##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Quarterly Period Ended March 31, 2004 OR [   ]
    

    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Transition Period From _____ to ___________ 000-50511
Commission File Number UNITED NATIONAL GROUP, LTD.  Cayman Islands(State or other jurisdiction
    
    98-0417107of incorporation or organization)
    
    (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 May 12, 2004, the registrant had outstanding 15,569,662 Class A Common
Shares and 12,687,500 Class B Common Shares.




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TABLE OF CONTENTS PagePART I  FINANCIAL INFORMATIONItem 1. Financial Statements:Consolidated Balance Sheets
    
    
    3Consolidated Statements of Operations
    
    
    4Consolidated Statements of Comprehensive Income
    
    
    5Consolidated Statements of Changes in Shareholders Equity
    
    
    6Consolidated Statements of Cash Flows
    
    
    7Notes to Consolidated Financial Statements
    
    
    8Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    14Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    27PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    28Item 2. Changes in Securities and Use of Proceeds
    
    
    28Item 3. Defaults Upon Senior Securities
    
    
    28Item 4. Submission of Matters to a Vote of Security Holders
    
    
    28Item 5. Other Information
    
    
    28Item 6. Exhibits and Reports on Form 8-K
    
    
    29SECTION 302 CERTIFICATION OF CEOSECTION 302 CERTIFICATION OF CFOSECTION 906 CERTIFICATION OF CEOSECTION 906 CERTIFICATION OF CFO
  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
(Bermuda), 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




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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 ofMarch 31, 2004
    
    December 31, 2003ASSETSBonds:Available for sale securities, at fair value
(amortized cost: $634,017 and $540,543)
    
    $
    645,760
    
    
    $
    549,966Preferred shares:Available for sale securities, at fair value
(cost: $4,838 and $4,372)
    
    
    5,345
    
    
    
    4,894Common shares:Available for sale securities, at fair value
(cost: $31,422 and $30,762)
    
    
    34,382
    
    
    
    33,219Other invested assets
    
    
    49,657
    
    
    
    45,434Total investments
    
    
    735,144
    
    
    
    633,513Cash and cash equivalents
    
    
    140,403
    
    
    
    214,796Agents balances, net
    
    
    56,234
    
    
    
    62,374Reinsurance receivables, net
    
    
    1,747,098
    
    
    
    1,762,988Accrued investment income
    
    
    6,059
    
    
    
    5,909Federal income taxes receivable
    
    
    3,971
    
    
    
    4,898Deferred federal income taxes, net
    
    
    24,491
    
    
    
    25,323Deferred acquisition costs, net
    
    
    15,732
    
    
    
    8,581Prepaid reinsurance premiums
    
    
    108,839
    
    
    
    117,936Other assets
    
    
    14,177
    
    
    
    12,443Total assets
    
    $
    2,852,148
    
    
    $
    2,848,761LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Unpaid losses and loss adjustment expenses
    
    $
    2,036,072
    
    
    $
    2,059,760Unearned premiums
    
    
    181,504
    
    
    
    177,408Amounts held for the account of others
    
    
    17,066
    
    
    
    20,201Ceded balances payable
    
    
    43,820
    
    
    
    59,876Payable for securities
    
    
    29,619
    
    
    
    Contingent commissions
    
    
    5,213
    
    
    
    5,178Senior notes payable to related party
    
    
    72,848
    
    
    
    72,848Junior subordinated debentures
    
    
    30,929
    
    
    
    30,929Other liabilities
    
    
    35,213
    
    
    
    41,769Total liabilities
    
    
    2,452,284
    
    
    
    2,467,969Commitments and contingencies (Note 6)
    
    
    
    
    
    
    Shareholders equity:Common shares, $0.0001 par value, 900,000,000 common
shares authorized, 15,568,003 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
    
    
    354,799
    
    
    
    347,487Accumulated other comprehensive income
    
    
    14,373
    
    
    
    10,031Retained earnings
    
    
    30,689
    
    
    
    23,271Total shareholders equity
    
    
    399,864
    
    
    
    380,792Total liabilities and shareholders equity
    
    $
    2,852,148
    
    
    $
    2,848,761
 See accompanying notes to consolidated financial statements. 3




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UNITED NATIONAL GROUP, LTD. 
 Consolidated Statements of Operations
(Dollars in thousands, except per share data) (Unaudited)
    
    (Unaudited)Successor
    
    PredecessorQuarter Ended
    
    Quarter EndedMarch 31, 2004
    
    March 31, 2003Revenues:Gross premiums written
    
    $
    117,938
    
    
    $
    214,460Net premiums written
    
    $
    58,617
    
    
    $
    53,636Net premiums earned
    
    $
    45,422
    
    
    $
    46,613Net investment income
    
    
    4,210
    
    
    
    5,284Net realized investment losses
    
    
    (70
    )
    
    
    (1,389
    )Total revenues
    
    
    49,562
    
    
    
    50,508Losses and Expenses:Net losses and loss adjustment expenses
    
    
    28,143
    
    
    
    32,831Acquisition costs and other underwriting expenses
    
    
    13,520
    
    
    
    8,336Provision for doubtful reinsurance receivables
    
    
    
    
    
    
    875Other operating expenses
    
    
    514
    
    
    
    444Interest expense
    
    
    1,315
    
    
    
    3Income before income taxes
    
    
    6,070
    
    
    
    8,019Income tax (benefit) expense
    
    
    (769
    )
    
