of gross premiums
written is as follows:  
    
    E&S gross premiums written were $68.5 million for the quarter ended
September 30, 2004, compared with $138.7 million for the quarter ended
September 30, 2003, a decrease of $70.2 million or 50.6%. This decrease
primarily resulted from the termination of 12 products within our four
product classes during 2003 and 11 products within our four product
classes during 2002, combined with a reduction in gross premiums written
of $7.9 million relative to our umbrella and excess product class,
exclusive of the terminated products, offset by renewal rate increases
of approximately 9% (as measured against expiring rates) on other
products. E&S gross premiums written relative to the terminated
products were $0.4 million for the quarter ended September 30, 2004,
compared with $54.8 million for the quarter ended September 30, 2003.  
    
    Specialty admitted gross premiums written were $40.2 million for the
quarter ended September 30, 2004, compared with $42.2 million for the
quarter ended September 30, 2003, a decrease of $2.0 million or 4.8%.
The decrease in specialty admitted gross premiums written was primarily
the result of the termination of 5 products during 2003 and 2 products
during 2002, combined with a reduction in gross premiums written of $2.8
million relative to our umbrella and excess product class, exclusive of
the terminated products, offset by renewal rate increases of
approximately 7% on other products. Specialty admitted gross premiums
written relative to the terminated products were $0.4 million for the
quarter ended September 30, 2004, compared with $6.4 million for the
quarter ended September 30, 2003. Net premiums written, which equal gross premiums written less ceded premiums
written, were $78.2 million for the quarter ended September 30, 2004, compared
with $49.3 million for the quarter ended September 30, 2003, an increase of
$28.9 million or 58.6%. The ratio of net premiums written to gross premiums
written increased to 72.0% for the quarter ended September 30, 2004, from 27.3%
for the quarter ended September 30, 2003. A further breakdown of net premiums
written is as follows:  
    
    E&S net premiums written were $42.9 million for the quarter ended
September 30, 2004, compared with $31.3 million for the quarter ended
September 30, 2003, an increase of $11.5 million or 36.9%. The ratio of
net premiums written to gross premiums written was 62.6% for the quarter
ended September 30, 2004, compared with 22.6% for the quarter ended
September 30, 2003. The increase in net premiums written was largely due
to increasing our retention relative to individual products and due to
rate increases of approximately 10%. These increases in net premiums
written were partially offset by decreases in net premiums written due
to the termination of the products previously mentioned. Net premiums
written relative to the terminated products were $0.9 million for the
quarter ended September 30, 2004, compared with $3.4 million for the
quarter ended September 30, 2003.  
    
    Specialty admitted net premiums written were $35.4 million for the
quarter ended September 30, 2004, compared with $18.0 million for the
quarter ended September 30, 2003, an increase of $17.3 million or 96.3%.
The ratio of net premiums written to gross premiums written was 88.0%
for the quarter ended September 30, 2004, compared with 42.7% for the
quarter ended September 30, 2003. The increase in net premiums written
was largely due to the increases in retentions and due to rate increases
of approximately 7%. The increases in net premiums written were
partially offset by decreases in net premiums written due to the
termination of the products previously mentioned. There were no net
premiums written relative to terminated products for the quarter ended
September 30, 2004 compared with $1.4 million for the quarter ended
September 30, 2003. Net premiums earned were $60.9 million for the quarter ended September 30,
2004, compared with $44.5 million for the quarter ended September 30, 2003, an
increase of $16.4 million or 36.8%. A further breakdown of net premiums earned
is as follows:  
    
    E&S net premiums earned were $34.5 million for the quarter ended
September 30, 2004, compared with $28.2 million for the quarter ended
September 30, 2003, an increase of $6.3 million or 22.5%. The increase
in net premiums earned was primarily due to the impact of the previously
mentioned retention increases and rate increases, partially offset by a
decrease due to the impact of the previously mentioned product
terminations.  
    
    Specialty admitted net premiums earned were $26.4 million for the
quarter ended September 30, 2004, compared with $16.3 million for
quarter ended September 30, 2003, an increase of $10.1 million or 61.5%.
The increase in net premiums earned was primarily due to the impact of
the previously mentioned retention increases and rate increases,
partially offset by a 29




