##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION  FORM 10-Q [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934
 For the Quarterly Period Ended June 30, 2004 OR [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the Transition
Period From
to 000-50511Commission 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 August 13, 2004, the registrant had outstanding 15,571,684 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
    
    
    30Item 4. Controls and Procedures
    
    
    31PART II  OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    32Item 2. Changes in Securities and Use of Proceeds
    
    
    32Item 3. Defaults Upon Senior Securities
    
    
    32Item 4. Submission of Matters to a Vote of Security Holders
    
    
    33Item 5. Other Information
    
    
    34Item 6. Exhibits and Reports on Form 8-K
    
    
    35CEO CERTIFICATION PURSUANT TO SECTION 302CFO CERTIFICATION PURSUANT TO SECTION 302CEO CERTIFICATION PURSUANT TO SECTION 906CFO CERTIFICATION PURSUANT TO SECTION 906
  As used in this quarterly report, unless the context requires otherwise, (1)
United National Group refers to United National Group, Ltd., an exempted
company incorporated with limited liability under the laws of the Cayman
Islands; (2) we, us and our refer to United National Group and its
subsidiaries as a whole; (3) our U.S. Operations refers to the insurance and
related operations conducted by American Insurance Service, Inc. and its
subsidiaries, including American Insurance Adjustment Agency, Inc., Diamond
State Insurance Company, J.H. Ferguson & Associates, LLC, United National
Casualty Insurance Company, United National Insurance Company and United
National Specialty Insurance Company; (4) our U.S. Insurance Subsidiaries
refers to United National Insurance Company, Diamond State Insurance Company,
United National Specialty Insurance Company and United National Casualty
Insurance Company; (5) U.N. Barbados refers to Wind River Insurance Company
(Barbados) Ltd.; (6) U.N. Bermuda refers to Wind River Insurance Company,
Ltd.; (7) our Non-U.S. Operations refers to the insurance and reinsurance and
related operations of U.N. Barbados and U.N. Bermuda; (8) Fox Paine & Company
refers to Fox Paine & Company, LLC and affiliated investment funds; and (9) $
or dollars refers to U.S. dollars. 2




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##### Table of Contents



PART I  FINANCIAL INFORMATION 
 Item 1. Financial Statements UNITED NATIONAL GROUP, LTD. 
 Consolidated Balance Sheets  (Unaudited)Successor
    
    Successoras of
    
    as ofJune 30, 2004
    
    December 31, 2003ASSETSBonds:Available for sale securities, at fair value
(amortized cost: $591,538 and $540,543)
    
    $
    592,565
    
    
    $
    549,966Preferred shares:Available for sale securities, at fair value
(cost: $4,838 and $4,372)
    
    
    5,054
    
    
    
    4,894Common shares:Available for sale securities, at fair value
(cost: $31,916 and $30,762)
    
    
    34,904
    
    
    
    33,219Other invested assets
    
    
    49,165
    
    
    
    45,434Total investments
    
    
    681,688
    
    
    
    633,513Cash and cash equivalents
    
    
    158,364
    
    
    
    214,796Agents balances, net
    
    
    47,515
    
    
    
    62,374Reinsurance receivables, net
    
    
    1,699,168
    
    
    
    1,762,988Accrued investment income
    
    
    6,678
    
    
    
    5,909Federal income taxes receivable
    
    
    5,986
    
    
    
    4,898Deferred federal income taxes, net
    
    
    28,812
    
    
    
    25,323Deferred acquisition costs, net
    
    
    20,154
    
    
    
    8,581Prepaid reinsurance premiums
    
    
    73,372
    
    
    
    117,936Other assets
    
    
    14,099
    
    
    
    12,443Total assets
    
    $
    2,735,836
    
    
    $
    2,848,761LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Unpaid losses and loss adjustment expenses
    
    $
    1,995,936
    
    
    $
    2,059,760Unearned premiums
    
    
    154,824
    
    
    
    177,408Amounts held for the account of others
    
    
    16,768
    
    
    
    20,201Ceded balances payable
    
    
    26,996
    
    
    
    59,876Contingent commissions
    
    
    4,354
    
    
    
    5,178Senior notes payable to related party
    
    
    72,848
    
    
    
    72,848Junior subordinated debentures
    
    
    30,929
    
    
    
    30,929Other liabilities
    
    
    31,631
    
    
    
    41,769Total liabilities
    
    
    2,334,286
    
    
    
    2,467,969Commitments and contingencies (Note 6)
    
    
    
    
    
    
    Shareholders equity:Common shares, $0.0001 par value, 900,000,000 common
shares authorized, 15,571,684 and 15,105,503 Class A
common shares issued and outstanding and 12,687,500
Class B common shares issued and outstanding
    
    
    3
    
    
    
    3Preferred shares, $0.0001 par value, 100,000,000
shares authorized, none issued and outstanding
    
    
    
    
    
    
    Additional paid-in capital
    
    
    356,302
    
    
    
    347,487Accumulated other comprehensive income
    
    
    6,449
    
    
    
    10,031Retained earnings
    
    
    38,796
    
    
    
    23,271Total shareholders equity
    
    
    401,550
    
    
    
    380,792Total liabilities and shareholders equity
    
    $
    2,735,836
    
    
    $
    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)
    
    (Unaudited)
    
    (Unaudited)Successor
    
    Predecessor
    
    Successor
    
    PredecessorQuarter Ended
    
    Quarter Ended
    
    Six Months Ended
    
    Six Months EndedJune 30, 2004
    
    June 30, 2003
    
    June 30, 2004
    
    June 30, 2003Revenues:Gross premiums written
    
    $
    88,138
    
    
    $
    148,493
    
    
    $
    206,076
    
    
    $
    362,953Net premiums written
    
    $
    68,183
    
    
    $
    45,825
    
    
    $
    126,800
    
    
    $
    99,461Net premiums earned
    
    $
    59,396
    
    
    $
    47,784
    
    
    $
    104,818
    
    
    $
    94,397Net investment income
    
    
    4,417
    
    
    
    4,045
    
    
    
    8,627
    
    
    
    9,329Net realized investment gains
    
    
    463
    
    
    
    4,505
    
    
    
    393
    
    
    
    3,116Total revenues
    
    
    64,276
    
    
    
    56,334
    
    
    
    113,838
    
    
    
    106,842Losses and Expenses:Net losses and loss adjustment expenses
    
    
    33,383
    
    
    
    29,015
    
    
    
    61,526
    
    
    
    61,846Acquisition costs and other underwriting expenses
    
    
    21,608
    
    
    
    12,397
    
    
    
    35,128
    
    
    
    20,733Provision for doubtful reinsurance receivables
    
    
    
    
    
    
    875
    
    
    
    
    
    
    
    1,750Other operating expenses (income)
    
    
    490
    
    
    
    (77
    )
    
    
    1,004
    
    
    
    367Interest expense
    
    
    1,394
    
    
    
    9
    
    
    
    2,709
    
    
    
    12Income before income taxes
    
    
    7,401
    
    
    
    14,115
    
    
    
    13,471
    
    
    
    22,134Income tax (benefit) expense
    
    
    (668
    )
    
    
    3,628
    
    
    
    (1,437
    )
    
    
    5,012Net income before equity in net income of partnerships
    
    
    8,069
    
    
    
    10,487
    
    
    
    14,908
    
    
    
    17,122Equity in net income of partnerships
    
    
    38
    
    
    
    1,074
    
    
    
    617
    
    
    
    1,487Net income
    
    $
    8,107
    
    
    $
    11,561
    
    
    $
    15,525
    
    
    $
    18,609Per share data:Net income:Basic
    
    $
    0.29
    
    
    $
    115,610
    
    
    $
    0.55
    
    
    $
    186,090Diluted
    
    $
    0.28
    
    
    $
    115,610
    
    
    $
    0.54
    
    
    $
    186,090Weighted-average number of shares outstanding:Basic
    
    
    28,257,184
    
    
    
    100
    
    
    
    28,238,564
    
    
    
    100Diluted
    
    
    28,823,086
    
    
    
    100
    
    
    
    28,854,740
    
    
    
    100
 See accompanying notes to consolidated financial statements. 4




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UNITED NATIONAL GROUP, LTD.  
 Consolidated Statements of Comprehensive Income
 (Unaudited)
    
    (Unaudited)
    
    (Unaudited)
    
    (Unaudited)Successor
    
    Predecessor
    
    Successor
    
    PredecessorQuarter Ended
    
    Quarter Ended
    
    Six Months Ended
    
    Six Months EndedJune 30, 2004
    
    June 30, 2003
    
    June 30, 2004
    
    June 30, 2003Net income
    
    $
    8,107
    
    
    $
    11,561
    
    
    $
    15,525
    
    
    $
    18,609Other comprehensive income (loss) before tax:Unrealized gains (losses) on securities:Unrealized holding gains (losses) arising during period
    
    
    (11,544
    )
    
    
    (867
    )
    
    
    (5,768
    )
    
    
    (825
    )Less:Reclassification adjustment for gains (losses) included
in net income
    
    
    464
    
    
    
    (7,189
    )
    
    
    173
    
    
    
    (7,914
    )Other comprehensive income (loss), before tax
    
    
    (12,008
    )
    
    
    6,322
    
    
    
    (5,941
    )
    
    
    7,089Income tax expense (benefit) related to items of other
comprehensive income
    
    
    (4,084
    )
    
    
    2,215
    
    
    
    (2,359
    )
    
    
    2,483Other comprehensive income (loss), net of tax
    
    
    (7,924
    )
    
    
    4,107
    
    
    
    (3,582
    )
    
    
    4,606Comprehensive income, net of tax
    
    $
    183
    
    
    $
    15,668
    
    
    $
    11,943
    
    
    $
    23,215
 See accompanying notes to consolidated financial statements. 5




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UNITED NATIONAL GROUP, LTD.  
 Consolidated Statements of Changes in Shareholders Equity
 (Unaudited)
    
    Successor
    
    PredecessorSuccessor
    
    September 6, 2003
    
    January 1, 2003Six Months Ended
    
    through
    
    throughJune 30, 2004
    
    December 31, 2003
    
    September 5, 2003Common shares:Number at beginning of period
    
    
    27,793,003
    
    
    
    10,000,000
    
    
    
    100Class A common shares issued in acquisition
    
    
    
    
    
    
    2,500,000
    
    
    
    Class A common shares issued under stock
purchase plan
    
    
    
    
    
    
    245,208
    
    
    
    Class A common shares issued in IPO
    
    
    462,500
    
    
    
    10,750,000Class A common shares issued in redemption of
Series A preferred shares
    
    
    
    
    
    
    1,610,295
    
    
    
    Class A common shares issued to directors
    
    
    3,681
    
    
    
    
    
    
    
    Class B common shares issued in exchange for
Series A preferred shares
    
    
    
    
    
    
    2,687,500
    
    
    
    Number at end of period
    
    
    28,259,184
    
    
    
    27,793,003
    
    
    
    100Common shares:Balance at beginning of period
    
    $
    3
    
    
    $
    1
    
    
    $
    Class A common shares issued in IPO
    
    
    
    
    
    
    2
    
    
    
    Balance at end of period
    
    $
    3
    
    
    $
    3
    
    
    $
    Preferred shares:
    
    
    
    
    
    
    
    
    
    
    Number at beginning of period
    
    
    
    
    
    
    14,000,000
    
    
    
    Preferred shares issued in acquisition
    
    
    
    
    
    
    3,500,000
    
    
    
    Preferred shares redeemed
    
    
    
    
    