    
    1,384Net income before equity in net income of partnerships
    
    
    6,839
    
    
    
    6,635Equity in net income of partnerships
    
    
    579
    
    
    
    413Net income
    
    $
    7,418
    
    
    $
    7,048Per share data:Net income:Basic
    
    $
    0.26
    
    
    $
    70,480Diluted
    
    $
    0.26
    
    
    $
    70,480Weighted-average number of shares outstanding:Basic
    
    
    28,219,926
    
    
    
    100Diluted
    
    
    28,897,621
    
    
    
    100
 See accompanying notes to consolidated financial statements. 4




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UNITED NATIONAL GROUP, LTD. 
 Consolidated Statements of Comprehensive Income
(Dollars in thousands) (Unaudited)
    
    (Unaudited)Successor
    
    PredecessorQuarter Ended
    
    Quarter EndedMarch 31, 2004
    
    March 31, 2003Net income
    
    $
    7,418
    
    
    $
    7,048Other comprehensive income, before tax:Unrealized gains (losses) on securities:Unrealized holding gains arising during period
    
    
    5,776
    
    
    
    42Less:Reclassification adjustment for losses
included in net income
    
    
    (291
    )
    
    
    (725
    )Other comprehensive income, before tax
    
    
    6,067
    
    
    
    767Income tax expense related to items of other
comprehensive income
    
    
    1,725
    
    
    
    268Other comprehensive income, net of tax
    
    
    4,342
    
    
    
    499Comprehensive income, net of tax
    
    $
    11,760
    
    
    $
    7,547
 See accompanying notes to consolidated financial statements. 5




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UNITED NATIONAL GROUP, LTD. 
 Consolidated Statements of Changes in Shareholders Equity
(Dollars in thousands) (Unaudited)
    
    Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    January 1, 2003Quarter Ended
    
    through
    
    throughMarch 31, 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 B common shares issued in exchange for
Series A preferred shares
    
    
    
    
    
    
    2,687,500
    
    
    
    Number at end of period
    
    
    28,255,503
    
    
    
    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
    
    
    
    
    
    
    29,250
    
    
    
    Preferred shares redeemed
    
    
    
    
    
    
    (149,998
    )
    
    
    Contributed capital from preferred shares
    
    
    
    
    
    
    35,000
    
    
    
    Contributed capital from common shares
    
    
    7,312
    
    
    
    193,238
    
    
    
    5,638Balance at end of period
    
    $
    354,799
    
    
    $
    347,487
    
    
    $
    86,824Accumulated other comprehensive income net of
deferred income tax:Balance at beginning of period
    
    $
    10,031
    
    
    $
    
    
    
    $
    7,329Other comprehensive income (loss)
    
    
    4,342
    
    
    
    10,031
    
    
    
    (1,962
    )Balance at end of period
    
    $
    14,373
    
    
    $
    10,031
    
    
    $
    5,367Retained earnings:Balance at beginning of period
    
    $
    23,271
    
    
    $
    
    
    
    $
    180,122Net income
    
    
    7,418
    
    
    
    52,521
    
    
    
    24,604Preferred share dividends
    
    
    
    
    
    
    (29,250
    )
    
    
    Balance at end of period
    
    $
    30,689
    
    
    $
    23,271
    
    
    $
    204,726Total shareholders equity
    
    $
    399,864
    
    
    $
    380,792
    
    
    $
    296,917
 See accompanying notes to consolidated financial statements. 6




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UNITED NATIONAL GROUP, LTD. 
 Consolidated Statements of Cash Flows
(Dollars in thousands) Successor
    
    PredecessorQuarter Ended
    
    Quarter EndedMarch 31, 2004
    
    March 31, 2003Cash flows from operating activities:Net income
    
    $
    7,418
    
    
    $
    7,048Adjustments to reconcile net income to net cash
(used for) provided by operating activities:Amortization of debt issuance costs
    
    
    45
    
    
    
    Deferred federal income taxes
    
    
    (1,198
    )
    
    
    (1,297
    )Amortization of bond premium and discount, net
    
    
    760
    
    
    
    389Net realized investment gains
    
    
    70
    
    
    
    666Equity in income of partnerships
    
    
    (579
    )
    
    
    (413
    )Unrealized loss on trading securities
    
    
    
    
    
    
    725Provision for doubtful reinsurance receivables
    
    
    
    
    
    
    875Proceeds from sale or maturity of trading securities
    
    
    
    
    
    
    3,618Purchase of trading securities
    
    
    
    
    
    
    (4,086
    )Changes in:Agents balances
    
    
    6,140
    
    
    
    (10,378
    )Reinsurance receivables
    
    
    15,890
    
    
    
    (48,883
    )Unpaid losses and loss adjustment expenses
    
    
    (23,688
    )
    
    
    56,422Unearned premiums
    
    
    4,096
    
    
    
    261Ceded balances payable
    
    
    (16,056
    )
    
    
    40,161Other liabilities
    
    
    (6,556
    )
    
    
    (11,290
    )Amounts held for the account of others
    
    
    (3,135
    )
    
    
    (2,620
    )Contingent commissions
    
    
    35
    
    
    
    1,170Federal income tax receivable
    
    
    927
    
    
    
    10,879Prepaid reinsurance premiums
    
    
    9,097
    
    
    
    6,762Other  net
    
    
    (9,085
    )
    
    
    905Net cash (used for) provided by operating activities
    
    
    (15,819
    )
    
