**UNITED
          STATES**
 **SECURITIES
          AND EXCHANGE COMMISSION******
 Washington,
          D.C. 20549
 
 **FORM
          10-Q**
 
 **xQUARTERLY
          REPORT
          PURSUANT TO SECTION 13 OR 15(d) OF THE** **SECURITIES
          EXCHANGE ACT OF 1934**
  For
          the
          quarterly period ended September 30, 2005
 
 **oTRANSITION
          REPORT
          PURSUANT TO SECTION 13 OR 15(d) OF THE** **SECURITIES
          EXCHANGE ACT OF 1934**
 
 For
          the
          transition period from  to
 
 Commission
          File Number 0-6964
 
 
 **21ST
          CENTURY INSURANCE GROUP**
 (Exact
          name of registrant as specified in its charter)
 
 
 **Delaware**
                **95-1935264**(State
                    or other jurisdiction of incorporation
                    or organization)
                (I.R.S.
                    Employer Identification
                    No.)**6301
                    Owensmouth Avenue****Woodland
                    Hills, California**
                **91367**(Address
                    of principal executive offices)
                (Zip
                    Code)**(818)
                    704-3700**
                **www.21st.com**(Registrant’s
                    telephone number,
                  including
                    area code)
                (Registrant’s
                    web site)
 
 
 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
o
 
 Indicate
          by check mark whether the registrant is an accelerated filer (as defined
          in
          Rule 12b-2 of the Exchange Act). Yes x No o
 
 The
          number of shares outstanding of the issuer’s common stock as of October 14, 2005
          was 85,835,838.
  
 
  **TABLE
          OF CONTENTS**
 
 
 Description
                
                Page
                    Number**PART
                    I - FINANCIAL INFORMATION**Item
                    1.
                Financial
                    Statements
                2Item
                    2.
                Management’s
                    Discussion and Analysis of Financial Condition
                    and Results of Operations
                16Item
                    3.
                Quantitative
                    and Qualitative Disclosures About Market
                    Risk
                31Item
                    4.
                Controls
                    and Procedures
                32**PART
                    II - OTHER INFORMATION**Item
                    1.
                Legal
                    Proceedings
                33Item
                    2.
                Unregistered
                    Sales of Equity Securities and Use of
                    Proceeds
                33Item
                    3.
                Defaults
                    Upon Senior Securities
                33Item
                    4.
                Submission
                    of Matters to a Vote of Security
                    Holders
                33Item
                    5.
                Other
                    Information
                33Item
                    6.
                Exhibits
                33**SIGNATURES**
                
                34**EXHIBIT
                    INDEX**
                3531.1
                    Certification of President and Chief Executive
                    Officer31.2
                    Certification of Chief Financial Officer32.1Certification Pursuant to 18 U.S.C. Section 1350, as Adopted
                    Pursuant toSection
                    906 of the Sarbanes-Oxley Act of 2002
  1
  **PART
          I** **-** **FINANCIAL
          INFORMATION**
 
 **ITEM 1.**
                **FINANCIAL
                    STATEMENTS**
 
 **21ST
                    CENTURY INSURANCE GROUP****CONDENSED
                    CONSOLIDATED BALANCE SHEETS**Unaudited*AMOUNTS
                    IN THOUSANDS, EXCEPT SHARE DATA*
                
                **September
                      30,**2005
                December
                      31,2004**Assets**Fixed
                    maturity investments available-for-sale, at fair value (amortized
                    cost:
                    $1,351,416 and $1,320,592)
                
                **$**
                **1,350,411**
                
                **$**
                1,342,130Equity
                    securities available-for-sale, at fair value (cost: $47,059 and
                    $41,450)
                
                
                **46,380**
                
                
                42,085Total
                    investments
                
                
                **1,396,791**
                
                
                1,384,215Cash
                    and cash equivalents
                
                
                **65,264**
                
                
                34,697Accrued
                    investment income
                
                
                **16,183**
                
                
                16,161Premiums
                    receivable
                
                
                **116,980**
                
                
                105,814Reinsurance
                    receivables and recoverables
                
                
                **5,914**
                
                
                7,160Prepaid
                    reinsurance premiums
                
                
                **1,870**
                
                
                1,787Deferred
                    income taxes
                
                
                **53,798**
                
                
                56,135Deferred
                    policy acquisition costs
                
                
                **63,760**
                
                
                58,759Leased
                    property under capital lease, net of deferred gain of $1,929
                    and $3,116
                    and net of accumulated amortization of $33,802 and $24,794
                
                
                **25,339**
                
                
                31,719Property
                    and equipment, at cost less accumulated depreciation of $83,687
                    and
                    $68,529
                
                
                **145,841**
                
                
                129,372Other
                    assets
                
                
                **29,930**
                
                
                38,495Total
                    assets
                
                **$**
                **1,921,670**
                
                $
                1,864,314**Liabilities
                    and stockholders’ equity**Unpaid
                    losses and loss adjustment expenses
                
                **$**
                **517,614**
                
                $
                495,542Unearned
                    premiums
                
                
                **340,055**
                
                
                331,036Debt
                
                
                **131,095**
                
                
                138,290Claims
                    checks payable
                
                
                **40,711**
                
                
                38,737Reinsurance
                    payable
                
                
                **663**
                
                
                633Other
                    liabilities
                
                
                **78,514**
                
                
                85,675Total
                    liabilities
                
                
                **1,108,652**
                
                
                1,089,913Commitments
                    and contingenciesStockholders’
                    equity:Common
                    stock, par value $0.001 per share; 110,000,000 shares authorized;
                    shares
                    issued and outstanding 85,835,038 and 85,489,061
                
                
                **86**
                
                
                85Additional
                    paid-in capital
                
                
                **423,795**
                
                
                420,425Retained
                    earnings
                
                
                **391,949**
                
                
                341,196Accumulated
                    other comprehensive (loss) income:Net
                    unrealized (losses) gains on available-for-sale investments,
                    net of
                    deferred income taxes of $(589) and $7,760
                
                
                **(1,095**
                **)**
                
                14,412Minimum
                    pension liability in excess of unamortized prior service cost,
                    net of
                    deferred income taxes of $(925) and $(925)
                
                
                **(1,717**
                **)**
                
                (1,717
                )Total
                    stockholders’ equity
                
                
                **813,018**
                
                
                774,401Total
                    liabilities and stockholders’ equity
                
                **$**
                **1,921,670**
                
                $
                1,864,314
  *See
          accompanying Notes to Condensed Consolidated Financial
          Statements.*
  2
 
 **21ST
                    CENTURY INSURANCE GROUP****CONDENSED
                    CONSOLIDATED STATEMENTS OF OPERATIONS**Unaudited*Three
                    Months Ended*
                  *September
                    30,*
                *Nine
                    Months Ended*
                  *September
                    30,**AMOUNTS
                    IN THOUSANDS, EXCEPT SHARE DATA*
                
                **2005**
                2004
                **2005**
                2004**Revenues**Net
                    premiums earned
                
                **$**
                **344,102**
                
                $
                333,440
                
                **$**
                **1,017,311**
                
                $
                978,681Net
                    investment income
                
                
                **17,042**
                
                
                15,118
                
                
                **51,085**
                
                
                42,579Other
                    (loss) income
                
                
                **(3**
                **)**
                
                —
                
                
                **364**
                
                
                —Net
                    realized investment (losses) gains
                
                
                **(939**
                **)**
                
                (162
                )
                
                **(2,666**
                **)**
                
                8,821Total
                    revenues
                
                
                **360,202**
                
                
                348,396
                
                
                **1,066,094**
                
                
                1,030,081**Losses
                    and expenses**Net
                    losses and loss adjustment expenses
                
                
                **258,105**
                
                
                252,359
                
                
                **757,420**
                
                
                744,429Policy
                    acquisition costs
                
                
                **60,852**
                
                
                55,866
                
                
                **188,931**
                
                
                164,338Other
                    operating expenses
                
                
                **8,786**
                
                
                8,942
                
                
                **24,908**
                
                
                25,186Interest
                    and fees expense
                
                
                **1,988**
                
                
                2,116
                
                
                **6,076**
                
                
                6,527Total
                    losses and expenses
                
                
                **329,731**
                
                
                319,283
                
                
                **977,335**
                
                
                940,480Income
                    before provision for income taxes
                
                
                **30,471**
                
                
                29,113
                
                
                **88,759**
                
                
                89,601Provision
                    for income taxes
                
                
                **9,369**
                
                
                4,554
                
                
                **27,725**
                
                
                23,843Net
                    income
                
                **$**
                **21,102**
                
                $
                24,559
                
                **$**
                **61,034**
                
                $
                65,758**Earnings
                    per share**Basic
                
                **$**
                **0.25**
                
                $
                0.29
                
                **$**
                **0.71**
                
                $
                0.77Diluted
                
                **$**
                **0.24**
                
                $
                0.29
                
                **$**
                **0.71**
                
                $
                0.77Weighted
                    average shares outstanding3⁄4basic
                
                
                **85,793,904**
                
                
                85,473,603
                
                
                **85,672,993**
                
                
                85,459,383Weighted
                    average shares outstanding3⁄4diluted
                
                
                **86,205,599**
                
                
                85,579,863
                
                
                **85,937,816**
                
                
                85,603,010
  *See
          accompanying Notes to Condensed Consolidated Financial
          Statements.*
  3
  **21ST
          CENTURY INSURANCE GROUP**
 **CONDENSED
          CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**
 Unaudited
 *Common
                    Stock**$0.001
                    par value**AMOUNTS
                      IN THOUSANDS,**EXCEPT
                    SHARE DATA*
                
                *Shares*
                *Amount*
                *Additional**Paid-in
                    Capital*
                *Retained*
                  *Earnings*
                *Accumulated
                          Other*
                        *Comprehensive*
                          *Income
                            (Loss)*
                *Total*Balance
                    - January 1, 2005
                
                
                85,489,061
                
                
                $
                85
                
                $
                420,425
                
                $
                341,196
                
                $
                12,695
                
                
                $
                774,401Comprehensive
                    income (loss)
                
                
                —
                
                
                
                —
                
                
                —
                
                
                61,034
                (1)
                
                (15,507
                )(2)
                
                
                45,527Cash
                    dividends declared on common stock ($0.12 per share)
                
                
                —
                
                
                
                —
                
                
                —
                
                
                (10,281
                )
                
                —
                
                
                
                (10,281
                )Other
                
                
                345,977
                
                
                
                1
                
                
                3,370
                
                
                —
                
                
                —
                
                
                
                3,371Balance
                    - September 30, 2005
                
                
                85,835,038
                
                
                $
                86
                
                $
                423,795
                
                $
                391,949
                
                $
                (2,812
                )
                
                $
                813,018
 
 *(1)*  *Net
          income.*
 *(2)*  *Net
          change in accumulated other comprehensive income (loss) for the nine months
          ended September 30, 2005,*  *is
          as
          follows:*
 
 *AMOUNTS
                    IN THOUSANDS*Unrealized
                    holding losses arising during the period, net of deferred income
                    taxes of
                    $7,483
                
                $
                (13,899
                )Reclassification
                    adjustment for investment losses included in net income, net
                    of income
                    taxes of $866
                
                
                (1,608
                )Total
                
                $
                (15,507
                )
 
 *See
          accompanying Notes to Condensed Consolidated Financial
          Statements.*
  4
 
 **21ST
                    CENTURY INSURANCE GROUP****CONDENSED
                    CONSOLIDATED STATEMENTS OF CASH FLOWS**Unaudited*AMOUNTS
                    IN THOUSANDS, EXCEPT SHARE DATA**Nine
                    Months Ended September 30,*
                
                **2005**
                2004**Operating
                    activities**Net
                    income
                
                **$**
                **61,034**
                
                $
                65,758Adjustments
                    to reconcile net income to net cashprovided
                    by operating activities:Depreciation
                    and amortization
                
                
                **24,502**
                
                
                16,182Net
                    amortization of investment premiums and discounts
                
                
                **7,205**
                
                
                4,865Amortization
                    of restricted stock grants
                
                
                **238**
                
                
                297Provision
                    for deferred income taxes
                
                
                **10,687**
                
                
                18,781Realized
                    losses (gains) on sale of investments
                
                
                **2,779**
                
                
                (8,738
                )Changes
                    in assets and liabilities:Premiums
                    receivable
                
                
                **(11,166**
                **)**
                
                (12,390
                )Deferred
                    policy acquisition costs
                
                
                **(5,001**
                **)**
                
                (5,824
                )Reinsurance
                    balances
                
                
                **1,193**
                
                
                4,009Federal
                    income taxes
                
                
                **(1,088**
                **)**
                
                697Other
                    assets
                
                
                **6,723**
                
                
                (110
                )Unpaid
                    losses and loss adjustment expenses
                
                
                **22,072**
                
                
                47,757Unearned
                    premiums
                
                
                **9,019**
                
                
                29,215Claims
                    checks payable
                
                
                **1,974**
                
                
                (5,560
                )Other
                    liabilities
                
                
                **(7,802**
                **)**
                
                14,272Net
                    cash provided by operating activities
                
                
                **122,369**
                
                
                169,211**Investing
                    activities**Investments
                    available-for-salePurchases
                
                
                **(333,513**
                **)**
                
                (809,793
                )Calls
                    or maturities
                
                
                **24,461**
                
                
                29,847Sales
                
                
                **262,827**
                
                
                623,157Purchases
                    of property and equipment
                
                
                **(32,539**
                **)**
                
                (29,567
                )Net
                    cash used in investing activities
                
                
                **(78,764**
                **)**
                
                (186,356
                )**Financing
                    activities**Repayment
                    of debt
                
                
                **(9,343**
                **)**
                
                (8,495
                )Dividends
                    paid (per share: $0.08 and $0.06)
                
                
                **(6,850**
                **)**
                
                (5,126
                )Proceeds
                    from the exercise of stock options
                
                
                **3,155**
                
                
                510Net
                    cash used in financing activities
                
                
                **(13,038**
                **)**
                
                (13,111
                )Net
                    increase (decrease) in cash and cash equivalents
                
                
                **30,567**
                
                
                (30,256
                )Cash
                    and cash equivalents, beginning of period
                
                
                **34,697**
                
                
                65,010Cash
                    and cash equivalents, end of period
                
                **$**
                **65,264**
                
                $
                34,754**Supplemental
                    information:**Income
                    taxes paid (refunded)
                
                **$**
                **19,281**
                
                $
                (474
                )Interest
                    paid
                
                
                **4,495**
                
                
                5,072
  *See
          accompanying Notes to Condensed Consolidated Financial
          Statements.*
  5
  **21ST
          CENTURY INSURANCE GROUP**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
          30, 2005**
 DOLLAR
          AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
 
 **NOTE** **1** **.
          FINANCIAL STATEMENT PRESENTATION**
 
 **General**
 
 21st
          Century Insurance Group and subsidiaries (the “Company”) prepared the
          accompanying unaudited condensed consolidated financial statements in accordance
          with the rules and regulations of the Securities and Exchange Commission
          for
          interim reporting. As permitted under those rules and regulations, certain
          notes
          or other information that are normally required by accounting principles
          generally accepted in the United States of America (“GAAP”) have been condensed
          or omitted if they substantially duplicate the disclosures contained in
          the
          annual audited consolidated financial statements. The unaudited condensed
          consolidated financial statements should be read in conjunction with the
          audited
          consolidated financial statements and notes thereto included in the Company’s
          Annual Report on Form 10-K for the year ended December 31, 2004.
  These
          condensed consolidated financial statements include all adjustments (including
          normal, recurring accruals) that are considered necessary for the fair
          presentation of our financial position and results of operations in accordance
          with GAAP. Intercompany accounts and transactions have been eliminated
          in
          consolidation. Operating results for the nine-month period ended September
          30,
          2005 are not necessarily indicative of results that may be expected for
          the
          remaining interim period or the year as a whole.
 