---



##### Table of Contents



decrease due to the impact of the previously mentioned product
terminations. Net Investment Income Gross investment income, excluding realized gains and losses, was $6.1 million
for the quarter ended September 30, 2004, compared with $5.6 million for the
quarter ended September 30, 2003, an increase of $0.5 million or 8.9%. The
increase in investment income is due to several factors. As a result of the
revaluation of our investment portfolio in connection with the Acquisition,
amortization of premiums on bonds reduced gross investment income by $0.3
million for the quarter ended September 30, 2004. Although the value of cash
and invested assets was $100.6 million higher at September 30, 2004 compared to
September 30, 2003, our average bond portfolio, net of securities that are
short-term in nature, was only $74.5 million greater for the quarter ended
September 30, 2004 compared to the corresponding period in 2003. Finally,
while there was an increase in cash and short-term investments, this was
mitigated by a general decline in short-term interest rates. The average duration of our fixed income investments, excluding securities that
are short-term in nature, approximated 3.8 years as of September 30, 2004,
compared with 4.2 years as of December 31, 2003. Our book yield on our fixed
income investments was 3.4% for the quarter ended September 30, 2004, compared
with 4.0% for the quarter ended September 30, 2003. Investment expenses were $1.1 million for the quarter ended September 30, 2004,
compared with $0.9 million for the quarter ended September 30, 2003, a increase
of $0.2 million or 28.0%. Net Realized Investment Gains (Losses) Net realized investment losses were $1.1 million for the quarter ended
September 30, 2004, compared with net realized investment gains of $1.8 million
for the quarter ended September 30, 2003. The net realized investment losses
for the current period consists of net losses of $0.3 million relative to our
equity portfolio (including a $0.2 million impairment charge), net losses of
$0.1 million relative to our fixed income investments, and net losses of $0.7
million relative to the market value of options. The net realized investment
gains for the quarter ended September 30, 2003 consisted of net gains of $2.2
million relative to our equity portfolio, net gains of $0.3 million relative to
our fixed income investments and net losses of $0.7 million relative to other
invested assets. Net Losses and Loss Adjustment Expenses Net losses and loss adjustment expenses were $34.6 million for the quarter
ended September 30, 2004, compared with $30.4 million for the quarter ended
September 30, 2003, an increase of $4.2 million or 13.9%. The loss ratio for
the quarter ended September 30, 2004 was 56.8% compared with 68.2% for the
quarter ended September 30, 2003. The loss ratio for the quarter ended
September 30, 2004 and 2003, excluding the impact of purchase accounting
adjustments, would have been 56.7% and 65.7%, respectively. The loss ratio is
calculated by dividing net losses and loss adjustment expenses by net premiums
earned. The improvement in the loss ratio was attributable to continuing rate
increases in 2004 and the termination of products that did not meet our
profitability targets in 2003. These improvements were offset by $1.7 million
of net losses related to Hurricanes Charley, Frances, Ivan, and Jeanne for the
quarter ended September 30, 2004, which had the impact of increasing our loss
ratio by 2.7 percentage points. A further breakdown of losses incurred is as
follows:  
    
    E&S net losses and loss adjustment expenses were $17.9 million for
the quarter ended September 30, 2004, compared with $17.4 million for
the quarter ended September 30, 2003. The loss ratio was 51.8% for the
quarter ended September 30, 2004, compared with 61.7% for the quarter
ended September 30, 2003. The improvement in the loss ratio was
attributable to continuing rate increases in 2004 and the termination of
products that did not meet our profitability targets in 2003. These
improvements were offset by $1.7 million of net losses related to the
hurricanes for the quarter ended September 30, 2004, which had the
impact of increasing our loss ratio by 4.8 percentage points.  
    
    Specialty admitted net losses and loss adjustment expenses were $16.7
million for the quarter ended September 30, 2004, compared with $13.0
million for the quarter ended September 30, 2003. The loss ratio for the
quarter ended September 30, 2004 was 63.4%, compared with 79.5% for the
quarter ended September 30, 2003. The improvement in the loss ratio was
attributable to continuing rate increases in 2004 and the termination of
products that did not meet our profitability targets in 2003. Acquisition Costs and Other Underwriting Expenses Acquisition costs and other underwriting expenses were $23.8 million for the
quarter ended September 30, 2004, compared with $14.3 million for the quarter
ended September 30, 2003, an increase of $9.5 million or 66.5%. This increase
can be attributed to a $13.4 million increase in acquisition costs and a $3.9
million decrease in other underwriting expenses. A further analysis of
acquisition costs and other underwriting expenses is as follows: 30




---



##### Table of Contents




    
    The $13.4 million increase in acquisition costs was primarily the
result of a reduction in ceding commissions earned of $25.8 million
partially offset by a decrease in direct commission expense of $10.1
million. Contingent commission expense increased $0.5 million and the
deferral of acquisition costs increased by $2.8 million. The reduction
in ceding commission income was a result of a decrease in ceded premiums
written resulting from an increase in our level of retention and
reduction in heavily reinsured business. The reduction in direct
commission was consistent with the reduction in gross premiums written.
While increased retentions have the impact of increasing acquisition
costs, our underwriting profit margins nonetheless increased based upon
an improvement in our loss experience.  
    