    
    (15,000,000
    )
    
    
    Preferred shares exchanged for Class B common
shares
    
    
    
    
    
    
    (2,500,000
    )
    
    
    Number at end of period
    
    
    
    
    
    
    
    
    
    
    Preferred shares:Balance at beginning of period
    
    $
    
    
    
    $
    2
    
    
    $
    Preferred shares redeemed
    
    
    
    
    
    
    (2
    )
    
    
    Preferred
shares exchanged for Class B common shares
    
    
    
    
    
    
    
    
    
    
    Balance at end of period
    
    $
    
    
    
    $
    
    
    
    $
    Additional paid-in capital:Balance at beginning of period
    
    $
    347,487
    
    
    $
    239,997
    
    
    $
    81,186Preferred share dividends
    
    
    
    
    
    
    29,250
    
    
    
    Preferred shares redeemed
    
    
    
    
    
    
    (149,998
    )
    
    
    Contributed capital from preferred shares
    
    
    
    
    
    
    35,000
    
    
    
    Contributed capital from common shares
    
    
    7,312
    
    
    
    193,238
    
    
    
    5,638Other
    
    
    1,503
    
    
    
    
    
    
    
    Balance at end of period
    
    $
    356,302
    
    
    $
    347,487
    
    
    $
    86,824Accumulated other comprehensive income net of
deferred income tax:Balance at beginning of period
    
    $
    10,031
    
    
    $
    
    
    
    $
    7,329Other comprehensive income (loss)
    
    
    (3,582
    )
    
    
    10,031
    
    
    
    (1,962
    )Balance at end of period
    
    $
    6,449
    
    
    $
    10,031
    
    
    $
    5,367Retained earnings:Balance at beginning of period
    
    $
    23,271
    
    
    $
    
    
    
    $
    180,122Net income
    
    
    15,525
    
    
    
    52,521
    
    
    
    24,604Preferred share dividends
    
    
    
    
    
    
    (29,250
    )
    
    
    Balance at end of period
    
    $
    38,796
    
    
    $
    23,271
    
    
    $
    204,726Total shareholders equity
    
    $
    401,550
    
    
    $
    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) (Unaudited)
    
    (Unaudited)Successor
    
    PredecessorSix Months Ended
    
    Six Months EndedJune 30, 2004
    
    June 30, 2003Cash flows from operating activities:Net income
    
    $
    15,525
    
    
    $
    18,609Adjustments to reconcile net income to net cash
(used for) provided by operating activities:Amortization of debt issuance costs
    
    
    90
    
    
    
    Restricted stock expense
    
    
    242
    
    
    
    Deferred federal income taxes
    
    
    (1,448
    )
    
    
    (1,188
    )Amortization of bond premium and discount, net
    
    
    1,499
    
    
    
    1,181Net realized investment gains
    
    
    (393
    )
    
    
    2,453Equity in income of partnerships
    
    
    (617
    )
    
    
    (1,487
    )Unrealized loss on trading securities
    
    
    
    
    
    
    (5,568
    )Provision for doubtful reinsurance receivables
    
    
    
    
    
    
    1,750Proceeds from sale or maturity of trading securities
    
    
    
    
    
    
    6,825Purchase of trading securities
    
    
    
    
    
    
    (8,197
    )Changes in:Agents balances
    
    
    14,859
    
    
    
    (11,709
    )Reinsurance receivables
    
    
    63,820
    
    
    
    (110,431
    )Unpaid losses and loss adjustment expenses
    
    
    (63,824
    )
    
    
    129,306Unearned premiums
    
    
    (22,584
    )
    
    
    (31,455
    )Ceded balances payable
    
    
    (32,880
    )
    
    
    10,408Other liabilities
    
    
    (8,877
    )
    
    
    (32,992
    )Amounts held for the account of others
    
    
    (3,433
    )
    
    
    1,068Contingent commissions
    
    
    (824
    )
    
    
    1,435Federal income tax receivable
    
    
    (1,088
    )
    
    
    10,364Prepaid reinsurance premiums
    
    
    44,564
    
    
    
    36,519Deferred acquisition costs, net
    
    
    (11,573
    )
    
    
    (1,807
    )Payable for securities
    
    
    
    
    
    
    (3,888
    )Other - net
    
    
    (1,908
    )
    
    
    340Net cash (used for) provided by operating activities
    
    
    (8,850
    )
    
    
    11,536Cash flows from investing activities:Proceeds from sale of bonds and stocks
    
    
    385,792
    
    
    
    63,772Proceeds from maturity of bonds
    
    
    3,200
    
    
    
    2,500Proceeds from sale of other invested assets
    
    
    587
    
    
    
    4,973Purchase of bonds and stocks
    
    
    (443,484
    )
    
    
    (82,932
    )Proceeds from sale or repayment of mortgages
    
    
    
    
    
    
    8Proceeds from sale of mortgage
    
    
    
    
    
    
    1,166Purchase of other invested assets
    
    
    (989
    )
    
    
    (2,256
    )Net cash (used for) provided by investing activities
    
    
    (54,894
    )
    
    
    (12,769
    )Cash flows from financing activities:Borrowing under credit facility
    
    
    
    
    
    
    4,650Repayments of credit facility
    
    
    
    
    
    
    (4,650
    )Net proceeds from IPO of common shares
    
    
    7,312
    
    
    
    Net cash provided by financing activities
    
    
    7,312
    
    
    
    Net change in cash and cash equivalents
    
    
    (56,432
    )
    
    
    (1,233
    )Cash and cash equivalents at beginning of period
    
    
    214,796
    
    
    
    72,942Cash and cash equivalents at end of period
    
    $
    158,364
    
    
    $
    71,709
 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, 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 June 30, 2004 and for the quarter
and six months ended June 30, 2004 and 2003 are unaudited, but in the opinion
of management have been prepared in conformity with accounting principles
generally accepted in the United States of America (GAAP) and on the same
basis as the annual audited consolidated financial statements. The preparation
of financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates. The consolidated financial statements include all adjustments that are, in the
opinion of management, necessary for a fair statement of results for the
interim periods. Results of operations for the quarter and six months ended
June 30, 2004 and 2003 are not necessarily indicative of the results of a full
year. The accompanying notes to the consolidated financial statements should
be read in conjunction with the notes to the consolidated financial statements
contained in the Companys 2003 Annual Report on Form 10-K. Certain prior period amounts have been reclassified to conform to current
period presentation. (2) Investments Assets of $411.0 million and $294.7 million as of June 30, 2004 and December
2003, respectively, were on deposit or subject to trusts to meet statutory and
other regulatory requirements enacted by states or stipulated by the insurance
departments. Assets on deposit or subject to trusts included cash of $54.9
million and $1.9 million and bonds with estimated fair values of $356.1 million
and $292.8 million as of June 30, 2004 and December 31, 2003, respectively. In
addition, bonds with an estimated fair market value of $5.4 million at June 30,
2004 and December 31, 2003 were held in a trust fund to meet the regulatory
requirements of U.N. Bermuda. The carrying amounts for the Companys investments approximate their estimated
fair value. The Company measures the fair value of investments in bonds and
stocks based upon quoted market prices. Other invested assets are comprised
primarily of limited liability partnership interests. Partnership interests of
3% ownership or greater are accounted for 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. During the quarter and six months ended June 30, 2003, the Company
recorded other than temporary impairment losses of $1.9 million on its bond
portfolio and $0.7 million on its investments in limited partnerships. There
were no realized losses recorded for the quarter and six months ended June 30,
2004 as a result of the Companys other than temporary impairment evaluation.  8




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##### Table of Contents



(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 June 30, 2004, the Company had total reinsurance receivables of $1,699.2
million, including $62.0 million of reinsurance receivables related to paid
losses. The carrying value of the receivables is net of a $32.6 million
reduction, which is equal to an estimate of potentially uncollectible
reinsurance receivables. The Companys estimate of potentially uncollectible
receivables, which was $49.1 million at the date of the Acquisition, has been
reduced to $32.6 million as of June 30, 2004 primarily as a result of the
commutation agreement with Trenwick America Reinsurance Corp. on October 29,
2003. As of December 31, 2003, the Company had net reinsurance receivables of
$1,763.0 million, net of a $33.7 million reduction related to potentially
uncollectible receivables. The U.S. Insurance Subsidiaries have 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 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. (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 EndedJune 30, 2004
    
    June 30, 2003% of Pre-
    
    
    
    
    
    % of Pre-(Dollars in thousands)
    
    Amount
    
    Tax Income
    
    Amount
    
    Tax IncomeExpected tax expense at the U. S. statutory rate
    
    $
    2,590
    
    
    
    35.0
    %
    
    $
    4,940
    
    
    
    35.0
    %Adjustments:Tax exempt interest
    
    
    (1,123
    )
    
    
    (15.2
    )
    
    
    (1,296
    )
    
    
    (9.2
    )Foreign income not expected to be taxed in the
U.S.
    
    
    (2,347
    )
    
    
    (31.7
    )
    
    
    
    
    
    
    Dividend exclusion
    
    
    (31
    )
    
    
    (0.4
    )
    
    
    (34
    )
    
    
    (0.2
    )Other
    
    
    243
    
    
    
    3.3
    
    
    
    18
    
    
    
    0.1Actual tax expense (benefit)
    
    $
    (668
    )
    
    
    (9.0
    )%
    
    $
    3,628
    
    
    
    25.7
    %
 Successor
    
    PredecessorSix Months Ended
    
    Six Months EndedJune 30, 2004
    
    June 30, 2003% of Pre-
    
    
    
    
    
    % of Pre-(Dollars in thousands)
    
    Amount
    
    Tax Income
    
    Amount
    
    Tax IncomeExpected tax expense at the U. S. statutory rate
    
    $
    4,715
    
    
    
    35.0
    %
    
    $
    7,747
    
    
    
    35.0
    %Adjustments:Tax exempt interest
    
    
    (2,338
    )
    
    
    (17.4
    )
    
    
    (2,676
    )
    
    
    (12.1
    )Foreign income not expected to be taxed in the
U.S.
    