 **Earnings
          Per Share**
 
 For
          each
          of the quarters and nine months ended September 30, 2005 and 2004, the
          numerator
          for the calculation of both basic and diluted earnings per share is equal
          to net
          income reported for that period. The difference between basic and diluted
          earnings per share denominators is due to dilutive stock options. Options
          to purchase an aggregate of 4,501,547 and 6,395,088 shares of common stock
          for
          the three and nine months ended September 30, 2005, respectively, and 6,568,759
          and 6,091,424 shares of common stock for the three and nine months ended
          September 30, 2004, respectively, were not included in the computation
          of
          diluted earnings per share because the options’ exercise prices were greater
          than the average market price of the common stock for each respective period. These
          options expire at various points in time through 2015.
 
 **Stock-Based
          Compensation**
 
 Statement
          of Financial Accounting Standard (“SFAS”) No. 148, *Accounting
          for Stock-Based Compensation-Transition and Disclosure* ,
          amends
          the disclosure requirements of SFAS No. 123, *Accounting
          for Stock-Based Compensation* ,
          to
          require prominent disclosures in both annual and interim financial statements
          about the method of accounting for stock-based employee compensation and
          the
          effect of the method used on reported results. As permitted by SFAS No.
          123, the
          Company accounts for its fixed stock options using the intrinsic-value
          method,
          prescribed in Accounting Principles Board Opinion (“APB”) No. 25, *Accounting
          for Stock Issued to Employees* ,
          which
          generally does not result in compensation expense recognition for stock
          options.
          Under the intrinsic-value method, compensation cost for stock options is
          measured at the date of grant as the excess, if any, of the quoted market
          price
          of the Company’s stock over the exercise price of the options.
 
 In
          addition to stock options, the Company also grants restricted stock awards
          to
          certain officers and employees. Upon issuance of grants under the plan,
          unearned
          compensation equivalent to the market value on the date of grant is charged
          to
          paid-in capital and subsequently amortized over the vesting period of the
          grant.
          The Company becomes entitled to an income tax deduction in an amount equal
          to
          the taxable income reported by the holders of the restricted shares when
          the
          restrictions are released.
  6
  **21ST
          CENTURY INSURANCE GROUP**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
          30, 2005**
 DOLLAR
          AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
 
 Restricted
          shares are forfeited if officers’ and employees’ employment with the Company is
          terminated prior to the lapsing of restrictions. The Company records forfeitures
          of restricted stock as treasury share repurchases and any compensation
          cost
          previously recognized with respect to unvested stock awards is reversed
          in the
          period of forfeiture. This accounting treatment results in compensation
          expense
          being recorded in a manner consistent with that required under SFAS No.
          123, and
          therefore, pro forma net income and earnings per share amounts for the
          Restricted Share Plan would be unchanged from those reported in the financial
          statements.
 
 Had
          compensation cost for the Company’s stock-based compensation plans been
          determined based on the fair-value-based method for all awards, net income
          would
          have been reduced by $1.2 million and $3.7 million for the three and nine
          months
          ended September 30, 2005, respectively, and reduced by $1.3 million and
          $4.5
          million for the three and nine months ended September 30, 2004, respectively.
          The pro forma net income and earnings per share amounts follow:
 
 *Three
                      Months Ended*
                    September
                      30,
                *Nine
                      Months Ended*
                    September
                      30,*AMOUNTS
                    IN THOUSANDS, EXCEPT SHARE DATA*
                
                **2005**
                2004
                **2005**
                2004**Net
                    income, as reported**
                
                **$**
                **21,102**
                
                $
                24,559
                
                **$**
                **61,034**
                
                $
                65,758*Add:*Stock-based employee compensation expense included in reported
                    net income,
                    net of related tax effects
                
                
                **65**
                
                
                66
                
                
                **155**
                
                
                196*Deduct*:
                    Total stock-based employee compensation expense determined under
                    fair-value-based method for all awards, net of related tax
                    effects
                
                
                **(1,278**
                **)**
                
                (1,401
                )
                
                **(3,844**
                **)**
                
                (4,681
                )**Net
                    income, pro forma**
                
                **$**
                **19,889**
                
                $
                23,224
                
                **$**
                **57,345**
                
                $
                61,273**Basic
                    earnings per share:**As
                    reported
                
                **$**
                **0.25**
                
                $
                0.29
                
                **$**
                **0.71**
                
                $
                0.77Pro
                    forma
                
                **$**
                **0.23**
                
                $
                0.27
                
                **$**
                **0.67**
                
                $
                0.72**Diluted
                    earnings per share:**As
                    reported
                
                **$**
                **0.24**
                
                $
                0.29
                
                **$**
                **0.71**
                
                $
                0.77Pro
                    forma
                
                **$**
                **0.23**
                
                $
                0.27
                
                **$**
                **0.67**
                
                $
                0.72
 
 For
          pro
          forma disclosure purposes, the fair value of stock options was estimated
          for
          grants during the nine-month periods ended September 30 using the Black-Scholes
          valuation model with the following weighted-average assumptions:
 
 *Nine
                    Months Ended*
                  *September
                    30,***2005**
                2004Risk-free
                    interest rate:Minimum
                
                
                **3.74**
                **%**
                
                3.43
                %Maximum
                
                
                **4.28**
                **%**
                
                4.24
                %Dividend
                    yield
                
                
                **1.13**
                **%**
                
                0.56
                %Volatility
                      factor of the expected market priceof the Company’s common
                      stock:Minimum
                
                
                **0.29**
                
                
                0.36Maximum
                
                
                **0.32**
                
                
                0.41Weighted-average
                    expected life of the options
                
                
                **6
                    years**
                
                
                6
                    years
 7
  **21ST
          CENTURY INSURANCE GROUP**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
          30, 2005**
 DOLLAR
          AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
 
 **Recent
          Accounting Standards**
 
 In
          March 2005, the Securities and Exchange Commission (the “SEC”) issued Staff
          Accounting Bulletin (“SAB”) No. 107, *Share-Based
          Payment* .
          SAB No.
          107 summarizes the views of the SEC staff regarding the interaction between
          SFAS
          No. 123 (Revised 2004), *Share-Based
          Payment* (“SFAS
          No. 123R”) and certain SEC rules and regulations, and is intended to assist in
          the initial implementation of SFAS No. 123R, which for the Company is required
          beginning in the first quarter of 2006. As a result of SFAS No. 123R, the
          Company will be required to recognize the cost of its stock options as
          an
          expense in the consolidated statement of operations. The Company is currently
          assessing the impact that the adoption of SFAS No. 123R will have on its
          consolidated results of operations. Although this assessment is ongoing,
          management believes that the effect of adopting SFAS No. 123R will be material
          to the Company’s consolidated results of operations. Had the Company adopted
          SFAS No. 123R in prior periods, the impact on net income and earnings per
          share
          would have been similar to the pro forma net income and earnings per share
          in
          accordance with SFAS No. 123 as disclosed earlier in this note.
 
 **NOTE
          2. PROPERTY AND EQUIPMENT**
 
 A
          summary
          of property and equipment follows:
 
 **September
                      30,**2005
                December
                      31,2004Land
                
                **$**
                **2,484**
                
                $
                —Building
                
                
                **9,722**
                
                
                —Furniture
                    and equipment
                
                
                **40,731**
                
                
                38,676Automobiles
                
                
                **339**
                
                
                881Leasehold
                    improvements
                
                
                **14,494**
                
                
                14,245Software
                    currently in service
                
                
                **152,926**
                
                
                87,283Software
                    development projects in progress
                
                
                **8,832**
                
                
                56,816Subtotal
                
                
                **229,528**
                
                
                197,901Less
                    accumulated depreciation, including $38,750 and $25,506 for software
                    currently in service
                
                
                **(83,687**
                **)**
                
                (68,529
                )Total
                
                **$**
                **145,841**
                
                $
                129,372
 
 On
          September 30, 2005, the Company purchased the land and building that house
          its
          136 thousand square foot service center in Texas. The Company had been
          leasing
          this property since June 2004. The operating lease provisions included
          a rent
          holiday through June 2005 and a $2.5 million tenant improvement allowance.
          As of
          September 29, 2005, the accrued rent obligation and tenant improvement
          allowance
          totaled $1.4 million and $2.5 million, respectively. These liabilities
          were
          offset against the facility cash purchase price of $17.6 million to arrive
          at a
          net cost of $13.7 million. The net cost consists of land, building and
          building
          equipment of $2.5 million, $9.7 million, and $1.5 million, respectively.
          The
          building and its equipment have been assigned useful lives of 39.5 years
          and 7
          years, respectively, and will be depreciated on a straight-line basis over
          their
          respective useful lives.
  8
 
 **21ST
          CENTURY INSURANCE GROUP**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
          30, 2005**
 DOLLAR
          AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
 
 **NOTE
          3. HOMEOWNER AND EARTHQUAKE LINES IN RUNOFF**
 
 More
          than
          ninety-eight percent of the claims submitted and litigation brought against
          the
          Company as a result of California Senate Bill 1899 (“SB 1899”) have been
          resolved. All of the Company’s remaining Northridge earthquake claims are in
          litigation. No class actions have been certified and the trial court has
          denied
          class action status for the two remaining cases seeking class action status.
          While the reserves established are the Company’s current best estimate of the
          cost of resolving its 1994 Northridge earthquake claims, including claims
          arising as a result of SB 1899, these reserves continue to be highly uncertain
          because of the difficulty in predicting how the remaining litigated cases
          will
          be resolved.  The estimate currently recorded by the Company assumes that
          relatively few of the remaining cases will require a full trial to resolve,
          that
          any trial costs will approximate those encountered by the Company in the
          past,
          that most cases will be settled without need for extensive pre-trial
          preparation, and that the trial court’s denial of class action status for those
          cases seeking such status will be upheld on appeal. Current reserves contain
          no
          provisions for extra-contractual or punitive damages, bad faith judgments
          or
          similar unpredictable hazards of litigation that possibly could result
          in the
          event an adverse verdict were to be sustained against the Company. To the
          extent
          these and other underlying assumptions prove to be incorrect, the ultimate
          amount to resolve these claims could exceed the Company’s current reserves,
          possibly by a material amount. The Company continues to seek reasonable
          settlements of claims brought under SB 1899 and other Northridge earthquake
          related theories, but will vigorously defend itself against excessive demands
          and fraudulent claims. The Company may, however, settle cases in excess
          of its
          assessment of its contractual obligations in order to reduce the future
          cost of
          litigation.
 
 SB
          1899,
          effective from January 1, 2001 to December 31, 2001, allowed the re-opening
          of
          previously closed earthquake claims arising out of the 1994 Northridge
          earthquake. The discovery stay imposed in early 2002 was lifted in the
          first
          quarter of 2003 and the Company obtained more information with which to
          estimate
          the ultimate cost of resolving its SB 1899 claims. Based on events occurring
          during the first quarter of 2003, the Company increased its SB 1899 reserves
          by
          $37.0 million, resulting in an after-tax charge of $24.1 million. The revised
          estimate was based on the pace and cost of settlements reached as of that
          point,
          the actual costs incurred during that quarter, and the Company’s assessment of
          the expected length and intensity of the litigation arising out of the
          remaining
          claims. The estimate was subsequently increased by $1.0 million during
          the first
          quarter of 2004 based on the Company’s reassessment of its remaining estimated
          litigation costs. Based upon information obtained in connection with settlement
          discussions and mediations conducted during the fourth quarter of 2004,
          the
          Company updated its case-by-case review of the remaining cases and reevaluated
          remaining litigation costs for resolving outstanding matters. As a result
          of
          this reassessment, the Company increased its reserve by $1.2 million during
          the
          fourth quarter of 2004. The Company’s total reserve for SB 1899 claims as of
          September 30, 2005, was $1.0 million.
 
 The
          Company has received some Northridge earthquake claims reported after the
          closing of the window established by SB 1899 which are based upon alternative
          legal theories. The Company is contesting these claims and the earthquake
          reserves include only nominal amounts for them. Should the courts ultimately
          determine that these claims, or additional claims brought in the future,
          are not
          barred by the applicable statute of limitations and the provisions of SB
          1899,
          additional reserves may be needed to resolve them. A recent Court of Appeal
          decision, *Cordova
          v. 21st Century Insurance Company* ,
          found
          that SB 1899 does not automatically bar claims brought outside its specified
          time limitations and that, under certain conditions, a 1994 Northridge
          earthquake claimant might be able to assert that the Company is equitably
          estopped to assert a time limitation defense. The California Supreme Court
          denied the Company’s request for review of this decision.
 