    The $3.9 million decrease in other underwriting expenses was
primarily due to reduced compensation and employee benefit costs which
were $4.7 million lower resulting from the termination of the stock
appreciation plan in the three months ended September 30, 2003 offset by
professional service costs which increased by $0.6 million. Expense and Combined Ratios Our expense ratio, which is calculated by dividing the sum of acquisition costs
and other underwriting expenses and provisions for doubtful reinsurance
receivables by premiums earned, was 39.0% for the quarter ended September 30,
2004, compared with 32.1% for the quarter ended September 30, 2003. The
expense ratio for the quarter ended September 30, 2004 and 2003, excluding the
impact of purchase accounting adjustments, would have been 37.4% and 33.0%,
respectively. The expense ratio for the quarter ended September 30, 2004 was
principally impacted by the changes to commissions and other underwriting
expenses described above. Part of our strategy is to continue to retain a
higher percentage of our premiums, and increase our underwriting profit through
improved loss experience. To the extent that we are able to accomplish a higher
retention percentage, we expect this increase in expense ratio to be more than
offset by a decrease in our loss ratio. Our combined ratio was 95.8% for the quarter ended September 30, 2004, compared
with 100.3% for the quarter ended September 30, 2003. This decrease in the
combined ratio was primarily due to an improvement in the loss ratio as
a result of our strategy described above, offset by 2.7% of catastrophe losses during the quarter ended
September 30, 2004, and a reduction in the amount of ceding commission income,
net of direct commission, related to terminated products. Other Operating Expenses (Income) Other operating expenses were $0.3 million for the quarter ended September 30,
2004, compared with $0.1 million of other operating expenses for the quarter
ended September 30, 2003, an increase of $0.2 million. Interest Expense Interest expense was $1.4 million for the quarter ended September 30, 2004, an
increase of $1.1 million compared to the same period in the prior year.
Interest expense for the current period consists of interest related to our
senior notes payable to a related party and junior subordinated debentures. Income Tax (Benefit) Expense Income tax benefit was $1.4 million for the quarter ended September 30, 2004,
compared with $0.7 million of tax expense for the quarter ended September 30,
2003. Our effective tax benefit for the quarter ended September 30, 2004 was
29.9%, compared with an effective tax rate of 12.5% for the quarter ended
September 30, 2003. The effective rates differed from the 35.0% U.S. statutory
rate due in part to investment in tax-exempt securities and foreign income not
expected to be taxed in the U.S. An alternative minimum tax credit carryover
of $9.3 million is available for 2004 and future years and does not expire. We
are limited by Internal Revenue Code sections 382 and 383 on the amount of our
income that can be offset by an alternative minimum tax carryover following the
Acquisition. The section 382 limitation is an amount equal to the value of the
purchase price of the Acquisition less stock redemptions multiplied by the
long-term tax-exempt rate. The limitation applies until the carryforward is
fully utilized. The income limitation as a result of the Acquisition is $8.3
million per year. Equity in Net Earnings of Partnerships Equity in net earnings of partnerships was $0.3 million for the quarter ended
September 30, 2004, compared with $0.6 million for the quarter ended September
30, 2003, a decrease of $0.3 million. The decrease is primarily attributable to
the performance of a limited partnership investment that invests mainly in
convertible bonds and equities. Extraordinary Gain The extraordinary gain of $1.2 million for the quarter ended September 30, 2004
represents the recognition of tax benefits derived from acquisitions costs
incurred in connection with the Acquisition, which are currently considered to
be deductible for federal tax 31




---



##### Table of Contents



purposes. The extraordinary gain of $46.4 million for the quarter ended
September 30, 2003 represents the excess of the estimated fair value of net
assets over purchase price from the Acquisition. Net Income and Net Operating Income The factors described above resulted in net income of $7.7 million for the
quarter ended September 30, 2004, compared with $52.2 million for the quarter
ended September 30, 2003, a decrease of $44.5 million or 85.3%. Net operating
income was $7.2 million for the quarter ended September 30, 2004, compared with
$4.7 million for the quarter ended September 30, 2003. Net operating income
for the quarter ended September 30, 2004 is equal to the sum of the quarter
ended September 30, 2004 net income and $0.7 million of after-tax realized
investment losses less the extraordinary gain of $1.2 million. Net operating
income for the quarter ended September 30, 2003 is equal to the quarter ended
September 30, 2003 net income less $1.1 million of after-tax realized
investment gains and the extraordinary gain of $46.4 million. Liquidity and Capital Resources Sources and Uses of Funds United National Group is a holding company. Its principal asset is its
ownership of the shares of its direct and indirect subsidiaries, including
United National Insurance Company, Diamond State Insurance Company, United
National Specialty Insurance Company, United National Casualty Insurance
Company, U.N. Barbados and U.N. Bermuda. United National Groups principal source of cash to meet short-term and
long-term liquidity needs, including the payment of dividends to stockholders
and corporate expenses, includes dividends and other permitted disbursements
from U.N. Barbados, which in turn is largely dependent on dividends and other
payments from U.N. Bermuda and our U.S. Insurance Subsidiaries. United National
Group has no planned capital expenditures that could have a material impact on
its long-term liquidity needs. The principal sources of funds at U.N. Barbados, U.N. Bermuda and our U.S.
Insurance Subsidiaries include underwriting operations, investment income and
proceeds from sales and redemptions of investments. Funds are used by U.N.
Barbados, U.N. Bermuda and our U.S. Insurance Subsidiaries principally to pay
claims and operating expenses, to purchase investments and to make dividend
payments. U.N. Barbados and U.N. Bermuda have generated no funds to date and
they have not paid any claims. United National Groups future liquidity is
dependent on the ability of U.N. Barbados, U.N. Bermuda and our U.S. Insurance
Subsidiaries to pay dividends. Our U.S. Insurance Subsidiaries are restricted by statute as to the amount of
dividends that they may pay without the prior approval of regulatory
authorities. Our U.S. Insurance Subsidiaries may pay dividends without advance
regulatory approval only out of unassigned surplus. The maximum dividend payout
that may be made without prior approval in 2004 is $34.1 million. Surplus Levels United National Insurance Company, Diamond State Insurance Company, United
National Specialty Insurance Company and United National Casualty Insurance
Company are required by law to maintain a certain minimum level of
policyholders surplus on a statutory basis. Policyholders surplus is
calculated by subtracting total liabilities from total assets. The NAIC adopted
risk-based capital standards designed to identify property and casualty
insurers that may be inadequately capitalized based on inherent risks of each
insurers assets and liabilities and mix of net premiums written. Insurers
falling below a calculated threshold may be subject to varying degrees of
regulatory action. Based on the standards currently adopted, our U.S. Insurance
Subsidiaries capital and surplus are in excess of the prescribed minimum
risk-based capital requirements. Cash Flows Sources of operating funds consist primarily of net premiums written and
investment income. Funds are used primarily to pay claims and operating
expenses and to purchase investments. Our reconciliation of net income to cash provided from operations is generally
influenced by the following:  
    
    the fact that we collect premiums in advance of losses paid;  
    
    the timing of our settlements with our reinsurers; and  
    
    the timing of our loss payments. Net cash flow (used for) provided by operating activities was $22.2 million and
$31.2 million, respectively, for the nine months ended 32