    
    (4,065
    )
    
    
    (30.2
    )
    
    
    
    
    
    
    Dividend exclusion
    
    
    (68
    )
    
    
    (0.5
    )
    
    
    (71
    )
    
    
    (0.3
    )Other
    
    
    319
    
    
    
    2.4
    
    
    
    12
    
    
    
    Actual tax expense (benefit)
    
    $
    (1,437
    )
    
    
    (10.7
    )%
    
    $
    5,012
    
    
    
    22.6
    %
 The Company has managed its business in a manner designed to reduce the risk
that U.N. Barbados will be treated as engaged in a U.S. trade or business for
U.S. federal income tax purposes. On July 14, 2004 a protocol was signed by
the U.S. Treasury Secretary and the Barbados Minister of Industry and
International Business to amend the U.S.  Barbados Convention for the
Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect
to Taxes on Income Signed on December 31, 1984, as amended. The treaty
amendment is subject to ratification by the U.S. and Barbados governments.
Provisions of the proposed amended treaty would be effective the first day of
the second month following ratification with respect to tax withheld by the
payor on amounts of interest not subject to a portfolio exemption and on
dividends or royalties paid or credited, and would be effective for taxable years beginning on or
after the first day of January following ratification for other taxes. Under
the protocol, U.N. Barbados investment income on an intercompany note
payable to U.N. Barbados on or after the effective dates of the amendment
would be subject to U.S. withholding tax of 30 percent, an increase from the
existing rate of 5 percent. The investment income subject to this tax was $2.9
million and $5.8 million for the quarter and six months ended June 30, 2004,
respectively. The Company believes that it has identified
alternatives that will mitigate the impact of the protocol. The Company intends
to implement a plan before year-end 2004 that will eliminate the effect of the
protocol on the Companys overall effective tax rate. 9




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(5) Liability for Unpaid Losses and Loss Adjustment Expenses The liability for unpaid losses and loss adjustment expenses reflects the
Companys best estimate for future amounts needed to pay losses and related
settlement expenses and the impact of the Companys reinsurance coverages with
respect to insured events. Estimating the ultimate claims liability of the
Company is necessarily a complex and judgmental process, inasmuch as the
amounts are based on managements informed estimates and judgments using data
currently available. In some cases, significant periods of time, up to several
years or more, may elapse between the occurrence of an insured loss and the
reporting of such to the Company. The method for determining the Companys
liability for unpaid losses and loss adjustment expenses includes, but is not
limited to, reviewing past loss experience and considering other factors such
as legal, social, and economic developments. As additional experience and data
become available, the Companys estimate for the liability for unpaid losses
and loss adjustment expenses is revised accordingly. If the Companys ultimate
losses, net of reinsurance, prove to differ substantially from the amounts
recorded with respect to unpaid losses and loss adjustment expenses at June 30,
2004, the related adjustments could have a material impact on the Companys
results of operations. (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. On January 22, 2004, Diamond State elected to enter into a settlement with Bank
of America, N.A. and Platinum Indemnity Limited relative to litigation pending
in the United States District Court for the Southern District of New York.
Under the terms of the settlement, Diamond State paid $17.8 million to Bank of
America and provided other non-financial consideration to Bank of America and
Platinum in exchange for a full and final release by Bank of America and
Platinum, and other consideration, relative to their claims of approximately
$29.0 million, plus interest in excess of $10.0 million and fees and costs,
related to facultative reinsurance policies issued by Worldwide Weather
Insurance Agency, and its principal Harold Mollin, purportedly on behalf of
Diamond State. As a result of the settlement, Diamond State is proceeding with an arbitration
against Partner Reinsurance Company, Ltd. and Partner Reinsurance Company of
the U.S. seeking recovery under a reinsurance agreement covering business
produced by Worldwide Weather Insurance Agency on a 100% basis with regard to
the type of risk involved. In that connection, Diamond State holds a letter of
credit dated March 31, 2004 from Partner Reinsurance Company, Ltd. in the
amount of $17.8 million. In addition, Diamond State is seeking indemnification
and contribution from Partner Reinsurance Company of the U.S. because of its
role in the appointment of Mr. Mollin and Worldwide Weather Insurance Agency.
Discovery is pending in advance of the scheduled November 2004 arbitration. On July 11, 2003, UNIC 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 UNIC with regard to an individual insurance policy written by UNIC and
ceded to Gulf. The facultative reinsurance certificate provided 100%
reinsurance to UNIC for loss and loss adjustment expenses paid under the
insurance policy. The lawsuit followed UNIC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. UNIC 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. A voluntary mediation held in
June 2004 was unsuccessful. Discovery proceedings have resumed, although
settlement opportunities continue to be explored. Management believes that the ultimate outcome of all litigation, arbitration,
reinsurance recoverable and coverage claim matters, after consideration of
applicable reserves, should not have a material adverse effect on the Companys
financial condition. 10




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##### Table of Contents



(7) Shareholders Equity In January 2004, the Company issued 462,500 Class A common shares at a price of
$17.00 per share in connection with the exercise by the underwriters of the
remaining overallotment option related to the Companys initial public
offering, which was consummated in December 2003. Proceeds to the Company, net
of underwriting discounts of $0.5 million, were $7.3 million. (8) Earnings Per Share Basic earnings per share is computed using the weighted average number of
common shares outstanding during the period. Diluted earning per share is
computed using the weighted average number of common shares outstanding during
the period, as well as the weighted average number of common share equivalents
outstanding during the period. The following table sets forth the computation
of basic and diluted earnings per share. Successor
    
    Predecessor
    
    Successor
    
    PredecessorQuarter Ended
    
    Quarter Ended
    
    Six Months Ended
    
    Six Months Ended(Dollars in thousands, except per share data)
    
    June 30, 2004
    
    June 30, 2003
    
    June 30, 2004
    
    June 30, 2003Net income
    
    $
    8,107
    
    
    $
    11,561
    
    
    $
    15,525
    
    
    $
    18,609Weighted average common shares outstanding
    
    
    28,257,184
    
    
    
    100
    
    
    
    28,238,564
    
    
    
    100Basic net income per share
    
    $
    0.29
    
    
    $
    115,610
    
    
    $
    0.55
    
    
    $
    186,090Weighted average common shares outstanding
    
    
    28,257,184
    
    
    
    100
    
    
    
    28,238,564
    
    
    
    100Weighted average common share equivalents outstanding
    
    
    565,902
    
    
    
    
    
    
    
    616,176
    
    
    
    Weighted average common shares and equivalents outstanding
    
    
    28,823,086
    
    
    
    100
    
    
    
    28,854,740
    
    
    
    100Diluted net income per share
    
    $
    0.28
    
    
    $
    115,610
    
    
    $
    0.54
    
    
    $
    186,090
 (9) Segment Information The Companys operations are classified into two reportable business segments
that are organized around its two underwriting divisions: excess and surplus
(E&S) lines and specialty admitted. The segments follow the same accounting
policies used for the Companys consolidated financial statements as described
in the summary of significant accounting policies in the Companys Annual
Report on Form 10-K for the year ended December 31, 2003. Management evaluates
a segments performance based upon premium production and the associated losses
and loss adjustment expense experience. Investments and investment performance,
acquisition costs and other underwriting expenses, including commissions,
premium taxes and other acquisition costs, and other operating expenses are
managed at a corporate level and are included in the Corporate segment. Gross premiums written by product class are as follows: Successor
    
    Predecessor
    
    Successor
    
    PredecessorQuarter Ended
    
    Quarter Ended
    
    Six Months Ended
    
    Six Months Ended(Dollars in thousands)
    
    June 30, 2004
    
    June 30, 2003
    
    June 30, 2004
    
    June 30, 2003Specific specialty
    
    $
    23,044
    
    
    $
    55,908
    
    
    $
    58,909
    
    
    $
    144,625Umbrella and excess
    
    
    7,935
    
    
    
    39,371
    
    
    
    20,566
    
    
    
    107,326Property and general liability
    
    
    41,639
    
    
    
    36,197
    
    
    
    85,556
    
    
    
    67,982Non-medical professional liability
    
    
    15,520
    
    
    
    17,017
    
    
    
    41,045
    
    
    
    43,020$
    88,138
    
    
    $
    148,493
    
    
    $
    206,076
    
    
    $
    362,953
 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 June 30, 2004:
    
    E&S(Dollars in thousands)
    
    Lines
    
    Specialty Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    54,504
    
    
    $
    33,634
    
    
    $
    
    
    
    $
    88,138Net premiums written
    
    $
    40,161
    
    
    $
    28,022
    
    
    $
    
    
    
    $
    68,183Net premiums earned
    
    $
    34,224
    
    
    $
    25,172
    
    
    $
    
    
    
    $
    59,396Net investment income
    
    
    
    
    
    
    
    
    
    
    4,417
    
    
    
    4,417Net realized investment gains
    
    
    
    
    
    
    
    
    
    
    463
    
    
    
    463Total revenues
    
    
    34,224
    
    
    
    25,172
    
    
    
    4,880
    
    
    
    64,276Losses and Expenses:Net losses and loss adjustment expenses
    
    
    19,019
    
    
    
    14,364
    
    
    
    
    
    
    
    33,383Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    21,608
    
    
    
    21,608Other operating expenses
    
    
    
    
    
    
    
    
    
    
    490
    
    
    
    490Interest expense
    
    
    
    
    
    
    
    
    
    
    1,394
    
    
    
    1,394Income (loss) before income taxes
    
    
    15,205
    
    
    
    10,808
    
    
    
    (18,612
    )
    
    
    7,401Income tax benefit
    
    
    
    
    
    
    
    
    
    
    (668
    )
    
    
    (668
    )Net income (loss) before equity in net
income of partnerships
    
    
    15,205
    
    
    
    10,808
    
    
    
    (17,944
    )
    
    
    8,069Equity in net income of partnerships
    
    
    
    
    
    
    
    
    
    
    38
    
    
    
    38Net income (loss)
    
    $
    15,205
    
    
    $
    10,808
    
    
    $
    (17,906
    )
    
    $
    8,107
 PredecessorQuarter Ended June 30, 2003:
    
    E&S(Dollars in thousands)
    
    Lines
    
    Specialty Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    105,424
    
    
    $
    43,069
    
    
    $
    
    
    
    $
    148,493Net premiums written
    
    $
    26,634
    
    
    $
    19,191
    
    
    $
    
    
    
    $
    45,825Net premiums earned
    
    $
    28,380
    
    
    $
    19,404
    
    
    $
    
    
    
    $
    47,784Net investment income
    
    
    
    
    
    
    
    
    
    
    4,045
    
    
    
    4,045Net realized investment gains
    
    
    
    
    
    
    
    
    
    
    4,505
    
    
    
    4,505Total revenues
    
    
    28,380
    
    
    
    19,404
    
    
    
    8,550
    
    
    
    56,334Losses and Expenses:Net losses and loss adjustment expenses
    
    
    17,759
    
    
    
    11,256
    
    
    
    
    
    
    
    29,015Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    12,397
    
    
    
    12,397Provision for doubtful reinsurance receivables
    
    
    
    
    
    
    
    
    
    
    875
    
    
    
    875Other operating income
    
    
    
    
    
    
    
    
    
    
    (77
    )
    
    
    (77
    )Interest expense
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    9Income (loss) before income taxes
    
    
    10,621
    
    
    
    8,148
    
    
    
    (4,654
    )
    
    
    14,115Income tax expense
    
    
    
    
    
    
    
    
    
    
    3,628
    
    
    
    3,628Net income (loss) before equity in net
income of partnerships
    
    
    10,621
    
    
    
    8,148
    
    
    
    (8,282
    )
    
    
    10,487Equity in net income of partnerships
    
    
    
    
    
    
    
    
    
    
    1,074
    
    
    
    1,074Net income (loss)
    
    $
    10,621
    
    
    $
    8,148
    
    
    $
    (7,208
    )
    
    $
    11,561
 12




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##### Table of Contents



SuccessorSix Months Ended June 30, 2004:
    
    E&S(Dollars in thousands)
    
    Lines
    
    Specialty Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    137,751
    
    
    $
    68,325
    
    
    $
    
    
    
    $
    206,076Net premiums written
    
    $
    74,915
    
    
    $
    51,885
    
    
    $
    
    
    
    $
    126,800Net premiums earned
    
    $
    60,863
    
    
    $
    43,955
    
    
    $
    
    
    
    $
    104,818Net investment income
    
    
    
    
    
    
    
    
    
    
    8,627
    
    
    
    8,627Net realized investment gains
    
    
    
    
    
    
    
    
    
    
    393
    
    
    
    393Total revenues
    
    
    60,863
    
    
    
    43,955
    
    
    
    9,020
    
    
    
    113,838Losses and Expenses:Net losses and loss adjustment expenses
    
    
    35,454
    
    
    
    26,072
    
    
    
    
    
    
    
    61,526Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    35,128
    
    
    
    35,128Other operating expenses
    
    
    
    
    
    
    
    
    
    
    1,004
    
    
    