    
    50,914Cash flows from investing activities:Proceeds from sale of bonds and stocks
    
    
    20,086
    
    
    
    28,639Proceeds from maturity of bonds
    
    
    5,766
    
    
    
    Proceeds from sale of other invested assets
    
    
    383
    
    
    
    2,320Purchase of bonds and stocks
    
    
    (91,371
    )
    
    
    (16,009
    )Proceeds from sale or repayment of mortgages
    
    
    
    
    
    
    1,172Purchase of other invested assets
    
    
    (750
    )
    
    
    (593
    )Net cash (used for) provided by investing activities
    
    
    (65,886
    )
    
    
    15,529Cash flows from financing activities:Net proceeds from IPO of common shares
    
    
    7,312
    
    
    
    Net cash provided by financing activities
    
    
    7,312
    
    
    
    Net change in cash and cash equivalents
    
    
    (74,393
    )
    
    
    66,443Cash and cash equivalents at beginning of period
    
    
    214,796
    
    
    
    72,942Cash and cash equivalents at end of period
    
    $
    140,403
    
    
    $
    139,385
 See accompanying notes to consolidated financial statements. 7




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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 (Bermuda), 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 March 31, 2004 and for the quarters
ended March 31, 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 and normal
recurring adjustments that are, in the opinion of management, necessary for a
fair statement of results for the interim periods. Results of operations for
the quarters ended March 31, 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 2003 Annual Report on Form
10-K. (2) Investments Bonds with an estimated fair market value of approximately $339.9 million and
$292.8 million were deposited with various governmental authorities in
accordance with statutory requirements at March 31, 2004 and December 31, 2003,
respectively. The $339.9 million includes
$3.0 million held in trust to meet statutory requirements of
UNIC. In addition, bonds with an estimated fair market value of $5.4
million at March 31, 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 under 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. There were no realized losses recorded for the quarters ended March
31, 2004 and 2003 as a result of the Companys other than temporary impairment
evaluation. 8




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(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 March 31, 2004, the Company had total reinsurance receivables of $1,747.1 million. The carrying value of the
receivables is net of a $33.1 million reduction related 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 Acquisition,
has been reduced to $33.1 million as of March 31, 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 $49.1 million reduction
related to potentially uncollectible receivables. The Company has converted
select quota share reinsurance arrangements to excess
of loss reinsurance. Gross premiums written were $117.9 million for the
quarter ended March 31, 2004 compared with $214.5 million for the quarter ended
March 31, 2003. Net premiums written were $58.6 million for the quarter ended
March 31, 2004 compared with $53.6 million for the quarter ended March 31,
2003. Net premiums written grew as a result of increasing rates
combined with increased retentions across
the Companys core book of business. Gross premiums written were lower as a result of exiting
from heavily reinsured products. The U.S. Insurance Subsidiaries entered into a quota share arrangement with
U.N. Barbados and U.N. Bermuda. This reinsurance arrangement stipulates that
60% of the Companys net retained insurance liability on new and renewal
business bound January 1, 2004 and later to be ceded to the Companys Non-U.S.
Operations. The agreement also stipulates that 60% of the December 31, 2003
unearned premium be ceded to the Companys Non-U.S. Operations. The impact of
this reinsurance arrangement is reflected in the Companys March 31, 2004
financial statements. (4) Federal Income Taxes The following table summarizes the differences between the effective tax rate
for financial statement purposes and the U.S. federal statutory rate: Successor
    
    PredecessorQuarter Ended
    
    Quarter EndedMarch 31, 2004
    
    March 31, 2003% of Pre-
    
    
    
    
    
    % of Pre-(Dollars in thousands)
    
    Amount
    
    Tax Income
    
    Amount
    
    Tax IncomeExpected tax expense at the U. S. statutory rate
    
    $
    2,125
    
    
    
    35.0
    %
    
    $
    2,807
    
    
    
    35.0
    %Adjustments:Tax exempt interest
    
    
    (1,215
    )
    
    
    (20.0
    )
    
    
    (1,380
    )
    
    
    (17.2
    )Foreign income not expected to be taxed in
the U.S.
    
    
    (1,718
    )
    
    
    (28.3
    )
    
    
    
    
    
    
    Dividend exclusion
    
    
    (37
    )
    
    
    (0.6
    )
    
    
    (37
    )
    
    
    (0.5
    )State income taxes
    
    
    32
    
    
    
    0.5
    
    
    
    (11
    )
    
    
    (0.1
    )Other
    
    
    44
    
    
    
    0.7
    
    
    
    5
    
    
    
    0.1Actual Taxes
    
    $
    (769
    )
    
    
    (12.7
    )%
    
    $
    1,384
    
    
    
    17.3
    %
 (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 our 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 March 31, 2004,
the related adjustments could have a material adverse impact on the Companys
results of operations. 9