---



##### Table of Contents



September 30, 2004 and 2003. Cash flow used for operating activities for the
nine months ended September 30, 2004 was negatively affected by a $30.1 million
reduction in ceded balances payable related to our exit from heavily reinsured
business and a $17.8 million payment to Bank of America as further discussed in
Legal Proceedings (Item I of Part II of this report). Cash flow provided by
operating activities for the nine months ended September 30, 2003 benefited by
$37.1 million due to an increase in net loss and loss adjustment expense
reserves and benefited by $16.8 million due to an increase in ceded balances
payable. Net cash used for investing activities was $55.2 million and $23.1 million,
respectively, for the nine months ended September 30, 2004 and 2003. The $32.1
million increase in the cash used for investing activities was caused by
efforts to invest high levels of cash and cash equivalents during the nine
months ended September 30, 2004. Cash and cash equivalents totaled $214.8
million and $72.9 million, respectively, as of December 31, 2003 and 2002.
Cash and cash equivalents as of December 31, 2003 exceeded cash and cash
equivalents as of December 31, 2002 by $141.9 million. The reasons for high
levels of cash and cash equivalents as of December 31, 2003 included the $240.0
million initial capital contribution made by Fox Paine & Company in September 2003, the
receipt of $165.6 million of net proceeds from our December 15, 2003 initial
public offering and the receipt of $30.0 million due to the issuance of trust
preferred securities in September and October 2003, offset by the $100.0
million used to purchase a portion of the common stock of Wind River Investment
Corporation owned by the Ball Family trusts and the $150.0 million used in the
redemption of our Series A preferred shares. Net cash provided by financing activities was $7.3 million for the nine months
ending September 30, 2004, compared with $17.6 million for the nine months
ending September 30, 2003. The source of this cash flow during the nine months
ended September 30, 2004 was the issuance of 462,500 Class A common shares at a
price of $17.00 per share in January 2004, in connection with exercise by the
underwriters of the remaining overallotment option related to our initial
public offering. Proceeds to United National Group, net of underwriting
discounts of $0.5 million, were $7.3 million. During the third quarter of 2003 in connection with the acquisition of Wind
River Investment Corporation on September 5, 2003, certain key executives
purchased 198,750 Class A common shares at $10.00 per share. On September 30, 2003,
American Insurance Service, Inc. (AIS), a wholly-owned indirect subsidiary of United
National Group, sold $10.0 million (aggregate liquidation amount) of floating
rate trust preferred securities to Dekania CDO I, Ltd., an exempted company
incorporated with limited liability under the law of Cayman Islands, in a
private placement through AIS wholly-owned statutory trust, United National
Group Capital Trust I (Trust I). AIS, through Trust I, together with other insurance companies and insurance
holding companies, issued trust preferred securities to the collateralized debt
obligation pool organized by Dekania Capital Management LLC, which in turn,
issued its securities to institutional and accredited investors. Trust I issued
10,000 trust preferred securities, having a stated liquidation amount of $1,000
per security, that mature on September 30, 2033 and bear a floating interest
rate, reset quarterly, equal to the London Interbank Offered Rate (LIBOR)
plus 4.05%. AIS, through Trust I, has the right to call the trust preferred
securities at par after September 30, 2008, five years from the date of
issuance. The entire proceeds from the sale of the trust preferred securities, including
the proceeds from the sale of the common securities of Trust I to AIS, were
used to fund the purchase of $10.3 million (in principal amount) of junior
subordinated deferrable interest notes issued by AIS under an indenture, dates
as of September 30, 2003, between AIS and JPMorgan Chase Bank, as trustee. Liquidity At September 30, 2004, we had $189.1 million of cash and cash equivalents. We
believe that our U.S. Insurance Subsidiaries maintain sufficient liquidity to
pay claims. Our U.S. Insurance Subsidiaries participate in an intercompany pooling
arrangement whereby premiums, losses, and expenses are shared pro rata among
the members of the group. United National Insurance Company is not an
authorized reinsurer in all states. As a result, any losses and unearned
premium that are ceded to United National Insurance Company by the other
companies in the group must be collateralized. The state insurance departments
that regulate the parties to the intercompany pooling agreements require United
National Insurance Company to place assets on deposit subject to trust
agreements for the protection of other group members. There are two intercompany pooling agreements in place. The first pooling
agreement governs policies that were written prior to July 1, 2002. The second
pooling agreement governs policies that are written on or after July 1, 2002.
The method by which intercompany reinsurance is ceded is different for each
pool. In the first pool, the U.S. Insurance Subsidiaries cede all business to
United National Insurance Company. United National Insurance Company cedes in
turn to external reinsurers. The remaining net premiums retained is allocated
to the companies in the group according to their respective pool participation
percentages. In the second pool, each company in the group first cedes to
external reinsurers. The remaining net is ceded to United National Insurance
Company where the net premiums written of the group are pooled and reallocated
to the group based on their respective participation percentages. The second
pool requires less trust funding by United National Insurance Company as a
result of it assuming less business from the other group 33