    1,004Interest expense
    
    
    
    
    
    
    
    
    
    
    2,709
    
    
    
    2,709Income (loss) before income taxes
    
    
    25,409
    
    
    
    17,883
    
    
    
    (29,821
    )
    
    
    13,471Income tax benefit
    
    
    
    
    
    
    
    
    
    
    (1,437
    )
    
    
    (1,437
    )Net income (loss) before equity in net
income of partnerships
    
    
    25,409
    
    
    
    17,883
    
    
    
    (28,384
    )
    
    
    14,908Equity in net income of partnerships
    
    
    
    
    
    
    
    
    
    
    617
    
    
    
    617Net income (loss)
    
    $
    25,409
    
    
    $
    17,883
    
    
    $
    (27,767
    )
    
    $
    15,525Total assets
    
    
    
    
    
    
    
    
    
    $
    2,735,836
    
    
    $
    2,735,836
 SuccessorSix Months Ended June 30, 2003:
    
    E&S(Dollars in thousands)
    
    Lines
    
    Specialty Admitted
    
    Corporate
    
    TotalRevenues:Gross premiums written
    
    $
    241,952
    
    
    $
    121,001
    
    
    $
    
    
    
    $
    362,953Net premiums written
    
    $
    57,493
    
    
    $
    41,968
    
    
    $
    
    
    
    $
    99,461Net premiums earned
    
    $
    56,240
    
    
    $
    38,157
    
    
    $
    
    
    
    $
    94,397Net investment income
    
    
    
    
    
    
    
    
    
    
    9,329
    
    
    
    9,329Net realized investment gains
    
    
    
    
    
    
    
    
    
    
    3,116
    
    
    
    3,116Total revenues
    
    
    56,240
    
    
    
    38,157
    
    
    
    12,445
    
    
    
    106,842Losses and Expenses:Net losses and loss adjustment expenses
    
    
    38,007
    
    
    
    23,839
    
    
    
    
    
    
    
    61,846Acquisition costs and other underwriting expenses
    
    
    
    
    
    
    
    
    
    
    20,733
    
    
    
    20,733Provision for doubtful reinsurance receivables
    
    
    
    
    
    
    
    
    
    
    1,750
    
    
    
    1,750Other operating expenses
    
    
    
    
    
    
    
    
    
    
    367
    
    
    
    367Interest expense
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    12Income (loss) before income taxes
    
    
    18,233
    
    
    
    14,318
    
    
    
    (10,417
    )
    
    
    22,134Income tax expense
    
    
    
    
    
    
    
    
    
    
    5,012
    
    
    
    5,012Net income (loss) before equity in net
income of partnerships
    
    
    18,233
    
    
    
    14,318
    
    
    
    (15,429
    )
    
    
    17,122Equity in net income of partnerships
    
    
    
    
    
    
    
    
    
    
    1,487
    
    
    
    1,487Net income (loss)
    
    $
    18,233
    
    
    $
    14,318
    
    
    $
    (13,942
    )
    
    $
    18,609Total assets
    
    
    
    
    
    
    
    
    
    $
    2,782,655
    
    
    $
    2,782,655
  (10)
    
    Supplemental Cash Flow Information Taxes and Interest Paid Successor
    
    Predecessor
    
    Successor
    
    PredecessorQuarter Ended
    
    Quarter Ended
    
    Six Months Ended
    
    Six Months Ended(Dollars in thousands)
    
    June 30, 2004
    
    June 30, 2003
    
    June 30, 2004
    
    June 30, 2003Federal income taxes paid
(received)
    
    $
    1,750
    
    
    $
    4,017
    
    
    $
    1,116
    
    
    $
    (4,166
    )Interest paid
    
    
    393
    
    
    
    
    
    
    
    793
    
    
    
    
 13




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Item 2. Managements Discussion and Analysis of Financial Condition and Results
of Operations The following discussion and analysis of our financial condition and results of
operations should be read in conjunction with the consolidated financial
statements and accompanying notes of United National Group and Wind River
Investment Corporation included elsewhere in this report. Some of the
information contained in this discussion and analysis or set forth elsewhere in
this report, including information with respect to our plans and strategy,
constitutes forward-looking statements that involve risks and uncertainties.
Please see Cautionary Note Regarding Forward-Looking Statements for a
discussion of important factors that could cause actual results to differ
materially from the results described in or implied by the forward-looking
statements contained herein. For more information regarding our business and
operations, please see our Annual Report on Form 10-K for the year ended
December 31, 2003. Overview We acquired all of the outstanding common stock of Wind River Investment
Corporation and its subsidiaries (Wind River or the Predecessor) on
September 5, 2003 (the Acquisition). As a result of the Acquisition, the
capital structure and basis of accounting of United National Group differ from
those of Wind River prior to the Acquisition. Therefore, the financial data
with respect to periods prior to the Acquisition (Predecessor period) may not
be comparable to data for periods subsequent to the Acquisition (Successor
period). We operate our business principally through two business segments: excess and
surplus lines (E&S) and specialty admitted. Our E&S segment focuses on
writing insurance for hard-to-place risks and risks that standard admitted
insurers specifically choose not to write. Our specialty admitted segment
focuses on writing insurance for risks that are unique and hard to place in the
standard market for insureds that are required, for marketing and regulatory
reasons, to purchase insurance from an admitted insurance company. We offer four general classes of insurance products across both our E&S and
specialty admitted business segments. These four classes of products are
specific specialty insurance products, umbrella and excess insurance products,
property and general liability insurance products, and non-medical professional
liability insurance products. Our insurance products target very specific, defined, homogenous groups of
insureds with customized coverages to meet their needs. Our products include
customized underwriting guidelines, rates, and forms tailored to our risk and
underwriting philosophy. We distribute the insurance products of our U.S. Operations through our
wholly-owned subsidiary, J.H. Ferguson, as well as through a group of 56
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 six months ended June 30, 2004, we realized additional insurance
policy rate increases at levels less than those levels realized during the six
months ended June 30, 2003. These increases have resulted primarily from a
number of industry wide factors, including a reduction in underwriting
capacity, ratings downgrades, the exit or insolvency of several insurers and
the industry wide recording of reserve charges resulting from reserve
deficiencies. 14




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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
$49.2 million as of June 30, 2004. Several of the limited partnerships invest
solely in securities that are publicly traded and are valued at the net asset
value as reported by the investment manager. As of June 30, 2004, our other
invested assets portfolio included $19.1 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 June 30, 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 June 30, 2004, we had total reinsurance receivables of $1,699.2 million.
The carrying value of these reinsurance receivables is net of a $32.6 million
reduction, which is equal to our estimate of potentially uncollectible
reinsurance receivables. Our estimate of 15




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potentially uncollectible reinsurance receivables, which was $49.1 million at
the date of the Acquisition, has been reduced to $32.6 million as of June 30,
2004 primarily as a result of the commutation agreement with Trenwick America
Reinsurance Corp. on October 29, 2003. As of December 31, 2003, the Company
had net reinsurance receivables of $1,763.0 million, net of a $33.7 million
reduction related to potentially uncollectible receivables. As of June 30, 2004, the amount of collateral securing individual reinsurance
receivables held by us aggregated $733.5 million, resulting in reinsurance
receivables net of collateral of $965.7 million. As of June 30, 2004, we also had total prepaid reinsurance premiums of $75.7
million, which were carried at $73.4 million. The carrying value of these
prepaid reinsurance premiums is net of a $2.3 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. Gross premiums written were $88.1 million and $206.1 million for the quarter
and six months ended June 30, 2004, respectively, compared with $148.5 million
and $363.0 million for the quarter and six months ended June 30, 2003,
respectively. Net premiums written were $68.2 million and $126.8 million for
the quarter and six months ended June 30, 2004, respectively, compared with
$45.8 million and $99.5 million for the quarter and six months ended June 30,
2003, respectively. Net premiums written grew as a result of increasing rates
combined with increased retentions across our core book of business as a result
of purchasing less reinsurance. In addition, we have recently converted select
quota share reinsurance arrangements to excess of loss reinsurance
arrangements. Gross premiums written were lower as a result of exiting from
heavily reinsured products. The U.S. Insurance Subsidiaries have entered into a quota share arrangement
with U.N. Barbados and U.N. Bermuda. This reinsurance arrangement stipulates
that 60% of our net retained insurance liability on new and renewal business
bound January 1, 2004 and later be ceded to our Non-U.S. Operations. This
agreement also stipulates that 60% of the December 31, 2003 unearned premium be
ceded to our Non-U.S. Operations. Income Tax We have managed our business in a manner designed to reduce the risk that U.N.
Barbados will be treated as engaged in a U.S. trade or business for U.S.
federal income tax purposes. On July 14, 2004 a protocol was signed by the
U.S. Treasury Secretary and the Barbados Minister of Industry and International
Business to amend the U.S.  Barbados Convention for the Avoidance of Double
Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income
Signed on December 31, 1984, as amended. The treaty amendment is subject to
ratification by the U.S. and Barbados governments. Provisions of the proposed
amended treaty would be effective the first day of the second month following
ratification with respect to tax withheld by the payor on amounts of interest
not subject to a portfolio exemption and on dividends or royalties paid or
credited, and would be effective for taxable years beginning on or after the first day of January
following ratification for other taxes. Under the protocol, U.N. Barbardos
investment income on an intercompany note payable to U.N. Barbados on or after
the effective dates of the amendment would be subject to U.S. withholding tax
of 30 percent, an increase from the existing rate of 5 percent. The investment
income subject to this tax was $2.9 million and $5.8 million for the quarter
and six months ended June 30, 2004, respectively. We believe that we have
identified alternatives that will mitigate the impact of the
protocol. We intend to implement a plan before year-end 2004 that will eliminate
the effect of the protocol on our overall effective tax rate. Stock Based Compensation We account for stock-based compensation in accordance with SFAS No. 123,
Accounting for Stock-Based Compensation which establishes a fair value-based
method of accounting for stock-based compensation plans. Our Business Segments We have two reporting business segments: E&S and specialty admitted.  
    
    Our E&S segment focuses on writing insurance for hard-to-place risks
and risks that standard admitted insurers specifically choose not to
write.  
    