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##### Table of Contents



(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. Management believes, however, that
the ultimate outcome of all litigation and coverage claim matters after
consideration of applicable reserves should not have a material adverse effect
on the Companys financial condition. On January 22, 2004, our subsidiary Diamond State, entered 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 has activated a pending
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 Company believes the recorded reinsurance receivable
from Partner Reinsurance Company will be fully collected. On July 11, 2003, our subsidiary United National Insurance Company was named a
defendant in a lawsuit filed in the Superior Court of Fulton County, Georgia,
by Gulf Underwriters Insurance Company (Gulf) seeking rescission of 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
followed United National Insurance Companys billing to Gulf for reimbursement
of a loss in the amount of $3.1 million that was paid under that insurance
policy. The rescission claim is based on allegations of breach of contract;
misrepresentation; non-disclosure and breach of duty of good faith; and fraud.
The complaint also seeks attorneys fees and costs. United National Insurance Company denies the allegations in the complaint and
has filed a counterclaim seeking payment of the amount of losses and loss
adjustment expenses paid under the insurance policy plus statutory damages of
$1.6 million as a result of late payment. A trial date has not been set for
this litigation. However, a voluntary mediation, to be held in June 2004, has
been agreed to by the parties. The Company believes the recorded reinsurance
receivable from Gulf will be fully collected. 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. (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. 10




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##### Table of Contents



(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 table sets forth the computation
of basic and diluted earnings per share. Successor
    
    PredecessorQuarter Ended
    
    Quarter Ended(Dollars in thousands, except per share data)
    
    March 31, 2004
    
    March 31, 2003Net income
    
    $
    7,418
    
    
    $
    7,048Weighted average common shares outstanding
    
    
    28,219,926
    
    
    
    100Basic net income per share
    
    $
    0.26
    
    
    $
    70,480Weighted average common shares outstanding
    
    
    28,219,926
    
    
    
    100Weighted average common share equivalents outstanding
    
    
    676,695
    
    
    
    Weighted average common shares and equivalents outstanding
    
    
    28,896,621
    
    
    
    100Diluted net income per share
    
    $
    0.26
    
    
    $
    70,480
 (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 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. Gross premiums written by product class are as follows: Successor
    
    PredecessorQuarter Ended
    
    Quarter Ended(Dollars in thousands)
    
    March 31, 2004
    
    March 31, 2003Specific specialty
    
    $
    37,730
    
    
    $
    90,526Umbrella and excess
    
    
    14,965
    
    
    
    70,738Property and general liability
    
    
    39,717
    
    
    
    27,193Non-medical professional liability
    
    
    25,526
    
    
    
    26,003$
    117,938
    
    
    $
    214,460
 The gross premiums written information is not segregated by business segment
because product lines cross segments. 11




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##### Table of Contents



Following is a tabulation of business segment information. Corporate
information is included to reconcile segment data to the consolidated financial
statements. SuccessorQuarter Ended March 31, 2004:
    
    E&S
    
    Specialty(Dollars in thousands)
    
    Lines
    
    Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    83,247
    
    
    $
    34,691
    
    
    $
    
    
    
    $
    117,938Net premiums written
    
    $
    34,754
    
    
    $
    23,863
    
    
    $
    
    
    
    $
    58,617Net premiums earned
    
    $
    26,639
    
    
    $
    18,783
    
    
    $
    
    
    
    $
    45,422Net investment income
    
    
    
    
    
    
    
    
    
    
    4,210
    
    
    
    4,210Net realized investment losses
    
    
    
    
    
    
    
    
    
    
    (70
    )
    
    
    (70
    )Total revenues
    
    
    26,639
    
    
    
    18,783
    
    
    
    4,140
    
    
    
    49,562Losses and Expenses:Net losses and loss adjustment expenses
    
    
    16,435
    
    
    
    11,708
    
    
    
    
    
    
    
    28,143Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    13,520
    
    
    
    13,520Other operating expenses
    
    
    
    
    
    
    
    
    
    
    514
    
    
    
    514Interest expense
    
    
    
    
    
    
    
    
    
    
    1,315
    
    
    
    1,315Income (loss) before income taxes
    
    
    10,204
    
    
    
    7,075
    
    
    
    (11,209
    )
    
    
    6,070Income tax benefit
    
    
    
    
    
    
    
    
    
    
    (769
    )
    
    
    (769
    )Net income (loss) before equity in net
income of partnerships
    
    
    10,204
    
    
    
    7,075
    
    
    
    (10,440
    )
    
    
    6,839Equity in net income of partnerships
    
    
    
    
    
    
    
    
    
    
    579
    
    
    
    579Net income (loss)
    
    $
    10,204
    
    
    $
    7,075
    
    
    $
    (9,861
    )
    
    $
    7,418Total assets
    
    
    
    
    
    
    
    
    
    $
    2,852,148
    
    
    $
    2,852,148
 PredecessorQuarter Ended March 31, 2003:
    
    E&S
    
    Specialty(Dollars in thousands)
    
    Lines
    
    Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    136,528
    
    
    $
    77,932
    
    
    $
    
    
    
    $
    214,460Net premiums written
    
    $
    30,859
    
    
    $
    22,777
    
    
    $
    
    
    
    $
    53,636Net premiums earned
    
    $
    27,860
    
    
    $
    18,753
    
    
    $
    
    
    
    $
    46,613Net investment income
    
    
    
    
    
    
    
    
    
    
    5,284
    
    
    
    5,284Net realized investment losses
    
    
    
    
    
    
    
    
    
    
    (1,389
    )
    
    
    (1,389
    )Total revenues
    
    
    27,860
    
    
    
    18,753
    
    
    
    3,895
    
    
    
    50,508Losses and Expenses:Net losses and loss adjustment expenses
    
    
    20,248
    
    
    
    12,583
    
    
    
    
    
    
    
    32,831Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    8,336
    
    
    
    8,336Provision for doubtful reinsurance receivables
    
    
    
    
    
    
    
    
    
    
    875
    
    
    