---



##### Table of Contents



members. United National Insurance Company only has to fund the portion that is
ceded to it after cessions have occurred with external reinsurers. United
National Insurance Company retains 80.0% of the risk associated with each pool.
To cover the required minimum exposure as of September 30, 2004, the trusts
were funded to approximately $366.5 million. It is anticipated that the
required funding amount will decline in future periods, which would improve the
overall liquidity of the domestic insurance group. The U.S. Insurance Subsidiaries have entered into a quota share arrangement
with U.N. Barbados and U.N. Bermuda. This reinsurance arrangement resulted in
45% and 15% of our net retained insurance liability on new and renewal business
bound January 1, 2004 through April 30, 2004 being ceded to U.N. Barbados and
U.N. Bermuda, respectively. The agreement also stipulates that 60% of the U.S.
Insurance Subsidiaries December 31, 2003 net unearned premium be ceded to our
Non-U.S. Operations. The quota share arrangement was modified as of May 1, 2004. The new arrangement
stipulates that 60% of the U.S. Insurance Subsidiaries net retained insurance
liability on new and renewal business bound May 1, 2004 and later be ceded to
U.N. Bermuda. The modified arrangement also stipulates that 60% of the U.S.
Insurance Subsidiaries April 30, 2004 unearned premium be ceded to U.N.
Bermuda. Reinsurance premiums ceded by our U.S. Insurance Subsidiaries through July 2004
were paid to U.N. Bermuda and U.N. Barbados. Since U.N. Barbados and U.N.
Bermuda are not authorized reinsurers in the United States, the insurance laws
and regulations of Pennsylvania, Indiana and Wisconsin require the
establishment of reinsurance trusts for the benefit of the U.S. Insurance
Subsidiaries. The funding requirement includes the amount of all paid loss and
loss adjustment expenses, ceded unearned premium reserves, and unpaid loss and
loss adjustment expenses. U.N. Bermuda and U.N. Barbados have each established
independent reinsurance trust accounts for the benefit of each U.S. Insurance
Subsidiary in the amount of $22.8 million and $68.3 million, respectively. We
intend to invest the funds in securities that have durations that closely match
the expected duration of the liabilities assumed. We believe that each of U.N.
Bermuda and U.N. Barbados will have sufficient liquidity to pay claims
prospectively. As a result of the cessions to our Non-U.S. Operations, we expect that our U.S.
Operations will have negative cash flow from operations and our Non-U.S.
Operations will have positive cash flow. This trend may continue for several
years. As mentioned above, our U.S. Operations have sufficient liquidity to pay
claims. We expect our overall cash flow to be positive in the future. We
monitor our portfolios to assure liability and investment durations are closely
matched. Investments made by our Non-U.S. Operations will be in taxable securities.
Currently, most of the investments of our U.S. Operations are in tax-exempt
investments. Prospectively, as fixed income investments mature and new cash is
obtained, it will likely be invested in taxable securities. Capital Resources We do not anticipate paying any cash dividends on any of our common shares in
the foreseeable future. We currently intend to retain any future earnings to
fund the development and growth of our business. As a result of the debt incurred during the Acquisition and the issuance of
trust preferred securities, our U.S. Operations will incur interest expense of
approximately $16.9 million in 2004. $11.6 million of this interest expense is
related to a note held by U.N. Barbados from U.N. Holdings II, and therefore
eliminated during consolidation while $5.3 million is related to senior notes
held by the Ball family trusts and the trust preferred securities. Interest of
$0.4 million and $1.2 million on the trust preferred securities has been paid
during the quarter and nine months ending September 30, 2004. Interest on the
senior notes held by the Ball family trusts of $3.9 million was paid in cash in
October 2004. Currently, the holding companies of our U.S. Insurance
Subsidiaries have cash and investments totaling $21.9 million. In 2004, we do
not anticipate that we will need to pay a dividend from our U.S. Insurance
Subsidiaries to fund this debt service. In 2005, and thereafter, dividends
from our U.S. Insurance Subsidiaries may be required to fund this debt service. As a result of the Acquisition, senior notes in an aggregate principal amount
of $72.8 million, subject to adjustment, were issued to the Ball family trusts,
by our subsidiary, Wind River Investment Corporation, as part of the purchase
price, which senior notes we have fully and unconditionally guaranteed. These
senior notes were amended and restated on November 24, 2003, and have an
interest rate of 5.0%, which may be paid either in cash or in kind. These
senior notes mature on September 5, 2015; however, in certain circumstances
Wind River Investment Corporation is required to make mandatory prepayments on
these senior notes on October 1 of each year. Wind River Investment Corporation
is only required to make such mandatory prepayments if we have generated
excess cash flow for the preceding fiscal year. Excess cash flow generally
means an amount equal to our consolidated net income, less such amounts as our
Board of Directors may determine are necessary to: (1) maintain an A.M. Best
rating of at least A (Excellent) for each of our U.S. Insurance Subsidiaries;
(2) make permitted dividend payments; (3) maintain the statutory surplus of our
U.S. Insurance Subsidiaries at acceptable levels and (4) provide our U.S.
Operations with adequate levels of working capital. During 2004, our U.S. Insurance Subsidiaries can pay a dividend of $34.1
million without regulatory approval. 34