    Our specialty admitted segment focuses on writing insurance for risks
that are unique and hard to place in the standard market, but that for
marketing and regulatory reasons must remain with an admitted insurance
company. 16




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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 Six Months Ended June 30,(Dollars in thousands)
    
    2004
    
    2003Gross premiums written:E&S
    
    $
    137,751
    
    
    $
    241,952Specialty admitted
    
    
    68,325
    
    
    
    121,001Gross premiums written
    
    $
    206,076
    
    
    $
    362,953Net premiums written:E&S
    
    $
    74,915
    
    
    $
    57,493Specialty admitted
    
    
    51,885
    
    
    
    41,968Net premiums written
    
    $
    126,800
    
    
    $
    99,461Net premiums earned:E&S
    
    $
    60,863
    
    
    $
    56,240Specialty admitted
    
    
    43,955
    
    
    
    38,157Net premiums earned
    
    $
    104,818
    
    
    $
    94,397Net losses and loss adjustment expenses:E&S
    
    $
    35,454
    
    
    $
    38,007Specialty admitted
    
    
    26,072
    
    
    
    23,839Net losses and loss adjustment expenses
    
    $
    61,526
    
    
    $
    61,846Net losses and loss adjustment expense ratio:E&S
    
    
    58.3
    %
    
    
    67.6
    %Specialty admitted
    
    
    59.3
    %
    
    
    62.5
    %Net losses and loss adjustment expense ratio
    
    
    58.7
    %
    
    
    65.5
    %
 For the Quarter Ended June 30,(Dollars in thousands)
    
    2004
    
    2003Gross premiums written:E&S
    
    $
    54,504
    
    
    $
    105,424Specialty admitted
    
    
    33,634
    
    
    
    43,069Gross premiums written
    
    $
    88,138
    
    
    $
    148,493Net premiums written:E&S
    
    $
    40,161
    
    
    $
    26,634Specialty admitted
    
    
    28,022
    
    
    
    19,191Net premiums written
    
    $
    68,183
    
    
    $
    45,825Net premiums earned:E&S
    
    $
    34,224
    
    
    $
    28,380Specialty admitted
    
    
    25,172
    
    
    
    19,404Net premiums earned
    
    $
    59,396
    
    
    $
    47,784Net losses and loss adjustment expenses:E&S
    
    $
    19,019
    
    
    $
    17,759Specialty admitted
    
    
    14,364
    
    
    
    11,256Net losses and loss adjustment expenses
    
    $
    33,383
    
    
    $
    29,015Net losses and loss adjustment expense ratio:E&S
    
    
    55.6
    %
    
    
    62.6
    %Specialty admitted
    
    
    57.1
    %
    
    
    58.0
    %Net losses and loss adjustment expense ratio
    
    
    56.2
    %
    
    
    60.7
    %
 17




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Results of Operations Six Months ended June 30, 2004 Compared with the Six Months ended June 30, 2003 The results of operations for the six months ended June 30, 2004 reflect the
financial performance of United National Group. The results of operations for
the six months ended June 30, 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 $206.1 million for the six months
ended June 30, 2004, compared with $363.0 million for the six months ended June
30, 2003, a decrease of $156.9 million or 43.2%. The decrease primarily
resulted from the termination of 17 products within our four product classes
during 2003 and 13 products within our four product classes during 2002. Gross
premiums written relative to those terminated products were $18.6 million for
the six months ended June 30, 2004, compared with $130.6 million for the six
months ended June 30, 2003. In addition, gross premiums written decreased
$52.3 million relative to our umbrella and excess product class, exclusive of
the terminated products. A further breakdown of gross premiums written is as
follows:  
    
    E&S gross premiums written were $137.8 million for the six months
ended June 30, 2004, compared with $242.0 million for the six months
ended June 30, 2003, a decrease of $104.2 million or 43.1%. This
decrease primarily resulted from the termination of 12 products within
our four product classes during 2003 and 11 products within our four
product classes during 2002, combined with a reduction in gross premiums
written of $25.6 million relative to our umbrella and excess product
class, exclusive of the terminated products, offset by renewal rate
increases of approximately 13% (as measured against expiring rates) on
other products. E&S gross premiums written relative to the terminated
products were $12.7 million for the six months ended June 30, 2004,
compared with $88.2 million for the six months ended June 30, 2003.  
    
    Specialty admitted gross premiums written were $68.3 million for the
six months ended June 30, 2004, compared with $121.0 million for the six
months ended June 30, 2003, a decrease of $52.7 million or 43.6%. The
decrease in specialty admitted gross premiums written was primarily the
result of the termination of 5 products during 2003 and 2 products
during 2002, combined with a reduction in gross premiums written of
$26.7 million relative to our umbrella and excess product class,
exclusive of the terminated products, offset by renewal rate increases
of approximately 10% on other products. Specialty admitted gross
premiums written relative to the terminated products were $5.9 million
for the six months ended June 30, 2004, compared with $42.4 million for
the six months ended June 30, 2003. Net premiums written, which equal gross premiums written less ceded premiums
written, were $126.8 million for the six months ended June 30, 2004, compared
with $99.5 million for the six months ended June 30, 2003, an increase of $27.3
million or 27.4%. The ratio of net premiums written to gross premiums written
increased to 61.5% for the six months ended June 30, 2004, from 27.4% for the
six months ended June 30, 2003. Net premiums written relative to terminated
products were $1.6 million for the six months ended June 30, 2004 compared with
$13.7 million for the six months ended June 30, 2003. A further breakdown of
net premiums written is as follows:  
    
    E&S net premiums written were $74.9 million for the six months ended
June 30, 2004, compared with $57.5 million for the six months ended June
30, 2003, an increase of $17.4 million or 30.3%. The ratio of net
premiums written to gross premiums written was 54.4% for the six months
ended June 30, 2004, compared with 23.8% for the six months ended June
30, 2003. The increase in net premiums written was largely due to
increasing our retention relative to individual products and due to rate
increases of approximately 14%. 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 $0.7 million for the six months
ended June 30, 2004, compared with $7.5 million for the six months ended
June 30, 2003.  
    
    Specialty admitted net premiums written were $51.9 million for the
six months ended June 30, 2004, compared with $42.0 million for the six
months ended June 30, 2003, an increase of $9.9 million or 23.6%. The
ratio of net premiums written to gross premiums written was 76.0% for
the six months ended June 30, 2004, compared with 34.7% for the six
months ended June 30, 2003. The increase in net premiums written was
largely due to the increases in retentions and due to rate increases of
approximately 9%. 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 $0.9 million for the six months ended June 30,
2004, compared with $6.2 million for the six months ended June 30, 2003. Net premiums earned were $104.8 million for the six months ended June 30, 2004,
compared with $94.4 million for the six months ended June 30, 2003, an increase
of $10.4 million or 11.0%. A further breakdown of net premiums earned is as
follows: 18




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
    
    E&S net premiums earned were $60.9 million for the six months ended
June 30, 2004, compared with $56.2 million for the six months ended June
30, 2003, an increase of $4.7 million or 8.4%. The increase in net
premiums earned was primarily due to the impact of the previously
mentioned retention increases and rate increases, partially offset by a
decrease due to the previously mentioned product terminations.  
    
    Specialty admitted net premiums earned were $43.9 million for the six
months ended June 30, 2004, compared with $38.2 million for six months
ended June 30, 2003, an increase of $5.8 million or 15.2%. Net premiums
earned increased primarily due to the impact of the previously mentioned
retention increases and rate increases, partially offset by a decrease
due to the impact of the previously mentioned product terminations. Net Investment Income Gross investment income, excluding realized gains and losses, was $10.4 million
for the six months ended June 30, 2004, compared with $11.5 million for the six
months ended June 30, 2003, a decrease of $1.1 million or 9.6%. The decrease
in investment income is due to several factors. As a result of the revaluation
of our investment portfolio in connection with the Acquisition, amortization of
premiums on bonds reduced gross investment income by $0.6 million for the six
months ended June 30, 2004. Although the value of cash and invested assets was
$204.5 million higher at June 30, 2004 compared to June 30, 2003, our average
bond portfolio, net of securities that are short-term in nature, was only $4.6
million greater for the six months ended June 30, 2004 compared to the
corresponding period in 2003. Finally, while there was an increase in cash and
short-term investments, this was mitigated by a general decline in short-term
interest rates. The average duration of our fixed income investments, excluding securities that
are short-term in nature, approximated 4.0 years as of June 30, 2004, compared
with 4.2 years as of December 31, 2003. Our book yield on our fixed income
investments was 3.2% for the six months ended June 30, 2004, compared with 4.1%
for the six months ended June 30, 2003. Investment expenses were $1.8 million for the six months ended June 30, 2004,
compared with $2.2 million for the six months ended June 30, 2003, a decrease
of $0.4 million or 18.2%. Net Realized Investment Gains (Losses) Net realized investment gains were $0.4 million for the six months ended June
30, 2004, compared with net realized investment gains of $3.1 million for the
six months ended June 30, 2003. The net realized investment gains for the
current period consists of net gains of $0.4 million relative to our equity
portfolio, net gains of $0.2 million relative to the market value of options,
net losses of $0.1 million relative to our fixed income investments, and net
losses of $0.1 million relative to our convertible bond and equity portfolios.
The net realized investment gains for the six months ended June 30, 2003
consisted of net gains of $2.8 million relative to our equity portfolio, net
gains of $1.3 million relative to our convertible bond and equity portfolios,
net losses of $0.8 million relative to our fixed income investments, and net
losses of $0.2 million relative to other invested assets. Net Losses and Loss Adjustment Expenses Net losses and loss adjustment expenses were $61.5 million for the six months
ended June 30, 2004, compared with $61.8 million for the six months ended June
30, 2003, a decrease of $0.3 million or 0.5%. The loss ratio for the six months
ended June 30, 2004 was 58.7% compared with 65.5% for the six months ended June
30, 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 $35.5 million for
the six months ended June 30, 2004, compared with $38.0 million for the
six months ended June 30, 2003. The loss ratio was 58.3% for the six
months ended June 30, 2004, compared with 67.6% for the six months ended
June 30, 2003. The improvement in the loss ratio was attributable to
continuing rate increases in 2004 and the termination of products that
did not meet our profitability targets in 2003.  
    
    Specialty admitted net losses and loss adjustment expenses were $26.1
million for the six months ended June 30, 2004, compared with $23.8
million for the six months ended June 30, 2003. The loss ratio for the
six months ended June 30, 2004 was 59.3%, compared with 62.5% for the
six months ended June 30, 2003. The improvement in the loss ratio was
attributable to continuing rate increases in 2004 and the termination of
products that did not meet our profitability targets in 2003. Acquisition Costs and Other Underwriting Expenses Acquisition costs and other underwriting expenses were $35.1 million for the
six months ended June 30, 2004, compared with $20.7 19




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million for the six months ended June 30, 2003, an increase of $14.4 million or
69.6%. This increase can be attributed to a $10.9 million increase in
acquisition costs and a $3.5 million increase in other underwriting expenses. A
further analysis of acquisition costs and other underwriting expenses is as
follows:  
    
    The $10.9 million increase in acquisition costs was primarily the
result of a reduction in ceding commissions of $53.6 million partially
offset by a decrease in direct commission expense of $31.0 million.
Contingent commission expense decreased $2.0 million and the deferral of
acquisition costs increased by $9.7 million. The reduction in ceding
commission income was a result of a decrease in ceded premiums written
resulting from an increase in our level of retention and reduction in
heavily reinsured business. The reduction in direct commission was
consistent with the reduction in gross premiums written. While increased
retentions have the impact of increasing acquisition costs, our
underwriting profit margins nonetheless increased based upon an
improvement in our loss experience.  
    