    875Other operating expenses
    
    
    
    
    
    
    
    
    
    
    444
    
    
    
    444Interest expense
    
    
    

    
    
    
    
    
    
    
    3
    
    
    
    3Income (loss) before income taxes
    
    
    7,612
    
    
    
    6,170
    
    
    
    (5,763
    )
    
    
    8,019Income tax expense
    
    
    
    
    
    
    
    
    
    
    1,384
    
    
    
    1,384Net income (loss) before equity in net
income of partnerships
    
    
    7,612
    
    
    
    6,170
    
    
    
    (7,147
    )
    
    
    6,635Equity in net income of partnerships
    
    
    
    
    
    
    
    
    
    
    413
    
    
    
    413Net income (loss)
    
    $
    7,612
    
    
    $
    6,170
    
    
    $
    (6,734
    )
    
    $
    7,048
 12




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##### Table of Contents



(10) Supplemental Cash Flow Information Taxes and Interest Paid Successor
    
    PredecessorQuarter Ended
    
    Quarter Ended(Dollars in thousands)
    
    March 31, 2004
    
    March 31, 2003Federal income taxes paid
(received)
    
    $
    (534
    )
    
    $
    (8,183
    )Interest paid
    
    
    400
    
    
    
    
 13




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##### 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 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). 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 47
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 quarter ended March 31, 2004, we realized additional insurance
policy rate increases at levels slightly less than those levels realized during
the quarter ended March 31, 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. 14




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##### Table of Contents



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
$49.7 million as of March 31, 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 March 31, 2004, our other
invested assets portfolio included $19.4 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. In connection with the Acquisition, all of the Predecessors investments at
September 5, 2003 were adjusted to their fair value on that date and the fair
value of all investments on September 5, 2003 became the book value
prospectively for us. As a result, at March 31, 2004, we had no securities
which had been continuously in an unrealized loss position for greater than a
year. 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. 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 March 31, 2004, we had total reinsurance receivables of $1,747.1 million. The carrying value of these reinsurance
receivables is net of $33.1 million 15




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##### Table of Contents



related 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 $33.1 million as of March 31, 2004 primarily as a result of the
commutation agreement with Trenwick America Reinsurance Corp. on October 29,
2003. As of March 31, 2004, the amount of collateral securing individual reinsurance
receivables held by the Company was an aggregated $752.6 million, resulting in
reinsurance receivables net of collateral of $994.5 million. As of March 31, 2004, we also had total prepaid reinsurance premiums of $122.4
million, which were carried at $108.8 million. The carrying value of these
prepaid reinsurance premiums is net of a $13.6 million fair value adjustment
recorded in connection with the Acquisition. At the time of the Acquisition,
gross and net unearned premium reserves were adjusted by discounting the
unearned premium reserves and applying a risk margin to those reserves. The Company has converted
select quota share reinsurance arrangements to excess of loss
reinsurance. Gross premiums written were $117.9 million for the
quarter ended March 31, 2004 compared with $214.5 million
for the quarter ended March 31, 2003. Net premiums written were
$58.6 million for the quarter ended March 31, 2004 compared
with $53.6 million for the quarter ended March 31, 2003.
Net premiums written grew as a result of increasing rates combined
with increased retentions across the Companys core book of
business as a result of purchasing less reinsurance. Gross premiums
written were lower as a result of exiting from heavily reinsured
products. The U.S. Insurance
Subsidiaries entered into a quota share arrangement with U.N.
Barbados and U.N. Bermuda. This reinsurance arrangement stipulates
that 60% of the Companys net retained insurance liability on
new and renewal business bound January 1, 2004 and later to be
ceded to the Companys Non-U.S. Operations. The agreement
also stipulates that 60% of the December 31, 2003 unearned
premium be ceded to the Companys Non-U.S. Operations. The impact of
this reinsurance arrangement is reflected in the Companys
March 31, 2004 financial statements. Stock Based Compensation The Company accounts 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
table sets forth an analysis of financial data for our segments during the
periods indicated: For the Quarters Ended March 31,(Dollars in thousands)
    
    2004
    
    2003Gross premiums written:E&S
    
    $
    83,247
    
    
    $
    136,528Specialty admitted
    
    
    34,691
    
    
    
    77,932Gross premiums written
    
    $
    117,938
    
    
    $
    214,460Net premiums written:E&S
    
    $
    34,754
    
    
    $
    30,859Specialty admitted
    
    
    23,863
    
    
    
    22,777Net premiums written
    
    $
    58,617
    
    
    $
    53,636Net premiums earned:E&S
    
    $
    26,639
    
    
    $
    27,860Specialty admitted
    
    
    18,783
    
    
    
    18,753Net premiums earned
    
    $
    45,422
    
    
    $
    46,613Net losses and loss adjustment expenses:E&S
    
    $
    16,435
    
    
    $
    20,248Specialty admitted
    
    
    11,708
    
    
    