---



##### Table of Contents



U.N. Barbados holds a note in the amount of $175.0 million from U.N. Holdings
II, Inc. The note has an interest rate of 6.64% and matures in 2018. It is
anticipated that interest will be paid yearly. U.N. Holdings II, Inc. has no
operations. The ability of U.N. Holdings II, Inc. to generate cash to repay the
note is dependent on dividends that it receives from its subsidiaries. On September 30, 2003, AIS, a wholly-owned
indirect subsidiary of United National Group, sold $10.0 million (aggregate
liquidation amount) of floating rate trust preferred securities to Dekania CDO
I, Ltd., an exempted company incorporated with limited liability under the law
of the Cayman Islands, in a private placement through AISs wholly-owned
Delaware subsidiary, Trust I. AIS, through Trust I, together with other insurance companies and insurance
holding companies, issued trust preferred securities to the collateralized debt
obligation pool organized by Dekania Capital Management LLC, which in turn,
issued its securities to institutional and accredited investors. Trust I
issued 10,000 trust preferred securities, having a stated liquidation amount of
$1,000 per security, that mature on September 30, 2033 and bear a floating
interest rate, reset quarterly, equal to the London Interbank Offered Rate
(LIBOR) plus 4.05%. AIS, through Trust I, has the right to call the trust
preferred securities at par after September 30, 2008, five years from the date
of issuance. The entire proceeds from the sale of the trust preferred securities, including
the proceeds from the sale of common securities of Trust I to AIS, were used to
fund the purchase of $10.3 million (in principal amount) of junior subordinated
deferrable interest notes issued by AIS under an indenture, dated as of
September 30, 2003, between AIS and JPMorgan Chase Bank, as trustee. On October 29, 2003, AIS sold $20.0 million (aggregate liquidation amount) of
floating rate trust preferred securities to I-Preferred Term Securities III,
Ltd., an exempted company incorporated with limited liability under the law of
the Cayman Islands, in a private placement through AIS wholly-owned
Connecticut subsidiary, United National Group Capital Statutory Trust II
(Trust II). AIS, through Trust II, together with other insurance companies and insurance
holding companies, issued trust preferred securities to the collateralized debt
obligation pool organized by I-Preferred Term Securities III, Ltd., which in
turn, issued its securities to institutional and accredited investors. Trust
II issued 20,000 trust preferred securities, having a stated liquidation amount
of $1,000 per security, that mature on October 29, 2033 and bear a floating
interest rate, reset quarterly, equal to LIBOR plus 3.85%. AIS, through Trust
II, has the right to call the trust preferred securities at par after October
29, 2008, five years from the date of issuance. The entire proceeds from the sale of the trust preferred securities, including
the proceeds from the sale of common securities of Trust II to AIS, were used
to fund the purchase of $20.6 million (in principal amount) of floating rate
junior subordinated deferrable interest debentures issued by AIS under an
indenture, dated as of October 29, 2003, between AIS and U.S. Bank National
Association, as trustee. In June and July of 2004, U.N. Barbados made capital contributions of $10.0
million and $15.0 million, respectively, to U.N. Bermuda. On September 5, 2003 we began paying annual management fees of $1.5 million in
the aggregate to Fox Paine & Company and The AMC Group, L.P. Management fee
payments of $1.5 million in the aggregate were made to Fox Paine & Company and
the AMC Group, L.P on November 1, 2004. The next management fee payment of $1.5
million is payable November 1, 2005. Pursuant to the Stock Purchase Agreement, United National Insurance Company has
agreed to purchase 100% of the common stock of Penn Independent
Corporation for $96.8 million. The purchase of
the common stock and outstanding options on the common stock of Penn
Independent Corporation and related transaction costs will be funded from the
cash and invested assets of United National Insurance Company. The transaction
is expected to close in the first quarter of 2005. Pursuant to the Merger, U.N. Holdings II, Inc. has agreed to purchase
approximately 10,012,479 shares of Penn-America common stock not held by Penn Independent
Corporation. We will require cash of approximately $15.0 million to pay $1.50
per share in cash in addition to shares of United National Group
Class A common shares issued in exchange for approximately 10,012,479 shares of Penn-America
common stock not
held by Penn Independent Corporation. The cash requirements of this
transaction,
including transaction costs, will be funded from cash and invested assets of our
subsidiaries exclusive of the U.S. Insurance Subsidiaries. The transaction is
expected to close in the first quarter of 2005. 35




---



##### Table of Contents



Off Balance Sheet Arrangements We have no off balance sheet arrangements. Inflation Property and casualty insurance premiums are established before we know the
amount of losses and loss adjustment expenses or the extent to which inflation
may affect such amounts. We attempt to anticipate the potential impact of
inflation in establishing our reserves. Substantial future increases in inflation could result in future increases in
interest rates, which in turn are likely to result in a decline in the market
value of the investment portfolio and resulting unrealized losses or reductions
in shareholders equity. Cautionary Note Regarding Forward-Looking Statements Some of the statements under Managements Discussion and Analysis of Financial
Condition and Results of Operations, and elsewhere in this report may include
forward-looking statements that reflect our current views with respect to
future events and financial performance. Such statements include
forward-looking statements both with respect to us specifically and the
insurance and reinsurance sectors in general, both as to underwriting and
investment matters. Statements that include the words expect, intend,
plan, believe, project, anticipate, seek, will and similar
statements of a future or forward-looking nature identify forward-looking
statements for purposes of the federal securities laws or otherwise. All forward-looking statements address matters that involve risks and
uncertainties. Accordingly, there are or will be important factors that could
cause actual results to differ materially from those indicated in such
statements. We believe that these factors include, but are not limited to, the
following:  
    
    ineffectiveness of our business strategy due to changes in current or
future market conditions;  
    
    inability to consummate one or both of the pending transaction with
Penn Independent Corporation or Penn-America due to the failure to
satisfy conditions, including shareholder approval to which the
transactions are subject;  
    
    the effects of competitors pricing policies, and of changes in laws
and regulations on competition, including industry consolidation and
development of competing financial products;  
    
    greater frequency or severity of claims and loss activity than our
underwriting, reserving or investment practices have anticipated;  
    
    decreased level of demand for our insurance products or increased
competition due to an increase in capacity of property and casualty
insurers;  
    
    our ability to implement our business plan for our Non-U.S.
Operations;  
    
    the inability to obtain or maintain financial strength or
claims-paying ratings by one or more of our insurance subsidiaries;  
    