    The $3.5 million increase in other underwriting expenses was
primarily due to a $3.1 million increase in professional services, which
includes a $1.5 million increase in legal expenses and a $0.8 million
increase in insurance expenses. Provision for Doubtful Reinsurance Receivables We recorded no charge for an allowance for doubtful reinsurance receivables for
the six months ended June 30, 2004 as compared to a $1.8 million charge for the
six months ended June 30, 2003. Expense and Combined Ratios Our expense ratio, which is calculated by dividing the sum of acquisition costs
and other underwriting expenses and provisions for doubtful reinsurance
receivables by premiums earned, was 33.5% for the six months ended June 30,
2004, compared with 23.8% for the six months ended June 30, 2003. The expense
ratio for the six months ended June 30, 2004 was principally impacted by the
changes to commissions and other underwriting expenses described above. Part
of our strategy is to continue to retain a higher percentage of our premiums,
and increase our underwriting profit through improved loss experience. To the
extent that we are able to accomplish a higher retention percentage, we expect
this increase in expense ratio to be more than offset by a decrease in our loss
ratio. Our combined ratio was 92.2% for the six months ended June 30, 2004, compared
with 89.3% for the six months ended June 30, 2003. This increase in the
combined ratio was primarily due to 1.9% of purchase accounting adjustments
during the six months ended June 30, 2004, and a reduction in the amount of
ceding commission income, net of direct commission, related to terminated
products, partially offset by an improvement in the loss ratio as described
above. Other Operating Expenses Other operating expenses were $1.0 million for the six months ended June 30,
2004, compared with $0.4 million for the six months ended June 30, 2003, an
increase of $0.6 million. Income Tax (Benefit) Expense Income tax benefit was $1.4 million for the six months ended June 30, 2004,
compared with $5.0 million of tax expense for the six months ended June 30,
2003. Our effective tax benefit for the six months ended June 30, 2004 was
10.7%, compared with an effective tax rate of 22.6% for the six months ended
June 30, 2003. The effective rates differed from the 35.0% U.S. statutory rate
due in part to investment in tax-exempt securities and foreign income not
expected to be taxed in the U.S. An alternative minimum tax credit carryover
of $8.3 million is available for 2004 and future years and does not expire. We
are limited by Internal Revenue Code sections 382 and 383 on the amount of our
income that can be offset by an alternative minimum tax carryover following the
Acquisition. The section 382 limitation is an amount equal to the value of the
purchase price of the Acquisition less stock redemptions multiplied by the
long-term tax-exempt rate. The limitation applies until the carryforward is
fully utilized. The income limitation as a result of the Acquisition is $8.3
million per year. Equity in Net Earnings of Partnerships Equity in net earnings of partnerships was $0.6 million for the six months
ended June 30, 2004, compared with $1.5 million for the six months ended June
30, 2003, a decrease of $0.9 million or 60.6%. The decrease is primarily
attributable to the performance of a limited partnership investment which
invests mainly in convertible bonds and equities. Net Income and Net Operating Income The factors described above resulted in net income of $15.5 million for the six
months ended June 30, 2004, compared with $18.6 20




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million for the six months ended June 30, 2003, a decrease of $3.1 million or 16.7%. Net operating income
was $15.2 million for the six months ended June 30, 2004, compared with $16.6
million for the six months ended June 30, 2003. Net operating income for the
six months ended June 30, 2004 is equal to the six months ended June 30, 2004
net income less $0.3 million of after-tax realized investment gains. Net
operating income for the six months ended June 30, 2003 is equal to the six
months ended June 30, 2003 net income less $2.0 million of after-tax realized
investment gains. The Quarter ended June 30, 2004 Compared with the Quarter ended June 30, 2003 The results of operations for the quarter ended June 30, 2004 reflect the
financial performance of United National Group. The results of operations for
the quarter ended June 30, 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 $88.1 million for the quarter ended
June 30, 2004, compared with $148.5 million for the quarter ended June 30,
2003, a decrease of $60.4 million or 40.7%. The decrease primarily resulted
from the termination of 17 products within our four product classes during 2003
and 13 products within our four product classes during 2002. Gross premiums
written relative to those terminated products were $5.4 million for the quarter
ended June 30, 2004, compared with $61.9 million for the quarter ended June 30,
2003. In addition, gross premiums written decreased $17.7 million relative to
our umbrella and excess product class, exclusive of the terminated products. A
further breakdown of gross premiums written is as follows:  
    
    E&S gross premiums written were $54.5 million for the quarter ended
June 30, 2004, compared with $105.4 million for the quarter ended June
30, 2003, a decrease of $50.9 million or 48.3%. This decrease primarily
resulted from the termination of 12 products within our four product
classes during 2003 and 11 products within our four product classes
during 2002, combined with a reduction in gross premiums written of
$11.6 million relative to our umbrella and excess product class,
exclusive of the terminated products, offset by renewal rate increases
of approximately 11% (as measured against expiring rates) on other
products. E&S gross premiums written relative to the terminated
products were $0.9 million for the quarter ended June 30, 2004, compared
with $41.5 million for the quarter ended June 30, 2003.  
    
    Specialty admitted gross premiums written were $33.6 million for the
quarter ended June 30, 2004, compared with $43.1 million for the quarter
ended June 30, 2003, a decrease of $9.4 million or 21.9%. The decrease
in specialty admitted gross premiums written was primarily the result of
the termination of 5 products during 2003 and 2 products during 2002,
combined with a reduction in gross premiums written of $6.1 million
relative to our umbrella and excess product class, exclusive of the
terminated products, offset by renewal rate increases of approximately
7% on other products. Specialty admitted gross premiums written
relative to the terminated products were $4.5 million for the quarter
ended June 30, 2004, compared with $20.4 million for the quarter ended
June 30, 2003. Net premiums written, which equal gross premiums written less ceded premiums
written, were $68.2 million for the quarter ended June 30, 2004, compared with
$45.8 million for the quarter ended June 30, 2003, an increase of $22.4 million
or 48.9%. The ratio of net premiums written to gross premiums written increased
to 77.4% for the quarter ended June 30, 2004, from 30.8% for the quarter ended June 30, 2003. A further
breakdown of net premiums written is as follows:  
    
    E&S net premiums written were $40.2 million for the quarter ended
June 30, 2004, compared with $26.6 million for the quarter ended June
30, 2003, an increase of $13.5 million or 50.8%. The ratio of net
premiums written to gross premiums written was 73.7% for the quarter
ended June 30, 2004, compared with 25.3% for the quarter ended June 30,
2003. The increase in net premiums written was largely due to increasing
our retention relative to individual products and due to rate increases
of approximately 12%. These increases in net premiums written were
partially offset by decreases in net premiums written due to the
termination of the products previously mentioned. Net premiums written
relative to the terminated products were $(0.2) million for the quarter
ended June 30, 2004, compared with $2.7 million for the quarter ended
June 30, 2003.  
    
    Specialty admitted net premiums written were $28.0 million for the
quarter ended June 30, 2004, compared with $19.2 million for the quarter
ended June 30, 2003, an increase of $8.8 million or 46.0%. The ratio of
net premiums written to gross premiums written was 83.3% for the quarter
ended June 30, 2004, compared with 44.6% for the quarter ended June 30,
2003. The increase in net premiums written was largely due to the
increases in retentions and due to rate increases of approximately 6% .
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 $0.6 million for the quarter ended June 30, 2004, compared
with $2.3 million for the quarter ended June 30, 2003. Net premiums earned were $59.4 million for the quarter ended June 30, 2004,
compared with $47.8 million for the quarter ended 21




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June 30, 2003, an increase of
$11.6 million or 24.3%. A further breakdown of net premiums earned is as
follows:  
    
    E&S net premiums earned were $34.2 million for the quarter ended June
30, 2004, compared with $28.4 million for the quarter ended June 30,
2003, an increase of $5.8 million or 20.6%. The increase in net premiums
earned was primarily due to the impact of the previously mentioned
retention increases and rate increases, partially offset by a decrease
due to the impact of the previously mentioned product terminations.  
    
    Specialty admitted net premiums earned were $25.2 million for the
quarter ended June 30, 2004, compared with $19.4 million for quarter
ended June 30, 2003, an increase of $5.8 million or 29.7%. The increase
in net premiums earned was primarily due to the impact of the previously
mentioned retention increases and rate increases, partially offset by a
decrease due to the impact of the previously mentioned product
terminations. Net Investment Income Gross investment income, excluding realized gains and losses, was $5.3 million
for the quarter ended June 30, 2004, compared with $5.2 million for the quarter
ended June 30, 2003, an increase of $0.1 million or 1.9%. The increase in
investment income is due to several factors. As a result of the revaluation of
our investment portfolio in connection with the Acquisition, amortization of
premiums on bonds reduced gross investment income by $0.2 million for the
quarter ended June 30, 2004. Although the value of cash and invested assets
was $204.5 million higher at June 30, 2004 compared to June 30, 2003, our
average bond portfolio, net of securities that are short-term in nature, was
only $31.6 million greater for the quarter ended June 30, 2004 compared to the
corresponding period in 2003. Finally, while there was an increase in cash and
short-term investments, this was mitigated by a general decline in short-term
interest rates. The average duration of our fixed income investments, excluding securities that
are short-term in nature, approximated 4.0 years as of June 30, 2004, compared
with 4.2 years as of December 31, 2003. Our book yield on our fixed income
investments was 3.1% for the quarter ended June 30, 2004, compared with 3.7 %
for the quarter ended June 30, 2003. Investment expenses were $0.9 million for the quarter ended June 30, 2004,
compared with $1.1 million for the quarter ended June 30, 2003, a decrease of $0.2 million or 18.2%. Net Realized Investment Gains (Losses) Net realized investment gains were $0.5 million for the quarter ended June 30,
2004, compared with net realized investment gains of $4.5 million for the
quarter ended June 30, 2003. The net realized investment gains for the current
period consists of net gains of $0.1 million relative to our equity portfolio,
$0.1 million of net losses relative to our fixed income investments, and net
gains of $0.5 million relative to the market value of options. The net
realized investment gains for the quarter ended June 30, 2003 consisted of net
gains of $4.2 million relative to our equity portfolio, net gains of $1.5
million relative to our convertible bond and equity portfolios, net losses of
$0.9 million relative to our fixed income investments, and net losses of $0.3
million relative to other invested assets. Net Losses and Loss Adjustment Expenses Net losses and loss adjustment expenses were $33.4 million for the quarter
ended June 30, 2004, compared with $29.0 million for the quarter ended June 30,
2003, an increase of $4.4 million or 15.2%. The loss ratio for the quarter
ended June 30, 2004 was 56.2% compared with 60.7% for the quarter ended June
30, 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 $19.0 million for
the quarter ended June 30, 2004, compared with $17.8 million for the
quarter ended June 30, 2003. The loss ratio was 55.6% for the quarter
ended June 30, 2004, compared with 62.6% for the quarter ended June 30,
2003. The improvement in the loss ratio was attributable to continuing
rate increases in 2004 and the termination of products that did not meet
our profitability targets in 2003.  
    
    Specialty admitted net losses and loss adjustment expenses were $14.4
million for the quarter ended June 30, 2004, compared with $11.3 million
for the quarter ended June 30, 2003. The loss ratio for the quarter
ended June 30, 2004 was 57.1%, compared with 58.0% for the quarter ended
June 30, 2003. The improvement in the loss ratio was attributable to
continuing rate increases in 2004 and the termination of products that
did not meet our profitability targets in 2003. Acquisition Costs and Other Underwriting Expenses Acquisition costs and other underwriting expenses were $21.6 million for the
quarter ended June 30, 2004, compared with $12.4 22




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million for the quarter ended
June 30, 2003, an increase of $9.2 million or 74.2%. This increase can be
attributed to a $6.5 million increase in acquisition costs and a $2.7 million
increase in other underwriting expenses. A further analysis of acquisition
costs and other underwriting expenses is as follows:  
    
    The $6.5 million increase in acquisition costs was primarily the
result of a reduction in ceding commissions earned of $23.0 million
partially offset by a decrease in direct commission expense of $11.7
million. Contingent commission expense decreased $0.5 million and the
deferral of acquisition costs increased by $4.3 million. The reduction
in ceding commission income was a result of a decrease in ceded premiums
written resulting from an increase in our level of retention and
reduction in heavily reinsured business. The reduction in direct
commission was consistent with the reduction in gross premiums written.
While increased retentions have the impact of increasing acquisition
costs, our underwriting profit margins nonetheless increased based upon
an improvement in our loss experience.  
    