    12,583Net losses and loss adjustment expenses
    
    $
    28,143
    
    
    $
    32,831Net losses and loss adjustment expense ratio:E&S
    
    
    61.7
    %
    
    
    72.7
    %Specialty admitted
    
    
    62.3
    %
    
    
    67.1
    %Net losses and loss adjustment expense ratio
    
    
    62.0
    %
    
    
    70.4
    %
 16




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##### Table of Contents



Results of Operations Quarter Ended March 31, 2004 Compared with the Quarter Ended March 31, 2003 The results of operations for the quarter ended March 31, 2004 reflect the
financial performance of United National Group. The results of operations for
the quarter ended March 31, 2003 reflects the performance of 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 $117.9 million for the quarter
ended March 31, 2004, compared with $214.4 million for the quarter ended March
31, 2003, a decrease of $96.5 million or 45.0%. The decrease primarily
resulted from the termination of 17 products within our four product classes
during 2003 as planned and 13 products within our four product classes during
2002. Gross premiums written relative to those terminated products were $13.2
million for the quarter ended March 31, 2004 compared with $68.7 million for
the quarter ended March 31, 2003. A further breakdown of gross premiums
written is as follows:  
    
    E&S gross premiums written were $83.2 million for the quarter ended
March 31, 2004, compared with $136.5 million for the quarter ended March
31, 2003, a decrease of $53.3 million or 39.0%. 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
relative to our Umbrella and excess product class, offset by renewal
rate increases of approximately 15% (as measured against expiring rates)
on other products. E&S gross premiums written relative to the terminated
products were $11.8 million for the quarter ended March 31, 2004,
compared with $46.7 million for the quarter ended March 31, 2003.
    
    Specialty admitted gross premiums written were $34.7 million for the
quarter ended March 31, 2004, compared with $77.9 million for the
quarter ended March 31, 2003, a decrease of $43.2 million or 55.5%. 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
relative to our Umbrella and excess product class, offset by renewal
rate increases of approximately 13% on other products. Specialty
admitted gross premiums written relative to the terminated products were
$1.4 million for the quarter ended March 31, 2004, compared with $22.0
million for the quarter ended March 31, 2003. Net premiums written, which equal gross premiums written less ceded premiums
written, were $58.6 million for the quarter ended March 31, 2004, compared with
$53.6 million for the quarter ended March 31, 2003, an increase of $5.0 million
or 9.3%. The ratio of net premiums written to gross premiums written increased
to 49.7% for the quarter ended March 31, 2004, from 25.0% for the quarter ended
March 31, 2003. A further breakdown of net premiums written is as follows:  
    
    E&S net premiums written were $34.7 million for the quarter ended
March 31, 2004, compared with $30.9 million for the quarter ended March
31, 2003, an increase of $3.8 million or 12.3%. The ratio of net
premiums written to gross premiums written was 41.8% for the quarter
ended March 31, 2004, compared with 22.6% for the quarter ended March
31, 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 16%. 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 $0.8 million for the quarter
ended March 31, 2004, compared with $4.8 million for the quarter ended
March 31, 2003.
    
    Specialty admitted net premiums written were $23.9 million for the
quarter ended March 31, 2004, compared with $22.8 million for the
quarter ended March 31, 2003, an increase of $1.1 million or 4.8%. The
ratio of net premiums written to gross premiums written was 68.9% for
the quarter ended March 31, 2004, compared with 29.3% for the quarter
ended March 31, 2003. The increase in net premiums written was largely
due to the increases in retentions and due to rate increases of
approximately 12%. 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 $0.4 million for the quarter ended March 31,
2004, compared with $3.8 million for the quarter ended March 31, 2003. Net premiums earned were $45.4 million for the quarter ended March 31, 2004,
compared with $46.6 million for the quarter ended March 31, 2003, a decrease of
$1.2 million or 2.6%. A further breakdown of net premiums earned is as follows:  
    
    E&S net premiums earned were $26.6 million for the quarter ended
March 31, 2004, compared with $27.9 million for the quarter ended March
31, 2003, a decrease of $1.3 million or 4.7%. The decrease in net
premiums earned was primarily due to the impact of the previously
mentioned product terminations, partially offset by previously mentioned
retention increases and 17




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rate increases.
    
    Specialty admitted net premiums earned were $18.8 million for the
quarter ended March 31, 2004, compared with $18.8 million for quarter
ended March 31, 2003. Although there was no total change, net premiums
earned increased primarily due to the impact of the previously mentioned
retention increases and rate increases, 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 $5.1 million
for the quarter ended March 31, 2004, compared with $6.3 million for the
quarter ended March 31, 2003, a decrease of $1.2 million or 19.0%. The decrease
was primarily due to an increase in the amount of cash and short-term
investments held during the quarter ended March 31, 2004, combined with a
decline in interest rates. Cash and invested assets grew to $875.5 million as of March 31, 2004, from
$848.3 million as of December 31, 2003, an increase of $27.2 million or 3.2%.
The growth in the investment portfolio was primarily due to a $29.6 million
increase in payable for securities during the quarter ended March 31, 2004
resulting from the timing of trades versus settlements on or close to March 31,
2004. The average duration of our fixed income investments approximated 2.7
years as of March 31, 2004, compared with 3.1 years as of December 31, 2003.
Our book yield on our fixed income investments was 2.91% at March 31, 2004,
compared with 4.89% at March 31, 2003. Investment expenses were $0.9 million for the quarter ended March 31, 2004,
compared with $1.0 million for the quarter ended March 31, 2003, a decrease of
$0.1 million or 10.0%. Net Realized Investment Gains (Losses) Net realized investment losses were $0.1 million for the quarter ended March
31, 2004, compared with a $1.4 million net realized investment
loss for the quarter ended March 31, 2003.
The net investment loss for the current period consists of net gains of $0.3
million relative to our equity portfolio and $0.4 million of net losses
relative to our convertible bond and equity portfolios. The net investment
loss for the quarter ended March 31, 2003 consisted of net losses of $1.4
million relative to our equity portfolio, net losses of $0.3 million relative
to our convertible bond portfolios, net gains of $0.2 million
relative to our fixed income investments, and net gains of $0.1 million
relative to other invested assets. Net Losses and Loss Adjustment Expenses Net losses and loss adjustment expenses were $28.1 million for the quarter
ended March 31, 2004, compared with $32.8 million for the quarter ended March
31, 2003, a decrease of $4.7 million or 14.3%. The loss ratio for the quarter
ended March 31, 2004 was 62.0% compared with 70.4% for the quarter ended March
31, 2003. 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. A further
breakdown of losses incurred is as follows:  
    