    United National Group, U.N. Barbados or U.N. Bermuda becoming subject to income taxes in the United States;  
    
    changes in regulations or tax laws applicable to us, our subsidiaries, brokers or customers;  
    
    acceptance of our products and services, including new products and services;  
    
    changes in the availability, cost or quality of reinsurance or a
deterioration of the claims-paying ability of reinsurers who have
payment obligations to us;  
    
    the effects of acts of terrorism;  
    
    the effects of terrorist-related insurance legislation and laws;  
    
    loss of key personnel; 36




---



##### Table of Contents




    
    political instability in the Cayman Islands, Barbados or Bermuda;  
    
    changes in accounting policies or practices; and  
    
    changes in general economic conditions, including interest rates,
inflation and other factors that could affect our investment portfolio. The foregoing review of important factors should not be construed as exhaustive
and should be read in conjunction with the other cautionary statements that are
included in our Annual Report on Form 10-K for the fiscal year ended December
31, 2003 under Business-Risk Factors. We undertake no obligation to publicly
update or review any forward-looking statement, whether as a result of new
information, future developments or otherwise. 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk We believe that we are principally exposed to two types of market risk: Interest Rate Risk Our primary market risk exposure is to changes in interest rates. Our fixed
income investments are exposed to interest rate risk. Fluctuations in interest
rates have a direct impact on the market valuation of these securities. As
interest rates rise, the market value of our fixed income investments fall, and
the converse is also true. We expect to manage interest rate risk through an
active portfolio management strategy that involves the selection, by our
managers, of investments with appropriate characteristics, such as duration,
yield, currency and liquidity, that are tailored to the anticipated cash
outflow characteristics of our liabilities. Our strategy for managing interest
rate risk also includes maintaining a high quality portfolio with a relatively
short duration to reduce the effect of interest rate changes on book value. A
significant portion of our investment portfolio matures each year, allowing for
reinvestment at current market rates. Our market risk associated with exposure
to interest rate risk has not materially changed since December 31, 2003. The
average duration of our fixed income investments, excluding securities that are
short  term in nature, approximated 3.8 years as of September 30, 2004,
compared with 4.2 years as of December 31, 2003. The table below provides information about our bonds that are sensitive to
changes in interest rates. (Dollars in thousands) Maturity
    
    Principal
    
    Book
    
    Average Interest Rate2004
    
    $
    102,891
    
    
    $
    102,909
    
    
    
    1.51
    %2005
    
    
    18,345
    
    
    
    18,531
    
    
    
    1.86
    %2006
    
    
    46,325
    
    
    
    46,898
    
    
    
    2.51
    %2007
    
    
    41,905
    
    
    
    42,252
    
    
    
    3.16
    %2008
    
    
    31,915
    
    
    
    32,874
    
    
    
    3.30
    %Thereafter
    
    
    368,651
    
    
    
    368,175
    
    
    
    4.41
    %Total
    
    $
    610,032
    
    
    $
    611,639
    
    
    
    3.55
    %Total Fair Value
    
    
    
    
    
    $
    621,636
 Credit Risk We have exposure to credit risk primarily as a holder of fixed income
investments. Our investment policy requires that we invest in debt instruments
of high credit quality issuers and limits the amount of credit exposure to any
one issuer based upon the rating of the security. In addition, we have credit risk exposure to our general agencies and
reinsurers. We seek to mitigate and control our risks to producers by
typically requiring our general agencies to render payments within no more than
45 days after the month in which a policy is effective and including provisions
within our general agency contracts that allow us to terminate a general
agencies authority in the event of non-payment. With respect to our credit exposure to reinsurers, we seek to mitigate and
control our risk by ceding business to only those reinsurers having adequate
financial strength and sufficient capital to fund their obligation. In
addition, we seek to mitigate credit risk to reinsurers through the use of
trusts and letters of credit for collateral. As of September 30, 2004, $725.9
million of collateral was held to support the reinsurance receivables. 37




---



##### Table of Contents



Item 4. Controls and Procedures Evaluation of Disclosure Controls and Procedures Based on their evaluation of our disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as
amended (the Exchange Act)), our chief executive officer and chief financial
officer have concluded that as of September 30, 2004, our disclosure controls
and procedures were designed to ensure that information required to be
disclosed by us in the reports that we file or submit under the Exchange Act is
recorded, processed, summarized and reported within the time periods specified
in the Securities and Exchange Commissions rules and forms and are operating
in an effective manner. Changes in Internal Controls There was not any change in our internal controls over financial reporting that
occurred during the quarter ended September 30, 2004 that has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting. 38