 Loss
          and
          loss adjustment expenses incurred for the homeowner and earthquake lines
          in
          runoff were $0.6 million and $1.0 million for
          the
          three and nine months ended September 30, 2005, respectively, compared
          to $0.4
          million and $0.9 million for the same periods in 2004.
  9
  **21ST
          CENTURY INSURANCE GROUP**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
          30, 2005**
 DOLLAR
          AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
 
 **NOTE
          4** **.
          COMMITMENTS AND CONTINGENCIES**
 
 *Litigation.* In
          the
          normal course of business, the Company is named as a defendant in lawsuits
          related to claims and insurance policy issues, both on individual policy
          files
          and by class actions seeking to attack the Company’s business practices. Many
          suits seek unspecified extra-contractual and punitive damages as well as
          contractual damages under the Company’s insurance policies in excess of the
          Company’s estimates of its obligations under such policies. The Company cannot
          estimate the amount or range of loss that could result from an unfavorable
          outcome on these suits and it denies liability for any such alleged damages.
          The
          Company has not established reserves for potential extra-contractual or
          punitive
          damages, or for contractual damages in excess of estimates the Company
          believes
          are correct and reasonable under its insurance policies. Nevertheless,
          extra-contractual and punitive damages, if assessed against the Company,
          could
          be material in an individual case or in the aggregate. The Company may
          choose to
          settle litigated cases for amounts in excess of its own estimate of contractual
          damages to avoid the expense and risk of litigation. Other than possibly
          for the
          contingencies discussed below, the Company does not believe the ultimate
          outcome
          of these matters will be material to its results of operations, financial
          condition, or cash flows. The Company denies liability and has not established
          a
          reserve for the matters discussed below. A range of potential losses in
          the
          event of a negative outcome is discussed where known.
 
 *Poss
          v. 21st Century Insurance Company* ** was
          filed
          on June 13, 2003, in Los Angeles Superior Court. The complaint sought injunctive
          and unspecified restitutionary relief against the Company under Business
          and
          Professions Code Sec. 17200 for alleged unfair business practices in violation
          of California Insurance Code Sec. 1861.02(c) relating to company rating
          practices. Based on California’s Proposition 64, passed in November 2004, the
          court granted the Company’s motion to dismiss the complaint, but allowed the
          addition of a second plaintiff, Leacy. The court stayed the litigation
          pending
          appellate court decisions involving similar issues but other parties. Because
          this matter is in the pleading stages and no discovery has taken place,
          no
          estimate of the range of potential losses in the event of a negative outcome
          can
          be made at this time.
 
 *Cecelia
          Encarnacion, individually and as the Guardian Ad Litem for Nubia Cecelia
          Gonzalez, a Minor, Hilda Cecelia Gonzalez, a Minor, and Ramon Aguilera
          v. 20th
          Century Insurance* was
          filed on July 3, 1997, in Los Angeles Superior Court. Plaintiffs allege
          bad
          faith, emotional distress, and estoppel involving the Company’s (the Company was
          formerly named 20th Century Insurance) handling of a 1994 homeowner's claim.
          On
          March 1, 1994, Ramon Aguilera, a homeowner policyholder, shot and killed
          Mr.
          Gonzalez (the minor children’s father) and was later sued by Ms. Encarnacion for
          wrongful death. On August 30, 1996, judgment was entered against Ramon
          Aguilera
          for $5.6 million. The Company paid for Aguilera’s defense costs through the
          civil trial; however, the homeowner’s policy did not provide indemnity coverage
          for the incident, and the Company refused to pay the judgment. After the
          trial,
          Aguilera assigned a portion of his action against the Company to Encarnacion
          and
          the minor children. Aguilera and the Encarnacion family then sued the Company
          alleging that the Company had promised to pay its bodily injury policy
          limit if
          Aguilera pled guilty to involuntary manslaughter. In August 2003, the trial
          court held a bench trial on the limited issues of promissory and equitable
          estoppel, and policy forfeiture. On September 26, 2003, the trial court
          issued a
          ruling that the Company cannot invoke any policy exclusions as a defense
          to
          coverage. On May 14, 2004, the court granted the Encarnacion plaintiffs’ motion
          for summary adjudication, ordering that the Company must pay the full amount
          of
          the underlying judgment of $5.6 million, plus interest, for a total of
          $10.5
          million. The Company disagrees with this ruling as it appears inconsistent
          with
          the court’s simultaneous ruling denying the Company’s motion for summary
          judgment on grounds that there are triable issues of material fact as to
          whether
          plaintiffs are precluded from recovering damages as a consequence of Aguilera’s
          inequitable conduct. The Company also believes that the court’s decision was not
          supported by the evidence in the case, demonstrating that no promise to
          settle
          was ever made. The Company has appealed the judgment as to the Encarnacions.
          The
          trial as to Aguilera began October 12, 2005 on his claims for bad faith,
          emotional distress, punitive damages and attorney fees. The Company believes
          it
          has meritorious defenses to these claims. The Company’s exposure in this case
          includes the aforementioned $10.5 million judgment, post-judgment interest,
          plaintiff’s attorney fees (which could approach $4 million) and any award for
          bad faith, emotional distress and punitive damages.
  10
  **21ST
          CENTURY INSURANCE GROUP**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
          30, 2005**
 DOLLAR
          AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
 
 *Insurance
          Company cases (Ramona Goldenburg)* was
          originally filed as *Bryan
          Speck, individually, and on behalf of others similarly situated v. 21st
          Century
          Insurance Company, 21st Century Casualty Company, and 21st Century Insurance
          Group* .
          The
          original action was filed on June 20, 2002, in Los Angeles Superior Court.
          Plaintiff seeks California class action certification, injunctive relief,
          and
          unspecified actual and punitive damages. The complaint contends that 21st
          Century uses “biased” software in determining the value of total-loss
          automobiles. Plaintiff alleges that database providers use improper methodology
          to establish comparable auto values and populate their databases with biased
          figures and that the Company and other carriers allegedly subscribe to
          the
          programs to unfairly reduce claims costs. This case is consolidated with
          similar
          actions against other insurers for discovery and pre-trial motions. The
          Company
          intends to vigorously defend the suit with other defendants in the coordinated
          proceedings. This matter is in the pleading stage of litigation and no
          reasonable estimate of potential losses in the event of a negative outcome
          can
          be made at this time.
 
 *Thomas
          Theis, on his own behalf and on behalf of all others similarly situated
          v. 21st
          Century Insurance* was
          filed on June 17, 2002, in Los Angeles Superior Court. Plaintiff seeks
          California class action certification, injunctive relief, and unspecified
          actual
          and punitive damages. The complaint contends that after insureds receive
          medical
          treatment, the Company used a medical-review program to adjust expenses
          to
          reasonable and necessary amounts for a given geographic area. Plaintiff
          alleges
          that the adjusted amount is “predetermined” and “biased,” creating an unfair
          pretext for reducing claims costs. This case is consolidated with similar
          actions against other insurers for discovery and pre-trial motions. The
          Company
          intends to vigorously defend the suit with other defendants in the coordinated
          proceedings. This matter is in the discovery stage of litigation and no
          reasonable estimate of potential losses in the event of a negative outcome
          can
          be made at this time.
 
 **NOTE
          5** **.
          STOCK - BASED COMPENSATION**
 
 **2004
          Stock Option Plan**
 
 The
          stockholders approved the 2004 Stock Option Plan (the “2004 Plan”) at the Annual
          Meeting of Shareholders on May 26, 2004. The 2004 Plan supersedes the 1995
          Stock
          Option Plan, which will remain in effect only as to outstanding awards
          under it.
          The 2004 Plan authorizes a committee of the Board of Directors to grant
          stock
          options in respect of 4,000,000 shares to eligible employees and nonemployee
          directors, subject to the terms of the 2004 Plan. Additionally, under the
          2004
          Plan, the aforementioned committee may grant stock options in respect of
          shares
          that were subject to outstanding awards under the 1995 Stock Option Plan
          to the
          extent such awards expire, are terminated, are cancelled, or are forfeited
          for
          any reason without shares being issued.
 
 At
          September 30, 2005, 4,170,209 stock options remain available for future
          grants
          under the 2004 Plan. Options granted to employees generally have ten-year
          terms
          and vest over various periods, generally three years. Options granted to
          nonemployee directors expire one year after a nonemployee director ceases
          service with the Company, or ten years from the date of grant, whichever
          is
          sooner. Nonemployee director options vest over one year, provided that
          the
          nonemployee director is in the service of the Company at that time. Currently,
          the Company uses the intrinsic-value method to account for stock-based
          compensation paid to employees and nonemployee directors for their
          services.
  11
  **21ST
          CENTURY INSURANCE GROUP**
 **NOTES
          TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **September
          30, 2005**
 DOLLAR
          AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED
 
 A
          summary
          of securities issuable and issued for the Company’s stock option plans and the
          Restricted Shares Plan at September 30, 2005, follows:
 
 *AMOUNTS
                    IN THOUSANDS*
                
                *1995
                    Stock Option Plan*
                *2004
                    Stock Option Plan*
                *Restricted**Shares
                    Plan*Total
                    number of securities authorized
                
                
                10,000
                
                
                4,000
                
                
                1,422Number
                    of securities issued
                
                
                (784
                )
                
                **—**
                
                
                (1,144
                )Number
                    of securities issuable upon the exercise of all outstanding
                    options
                
                
                (7,152
                )
                
                (1,894
                )
                
                **—**Number
                    of securities forfeited
                
                
                (2,350
                )
                
                **—**
                
                
                **—**Number
                    of forfeited securities returned to plan
                
                
                2,350
                
                
                **—**
                
                
                159Unused
                    options assumed by 2004 Stock Option Plan
                
                
                (2,064
                )
                
                2,064
                
                
                **—**Number
                    of securities remaining available for future grants under each
                    plan
                
                
                **—**
                
                
                4,170
                
                
                437
 
 Exercise
          prices for options outstanding at September 30, 2005, ranged from $11.68
          to
          $29.25. The weighted-average remaining contractual life of those options
          is 6.7
          years.
 
 A
          summary
          of the Company’s stock option activity for the nine months ended September 30,
          2005, and related information follows:
 
 *AMOUNTS
                    IN THOUSANDS, EXCEPT PRICE DATA*
                
                *Number
                      of*Options
                *Weighted-*Average
                      Exercise
                        PriceOptions
                    outstanding December 31, 2004
                
                
                8,109
                
                $
                16.49Granted
                    in 2005
                
                
                1,725
                
                
                14.19Exercised
                    in 2005
                
                
                (259
                )
                
                14.47Forfeited
                    in 2005
                
                
                (529
                )
                
                14.89Options
                    outstanding September 30, 2005
                
                
                9,046
                
                
                16.20
 
 Of
          the
          9,046,092 and 8,108,558 in options outstanding at September 30, 2005 and
          December 31, 2004, respectively, 5,901 ,196
          and
          5,068,493 options were exercisable as of September 30, 2005 and December
          31,
          2004, respectively. The remaining 3,144,896 and 3,040,065 options outstanding
          as
          of September 30, 2005 and December 31, 2004, respectively, were not yet
          vested.
  **NOTE** **6.
          EMPLOYEE BENEFIT PLANS**
 
 The
          Company has both funded and unfunded non-contributory defined benefit pension
          plans, which together cover essentially all employees who have completed
          at
          least one year of service. For certain key employees designated by the
          Board of
          Directors, the Company sponsors an unfunded non-qualified supplemental
          executive
          retirement plan. The supplemental plan benefits are based on years of service
          and compensation during the three highest of the last ten years of employment
          prior to retirement and are reduced by the benefit payable from the pension
          plan
          and 50% of the social security benefit. For other eligible employees, the
          pension benefits are based on employees’ compensation during all years of
          service. The Company’s funding policy is to make annual contributions as
          required by applicable regulations.


12




21ST
      CENTURY INSURANCE
      GROUP  **NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**September
      30, 2005**


DOLLAR
      AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED





**Components
      of Net Periodic Cost**





Net
      pension costs for all plans were comprised of the following:




*Three
                Months Ended*
              *September
                30,*
            *Nine
                Months Ended*
              *September
                30,***2005**
            2004
            **2005**
            2004Service
                cost
            
            **$**
            **1,620**
            
            $
            1,891
            
            **$**
            **5,145**
            
            $
            4,870Interest
                cost
            
            
            **1,763**
            
            
            1,758
            
            
            **5,473**
            
            
            4,979Expected
                return on plan assets
            
            
            **(1,827**
            **)**
            
            (1,608
            )
            
            **(5,487**
            **)**
            
            (4,831
            )Amortization
                of prior service cost
            
            
            **78**
            
            
            29
            
            
            **131**
            
            
            81Amortization
                of net loss
            
            
            **428**
            
            
            635
            
            
            **1,442**
            
            
            1,624Total
            
            **$**
            **2,062**
            
            $
            2,705
            
            **$**
            **6,704**
            
            $
            6,723




**Employer
      Contributions**





The
      Company previously disclosed in its financial statements for the year ended
      December 31, 2004, that it did not expect to contribute to its qualified defined
      benefit pension plan in 2005. As of September 30, 2005, no contributions have
      been made. After consideration of currently available information, the Company
      anticipates that it may make a cash contribution between $6.0 million and $14.0
      million to its qualified defined benefit pension plan before the end of 2005.
      The amount and timing of future contributions to the Company’s qualified defined
      benefit pension plan depends on a number of unpredictable factors including
      the
      market performance of the plan’s assets and future changes in interest rates
      that affect the actuarial measurement of the plan’s obligations.





Contributions
      to the Company’s non-qualified defined benefit pension plan generally are
      limited to amounts needed to make benefit payments to retirees, which are
      expected to total approximately $0.9 million in 2005.





**NOTE
      7. SEGMENT INFORMATION**





The
      Company’s “Personal Auto Lines” reportable segment primarily markets and
      underwrites personal automobile, motorcycle and umbrella insurance. The
      Company’s “Homeowner and Earthquake Lines in Runoff” reportable segment, which
      is in runoff, manages the wind-down of the Company’s homeowner and earthquake
      programs. The Company has not written any earthquake coverage since 1994 and
      ceased writing homeowner policies in February 2002.