    The $2.7 million increase in other underwriting expenses was
primarily due a $2.2 million increase in professional services, which
includes a $1.3 million increase in legal expenses and $0.4 million
increase in insurance expenses. Provision for Doubtful Reinsurance Receivables We recorded no charge for an allowance for doubtful reinsurance receivables for
the quarter ended June 30, 2004 as
compared to a $0.9 million charge for the quarter ended June 30, 2003. Expense and Combined Ratios Our expense ratio, which is calculated by dividing the sum of acquisition costs
and other underwriting expenses and provisions for doubtful reinsurance
receivables by premiums earned, was 36.4% for the quarter ended June 30, 2004,
compared with 27.8% for the quarter ended June 30, 2003. The expense ratio for
the quarter ended June 30, 2004 was principally impacted by the changes to
commissions and other underwriting expenses described above. Part of our
strategy is to continue to retain a higher percentage of our premiums, and
increase our underwriting profit through improved loss experience. To the
extent that we are able to accomplish a higher retention percentage, we expect
this increase in expense ratio to be more than offset by a decrease in our loss
ratio. Our combined ratio was 92.6% for the quarter ended June 30, 2004, compared with
88.5% for the quarter ended June 30, 2003. This increase in the combined ratio
was primarily due to 2.9% of purchase accounting adjustments during the quarter
ended June 30, 2004, and a reduction in the amount of ceding commission income,
net of direct commission, related to terminated products, partially offset by
an improvement in the loss ratio as described above. Other Operating Expenses (Income) Other operating expenses were $0.5 million for the quarter ended June 30, 2004,
compared with $0.1 million of other operating income for the quarter ended June
30, 2003, a change of $0.6 million. Income Tax (Benefit) Expense Income tax benefit was $0.7 million for the quarter ended June 30, 2004,
compared with $3.6 million of tax expense for the quarter ended June 30, 2003.
Our effective tax benefit for the quarter ended June 30, 2004 was 9.0%,
compared with an effective tax rate of 25.7% for the quarter ended June 30,
2003. The effective rates differed from the 35.0% U.S. statutory rate due in
part to investment in tax-exempt securities and foreign income not expected to
be taxed in the U.S. An alternative minimum tax credit carryover of $8.3
million is available for 2004 and future years and does not expire. We are
limited by Internal Revenue Code sections 382 and 383 on the amount of our
income that can be offset by an alternative minimum tax carryover following the
Acquisition. The section 382 limitation is an amount equal to the value of the
purchase price of the Acquisition less stock redemptions multiplied by the
long-term tax-exempt rate. The limitation applies until the carryforward is
fully utilized. The income limitation as a result of the Acquisition is $8.3
million per year. Equity in Net Earnings of Partnerships Equity in net earnings of partnerships was $0.0 million for the quarter ended
June 30, 2004, compared with $1.1 million for the quarter ended June 30, 2003,
a decrease of $1.1 million. The decrease is primarily attributable to the
performance of a limited partnership investment which invests mainly in
convertible bonds and equities. Net Income and Net Operating Income The factors described above resulted in net income of $8.1 million for the
quarter ended June 30, 2004, compared with $11.6 million for the quarter ended
June 30, 2003, a decrease of $3.5 million or 30.2%. Net operating income was
$7.8 million for the quarter ended 23




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June 30, 2004, compared with $8.6 million
for the quarter ended June 30, 2003. Net operating income for the quarter
ended June 30, 2004 is equal to the quarter ended June 30, 2004 net income less
$0.3 million of after-tax realized investment gains. Net operating income for
the quarter ended June 30, 2003 is equal to the quarter ended June 30, 2003 net
income less $3.0 million of after-tax realized investment gains. 24




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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 ($8.9) million
and $14.9 million, respectively, for the six months ended June 30, 2004 and
2003. Cash flow used for operating activities for the six months ended June
30, 2004 was negatively affected by a $32.9 million reduction in ceded balances
payable related to our exit from heavily reinsured business and a $17.8 million
payment to Bank of America as further discussed in Legal Proceedings (Item I
of Part II of this report). Cash flow provided by operating activities for the
six months ended June 30, 2003 benefited by $18.2 million due to an increase in net loss and loss adjustment
expense reserves and benefited by $10.4 million due to an increase in ceded
balances payable. Net cash used for investing activities was $54.9 million and $16.1 million,
respectively, for the six months ended June 30, 2004 and 2003. The $38.8
million increase in the cash used for investing activities was caused by
efforts to invest high levels of cash and cash equivalents during the six
months ended June 30, 2004. Cash and cash equivalents totaled $214.8 million
and $72.9 million, respectively, as of December 31, 2003 and 2002. Cash and
cash equivalents as of December 31, 2003 exceeded cash and cash equivalents as
of December 31, 2002 by $141.9 million. The reasons for high levels of cash
and cash equivalents as of December 31, 2003 included the $240.0 million
initial capital contribution made by Fox Paine in September 2003, the receipt
of $165.6 million of net proceeds from our December 15, 2003 initial public
offering and the receipt of $30.0 million due to the issuance of trust
preferred 25




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securities in September and October 2003, offset by the $100.0
million used to purchase a portion of the common stock of Wind River Investment
Corporation owned by the Ball Family trusts and the $150.0 million used in the
redemption of our Series A preferred shares. Net cash provided by financing activities was $7.3 million for the six months
ending June 30, 2004, compared with none for the six months ending June 30,
2003. The source of this cash flow during the quarter ending June 30, 2004 was
the issuance of 462,500 Class A common shares at a price of $17.00 per share in
January 2004, in connection with exercise by the underwriters of the remaining
overallotment option related to our initial public offering. Proceeds to
United National Group, net of underwriting discounts of $0.5 million, were $7.3
million. Liquidity At June 30, 2004, we had $158.4 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 assuming less business from 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 June 30, 2004, the trusts were funded to
approximately $354.9 million. It is anticipated that the required funding
amount will decline in future periods, which would improve the overall
liquidity of the domestic insurance group. The U.S. Insurance Subsidiaries have entered into a quota share arrangement
with U.N. Barbados and U.N. Bermuda. Under this reinsurance arrangement, 60%
of our net retained insurance liability on new and renewal business bound on or
after January 1, 2004, is ceded to our Non-U.S. Operations. The agreement also
stipulates that 60% of the December 31, 2003 unearned premium be ceded to our
Non-U.S. Operations. The impact of this reinsurance arrangement is reflected
in our June 30, 2004 financial statements. Reinsurance premiums ceded by our U.S. Insurance Subsidiaries through April
2004 were paid to U.N. Bermuda and U.N. Barbados. Since U.N. Barbados and U.N.
Bermuda are not authorized reinsurers in the United States, the insurance laws
and regulations of Pennsylvania, Indiana and Wisconsin require the
establishment of reinsurance trusts for the benefit of the U.S. Insurance Subsidiaries. The funding
requirement includes the amount of all paid loss and loss adjustment expenses,
ceded unearned premium reserves, and unpaid loss and loss adjustment expenses.
U.N. Bermuda and U.N. Barbados have each established independent reinsurance
trust accounts for the benefit of each U.S. Insurance Subsidiary in the amount
of $12.9 million and $43.1 million, respectively. We intend to invest the
funds in securities that have durations that closely match the expected
duration of the liabilities assumed. We believe that each of U.N. Bermuda and
U.N. Barbados will have sufficient liquidity to pay claims prospectively. As a result of the cessions to our Non-U.S. Operations, we expect that our U.S.
Operations will have negative cash flow from operations and our Non-U.S.
Operations will have positive cash flow. This trend may continue for several
years. As mentioned above, our U.S. Operations have sufficient liquidity to pay
claims. We expect our overall cash flow to be positive in the future. We
monitor our portfolios to assure liability and investment durations are closely
matched. Investments made by our Non-U.S. Operations will be in taxable securities.
Currently, most of the investments of our U.S. Operations are in tax exempt
investments. Prospectively, as fixed income investments mature and new cash is
obtained, it will likely be invested in taxable securities. 26




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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, our U.S. Operations will incur interest expense of
approximately $16.9 million in 2004. $11.6 million of this interest expense is
related to a note held by U.N. Barbados from U.N. Holdings II, and therefore
eliminated during consolidation while $5.3 million is related to senior notes
held by the Ball family trusts and the trust preferred securities. $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. Insurance Subsidiaries have cash and
investments totaling $32.6
million. In 2004, we do not anticipate that we will need to pay a dividend
from our U.S. Insurance Subsidiaries to fund this debt service. In 2005, and thereafter,
dividends from our U.S. Insurance Subsidiaries may be required to fund this debt service. As a result of the Acquisition, senior notes in an aggregate principal amount
of $72.8 million, subject to adjustment, were issued to the Ball family trusts,
by our subsidiary, Wind River Investment Corporation, as part of the purchase
price, which senior notes we have fully and unconditionally guaranteed. These
senior notes were amended and restated on November 24, 2003, and have an
interest rate of 5.0%, which may be paid either in cash or in kind. These
senior notes mature on September 5, 2015; however, in certain circumstances
Wind River Investment Corporation is required to make mandatory prepayments on
these senior notes on October 1 of each year. Wind River Investment Corporation
is only required to make such mandatory prepayments if we have generated
excess cash flow for the preceding fiscal year. Excess cash flow generally
means an amount equal to our consolidated net income, less such amounts as our
Board of Directors may determine are necessary to: (1) maintain an A.M. Best
rating of at least A (Excellent) for each of our U.S. Insurance Subsidiaries;
(2) make permitted dividend payments; (3) maintain the statutory surplus of our
U.S. Insurance Subsidiaries at acceptable levels and (4) provide our U.S.
Operations with adequate levels of working capital. During 2004, our U.S. Insurance Subsidiaries can pay a dividend of $34.1
million without regulatory approval. 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 at par after September 30, 2008, five years from the date
of issuance. The entire proceeds from the sale of the trust preferred securities, including
the proceeds from the sale of common securities of Trust I to AIS, were used to
fund the purchase of $10.3 million (in principal amount) of junior subordinated
deferrable interest notes issued by AIS under an indenture, dated as of
September 30, 2003, between AIS and JPMorgan Chase Bank, as trustee. On October 29, 2003, AIS sold $20.0 million (aggregate liquidation amount) of
floating rate trust preferred securities to I-Preferred Term Securities III,
Ltd., an exempted company incorporated with limited liability under the law of
the Cayman Islands, in a private placement through AISs wholly-owned
Connecticut subsidiary, United National Group Capital Statutory Trust II (Trust II). AIS, through Trust II, together with other insurance companies and insurance
holding companies, issued trust preferred securities to the collateralized debt
obligation pool organized by I-Preferred Term Securities III, Ltd., which in
turn, issued its securities to institutional and accredited investors. Trust
II issued 20,000 trust preferred securities, having a stated liquidation amount
of $1,000 per security, that mature on October 29, 2033 and bear a floating
interest rate, reset quarterly, equal to LIBOR plus 3.85%. AIS, through Trust
II, has the right to call the trust preferred securities at par after October
29, 2008, five years from the date of issuance. 27




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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. In June and July of 2004, U.N. Barbados made capital contributions of $10.0
million and $15.0 million, respectively, to U.N. Bermuda. On September 5, 2003 we began paying annual management fees of $1.5 million in
the aggregate to Fox Paine & Company and The AMC Group, L.P. The next
management fee payment of $1.5 million is payable November 1, 2004. 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; 28