---



##### Table of Contents



PART II  OTHER INFORMATION 
 Item 1. Legal Proceedings We are, from time to time, involved in various legal proceedings in the
ordinary course of business, including litigation regarding claims. Other than
the matters described below, we do not believe that the resolution of any
currently pending legal proceedings, either individually or taken as a whole,
will have a material adverse effect on our business, results of operations or
financial condition. We anticipate that, similar to the rest of the insurance
and reinsurance industry, we will continue to be subject to litigation and
arbitration proceedings in the ordinary course of business. On January 22, 2004, our subsidiary Diamond State Insurance Company (Diamond
State), elected to enter into a settlement with Bank of America, N.A. and
Platinum Indemnity Limited relative to litigation pending in the United States
District Court for the Southern District of New York. Under the terms of the
settlement, Diamond State paid $17.8 million to Bank of America and provided
other non-financial consideration to Bank of America and Platinum in exchange
for a full and final release by Bank of America and Platinum, and other
consideration, relative to their claims of approximately $29.0 million, plus
interest in excess of $10.0 million and fees and costs, related to facultative
reinsurance policies issued by Worldwide Weather Insurance Agency, and its
principal Harold Mollin, purportedly on behalf of Diamond State. As a result of the settlement, Diamond State is proceeding with an arbitration
against Partner Reinsurance Company, Ltd. and Partner Reinsurance Company of
the U.S. seeking recovery under a reinsurance agreement covering business
produced by Worldwide Weather Insurance Agency on a 100% basis with regard to
the type of risk involved. In that connection, Diamond State holds a letter of
credit dated March 31, 2004 from Partner Reinsurance Company, Ltd. in the
amount of $17.8 million. In addition, Diamond State is seeking indemnification
and contribution from Partner Reinsurance Company of the U.S. because of its
role in the appointment of Mr. Mollin and Worldwide Weather Insurance Agency.
The arbitration hearing commenced on November 8, 2004. On October 5, 2004, our subsidiary United National Insurance Company agreed in
principle to settle, in consideration of a payment by Gulf Underwriters
Insurance Company (Gulf) to United National Insurance Company in the amount
of $1.8 million, a lawsuit instituted by Gulf pending in the Superior Court of
Fulton County, Georgia. The lawsuit had sought to rescind a facultative
reinsurance certificate issued by Gulf to United National Insurance Company
with regard to an individual insurance policy written by United National
Insurance Company and ceded to Gulf. The facultative reinsurance certificate
provided 100% reinsurance to United National Insurance Company for loss and
loss adjustment expenses paid under the insurance policy. The lawsuit had
followed United National Insurance Companys billing to Gulf for reimbursement
of a loss in the amount of $3.1 million that United National Insurance Company
had paid under that insurance policy and for which United National Insurance
Company filed a counterclaim against Gulf. We believe that the ultimate outcome of all litigation, arbitration,
reinsurance recoverable and coverage claim matters, after consideration of
applicable reserves, should not have a material adverse effect on our financial
condition. Nevertheless, we cannot assure you that lawsuits, arbitrations or
other litigation will not have a material adverse effect on our business,
financial condition or results of operations. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Not applicable. 
 Item 3. Defaults Upon Senior Securities Not applicable. 
 Item 4. Submission of Matters to a Vote of Security Holders Not applicable. 
 Item 5. Other Information Not applicable. 39




---



##### Table of Contents



Item 6. Exhibits  2.1
    
    Agreement and Plan of Merger, dated as of October 14, 2004, by and
among Penn-America Group, Inc., United National Group, Ltd., U.N.
Holdings II, Inc. and Cheltenham Acquisition Corp.
(incorporated herein by reference to Exhibit 2.1 of our Current Report
on Form 8-K dated October 15, 2004).2.2
    
    Stock Purchase Agreement, dated as of October 14, 2004, by and among
United National Group, Ltd., United National Insurance Company, Penn
Independent Corporation, the Shareholders named therein and the
Shareholders representative (incorporated herein by reference to
Exhibit 2.2 of our Current Report on Form 8-K dated October 15, 2004).2.3
    
    Stock Purchase Agreement, dated as of October 14, 2004, by and among
United National Group, Ltd., United National Insurance Company and Irvin
Saltzman (incorporated herein by reference to Exhibit 2.3 of our Current
Report on Form 8-K dated October 15, 2004).2.4
    
    Stock Purchase Agreement, dated as of October 14, 2004, by and among
United National Group, Ltd., United National Insurance Company, Jon S.
Saltzman and Joanne Lynch Saltzman (incorporated herein by reference to
Exhibit 2.4 of our Current Report on Form 8-K dated October 15, 2004).31.1+
    
    Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2+
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1+
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.32.2+
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.  + Filed herewith. 40




---



##### Table of Contents



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. UNITED NATIONAL GROUP, LTD.RegistrantNovember 11, 2004
    
    By:
    
    /s/ David R. BradleyDateDavid R. BradleyChief Executive OfficerNovember 11, 2004
    
    By:
    
    /s/ Kevin L. TateDateKevin L. TateChief Financial Officer
 41




---



##### Table of Contents



Exhibit Index Exhibit Number2.1
    
    Agreement and Plan of Merger, dated as of October 14, 2004, by and
among Penn-America Group, Inc., United National Group, Ltd., U.N.
Holdings II, Inc. and Cheltenham Acquisition Corp.
(incorporated herein by reference to Exhibit 2.1 of our Current Report
on Form 8-K dated October 15, 2004).2.2
    
    Stock Purchase Agreement, dated as of October 14, 2004, by and among
United National Group, Ltd., United National Insurance Company, Penn
Independent Corporation, the Shareholders named therein and the
Shareholders representative (incorporated herein by reference to
Exhibit 2.2 of our Current Report on Form 8-K dated October 15, 2004).2.3
    
    Stock Purchase Agreement, dated as of October 14, 2004, by and among
United National Group, Ltd., United National Insurance Company and Irvin
Saltzman (incorporated herein by reference to Exhibit 2.3 of our Current
Report on Form 8-K dated October 15, 2004).2.4
    
    Stock Purchase Agreement, dated as of October 14, 2004, by and among
United National Group, Ltd., United National Insurance Company, Jon S.
Saltzman and Joanne Lynch Saltzman (incorporated herein by reference to
Exhibit 2.4 of our Current Report on Form 8-K dated October 15, 2004).31.1+
    
    Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2+
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as amended,
as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1+
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.32.2+
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.
  + Filed herewith.