Insurers
      offering homeowner insurance in California are required to participate in the
      California FAIR Plan (“FAIR Plan”). FAIR Plan is a state administered pool of
      difficult to insure homeowners. Each participating insurer is allocated a
      percentage of the total premiums written and losses and loss adjustment expense
      (“LAE”) incurred by the pool according to its share of total homeowner direct
      premiums written in California. Participation in FAIR Plan operations is based
      on the pool from two years prior. Since the Company ceased writing homeowners
      business in 2002, the Company no longer receives assignments for plan years
      beyond 2004, but continues to participate in prior plan year activity, which
      is
      in runoff.





The
      Company evaluates segment performance based on pre-tax underwriting profit
      (loss). The Company does not allocate assets, net investment income, net
      realized investment gains (losses), other revenues, nonrecurring items, interest
      and fees expense, or income taxes to operating segments. The accounting policies
      of the reportable segments are the same as those described in Note 2 of the
      Notes to Consolidated Financial Statements included in our Annual Report on
      Form
      10-K for the year ended December 31, 2004. All revenues are generated from
      external customers and the Company does not rely on any major
      customer.





13





**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**September
      30, 2005**


DOLLAR
      AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED





The
      following table presents net premiums earned, depreciation and amortization
      expense, and segment profit (loss) for the Company’s segments.





*Personal*
              *Auto
                Lines*
            *Homeowner
                    and Earthquake Lines in
                    Runoff1*
            *Total**Three
                Months Ended September 30, 2005*Net
                premiums earned
            
            **$**
            **344,099**
            
            **$**
            **3**
            
            **$**
            **344,102**Depreciation
                and amortization expense
            
            
            **9,504**
            
            
            **3**
            
            
            **9,507**Segment
                profit (loss)
            
            
            **16,972**
            
            
            **(613**
            **)**
            
            **16,359***Three
                Months Ended September 30, 2004*Net
                premiums earned
            
            $
            333,443
            
            $
            (3
            )
            $
            333,440Depreciation
                and amortization expense
            
            
            5,493
            
            
            7
            
            
            5,500Segment
                profit (loss)
            
            
            16,709
            
            
            (436
            )
            
            16,273*Nine
                Months Ended September 30, 2005*Net
                premiums earned
            
            **$**
            **1,017,302**
            
            **$**
            **9**
            
            **$**
            **1,017,311**Depreciation
                and amortization expense
            
            
            **24,495**
            
            
            **7**
            
            
            **24,502**Segment
                profit (loss)
            
            
            **47,035**
            
            
            **(983**
            **)**
            
            **46,052***Nine
                Months Ended September 30, 2004*Net
                premiums earned
            
            $
            978,573
            
            $
            108
            
            $
            978,681Depreciation
                and amortization expense
            
            
            16,104
            
            
            78
            
            
            16,182Segment
                profit (loss)
            
            
            45,552
            
            
            (824
            )
            
            44,728





The
      following table reconciles segment profit to consolidated income before
      provision for income taxes:





*Three
                  Months Ended*
                *September
                  30,*
            *Nine
                  Months Ended*
                *September
                  30,***2005**
            2004
            **2005**
            2004Segment
                profit
            
            **$**
            **16,359**
            
            $
            16,273
            
            **$**
            **46,052**
            
            $
            44,728Net
                investment income
            
            
            **17,042**
            
            
            15,118
            
            
            **51,085**
            
            
            42,579Other
                (loss) income
            
            
            **(3**
            **)**
            
            —
            
            
            **364**
            
            
            —Realized
                investment (losses) gains
            
            
            **(939**
            **)**
            
            (162
            )
            
            **(2,666**
            **)**
            
            8,821Interest
                and fees expense
            
            
            **(1,988**
            **)**
            
            (2,116
            )
            
            **(6,076**
            **)**
            
            (6,527
            )Income
                before provision for income taxes
            
            **$**
            **30,471**
            
            $
            29,113
            
            **$**
            **88,759**
            
            $
            89,601




1
              Segment
                  revenue represents premium earned as a result of the Company’s
                  participation in the California FAIR Plan.




14





**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**September
      30, 2005**


DOLLAR
      AMOUNTS IN THOUSANDS, EXCEPT WHERE NOTED





**NOTE
      8. VARIABLE INTEREST ENTITIES**





In
      January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB
      Interpretation No. 46, *Consolidation
      of Variable Interest Entities, an interpretation of Accounting Research Bulletin
      No. 51* (“FIN
      46”), and amended it in December 2003. An entity is subject to the consolidation
      rules of FIN 46 and is referred to as a variable interest entity (“VIE”) if it
      lacks sufficient equity to finance its activities without additional financial
      support from other parties or if its equity holders lack adequate decision
      making ability based on criteria set forth in the interpretation.





FIN
      46
      also requires disclosures about VIEs that a company is not required to
      consolidate, but in which a company has a significant variable interest. The
      Company’s Board of Directors has chosen to invest some of its assets in low
      income and economically disadvantaged communities. To that end, the Company
      is a
      member, along with other participating insurance organizations, of Impact
      Community Capital, LLC (“Impact”). Impact’s charter is to make loans and other
      investments in such communities. On August 29, 2003, the Company funded a
      revolving loan agreement with Impact C.I.L., LLC (“Impact C.I.L.”), a subsidiary
      of Impact and a VIE. At present, the Company has contributed $5.1 million to
      be
      used to purchase mortgage loans in economically disadvantaged areas. The Company
      is not the primary beneficiary of the VIE. The Company’s maximum participation
      in Impact C.I.L. is for up to 11.1% ($24.0 million) of $216.0 million of the
      entity’s funding activities. These commitments consist of a $4.8 million minimum
      investment and a $19.2 million guarantee of the warehouse lending facility.
      Potential losses are limited to the Company’s participation as well as
      associated operating fees.





At
      present, the Company also has a $2.0 million note receivable from an Impact
      subsidiary in addition to the $5.0 million investment noted above. The Company
      has voting rights, beneficiary rights, obligations, and ownership of Impact
      in
      proportion to its investment (approximately 10%).





The
      Company has also committed $2.8 million to three other Impact affiliates managed
      by Impact, and owned by Impact members, for other community investment purposes.
      An advance of $0.5 million to one of the programs was made in September 2005.
      However, such funds have not been invested as of September 30, 2005. The Company
      has voting rights, beneficiary rights and obligations for these Impact
      affiliates.





The
      Company does not have any other material VIEs that it needs, or will need,
      to
      consolidate or disclose.





15





**ITEM
                2.**
            **MANAGEMENT’S
                DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND********RESULTS
                OF OPERATIONS**





**Overview**





Founded
      in 1958, 21st Century Insurance Group (together with its subsidiaries, referred
      to hereinafter as the “Company”, “we”, “us” or “our”) is a direct-to-consumer
      provider of personal auto insurance. With $1.3 billion of revenue in 2004,
      the
      Company insures over 1.5 million vehicles in California, Texas, Illinois and
      six
      other states. We also provide motorcycle and personal umbrella insurance in
      California. We believe that we deliver superior policy features and customer
      service at a competitive price.





Our
      long-term financial goals include achieving a 96% combined ratio or lower and
      15% annual growth in premiums written in our personal auto lines. Third quarter
      2005 direct premiums written increased 0.9% ($3.1 million) to $349.1 million
      from $346.0 million in the third quarter of 2004. California direct premiums
      written decreased by 2.2% to $326.0 million, compared to $333.3 million for
      the
      same period in 2004, as a result of the high level of competitor marketing
      activity in the state. Direct premiums written outside of California increased
      by 81.9% to $23.1 million, compared to $12.7 million for the same period in
      2004. The Company currently plans on expanding into six additional states in
      2006 to further its geographic expansion strategy.





Underwriting
      profit of $16.4 million in the third quarter of 2005 was consistent with the
      $16.3 million for the same period in 2004. The third quarter 2005 underwriting
      profit includes $1.2 million of favorable development related to prior accident
      years’ reserves, compared to $3.4 million of favorable development related to
      prior accident years’ reserves in the same period of 2004. For the nine months
      ended September 30, 2005, underwriting profit was $46.1 million, an increase
      of
      3.0% over underwriting profit of $44.7 million for same period in 2004. The
      nine
      months ended September 30, 2005 underwriting profit includes $20.8 million
      of
      favorable development related to prior accident years’ reserves, compared to
      $2.9 million of favorable development related to prior accident years’ reserves
      in the same period of 2004.





The
      combined ratio of 95.2% for the quarter ended September 30, 2005, was consistent
      with the 95.1% ratio for the same period in 2004. For the nine months ended
      September 30, 2005, the combined ratio was 95.5%, compared to 95.4% in
      2004.





Net
      income for the quarter ended September 30, 2005, was $21.1 million, or $0.25
      per
      basic share, compared to net income of $24.6 million,
      or $0.29 per basic share, for the same period in 2004. The third quarter results
      include net realized capital losses of $0.9 million and $0.2 million in 2005
      and
      2004, respectively. For the nine months ended September 30, 2005, net income
      was
      $61.0 million, or $0.71 per share, compared to $65.8 million, or $0.77 per
      share, for the same period in 2004. The 2005 nine months results include net
      realized capital losses of $2.7 million, compared to net realized capital gains
      of $8.8 million for the same period in 2004. The three and nine months ended
      September 30, 2004 include a $4.9 million reduction in income tax expense ($0.06
      per share) associated with the resolution of California legislation (AB 263)
      related to holding company taxes on dividends from insurance
      subsidiaries.





For
      the
      quarter ended September 30, 2005, cash flow from operations decreased 2.0%
      to
      $52.1 million, compared to $53.2 million for the same period in 2004. For the
      nine months ended September 30, 2005, cash flow from operations decreased by
      27.7% to $122.4 million from $169.2 million for the same period in 2004. The
      $46.8 million decrease in operating cash flow is primarily attributable to
      a
      $19.8 million increase in income tax payments and a $20.2 million increase
      in
      underwriting expense payments. Federal income tax payments in the first nine
      months of 2005 increased $1.8 million over the comparable period of 2004 because
      the Company has fully utilized the alternative minimum tax net
      operating losses (“NOLs”) that previously helped to minimize such taxes; and
      state income taxes of $6.8 million were paid in February 2005 in settlement
      of
      our holding company’s California tax obligation for dividends received from its
      insurance subsidiary and certain other disputed items for tax years 1998 to
      2003. Underwriting expenses and payments increased in 2005 as a result of our
      investments in the geographic expansion strategy, the conversion to our new
      technology platform, and the build-up of our Dallas service center.





16




Total
      assets were $1,921.7 million at September 30, 2005 compared to $1,864.3 million
      at December 31, 2004. Statutory surplus increased 7.0% to $657.7 million at
      September 30, 2005 from $614.9 million at December 31, 2004. The net premiums
      written to statutory surplus ratio was 2.1 at September 30, 2005, compared
      to
      2.2 at December 31, 2004.





Conversion
      to the Company’s new computer platforms known as APS is proceeding as planned.
      The APS:Claims component began taking 100% of new claims in the third quarter
      of
      2004. Over 85% of the Company’s pending claims are now on the new system.
      Conversion of the Company’s California  personal
      auto policies to APS:Policy component began in the first quarter of 2005. As
      of
      October 13, 2005 over 90% of these policies are on the new system. APS is a
      web-based application with a multi-tier technical architecture. Underwriting
      expenses have been higher than normal in prior periods due to costs of the
      conversion process and the training of service staff.




Since
      2002, the Company has been actively engaged in a community education effort
      concerning proper installation and use of child safety seats. According to
      the
      National Highway Traffic Safety Administration, motor vehicle crashes are the
      leading cause of death for children from two to 14 years of age. Data show
      that
      80% of child safety seats are improperly installed and are a potential source
      of
      injury for children, up from 73% in 2004. The Company’s program is endorsed by
      the California Highway Patrol and the Governors’ Offices of Texas,
      Illinois, Indiana, Ohio and Arizona. Education events typically include the
      participation of political representatives, local media, law enforcement,
      trained safety technicians and 21st managers and staff. Since inception, the
      Company has held 58 education events, technicians have inspected over 5,000
      vehicles and discarded (and then destroyed) over 2,200 defective child
      safety seats. The Company has donated over 4,000 new seats so that no family
      leaves an education event without every child in a properly fitted child
      safety seat.





Premiums
      written and statutory surplus have been presented to enhance investors’
understanding of the Company’s operations. These financial measures are not
      presented in accordance with accounting principles generally accepted in the
      United States of America (“GAAP”). Premiums written represent the premiums
      charged on policies issued during a fiscal period. Premiums earned, the most
      directly comparable GAAP measure, represents the portion of premiums written
      that is recognized as income in the financial statements for the periods
      presented and earned on a pro-rata basis over the term of the policies.
      Statutory surplus represents equity as of the end of a fiscal period for the
      Company’s insurance subsidiaries, determined in accordance with statutory
      accounting principles prescribed by insurance regulatory authorities.
      Stockholders’ equity is the most directly comparable GAAP measure. ** The
      reconciliations of these financial measures to the most directly comparable
      GAAP
      measure are located in *Results
      of Operations* and *Liquidity
      and Capital Resources* ,
      respectively. These financial measures are not intended to replace, and should
      be read in conjunction with, the GAAP financial results.





See *Results
      of Operations* for more
      details as to our overall and personal auto lines results.





The
      remainder of our Management’s Discussion and Analysis of Financial Condition and
      Results of Operations should be read in conjunction with the accompanying
      condensed consolidated financial statements. It includes the following
      sections:




·
              Financial
                  Condition
 ·
              Liquidity
                  and Capital Resources
 ·
              Contractual
                  Obligations and Commitments
 ·
              Results
                  of Operations
 ·
              Underwriting
                  Results
 ·
              Investment
                  Income
 ·
              Other
                  Revenues
 ·
              Critical
                  Accounting Estimates
 ·
              Forward-Looking
                  Statements


17





**Financial
      Condition**





Investments
      and cash increased $43.1 million (3.0%) to $1,462.0 million, compared to
      $1,418.9 million at December 31, 2004, due to $122.4 million of operating cash
      flow primarily offset by cash outflows of $32.5 million for property and
      equipment, $6.9 million in shareholder dividends, $23.9 million in net
      unrealized losses during the nine month period ended September 30, 2005 due
      to
      changes in interest rates, and $9.3 million of debt repayment.