    E&S net losses and loss adjustment expenses were $16.4 million for
the quarter ended March 31, 2004, compared with $20.2 million for the
quarter ended March 31, 2003. The loss ratio was 61.7% for the quarter
ended March 31, 2004, compared with 72.7% for the quarter ended March
31, 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.
    
    Specialty admitted net losses and loss adjustment expenses were $11.7
million for the quarter ended March 31, 2004, compared with $12.6
million for the quarter ended March 31, 2003. The loss ratio for the
quarter ended March 31, 2004 was 62.3%, compared with 67.1% for the
quarter ended March 31, 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 $13.5 million for the
quarter ended March 31, 2004, compared with $8.3 million for the quarter ended
March 31, 2003, an increase of $5.2 million. This increase can be attributed to
a $4.4 million increase in acquisition costs and a $0.8 million increase in
other underwriting expenses. A further analysis of acquisition costs and other
underwriting expenses is as follows:  
    
    The $4.4 million increase in acquisition costs was primarily the
result of a reduction in ceding commissions of $30.6 million
partially offset by a decrease in direct commission expense of $19.2
million. Contingent commission expense 18




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decreased $1.6 million and the deferral of acquisition costs increased by
$5.4 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. 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 $0.8 million increase in other underwriting expenses was
primarily due to a $0.7 million increase in excise tax payments on
premium ceded to our off-shore affiliates. Provision for Doubtful Reinsurance Receivables We recorded no charge for an allowance for doubtful reinsurance receivables for
the quarter ended March 31, 2004 as compared to a $0.9 million charge for the
quarter ended March 31, 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 29.7% for the quarter ended March 31, 2004,
compared with 19.7% for the quarter ended March 31, 2003. The expense ratio
for the quarter ended March 31, 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 offset by a decrease in our loss ratio. Our combined ratio was 91.7% for the quarter ended March 31, 2004, compared
with 90.2% for the quarter ended March 31, 2003. This increase in the combined
ratio was primarily due to 0.6% of purchase accounting adjustments during the
quarter ended March 31, 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 $0.5 million for the quarter ended March 31,
2004, compared with $0.4 million for the quarter ended March 31, 2003, an
increase of $0.1 million. Income Tax (Benefit) Expense Income tax benefit was $0.8 million for the quarter ended March 31, 2004,
compared with $1.4 million of tax expense for the quarter ended March 31, 2003.
Our effective tax benefit for the quarter ended March 31, 2004 was 12.7%,
compared with an effective tax rate of 17.3% for the quarter ended March 31,
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 $8.3
million is available for 2004 and future years and does not expire. Due to the
acquisition of the Company, Internal Revenue Code sections 382 and 383 place
limits on the amount of the income that can be offset by the alternative
minimum tax carryover. The section 382 limitation is an amount equal to the
value of the purchase price of the corporation less stock redemptions
multiplied by the long-term tax-exempt rate. The limitation applies until the
carryforward is fully utilized. The income limitation is $8.3 million per
year. Equity in Net Earnings of Partnerships Equity in net earnings of partnerships was $0.6 million for the quarter ended
March 31, 2004, compared with $0.4 million for the quarter ended March 31,
2003, an increase of $0.2 million. The gain is primarily attributable to the
performance of our investment in a high yield limited partnership. Net Income and Net Operating Income The factors described above resulted in net income of $7.4 million for the
quarter ended March 31, 2004, compared with $7.0 million for the quarter ended
March 31, 2003. Net operating income was $7.5 million for the quarter ended
March 31, 2004, compared with $7.9 million for the quarter ended March 31,
2003. Net operating income for the quarter ended March 31, 2004 is equal to
the quarter ended March 31, 2004 net income plus $0.1 million of after-tax
realized investment losses. Net operating income for the quarter ended March
31, 2003 is equal to the quarter ended March 31, 2003 net income plus $0.9
million of after-tax realized investment losses. 19




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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 ($15.8) million
and $50.9 million, respectively, for the quarters ended March 31, 2004 and
2003. Cash flow used for operating activities for the quarter ended March 31,
2004 was negatively affected by $16.1 million due to the timing of our
settlements with our reinsurers relative to ceded balances payable. Cash flow
provided by operating activities for the quarter ended March 31, 2003 benefited
by $40.2 million due to an increase in ceded balances payable during the
quarter. Net cash used for investing activities was $65.9 million for the quarter ended
March 31, 2004. Net cash provided by investing activities was $15.5 million
for the quarter ended March 31, 2003. The increase in the cash used for
investing activities was caused by efforts to invest high levels of cash and
cash equivalents during the quarter ended March 31, 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
in September 2003, the receipt of $165.6 million of net proceeds from our
December 15, 2003 common share sale 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 20