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##### Table of Contents




    
    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  
    
    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. 29




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures about Market Risk We believe that we are principally exposed to two types of market risk: Interest Rate Risk Our primary market risk exposure is to changes in interest rates. Our fixed
income investments are exposed to interest rate risk. Fluctuations in interest
rates have a direct impact on the market valuation of these securities. As
interest rates rise, the market value of our fixed income investments fall, and
the converse is also true. We expect to manage interest rate risk through an
active portfolio management strategy that involves the selection, by our
managers, of investments with appropriate characteristics, such as duration,
yield, currency and liquidity, that are tailored to the anticipated cash
outflow characteristics of our liabilities. Our strategy for managing interest
rate risk also includes maintaining a high quality portfolio with a relatively
short duration to reduce the effect of interest rate changes on book value. A
significant portion of our investment portfolio matures each year, allowing for
reinvestment at current market rates. Our market risk associated with exposure
to interest rate risk has not materially changed since December 31, 2003. The table below provides information about our bonds that are sensitive to
changes in interest rates. (Dollars in thousands)Maturity
    
    Principal
    
    Book
    
    Average Interest Rate2004
    
    $
    121,086
    
    
    $
    121,136
    
    
    
    1.20
    %2005
    
    
    16,545
    
    
    
    16,816
    
    
    
    1.84
    %2006
    
    
    44,875
    
    
    
    45,514
    
    
    
    2.50
    %2007
    
    
    47,560
    
    
    
    45,611
    
    
    
    3.15
    %2008
    
    
    27,315
    
    
    
    27,612
    
    
    
    3.17
    %Thereafter
    
    
    353,733
    
    
    
    334,849
    
    
    
    4.27
    %Total
    
    $
    611,114
    
    
    $
    591,538
    
    
    
    3.30
    %Total Fair Value
    
    
    
    
    
    $
    592,565
 Credit Risk We have exposure to credit risk primarily as a holder of fixed income
investments. Our investment policy requires that we invest in debt instruments
of high credit quality issuers and limits the amount of credit exposure to any
one issuer based upon the rating of the security. In addition, we have credit risk exposure to our general agencies and
reinsurers. We seek to mitigate and control our risks to producers by
typically requiring our general agencies to render payments within no more than
45 days after the month in which a policy is effective and including provisions
within our general agency contracts that allow us to terminate a general
agencies authority in the event of non-payment. With respect to our credit exposure to reinsurers, we seek to mitigate and
control our risk by ceding business to only those reinsurers having adequate
financial strength and sufficient capital to fund their obligation. In
addition, we seek to mitigate credit risk to reinsurers through the use of
trusts and letters of credit for collateral. As of June 30, 2004, $733.5
million of collateral was held to support the reinsurance receivables. 30




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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 June 30, 2004, our disclosure controls and
procedures were designed to ensure that information required to be disclosed by
us in the reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commissions rules and forms and are operating in an
effective manner. Changes in Internal Controls There was not any change in our internal controls over financial reporting that
occurred during the quarter ended June 30, 2004 that has materially affected,
or is reasonably likely to materially affect, our internal control over
financial reporting. 31




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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), elected to enter into a settlement with Bank of America, N.A. and
Platinum Indemnity Limited relative to litigation pending in the United States
District Court for the Southern District of New York. Under the terms of the
settlement, Diamond State paid $17.8 million to Bank of America and provided
other non-financial consideration to Bank of America and Platinum in exchange
for a full and final release by Bank of America and Platinum, and other
consideration, relative to their claims of approximately $29.0 million, plus
interest in excess of $10.0 million and fees and costs, related to facultative
reinsurance policies issued by Worldwide Weather Insurance Agency, and its
principal Harold Mollin, purportedly on behalf of Diamond State. As a result of the settlement, Diamond State is proceeding with an arbitration
against Partner Reinsurance Company, Ltd. and Partner Reinsurance Company of
the U.S. seeking recovery under a reinsurance agreement covering business
produced by Worldwide Weather Insurance Agency on a 100% basis with regard to
the type of risk involved. In that connection, Diamond State holds a letter of
credit dated March 31, 2004 from Partner Reinsurance Company, Ltd. in the
amount of $17.8 million. In addition, Diamond State is seeking indemnification
and contribution from Partner Reinsurance Company of the U.S. because of its
role in the appointment of Mr. Mollin and Worldwide Weather Insurance Agency.
Discovery is proceeding in advance of the scheduled November 2004 arbitration. 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. A voluntary
mediation held in June 2004 was unsuccessful. Discovery proceedings have
resumed, although settlement opportunities continue to be explored. We believe that the ultimate outcome of all litigation, arbitration,
reinsurance recoverable and coverage claim matters, after consideration of
applicable reserves, should not have a material adverse effect on our financial
condition. Nevertheless, we cannot assure you that lawsuits,
arbitrations or other litigation will not have a material adverse
effect on our business, financial condition or results of operations. 
 Item 2. Changes in Securities and Use of Proceeds Not applicable. 
 Item 3. Defaults Upon Senior Securities Not applicable. 32




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Item 4. Submission of Matters to a Vote of Security Holders The following matters were submitted to a vote of shareholders at our Annual
General Meeting of Shareholders held on May 4, 2004:  1.
    
    Approval of the appointments of the following nominees to the United
National Group, Ltd. Board of Directors. Nominee
    
    Votes For
    
    Votes Against
    
    Votes AbstainedSaul A. Fox
    
    
    136,919,507
    
    
    
    49,914
    
    
    
    2,713,334David R. Bradley
    
    
    136,923,907
    
    
    
    52,914
    
    
    
    2,705,934Troy W. Thacker
    
    
    136,919,507
    
    
    
    49,914
    
    
    
    2,713,334W. Dexter Paine, III
    
    
    136,919,507
    
    
    
    49,914
    
    
    
    2,713,334Angelos J. Dassios
    
    
    136,919,507
    
    
    
    49,914
    
    
    
    2,713,334Michael J. McDonough
    
    
    136,919,507
    
    
    
    49,914
    
    
    
    2,713,334Russell C. Ball, III
    
    
    139,265,938
    
    
    
    49,914
    
    
    
    366,903John J. Hendrickson
    
    
    139,265,938
    
    
    
    49,914
    
    
    
    366,903Edward J. Noonan
    
    
    139,302,638
    
    
    
    13,214
    
    
    
    366,903Kenneth J. Singleton
    
    
    139,302,638
    
    
    
    13,214
    
    
    
    366,903
  2.
    
    Approval of our Share Incentive Plan. Votes For
    
    Votes Against
    
    Votes Abstained138,831,613
    
    
    850,142
    
    
    
    1,000
  3.
    
    Approval of the appointment of PricewaterCoopers LLP as the independent
auditor of United National Group, Ltd. for 2004 and of the setting of fees
for the independent auditor by the Board of Directors of United National
Group, Ltd. acting by its Audit Committee. Votes For
    
    Votes Against
    
    Votes Abstained139,314,388
    
    
    367,767
    
    
    
    600
  4.
    
    Approval of the appointments of the following nominees to the Wind River
Insurance Company (Barbados) Ltd. Board of Directors. Nominee
    
    Votes For
    
    Votes WithheldSaul A. Fox
    
    
    136,956,257
    
    
    
    2,726,498Troy W. Thacker
    
    
    136,956,257
    
    
    
    2,695,298Angelos J. Dassios
    
    
    136,956,257
    
    
    
    2,726,498David N. King
    
    
    139,504,688
    
    
    
    178,067
  5.
    
    Approval of the appointment of PricewaterCoopers, LLP, St. Michael,
Barbados, as the independent auditor of Wind River Insurance Company
(Barbados) Ltd. for 2004 and of the setting of fees for the independent
auditor by the Board of Directors of Wind River Insurance Company
(Barbados) Ltd. Votes For
    
    Votes Against
    
    Votes Abstained139,315,988
    
    
    366,167
    
    
    
    600
  6.
    
    Approval of the financial statements of Wind River Insurance Company
(Barbados) Ltd. and the report of the independent auditors on these
financial statements. Votes For
    
    Votes Against
    
    Votes Abstained110,015,996
    
    
    0
    
    
    
    0
 33




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##### Table of Contents



7.
    
    Approval of the appointments of the following nominees to the Wind River
Insurance Company (Bermuda), Ltd. Board of Directors. Nominee
    
    Votes For
    
    Votes WithheldSaul A. Fox
    
    
    136,953,257
    
    
    
    2,729,498Troy W. Thacker
    
    
    136,956,257
    
    
    
    2,726,498Angelos J. Dassios
    
    
    136,956,257
    
    
    
    2,726,498David R. Bradley
    
    
    136,960,657
    
    
    
    2,722,098Alan Bossin
    
    
    139,504,688
    
    
    
    178,067Michael J. Tait
    
    
    139,504,688
    
    
    
    178,067Janita Burke Waldron
    
    
    139,504,688
    
    
    
    178,067(Alternate Director)Kaela Keen
    
    
    139,504,688
    
    
    
    178,067(Alternate Director)
  8.
    
    Approval of the appointment of PricewaterCoopers LLP, Hamilton, Bermuda,
as the independent auditor of Wind River Insurance Company (Bermuda), Ltd.
for 2004. Votes For
    
    Votes Against
    
    Votes Abstained139,313,438
    
    
    366,717
    
    
    
    2,600
  9.
    
    Approval of the financial statements of Wind River Insurance Company
(Bermuda), Ltd. and the report of the independent auditors on these
financial statements. Votes For
    
    Votes Against
    
    Votes Abstained110,015,996
    
    
    0
    
    
    
    0
  10.
    
    Approval of amendments to the Certification of Incorporation and the
Memorandum of Association of Wind River Insurance Company (Bermuda), Ltd.
in order to change the name of the company from Wind River Insurance
Company (Bermuda), Ltd. to Wind River Insurance Company, Ltd. Votes For
    
    Votes Against
    
    Votes Abstained110,015,996
    
    
    0
    
    
    
    0
  11.
    
    Approval of the appointments of the following nominees to the Wind River
Services, Ltd. Board of Directors. Nominee
    
    Votes For
    
    Votes WithheldSaul A. Fox
    
    
    136,957,207
    
    
    
    2,725,548Troy W. Thacker
    
    
    136,957,207
    
    
    
    2,725,548Angelos J. Dassios
    
    
    136,957,207
    
    
    
    2,725,548David R. Bradley
    
    
    136,961,607
    
    
    
    2,721,148Kevin L. Tate
    
    
    136,954,207
    
    
    
    2,728,548
  12.
    
    Approval of the appointment of PricewaterhouseCoopers LLP, Hamilton,
Bermuda, as the independent auditor of Wind River Services, Ltd. for 2004. Votes For
    
    Votes Against
    
    Votes Abstained139,314,388
    
    
    359,467
    
    
    
    8,900
  13.
    
    Approval of the financial statements of Wind River Services, Ltd. and the
report of the independent auditors on these financial statements. Votes For
    
    Votes Against
    
    Votes Abstained110,015,996
    
    
    0
    
    
    
    0
 
 Item 5. Other Information Not applicable. 34




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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 the Sarbanes-Oxley
Act of 2002.32.2+
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002.+
    
    Filed herewith.
  b.
    
    Reports on Form 8-KWe furnished the following report on Form 8-K during the quarterly period
ended June 30, 2004: Date of Report
    
    Item ReportedMay 4, 2004
    
    Item 12  Regarding earnings release with respect to thequarter ended March 31, 2004 financial results.
 35




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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.
RegistrantAugust 12, 2004
    
    By:
    
    /s/ David R. BradleyDate

    
    David R. BradleyChief Executive OfficerAugust 12, 2004
    
    By:
    
    /s/ Kevin L. TateDate
    
    Kevin L. TateChief Financial Officer
 36