At
      September 30, 2005, investment-grade bonds comprised substantially all of the
      carrying value of the fixed maturity portfolio. As of September 30, 2005, six
      positions in fixed maturity securities were rated below BBB. These securities
      represent approximately 0.9% of our total investments.





Increased
      advertising, sales and customer service costs through September 30, 2005
      contributed to an increase in deferred policy acquisition costs (“DPAC”) of $5.0
      million to $63.8 million, compared to $58.8 million at December 31, 2004. Our
      DPAC is estimated to be fully recoverable (see *Critical
      Accounting Estimates - Deferred Policy Acquisition Costs* ).





The
      following table summarizes unpaid losses and loss adjustment expenses (“LAE”),
      gross and net of applicable reinsurance, with respect to our lines of business:





***September**30, 2005***
            
            *December
                31, 2004**AMOUNTS
                IN THOUSANDS*
            
            **Gross**
            
            **Net**
            
            Gross
            
            NetUnpaid
                Losses and LAEPersonal
                auto lines
            
            **$**
            **514,892**
            
            **$**
            **510,181**
            
            $
            489,411****
            
            $
            485,759****Homeowner
                and earthquake lines in runoff
            
            
            **2,722**
            
            
            **1,901**
            
            
            6,131****
            
            
            5,138****Total
            
            **$**
            **517,614**
            
            **$**
            **512,082**
            
            $
            495,542****
            
            $
            490,897****





The
      following table summarizes losses and LAE incurred, net of applicable
      reinsurance, for the periods indicated:





*Three
                  Months Ended*September 30,
            
            *Nine
                  Months Ended*September 30,*AMOUNTS
                IN THOUSANDS*
            
            **2005**
            
            2004
            
            **2005**
            
            2004Net
                losses and LAE:Current
                accident year:Personal
                auto lines
            
            **$**
            **259,301**
            
            $
            255,747****
            
            **$**
            **778,203**
            
            $
            747,287****Homeowner
                and earthquake lines in runoff
            
            
            **—**
            
            
            39****
            
            
            **—**
            
            
            39****Total
                current accident year
            
            
            **259,301**
            
            
            255,786****
            
            
            **778,203**
            
            
            747,326****Prior
                accident years:Personal
                auto lines
            
            
            **(1,811)**
            
            
            (3,822)****
            
            
            **(21,774)**
            
            
            (3,790)****Homeowner
                and earthquake lines in runoff
            
            
            **615**
            
            
            395****
            
            
            **991**
            
            
            893****Total
                prior accident years
            
            
            **(1,196)**
            
            
            (3,427)****
            
            
            **(20,783)**
            
            
            (2,897)****Total
                net losses and LAE
            
            **$**
            **258,105**
            
            $
            252,359****
            
            **$**
            **757,420**
            
            $
            744,429****





At
      September 30, 2005, gross unpaid losses and LAE increased $25.5 million for
      our
      personal auto lines and decreased $3.4 million for the homeowner and earthquake
      lines in runoff from the prior year end. The methods used to determine such
      estimates and to establish the resulting reserves are continually reviewed
      and
      updated. Any adjustments resulting therefrom are reflected in current operating
      income. It is management’s belief that the unpaid losses and LAE are adequate to
      cover unpaid losses and LAE as of September 30, 2005. While we perform quarterly
      reviews of the adequacy of established unpaid losses and LAE, there can be
      no
      assurance that our ultimate unpaid losses and LAE will not develop redundancies
      or deficiencies and materially differ from our unpaid losses and LAE as of
      September 30, 2005. In the future, if the unpaid losses and LAE develop
      redundancies or deficiencies, such redundancy or deficiency would have a
      positive or adverse impact, respectively, on future results of
      operations.





18





The
      process of making quarterly changes to unpaid losses and LAE begins with the
      preparation of several point estimates, a review of the actual claims experience
      in the quarter, actual rate changes achieved, actual changes in coverage, mix
      of
      business, and changes in certain other factors such as weather and recent tort
      activity that may affect the loss and LAE ratio. Our actuaries prepare several
      point estimates of unpaid losses and LAE for each of the coverages, and they
      use
      their experience and judgment to arrive at an overall actuarial point estimate
      of the unpaid losses and LAE for that coverage.





Meetings
      are held with appropriate departments to discuss significant issues as a result
      of the review. This process culminates in a reserve meeting to review the unpaid
      losses and LAE. The basis for carried unpaid losses and LAE is the overall
      actuarial point estimate. Other relevant internal and external factors
      considered include a qualitative assessment of inflation and other economic
      conditions, changes in the legal, regulatory, judicial and social environments,
      underlying policy pricing, exposure and policy forms, claims handling, and
      geographic distribution shifts. As a result of the meeting, unpaid losses and
      LAE are finalized and we record quarterly changes in unpaid losses and LAE
      for
      each of our coverages. The change in unpaid losses and LAE for the quarter
      for
      each coverage is the difference between net ultimate losses and LAE and the
      net
      paid losses and LAE recorded through the end of the quarter. The overall change
      in our unpaid losses and LAE is based on the sum of these coverage level
      changes.





The
      point
      estimate methods include the use of paid loss triangles, incurred loss
      triangles, claim count triangles, severity triangles, as well as expected loss
      ratio methods. Quantitative techniques frequently have to be supplemented by
      subjective consideration, including managerial judgment, to assure management
      satisfaction that the overall unpaid losses and LAE are adequate to meet
      projected losses. For example, in property damage coverages, repair cost trends
      by geographic region vary significantly. These factors are periodically reviewed
      and subsequently adjusted, as appropriate, to reflect emerging trends that
      are
      based upon past loss experience. Thus, many factors are implicitly considered
      in
      estimating loss costs to be recognized for the quarter.





Judgment
      is required in analyzing the appropriateness of the various methods and factors
      to avoid overreacting to data anomalies that may distort such prior trends.
      For
      example, changes in limits distributions or development in the most recent
      accident quarters would require more actuarial judgment. We do not believe
      disclosure of specific point estimates calculated by the actuaries would be
      meaningful. Any one actuarial point estimate is based on a particular series
      of
      judgments and assumptions of the actuary. Another actuary may make different
      assumptions, and therefore reach a different point estimate.





There
      is
      a potential for significant variation in ultimate development of unpaid losses
      and LAE. Most automobile claims are reported within two to three months, whereas
      the estimates of ultimate severities exhibit greater variability at the same
      maturity. Generally, historical loss development factors are used to project
      future loss development, and there can be no assurance that future loss
      development patterns will be the same as in the past. However, we believe that
      our reserving methodologies are in line with other personal lines insurers
      and
      would normally expect ultimate unpaid losses and LAE development to vary
      approximately 5% from the carried unpaid losses and LAE.





As
      a
      result of the significant growth in the non-Los Angeles County regions, the
      Company has experienced changes in the mix of business relative to geography
      and
      policy limits. We believe that the assumption with the highest likelihood of
      change that could materially affect carried unpaid losses and LAE is property
      damage and collision severity in the San Francisco and Bay Area regions of
      California. These areas have significantly different repair costs and have
      exhibited significant policy growth. A 5% change in the severity assumption
      for
      these regions would result in an increase or decrease in total unpaid losses
      and
      LAE of 0.13%, or $1.9 million.





While
      we
      have settled over ninety-eight percent of reported earthquake claims and are
      making progress in resolving the remaining litigation, estimates of both the
      litigation costs and ultimate settlement or judgment amounts related to these
      claims are subject to a high degree of uncertainty. Please see Note 3 of the
      Notes to Condensed Consolidated Financial Statements for additional background
      on the 1994 Northridge earthquake and SB 1899.





19





Debt
      of
      $131.1 million consists of $29.4 m illion
      of
      capital lease obligations, $1.8 million of capital auto lease obligations,
      and
      $99.9 million of senior notes, net of discount. The primary purpose of the
      capital lease and senior note borrowings was to increase the statutory surplus
      of 21st Century Insurance Company, our wholly-owned insurance subsidiary. The
      decrease in debt of $7.2 million during the nine months ended September 30,
      2005
      is primarily attributable to principal payments on the capital
      lease.





Stockholders’
      equity and book value per share increased $38.6 million (5.0%) to $813.0 million
      and $9.47, respectively, at September 30, 2005, compared to $774.4
      million and
      $9.06 at December 31, 2004, respectively. The increase in stockholders’ equity
      for the nine months ended September 30, 2005 was primarily due to net income
      of
      $61.0 million and $3.2 million in proceeds from stock option exercises, offset
      by dividends to stockholders of $10.3 million and unrealized losses on
      investments of $15.5 million.





**Liquidity
      and Capital Resources**





*21st
      Century Insurance Group* .
      Our
      holding company’s main sources of liquidity historically have been dividends
      received from our insurance subsidiaries and proceeds from issuance of debt
      or
      equity securities. Apart from the exercise of stock options and restricted
      stock
      grants to employees, the effects of which have not been significant, we have
      not
      issued any equity securities since 1998 when American International Group,
      Inc.
      (“AIG”) exercised its warrants to purchase common stock for cash of $145.6
      million. Our insurance subsidiaries have not paid any dividends to our holding
      company since 2001 due to the previous uncertainty that surrounded the
      taxability of dividends received by holding companies from their insurance
      subsidiaries in California. See further discussion of the *Ceridian* case in *Critical
      Accounting Estimates - Income Taxes* .





In
      December 2003, we completed a private offering of $100 million principal amount
      of 5.9 percent Senior Notes due in December 2013. The effective interest rate
      on
      the Senior Notes, when all offering costs are taken into account and amortized
      over the term of the Senior Notes, is approximately 6 percent per annum. Of
      the
      $99.2 million net proceeds from the offering, $85.0 million was used to increase
      the statutory surplus of our wholly-owned insurance subsidiary, 21st Century
      Insurance Company, and the balance was retained by our holding company. On
      July
      8, 2004, the Company completed an exchange offer in which all of the private
      offering notes were exchanged for publicly registered notes having the same
      terms.





Effective
      December 31, 2003, the California Department of Insurance approved an
      intercompany lease whereby 21st Century Insurance Company has leased certain
      computer software from our holding company. The monthly lease payment, currently
      $0.7 million, started in January 2004 and is subject to upward adjustment based
      on the cost incurred by the holding company to complete certain enhancements
      to
      the software.





Our
      holding company’s significant cash obligations over the next several years,
      exclusive of any dividends to stockholders that our directors may declare,
      consist of interest payments on the Senior Notes (approximately $5.9 million
      annually), costs to develop our California policy servicing system and the
      repayment of the $100 million principal on the Senior Notes due in 2013. We
      expect to be able to meet those obligations from sources of cash currently
      available (i.e., cash and investments at the holding company, which totaled
      $22.0 million at September 30, 2005, payments received from the intercompany
      lease, and borrowing from our insurance subsidiary), additional
      funds obtainable from the capital markets or dividends received from our
      insurance subsidiaries. California currently levies state income taxes of
      approximately 1.8% on the amount of any such dividends received.





In
      2005,
      our insurance subsidiaries could pay $109.8 million as dividends to the holding
      company without prior written approval from insurance regulatory authorities.





*Insurance
      Subsidiaries* .
      We have
      achieved underwriting profits in our core auto insurance operations for the
      last
      fifteen quarters and have thereby enhanced our liquidity. Our cash flow from
      operations and short-term cash position generally are more than sufficient
      to
      meet obligations for claim payments, which by the nature of the personal
      automobile insurance business tend to have an average duration of less than
      a
      year. In California, where approximately 94.0% of our premiums were written
      for
      the nine months ended September 30, 2005, underwriting profit improved in 2004
      and 2005 without additional rate increases. We implemented a 3.9% auto premium
      rate increase effective March 31, 2003 and a 5.7% rate increase in May 2002,
      both of which continued a series of actions we began taking in 2000 to restore
      underwriting profitability. Effective October 23, 2005, we will be implementing
      a class plan revision for our California business. This is a rate neutral change
      overall, but is intended to improve the accuracy of our pricing and make us
      more
      competitive in Southern California.





20




Although
      in the past years we have been successful in gaining California regulatory
      approval for rate increases, there can be no assurance that insurance regulators
      will grant future rate increases that may be necessary to offset possible future
      increases in claims cost trends. Furthermore, we could be required to liquidate
      investments to pay claims, possibly during unfavorable market conditions, which
      could lead to the realization of losses on sales of investments. Adverse
      outcomes to any of the foregoing uncertainties would create some degree of
      downward pressure on the insurance subsidiaries’ earnings or cash flows, which
      in turn, could negatively impact our liquidity.





As
      of
      September 30, 2005, our insurance subsidiaries had a combined statutory surplus
      of $657.7 million compared to $614.9 million at December 31, 2004. The increase
      in statutory surplus was primarily due to statutory net income of $74.7 million
      offset by an increase in nonadmitted assets of $15.5 million, an increase in
      net
      unrealized investment losses of $0.9 million and a $15.5 million decrease in
      the
      deferred income tax asset. The net premiums written to statutory surplus ratio
      was 2.1 at September 30, 2005, compared to 2.2 at December 31,
      2004.





The
      following is a reconciliation of our stockholders’ equity to statutory
      surplus:





*AMOUNTS
                IN THOUSANDS*
            
            **September
                30,****2005**
            December
                31, 2004Stockholders’
                equity - GAAP
            
            **$**
            **813,018**
            
            $
            774,401Condensed
                adjustments to reconcile GAAP shareholders’ equity to statutory
                surplus:Net
                book value of fixed assets under capital leases
            
            
            **(27,268**
            **)**
            
            (34,834
            )Deferred
                gain under capital lease transactions
            
            
            **(838**
            **)**
            
            (610
            )Capital
                lease obligation
            
            
            **31,201**
            
            
            38,405Nonadmitted
                net deferred tax assets
            
            
            **(61,070**
            **)**
            
            (67,260
            )Net
                deferred tax assets related to items nonadmitted under SAP
            
            
            **38,394**
            
            
            50,712Intercompany
                receivables
            
            
            **(50,146**
            **)**
            
            (19,917
            )Fixed
                assets
            
            
            **(23,154**
            **)**
            
            (25,017
            )Equity
                in non-insurance entities
            
            
            **22,073**
            
            
            8,082Unrealized
                losses (gains) on investments
            
            
            **644**
            
            
            (21,709
            )Deferred
                policy acquisition costs
            
            
            **(63,760**
            **)**
            
            (58,759
            )Prepaid
                pension costs and intangible pension asset
            
            
            **(13,050**
            **)**
            
            (17,253
            )Other
                prepaid expenses
            
            
            **(9,590**
            **)**
            
            (12,235
            )Other,
                net
            
            
            **1,212**
            
            
            887Statutory
                surplus
            
            **$**
            **657,666**
            
            $
            614,893





*Transactions
      with Related Parties.* Since
      1995, we have entered into several transactions with AIG subsidiaries, including
      various reinsurance agreements. At September 30, 2005, reinsurance recoverables,
      net of payables, from AIG subsidiaries were $0.2 million, compared to $1.4
      million at December 31, 2004. In October 2003, as a result of a competitive
      bidding process, we entered into an agreement with an AIG subsidiary to provide
      investment management and investment accounting services to the Company. This
      agreement was approved by the California Department of Insurance. AIG also
      provides corporate insurance for the Company, including Errors and Omissions,
      Workers Compensation, and General Liability coverages, for which we paid $1.1
      million and $3.3 million for the three and nine months ended September 30,
      2005,
      respectively, and $0.3 million and $1.5 million for the three and nine months
      ended September 30, 2004, respectively.