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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. During the quarter ended March 31, 2004, purchases of bonds and stocks
were $75.4 million greater than during the quarter ended March 31, 2003. Net cash provided by financing activities was $7.3 million in the quarter
ending March 31 2004, compared with none in the quarter ending March 31, 2003.
The source of this cash flow during the quarter ending March 31, 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 the
Company, net of underwriting discounts of $0.5 million, were $7.3 million. Liquidity At March 31, 2004, we
had $140.4 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. United National Insurance
Company has trusts in place to assist the other members of the group in meeting
their regulatory requirements. 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 ceding less business to the other group 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 March 31, 2004, the trusts were funded to
approximately $338.0 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 entered into a quota share arrangement with
U.N. Barbados and U.N. Bermuda. This reinsurance arrangement stipulates that
60% of the Companys net retained insurance liability on new and renewal
business bound January 1, 2004 and later to be ceded to the Companys Non-U.S.
Operations. The agreement also stipulates that 60% of the December 31, 2003
unearned premium be ceded to the Companys Non-U.S. Operations. The impact of
this reinsurance arrangement is reflected in the Companys March 31, 2004
financial statements. Reinsurance premiums ceded by our U.S. Insurance Subsidiaries during the first
quarter of 2004 will be paid to U.N. Bermuda and U.N. Barbados on or before May
31st, 2004. 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. Each of U.N.
Bermuda and U.N. Barbados will establish independent reinsurance trust accounts
for the benefit of each U.S. Insurance Subsidiary. 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. Oerations 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. 21




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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, the 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. $13.3
million of the $16.9 million of interest expense will be paid in cash in 2004,
while $3.6 million may be paid in cash or in kind. Currently, the holding
companies of our U.S. Operations have cash and investments totaling $32.8
million. In 2004, we do not anticipate that we will need to pay a dividend
from our U.S. Operations to fund this debt service. In 2005, and thereafter,
dividends from our U.S. Operations may be required to fund this debt service. As a result of the acquisition of our U.S. Operations, 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. 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, 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 the Cayman Islands, in a private placement through AISs wholly-owned
Delaware subsidiary 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 as 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. AIS paid
$300,000 in fees to the placement agent in connection with this transaction. 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s wholly-owned
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. 22




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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. 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. The management
fee of $1.5 million is payable September 5, 2004. 23




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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;
    
    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;
    
    political instability in the Cayman Islands, Barbados or Bermuda;
    
    changes in accounting policies or practices; and 24




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
    
    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. 25




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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. The Companys market risk associated
with exposure to interest rate risk has not materially changed since December
31, 2003. The table below provides information about the Companys bonds that are
sensitive to changes in interest rates. (Dollars in thousands)
    
    Principal
    
    Book
    
    Average Interest Rate2004
    
    $
    222,780
    
    
    $
    222,890
    
    
    
    1.12
    %2005
    
    
    16,545
    
    
    
    16,893
    
    
    
    1.84
    %2006
    
    
    26,875
    
    
    
    27,590
    
    
    
    2.37
    %2007
    
    
    19,200
    
    
    
    17,418
    
    
    
    3.12
    %2008
    
    
    25,715
    
    
    
    25,345
    
    
    
    3.16
    %Thereafter
    
    
    341,803
    
    
    
    323,880
    
    
    
    4.19
    %Total
    
    $
    652,918
    
    
    $
    634,016
    
    
    
    2.90
    %Total Fair Value
    
    
    
    
    
    $
    645,760
 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 for collateral. As of March 31, 2004, $752.6 million of collateral was
held in trust to support the reinsurance receivables. 26




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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 March 31, 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 March 31, 2004 that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting. 27




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##### 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), entered 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 has activated a pending
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 Company believes the recorded reinsurance receivable
from Partner Reinsurance Company will be fully collected. On July 11, 2003, our subsidiary United National Insurance Company was named a
defendant in a lawsuit filed in the Superior Court of Fulton County, Georgia,
by Gulf Underwriters Insurance Company (Gulf) seeking rescission of 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
followed United National Insurance Companys billing to Gulf for reimbursement
of a loss in the amount of $3.1 million that was paid under that insurance
policy. The rescission claim is based on allegations of breach of contract;
misrepresentation; non-disclosure and breach of duty of good faith; and fraud.
The complaint also seeks attorneys fees and costs. United National Insurance Company denies the allegations in the complaint and
has filed a counterclaim seeking payment of the amount of losses and loss
adjustment expenses paid under the insurance policy plus statutory damages of
$1.6 million as a result of late payment. A trial date has not been set for
this litigation. However, a voluntary mediation, to be held in June 2004, has
been agreed to by the parties. The Company believes the recorded reinsurance
receivable from Gulf will be fully collected. 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. Changes in 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. 28




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Item 6. Exhibits and Reports on Form 8-K a. Exhibits  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 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. b. Reports on Form 8-K  The Company furnished the following report on Form 8-K during the quarterly
period ended March 31, 2004: Date of Report
    
    Item ReportedFebruary 18, 2004
    
    Item 12  Regarding earnings release with respect to fourth
quarter and fiscal year ended December 31, 2003 financial results
 29




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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.RegistrantMay 17, 2004
    
    By:
    
    /s/ David R. BradleyDate
    
    David R. BradleyChief Executive OfficerMay 17, 2004
    
    By:
    
    /s/ Kevin L. TateDate
    
    Kevin L. TateChief Financial Officer
 30