21




**Contractual
      Obligations and Commitments**




See
      our
      discussion about variable interest entities and commitments in Note 8 of the
      Notes to Condensed Consolidated Financial Statements. There were no material
      changes outside the ordinary course of our business in our contractual
      obligations during the three and nine months ended September 30,
      2005.




**Results
      of Operations**





*Overall
      Results.* We
      reported net income of $21.1 million, or earnings **** per
      share
      (basic and diluted) of $0.25 and $0.24, respectively, on direct premiums written
      of $349.1 million in the quarter ended September 30, 2005, compared to a net
      income of $24.6 million, or earnings per share (basic and diluted) of $0.29,
      on
      direct premiums written of $346.0 million for the same quarter last year. For
      the nine months ended September 30, 2005, net income was $61.0 million, or
      earnings per share (basic and diluted) of $0.71, on direct premiums written
      of
      $1,029.9 million. Net income for the nine months ended September 30, 2004,
      was
      $65.8 million, or earnings per share (basic and diluted) of $0.77, on direct
      premiums written of $1,011.4 million.





*Personal
      Auto Lines Results.*  The
      following table presents the components of our personal auto lines underwriting
      profit and the components of the combined ratio:





*Three
                  Months Ended*
                *September
                  30,*
            *Nine
                  Months Ended*
                *September
                  30,**AMOUNTS
                IN THOUSANDS*
            
            **2005**
            2004
            **2005**
            2004Direct
                premiums written
            
            **$**
            **349,119**
            
            $
            346,087
            
            **$**
            **1,029,905**
            
            $
            1,011,430Net
                premiums written
            
            **$**
            **347,827**
            
            $
            344,823
            
            **$**
            **1,026,247**
            
            $
            1,007,840Net
                premiums earned
            
            **$**
            **344,099**
            
            $
            333,443
            
            **$**
            **1,017,302**
            
            $
            978,573Net
                loss and loss adjustment expenses
            
            
            **257,489**
            
            
            251,926
            
            
            **756,428**
            
            
            743,497Underwriting
                expenses incurred
            
            
            **69,638**
            
            
            64,808
            
            
            **213,839**
            
            
            189,524Personal
                auto lines underwriting profit
            
            **$**
            **16,972**
            
            $
            16,709
            
            **$**
            **47,035**
            
            $
            45,552Ratios:Loss
                and LAE ratio
            
            
            **74.8**
            **%**
            
            75.6
            %
            
            **74.4**
            **%**
            
            76.0
            %Underwriting
                expense ratio
            
            
            **20.3**
            **%**
            
            19.4
            %
            
            **21.0**
            **%**
            
            19.3
            %Combined
                ratio
            
            
            **95.1**
            **%**
            
            95.0
            %
            
            **95.4**
            **%**
            
            95.3
            %





The
      following table reconciles our personal auto lines underwriting profit to our
      consolidated net income:





*Three
                  Months Ended*
                September
                  30,
            *Nine
                  Months Ended*
                September
                  30,*AMOUNTS
                IN THOUSANDS*
            
            **2005**
            2004
            **2005**
            2004Personal
                auto lines underwriting profit
            
            **$**
            **16,972**
            
            $
            16,709
            
            **$**
            **47,035**
            
            $
            45,552Homeowner
                and earthquake lines inrunoff,
                underwriting loss
            
            
            **(613**
            **)**
            
            (436
            )
            
            **(983**
            **)**
            
            (824
            )Net
                investment income
            
            
            **17,042**
            
            
            15,118
            
            
            **51,085**
            
            
            42,579Other
                (loss) income
            
            
            **(3**
            **)**
            
            —
            
            
            **364**
            
            
            —Realized
                investment (losses) gains
            
            
            **(939**
            **)**
            
            (162
            )
            
            **(2,666**
            **)**
            
            8,821Interest
                and fees expense
            
            
            **(1,988**
            **)**
            
            (2,116
            )
            
            **(6,076**
            **)**
            
            (6,527
            )Provision
                for income taxes
            
            
            **(9,369**
            **)**
            
            (4,554
            )1
            
            **(27,725**
            **)**
            
            (23,843
            )Net
                income
            
            **$**
            **21,102**
            
            $
            24,559
            
            **$**
            **61,034**
            
            $
            65,758




1
              Includes
                  the effect of afavorable
                  adjustment in tax provision of approximately $4.9 million due to
                  the
                  effect of Californialegislation
                  (AB 263) relating to holding company taxes on dividends from insurance
                  subsidiaries.




22




The
      following table reconciles our direct premiums written to net premiums
      earned:





*Three
                  Months Ended*
                September
                  30,
            *Nine
                  Months Ended*
                September
                  30,*AMOUNTS
                IN THOUSANDS*
            
            **2005**
            2004
            **2005**
            2004Direct
                premiums written
            
            **$**
            **349,119**
            
            $
            346,087
            
            **$**
            **1,029,905**
            
            $
            1,011,430Ceded
                premiums written
            
            
            **(1,292**
            **)**
            
            (1,264
            )
            
            **(3,658**
            **)**
            
            (3,590
            )Net
                premiums written
            
            
            **347,827**
            
            
            344,823
            
            
            **1,026,247**
            
            
            1,007,840Net
                change in unearned premiums
            
            
            **(3,728**
            **)**
            
            (11,380
            )
            
            **(8,945**
            **)**
            
            (29,267
            )Net
                premiums earned
            
            **$**
            **344,099**
            
            $
            333,443
            
            **$**
            **1,017,302**
            
            $
            978,573





Comments
      relating to the underwriting results of the personal auto lines and the
      homeowner and earthquake lines in runoff are presented below.





**Underwriting
      Results**





*Personal
      Auto Lines.* Personal
      automobile insurance is our primary line of business. Vehicles insured outside
      of California accounted for 6.6% and 6.0% of our direct premiums written in
      the
      three and nine months ended September 30, 2005, respectively, compared to 3.7%
      and 3.3% for our direct premiums written for the three and nine months ended
      September 30, 2004, respectively.





Direct
      premiums written in the three months ended September 30, 2005, increased $3.0
      million (0.9%) to $349.1 million compared to $346.1 million for the same period
      in 2004. This increase was primarily due to a higher number of insured vehicles
      from non-California states. Direct premiums written for the nine months ended
      September 30, 2005, increased $18.5 million (1.8%) to $1,029.9 million, compared
      to $1,011.4 million for the same period in 2004, primarily due to a higher
      number of insured vehicles from non-California states.





Net
      premiums earned increased $10.7 million (3.2%) to $ 344.1 million for the three
      months ended September 30, 2005, compared to $333.4 million for the same period
      a year ago, attributable to the higher number of insured vehicles, as previously
      mentioned. Net premiums earned increased $38.7 million (4.0%) to $1,017.3
      million for the nine months ended September 30, 2005, compared to $978.6 million
      for the same period in 2004.





The
      auto
      renewal ratio was 92.0% for the quarter ended September 30, 2005, compared
      to
      92.5% for the three months ended September 30, 2004. The auto renewal ratio
      for
      the nine months ended September 30, 2005, was 92.7%, compared to 92.7% for
      the
      same period in 2004.





Net
      losses and LAE incurred increased $5.6 million (2.2%) to $257.5 million for
      the
      three months ended September 30, 2005, compared to $251.9 million for the same
      period last year. For the nine months ended September 30, 2005, net losses
      and
      LAE incurred increased $12.9 million (1.7%) to $756.4 million, compared to
      $743.5 million for the same period in 2004. The third quarter 2005 underwriting
      profit includes $1.2 million of favorable development related to prior accident
      years’ reserves, compared to $3.4 million of favorable development related to
      prior accident years’ reserves in the same period of 2004. The nine months ended
      September 30, 2005 underwriting profit includes $20.8 million of favorable
      development related to prior accident years’ reserves, compared to $2.9 million
      of favorable development related to prior accident years’ reserves in the same
      period of 2004. The effect on the loss and LAE ratios of changes in estimates
      relating to insured events of prior years during the third quarter of 2005
      was
      approximately 0.5%, compared to 1.2% in the same quarter last year. For the
      nine
      months ended September 30, 2005, the effect on the loss and LAE ratios of
      changes in estimates relating to insured events in prior years was 2.1%,
      compared to 0.4% for the same period in 2004. Changes in estimates are recorded
      in the period in which new information becomes available indicating that a
      change is warranted, usually in conjunction with our quarterly actuarial
      review.





The
      ratios of net underwriting expenses to net premiums earned were 20.3% and 19.4%
      for the quarters ended September 30, 2005 and 2004, respectively. The ratios
      of
      net underwriting expenses to net premiums earned were 21.0% and 19.3% for the
      nine months ended September 30, 2005 and 2004, respectively. The increase was
      primarily due to growth in advertising costs, the development of new markets,
      costs associated with the conversion to our new technology platform, and
      facility and support costs.





23




The
      combined ratio was 95.1% for the quarter ended September 30, 2005, compared
      to
      95.0% for the same period a year ago. The combined ratios for the nine months
      ended September 30, 2005 and 2004 were 95.4% and 95.3%, respectively.





*Homeowner
      and Earthquake Lines in Runoff.* Underwriting
      results of the homeowner and earthquake lines, which are in runoff, were losses
      and LAE incurred of $0.6 million for the three months ended September 30, 2005,
      compared to $0.4 million for the same period a year ago. For the nine months
      ended September 30, 2005 and 2004, losses and LAE for those same lines were
      $1.0
      million and $0.8 million, respectively. We have not written any earthquake
      policies since 1994 and we exited the homeowner insurance business at the
      beginning of 2002. Earthquake LAE incurred was $1.0 million in the first quarter
      of 2004, as reserves were increased to provide for additional legal defense
      costs expected to be incurred in settling outstanding claims.





We
      have
      executed various transactions to exit from our homeowner line. Under a January
      1, 2002 agreement with Balboa Insurance Company (“Balboa”), a subsidiary of
      Countrywide Financial Corporation (“Countrywide”), 100% of homeowner unearned
      premium reserves and losses on or after that date were ceded to Balboa. Under
      the terms of this agreement, we retain certain loss adjustment expenses. We
      began non-renewing homeowner policies expiring on February 21, 2002 and
      thereafter. Substantially all of these customers were offered homeowner coverage
      through an affiliate of Countrywide. We have completed this process and no
      longer have any homeowner policies in force.





**Investment
      Income**





We
      utilize a conservative investment philosophy. No derivatives or nontraditional
      securities are held in our investment portfolio and only 3.3% of the portfolio
      consists of equity securities. Substantially the entire fixed maturity portfolio
      is investment grade. Net investment income was $17.0 million for the three
      months ended September 30, 2005 compared to $15.1 million for the same period
      in
      2004. Net
      investment income for the nine months ended September 30, 2005 and 2004, was
      $51.1 million and $42.6 million, respectively. The increase in net investment
      income is the result of higher average investment balances and higher pre-tax
      yields.





At
      September 30, 2005, $304.1 million, or 22.5%, of our total fixed maturity
      investments at fair value were invested in tax-exempt bonds with the remainder,
      representing 77.5% of the portfolio, invested in taxable securities, compared
      to
      22.3% and 77.7%, respectively, at December 31, 2004.





The
      average annual yields on invested assets for the three and nine months ended
      September 30, were as follows:




*Three
                  Months Ended*
                September
                  30,
            *Nine
                  Months Ended*
                September
                  30,**2005**
            2004
            **2005**
            2004Pre-tax
            
            
            **4.7**%****
            
            
            4.4%
            
            
            **4.8**%****
            
            
            4.3%After-tax
            
            
            **3.4**%****
            
            
            3.2%
            
            
            **3.5**%****
            
            
            3.3%




Net
      realized losses on the sale of investments 2  were
      $0.9
      million (realized gains of $1.3 million and realized losses of $2.2 million)
      and
      $2.7 million (realized gains were $4.6 million and realized losses were $7.3
      million) for the three and nine months ended September 30, 2005, respectively.
      This compares to a $0.2 million net realized loss (realized gains were $0.1
      million and realized losses were $0.3 million) and an $8.8 million net realized
      gain (realized gains were $11.3 million and realized losses were $2.5 million)
      for the three and nine months ended September 30, 2004, respectively. Our policy
      is to investigate, on a quarterly basis, all investments for possible
“other-than-temporary” impairment when the fair value of a security falls below
      its amortized cost, based on all relevant facts and circumstances. No such
      impairments were recorded in the three and nine months ended September 30,
      2005
      or 2004.





2
            Includes
                loss on disposal of fixed assets of $0.0 million and $0.2 million
                for the
                three and nine months ended September 30, 2005, respectively, and
                $0.2
                million and $0.8 million for the three and nine months ended September
                30,
                2004, respectively.




24





**Other
      Revenues**





Other
      revenues of $0.4 million in 2005 relate to interest income for refund claims
      with the taxing authorities.





**Critical
      Accounting Estimates**





Our
      condensed consolidated financial statements are prepared in accordance with
      GAAP. The financial information contained within those statements is, to a
      significant extent, financial information that is based on approximate measures
      of the financial effects of transactions and events that have already occurred.
      Our significant accounting policies are essential to understanding Management’s
      Discussion and Analysis of Financial Condition and Results of Operations. Some
      of our accounting policies require significant judgment to estimate values
      of
      either assets or liabilities. In addition, significant judgment may be needed
      to
      apply what often are complex accounting principles to individual transactions
      to
      determine the most appropriate treatment. We have established procedures and
      processes to facilitate making the judgments necessary to prepare financial
      statements.





The
      following is a summary of the more judgmental and complex accounting estimates
      and principles. In each area, we have discussed the assumptions most important
      in the estimation process. We have used the best information available to
      estimate the related items involved. Actual performance that differs from our
      estimates and future changes in the key assumptions could change future
      valuations and materially impact our financial condition and results of
      operations.





Management
      has discussed our critical accounting policies and estimates, together with
      any
      changes therein, with the Audit Committee of our Board of Directors.





*Losses
      and Loss Adjustment Expenses.* **** The
      estimated liabilities for losses and LAE include estimates of losses for known
      claims reported on or prior to the balance sheet dates, estimates of losses
      for
      claims incurred but not reported, and estimates of expenses for investigating,
      adjusting and settling all incurred claims. Amounts reported are estimates
      of
      the ultimate costs of settlement, net of estimated salvage and subrogation.
      The
      estimated liabilities are necessarily subject to the outcome of future events,
      such as changes in medical and repair costs, as well as economic and social
      conditions that impact the settlement of claims. In addition, time can be a
      critical part of reserving determinations since the longer the span between
      the
      incidence of a loss and the payment or settlement of the claim, the more
      variable the ultimate settlement amount can be. Accordingly, short-tail claims,
      such as property damage claims, tend to be more reasonably predictable than
      relatively longer-tail liability claims. For our current mix of auto exposures,
      which include both property and liability exposures, on average approximately
      80% of the ultimate losses are settled within twelve months of the date of
      loss.
      Given the inherent variability in the estimates, management believes the
      aggregate reserves are adequate. The methods of estimating losses and
      establishing the resulting reserves are reviewed and updated quarterly and
      any
      resulting adjustments are reflected in current operations.





Changes
      in these recorded reserves flow directly to the income statement on a
      dollar-for-dollar basis. For example, an upward revision of $1 million in the
      estimated recorded liability for unpaid losses and LAE would decrease
      underwriting profit, and pre-tax income, by the same $1 million amount.
      Conversely, a downward revision of $1 million would increase pre-tax income
      by
      the same $1 million amount.





*Property
      and Equipment.* Accounting standards require a write-off to be recognized when an asset is
      abandoned or an asset group’s carrying value exceeds its fair value. For
      purposes of recognition and measurement of an impairment loss, a long-lived
      asset or assets are grouped with other assets and liabilities at the lowest
      level for which identifiable cash flows are largely independent of the cash
      flows of other assets and liabilities. Accounting standards require asset groups
      to be tested for possible impairment under certain conditions. There have been
      no events or circumstances in 2005 that would require a reassessment of any
      asset group for impairment.





25





*Income
      Taxes* .
      Determining the consolidated provision for income tax expense, deferred tax
      assets and liabilities and any related valuation allowance involves judgment.
      GAAP requires deferred tax assets and liabilities (“DTAs” and “DTLs,”
respectively) to be recognized for the estimated future tax effects attributed
      to temporary differences and carryforwards based on provisions of the enacted
      tax law. The effects of future changes in tax laws or rates are not anticipated.
      Temporary differences are differences between the tax basis of an asset or
      liability and its reported amount in the financial statements. For example,
      we
      have a DTA because the tax bases of our loss and LAE reserves are smaller than
      their book bases. Similarly, we have a DTL because the book basis of our
      capitalized software exceeds its tax basis. Carryforwards include such items
      as
      alternative minimum tax credits, which may be carried forward indefinitely,
      and
      NOL, which can be carried forward 15 years for losses incurred before 1998
      and
      20 years thereafter.





At
      September 30, 2005, our DTAs totaled $127.1 million and our DTLs totaled $73.3
      million. The net of those amounts, $53.8 million, represents the net deferred
      tax asset reported in the condensed consolidated balance sheets.





We
      are
      required to reduce DTAs (but not DTLs) by a valuation allowance to the extent
      that, based on the weight of available evidence, it is “more likely than not”
(i.e., a likelihood of more than 50%) that any DTAs will not be realized.
      Recognition of a valuation allowance would decrease reported earnings on a
      dollar-for-dollar basis in the year in which any such recognition were to occur.
      The determination of whether a valuation allowance is appropriate requires
      the
      exercise of management judgment. In making this judgment, management is required
      to weigh the positive and negative evidence as to the likelihood that the DTAs
      will be realized.





Portions
      of our NOL carryforward are scheduled to expire beginning in 2017, as shown
      in
      the table below (amounts in thousands):




**Year
                    of****Expiration**
                
                **NOL
                    Excluding**
                  **21st
                    of the**
                  **Southwest**
                **SRLY****3****NOL
                      of**
                    **21st
                      of the**
                    **Southwest**
                **Consolidated**
                  **NOL**2017
                
                $
                —
                
                $
                1,644
                
                $
                1,6442018
                
                
                —
                
                
                1,068
                
                
                1,0682019
                
                
                —
                
                
                1,466
                
                
                1,4662020
                
                
                —
                
                
                3,172
                
                
                3,1722021
                
                
                81,759
                
                
                2,180
                
                
                83,9392022
                
                
                37,316
                
                
                —
                
                
                37,316Total
                
                $
                119,075
                
                $
                9,530
                
                $
                128,605


Our
      auto
      business generated underwriting profit of $47.0 million for the nine months
      ended September 30, 2005 and has generated an underwriting profit for the past
      fifteen quarters. The consolidated NOL decreased to $128.6 million as of
      September 30, 2005, from $216.7 million as of December 31, 2004. Management
      believes it is reasonable to expect future underwriting profits and to conclude
      it is at least more likely than not that we will be able to realize the benefits
      of our DTAs. If necessary, we believe we could implement tax-planning strategies
      to generate sufficient future taxable income to utilize the NOL carryforwards
      prior to their expiration. Accordingly, no valuation allowance has been
      recognized as of September 30, 2005. However, generating future taxable income
      is dependent on a number of factors, including regulatory and competitive
      influences that may be beyond our ability to control. Future underwriting losses
      could possibly jeopardize our ability to utilize our NOLs. In the event adverse
      development or underwriting losses due to either SB 1899 matters or other causes
      were to occur, management might reach a different conclusion about the
      realization of the DTAs and, if so, recognize a valuation allowance at that
      time.





3
            “SRLY”
                stands for Separate Return Limitation Year. Under the Federal tax
                code,
                only future income generated by 21st Century Insurance Company of
                the
                Southwest (“21st of the Southwest”) (formerly 21st Century Insurance
                Company of Arizona) may be utilized against this portion of our
                NOL.




26




In
      a
      December 21, 2000 court ruling, *Ceridian
      Corporation v. Franchise Tax Board* ,
      a
      California statute that allowed a tax deduction for the dividends received
      from
      wholly-owned insurance subsidiaries was held unconstitutional on the grounds
      that it discriminated against out-of-state insurance holding companies.
      Subsequent to the court ruling, the staff of the California Franchise Tax Board
      (“FTB”) took the position that the discriminatory sections of the statute are
      not severable and the entire statute is invalid. As a result, the FTB began
      disallowing dividends-received deductions for all insurance holding companies,
      regardless of domicile, for open tax years ending on or after December 1, 1997.
      Although the FTB made no formal assessment, the Company anticipated a
      retroactive disallowance that would result in additional tax assessments and
      recorded a provision for this contingency in a prior year.





In
      the
      third quarter of 2004, California enacted AB 263, which allowed the Company
      to
      file certain amended California tax returns and claim a dividends-received
      deduction. As a result, the Company re-estimated its liability and reduced
      its
      tax provision by approximately $4.9 million in the third quarter of 2004, which
      reduced the effective tax rate for 2004. In the first quarter of 2005, the
      Company filed amended California tax returns and paid the State of California
      approximately $6.8 million to cover all issues outstanding with the FTB,
      including certain matters paid under protest as to which the Company has
      reserved all its rights to file for refunds and appeal any adverse rulings
      the
      FTB may make in the course of finalizing its audit.





*Deferred
      Policy Acquisition Costs* .
      Deferred policy acquisition costs (“DPAC”) primarily include premium taxes,
      advertising, and other variable costs incurred with writing business. These
      costs are deferred and amortized over the 6-month policy period in which the
      related premiums are earned.





Management
      assesses the recoverability of deferred policy acquisition costs on a quarterly
      basis. The assessment calculates the relationship of actuarially estimated
      costs
      incurred to premiums from contracts issued or renewed for the period. We do
      not
      consider anticipated investment income in determining the recoverability of
      these costs. Based on current indications, management believes these costs
      are
      fully recoverable as of September 30, 2005.




The
      loss
      and LAE ratio used in the recoverability estimate is based primarily on expected
      ultimate ratios provided by our actuaries. While management believes that is
      a
      reasonable assumption, actual results could differ materially from such
      estimates.





*Investments* .
      Under
      the provisions of Statement of Financial Accounting Standards No. 115, *Accounting
      for Certain Investments in Debt and Equity Securities* ,
      investment securities generally must be classified as held-to-maturity,
      available-for-sale or trading. The appropriate classification is based partially
      on our ability to hold the securities to maturity and largely on management’s
      intentions with respect to either holding or selling the securities. The
      classification of investment securities is significant since it directly impacts
      the accounting for unrealized gains and losses on securities. Unrealized gains
      and losses on trading securities flow directly through earnings during the
      periods in which they arise, whereas for available-for-sale securities, they
      are
      recorded as a separate component of stockholders’ equity (accumulated other
      comprehensive income or loss) and do not affect earnings until realized. The
      fair values of our investment securities are generally determined by reference
      to quoted market prices and reliable independent sources.





We
      are
      obligated to assess, at each reporting date, whether there is an
“other-than-temporary” impairment to our investment securities. For investments
      with unrealized losses due to market conditions or industry-related events,
      where the Company has the positive intent and ability to hold the investment
      for
      a period of time sufficient to allow a market recovery or to maturity, declines
      in value below cost are not assumed to be other-than-temporary.





Where
      declines in values of securities below cost or amortized cost are considered
      to
      be other-than-temporary, a charge is required to be reflected in income for
      the
      difference between cost or amortized cost and the fair value. The determination
      of whether a decline in market value is “other-than-temporary” is a matter of
      subjective judgment. No such charges were recorded in the three or nine months
      ended September 30, 2005 and 2004. The timing and amount of realized losses
      and
      gains reported in income could vary if conclusions other than those made by
      management were to determine whether an other-than-temporary impairment exists.
      However, there would be no impact on equity because any unrealized losses are
      already included in accumulated other comprehensive income (loss).





27




The
      Company had total investments of $1,396.8 million and $1,384.2 million as of
      September 30, 2005 and December 31, 2004, respectively. Non-investment grade
      and
      unrated securities represented 1.4% of our total portfolio as of September
      30,
      2005 and December 31, 2004. The following is a summary by issuer of
      non-investment grade securities and unrated securities held at September 30,
      2005 and December 31, 2004 (at fair value):





*AMOUNTS
                IN THOUSANDS*
            
            **September
                  30,**2005
            December
                  31, 2004Non-investment
                grade fixed maturity securities (i.e., rated below BBB):Cox
                Communications, Inc.
            
            **$**
            **2,187**
            
            $
            2,240Ford
                Motor Credit Company
            
            
            —
            
            
            4,615General
                Motors Acceptance Corp
            
            
            —
            
            
            5,643News
                America, Inc.
            
            
            **1,601**
            
            
            —The
                Kroger Co.
            
            
            **4,763**
            
            
            —Xcel
                Energy, Inc.
            
            
            **2,895**
            
            
            —Non-investment
                grade equity securities:AmerUs
                Group Co.
            
            
            **824**
            
            
            —Southern
                California Edison Company
            
            
            **511**
            
            
            —Unrated
                securities:Impact
                Community Capital, LLC4
            
            
            **2,024**
            
            
            2,023Impact
                Health, LLC
            
            
            **445**
            
            
            —Impact
                C.I.L., LLC
            
            
            4,977
            
            
            5,111Total
                non-investment grade and unrated securities5
            
            **$**
            **20,227**
            
            $
            19,632





The
      following table summarizes investments held by us having an unrealized loss
      of
      $0.1 million or more and aggregate information relating to all other investments
      in unrealized loss positions as of September 30, 2005 and December 31,
      2004:





**September
                30, 2005**
            December
                31, 2004*AMOUNTS
                IN THOUSANDS,*
              *EXCEPT
                NUMBER OF ISSUES*
            
            ***#
                issues***
            ***Carrying
                Value***
            ***Unrealized
                Loss***
            *#
                issues*
            *Carrying
                Value*
            *Unrealized
                Loss*Investments
                with unrealized losses:Fixed
                maturity securities:Exceeding
                $0.1 million and in a loss position for:Less
                than 6 months
            
            
            **15**
            
            **$**
            **159,194**
            
            **$**
            **2,451**
            
            
            7
            
            $
            88,258
            
            $
            1,0456-12
                months
            
            
            **29**
            
            
            **268,079**
            
            
            **7,192**
            
            
            15
            
            
            154,284
            
            
            3,415More
                than 1 year
            
            
            **22**
            
            
            **183,676**
            
            
            **6,271**
            
            
            2
            
            
            4,765
            
            
            326Less
                than $0.1 million
            
            
            **131**
            
            
            **295,906**
            
            
            **4,920**
            
            
            91
            
            
            306,984
            
            
            2,387Total
                fixed maturity securities withunrealized
                losses
            
            
            **197**
            
            
            **906,855**
            
            
            **20,834**
            
            
            115
            
            
            554,291
            
            
            7,173Equity
                securities:Exceeding
                $0.1 million
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —
            
            
            —Less
                than $0.1 million
            
            
            **165**
            
            
            **25,798**
            
            
            **1,105**
            
            
            64
            
            
            15,479
            
            
            293Total
                equity securities withunrealized
                losses
            
            
            **165**
            
            
            **25,798**
            
            
            **1,105**
            
            
            64
            
            
            15,479
            
            
            293Total
                investments with unrealized losses6
            
            
            **362**
            
            **$**
            **932,653**
            
            **$**
            **21,939**
            
            
            179
            
            $
            569,770
            
            $
            7,466





4
            Impact
                Community Capital, LLC is a limited liability corporation that was
                voluntarily established by a group of California insurers to make
                loans
                and other investments in economically disadvantaged
                areas.


5
            The
                total net unrealized (loss) gain for these securities as of September
                30,
                2005 and December 31, 2004 was $(0.1) million and $0.4 million,
                respectively.


6
            Unrealized
                losses represent 2.4% and 1.3% of the total carrying value of investments
                with unrealized losses at September 30, 2005 and December 31, 2004,
                respectively.





28




A
      summary
      by contractual maturity of fixed maturity securities in an unrealized loss
      position by year of maturity follows:




**September
                30, 2005**
            December
                31, 2004*AMOUNTS
                IN THOUSANDS*
            
            ***Amortized
                Cost***
            ***Carrying
                Value***
            ***Unrealized
                Loss***
            *Amortized
                Cost*
            *Carrying
                Value*
            *Unrealized
                Loss*Fixed
                maturity securities:Due
                in one year or less
            
            **$**
            **4,021**
            
            **$**
            **4,010**
            
            **$**
            **11**
            
            $
            9,778
            
            $
            9,738
            
            $
            40Due
                after one year through five years
            
            
            **153,705**
            
            
            **151,016**
            
            
            **2,689**
            
            
            26,537
            
            
            26,073
            
            
            464Due
                after five years through ten years
            
            
            **470,550**
            
            
            **458,919**
            
            
            **11,631**
            
            
            318,644
            
            
            314,898
            
            
            3,746Due
                after ten years
            
            
            **299,413**
            
            
            **292,910**
            
            
            **6,503**
            
            
            206,505
            
            
            203,582
            
            
            2,923Total
                fixed maturity securities with unrealized losses
            
            **$**
            **927,689**
            
            **$**
            **906,855**
            
            **$**
            **20,834**
            
            $
            561,464
            
            $
            554,291
            
            $
            7,173





*Stock-based
      compensation* .
      Under
      the provisions of Statement of Financial Accounting Standard No. 123, *Accounting
      for Stock-Based Compensation* ,
      we have
      elected to continue using the intrinsic-value method of accounting for
      stock-based awards granted to employees in accordance with Accounting Principles
      Board Opinion No. 25, *Accounting
      for Stock Issued to Employees* .
      Accordingly, we have not recognized in income any compensation expense for
      the
      fair value of stock options awarded to employees. Companies electing to continue
      to follow the intrinsic-value method must make pro forma disclosures, as if
      the
      fair-value-based method of accounting had been applied. A summary of the expense
      that would have been recorded, together with the underlying assumptions, had
      compensation cost for the Company’s stock-based compensation plans been
      determined based on the fair-value-based method for of all awards, is included
      in Note 1 of the Notes to Condensed Consolidated Financial
      Statements.








**Forward-Looking
      Statements**





This
      report contains statements that constitute forward-looking information.
      Investors are cautioned that these forward-looking statements are not guarantees
      of future performance or results and involve risks and uncertainties, and that
      actual results or developments may differ materially from the forward-looking
      statements as a result of various factors. You should not rely on
      forward-looking statements in this quarterly report on Form 10-Q.
      Forward-looking statements are statements not based on historical information
      and which relate to future operations, strategies, financial results or other
      developments. You can usually identify forward-looking statements by terminology
      such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “believe,”
“estimate,” “predict,” “intend,” “potential,” or “continue” or with the negative
      of these terms or other comparable terminology.





Although
      we believe that the expectations reflected in these forward-looking statements
      are reasonable, we cannot guarantee our future results, level of activity,
      performance or achievements. Forward-looking statements include, among other
      things, discussions concerning our potential expectations, beliefs, estimates,
      forecasts, projections and assumptions. Forward-looking statements may address,
      among other things:




·
              Our
                  strategy for growth;
 ·
              Underwriting
                  results;
 ·
              Our
                  expected combined ratio and growth of written
                  premiums;
 ·
              Product
                  development;
 ·
              Computer
                  systems;
 ·
              Regulatory
                  approvals;
 ·
              Market
                  position;
 ·
              Financial
                  results;
 ·
              Dividend
                  policy; and
 ·
              Reserves.


29





It
      is
      possible that our actual results, actions and financial condition may differ,
      possibly materially, from the anticipated results, actions and financial
      condition indicated in these forward-looking statements. Other important factors
      that could cause our actual results and actions to differ, possibly materially,
      from those in the specific forward-looking statements include those discussed
      in
      this report under the heading *Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations* as well
      as:




·
              The
                  effects of competition and competitors’ pricing
                  actions;
 ·
              Changes
                  in consumer preferences or buying
                  habits;
 ·
              Adverse
                  underwriting and claims experience, including experience as a result
                  of
                  revived earthquake claims under SB 1899;
 ·
              Customer
                  service problems;
 ·
              The
                  impact on our operations of natural disasters, principally earthquake,
                  or
                  civil disturbance, due to the concentration of our facilities and
                  employees in Southern California;
 ·
              Information
                  system problems, including failures to implement information technology
                  projects on time and within budget;
 ·
              Control
                  environment failures;
 ·
              Adverse
                  developments in financial markets or interest rates;
 ·
              Results
                  of legislative, regulatory or legal actions, including the inability
                  to
                  obtain approval for necessary licenses, rate increases and product
                  changes
                  and possible adverse actions taken by state regulators in market
                  conduct
                  examinations; and
 ·
              Our
                  ability to service our debt, including our ability to receive dividends
                  and/or sufficient payments from our subsidiaries to service our
                  obligations.


We
      do not
      undertake any obligation to update or revise any forward-looking statements,
      whether as a result of new information, future events or otherwise.





30




**ITEM
                  3.**
              **QUANTITATIVE
                  AND QUALITATIVE DISCLOSURES ABOUT MARKET
                  RISK**





Market
      risk is the risk of loss from adverse changes in market prices and interest
      rates. In addition to market risk we are exposed to other risks, including
      the
      credit risk related to the issuers of our financial instruments; the underlying
      insurance risk related to our core business and the exposure of the personal
      lines insurance business; as a regulated industry, to legal, legislative,
      judicial, political and regulatory action. Financial instruments are not used
      for trading purposes. The following disclosure reflects estimated changes in
      value that may result from selected hypothetical changes in market rates and
      prices. Actual results may differ.




Our
      cash
      flow from operations and short-term cash position generally are more than
      sufficient to meet our projected obligations for claim payments, which by the
      nature of the personal automobile insurance business tend to have an average
      duration of less than one year. As a result, it has been unnecessary for us
      to
      employ elaborate market risk management techniques involving complicated asset
      and liability duration matching or hedging strategies. Accordingly, the Company
      primarily invests in fixed maturity investments, which at September 30, 2005,
      comprised 96.7% of the fair value of the Company’s total investments. The
      remainder of the Company’s investments, representing approximately 3.3% of total
      investments at market value, is held in equity securities.




For
      all
      of our fixed maturity investments, we seek to provide for liquidity and
      diversification while maximizing income, without sacrificing investment quality.
      The value of the fixed maturity portfolio is subject to interest rate risk
      where
      the value of the fixed maturity portfolio decreases as market interest rates
      increase, and conversely, when market interest rates decrease, the value of
      the
      fixed maturity portfolio increases. Duration is a common measure of the
      sensitivity of a fixed maturity security’s value to changes in interest rates.
      The higher the duration, the more sensitive a fixed maturity security is to
      market interest rate fluctuations. Effective duration also measures this
      sensitivity, but it takes into account call terms, as well as changes in
      remaining term, coupon rate, and cash flow.




Since
      fixed maturity investments with longer remaining terms to maturity tend to
      realize higher yields, the Company’s investment philosophy typically resulted in
      a portfolio with an effective duration of over 6 years. Due to the current
      interest rate environment, management, in consultation with the Investment
      Committee, targeted a lower duration for the Company’s fixed maturity investment
      portfolio to reduce the negative impact of potential increases in interest
      rates. As a result, the effective duration of the fixed maturity portfolio
      declined from 5.4 years as of December 31, 2004 to 4.8 years at September 30,
      2005.




The
      Company has also obtained long-term fixed rate financing as a means of
      increasing the statutory surplus of the Company’s largest insurance
      subsidiary.




The
      following table shows the financial statement carrying values of our fixed
      maturity investments, which are reported at fair value, and our debt, which
      is
      reported at amortized cost. The table also presents estimated carrying values
      at
      adjusted market rates assuming a 100 basis point increase in market interest
      rates, given the effective duration noted above, for the fixed maturity
      investment portfolio and a 100 basis point decrease in market interest rates
      for
      the debt determined from a present value calculation. The following sensitivity
      analysis summarizes only the exposure to market interest rate risk:





*DOLLAR
                AMOUNTS IN MILLIONS*
              *September
                30, 2005*
            
            *Carrying*
              *Value*
            *Estimated
                Carrying*
              *Value
                at Adjusted*
              *Market
                Rates/Prices*
              *Indicated
                Above*
            *Change
                in*
              *Value
                as a*
              *Percentage
                of*
              *Carrying
                Value*Fixed
                maturity investments available-for-sale, at fair value
            
            $
            1,350.4
            
            $
            1,285.0
            
            
            (4.84
            %)Debt
            
            
            131.1
            
            
            138.6
            
            
            5.72
            %




31




The
      equity securities portfolio, which represents approximately 3.3% of total
      investments at market value, consists primarily of financial services,
      industrial, and miscellaneous stocks. Beta is a measure of a security’s
      systematic (non-diversifiable) risk, which is the percentage change in an
      individual security’s price for a 1% change in the return of the market. The
      average Beta for the Company’s equity securities portfolio was 0.86.





The
      following table presents the financial statement carrying value of our equity
      securities portfolio and the effect of a hypothetical 20% reduction in the
      overall value of the stock market using the Beta noted above and accordingly
      summarizes only the exposure to equity price risk for the Company’s equity
      securities portfolio:





*DOLLAR
                AMOUNTS IN MILLIONS*
              *September
                30, 2005*
            
            *Carrying*
              *Value*
            *Estimated
                Carrying*
              *Value
                at Hypothetical*
              *20%
                Reduction in*
              *Overall
                Value of*
              *Stock
                Market*
            *Change
                in*
              *Value
                as a*
              *Percentage
                of*
              *Carrying
                Value*Equity
                securities available-for-sale, at fair value
            
            $
            46.4
            
            $
            38.4
            
            
            (17.2
            %)





The
      discussion above provides only a limited, point-in-time view of the market
      risk
      sensitivity of our financial instruments. The actual impact of market interest
      rate and price changes on the financial instruments may differ significantly
      from those shown.





**ITEM
              4.**
            **CONTROLS
                AND PROCEDURES**





We
      have
      established disclosure controls and procedures to ensure that material
      information relating to the Company, including its consolidated subsidiaries,
      is
      communicated to our management, including the Chief Executive Officer and Chief
      Financial Officer, to allow timely decisions regarding required
      disclosure.





Based
      on
      their evaluation of the effectiveness of 21st Century Insurance Group’s
      disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
      under the Securities Exchange Act of 1934) as of September 30, 2005, the Chief
      Executive Officer and Chief Financial Officer of 21st Century Insurance Group
      have concluded that such disclosure controls and procedures are effective to
      ensure that the information required to be disclosed by 21st Century Insurance
      Group in reports that it files or submits under the Securities Exchange Act
      of
      1934 is recorded, processed, summarized and reported within the time periods
      specified in SEC rules and forms.





Management,
      with the participation of the Chief Executive Officer and Chief Financial
      Officer, has evaluated any changes in 21st Century Insurance Group’s internal
      control over financial reporting that occurred during the most recent fiscal
      quarter. Based on the evaluation, management, including the Chief Executive
      Officer and Chief Financial Officer, have concluded that no change in our
      internal control over financial reporting (as defined in Rule 13a-15(f) under
      the Securities Exchange Act of 1934) occurred during the quarter ended September
      30, 2005 that has materially affected, or is reasonably likely to materially
      affect, our internal control over financial reporting.




32




**PART
        II** **-** **OTHER
        INFORMATION**
 
 **ITEM
                  1.**
              **LEGAL
                  PROCEEDINGS**
 
 In
        the
        normal course of business, the Company is named as a defendant in lawsuits
        related to claims and insurance policy issues, both on individual policy
        files
        and by class actions seeking to attack the Company’s business practices. A
        description of the legal proceedings to which the Company and its subsidiaries
        are a party is contained in Note 4 of the Notes to Condensed Consolidated
        Financial Statements.
 
 **ITEM
                  2.**
              **UNREGISTERED
                  SALES OF EQUITY SECURITIES AND USE OF
                  PROCEEDS**
 
 None.
 
 **ITEM3.**
              **DEFAULTS
                  UPON SENIOR SECURITIES**
 
 None.
  **ITEM4.**
              **SUBMISSION
                  OF MATTERS TO A VOTE OF SECURITY
                  HOLDERS**
 
 None.
  **ITEM
                  5.**
              **OTHER
                  INFORMATION**
 
 None.
 
 **ITEM6.**
              **EXHIBITS**
  See
        accompanying exhibit index.


33





**SIGNATURES**





Pursuant
      to the requirements of the Securities and Exchange Act of 1934, the registrant
      has duly caused this report to be signed on its behalf by the undersigned
      thereunto duly authorized.







21ST
                CENTURY INSURANCE GROUP(Registrant)Date:
            October 27, 2005
            
            /s/
                Bruce W. MarlowBRUCE
                W. MARLOWPresident
                and Chief Executive OfficerDate:
            October 27, 2005
            
            /s/
                Lawrence P. BascomLAWRENCE
                P. BASCOMSr.
                Vice President and Chief Financial Officer




34




**EXHIBIT
      INDEX**





Exhibit
                No.
            Description31.1
            Certification
                of President and Chief Executive Officer Pursuant to Exchange Act
                Rule
                13a-14(a).31.2
            Certification
                of Chief Financial Officer Pursuant to Exchange Act Rule
                13a-14(a).32.1
            Certification
                Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002.




35