**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C.  20549





**FORM
      10-Q**





x******QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE**


**SECURITIES
      EXCHANGE ACT OF 1934**


For
      the
      quarterly period ended June 30, 2007




o******TRANSITION
      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










(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 a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.
      (Check one):




Large
                  accelerated filer o
              Accelerated
                  filer x
              Non-accelerated
                  filer o





Indicate
      by check mark whether the registrant is a shell company (as defined in
      Rule 12b-2 of the Exchange Act).


Yes o  
      No x





The
      number of shares outstanding of the issuer’s common stock as of July 18, 2007
      was 88,126,045.











**TABLE
      OF CONTENTS**




Description
                Page
                    Number**PART
                    I – FINANCIAL INFORMATION**Item
                    1.
                Financial
                    Statements (unaudited)
                2Item
                    2.
                Management’s
                    Discussion and Analysis of Financial Condition
                    and Results of Operations
                15Item
                    3.
                Quantitative
                    and Qualitative Disclosures About Market
                    Risk
                31Item
                    4.
                Controls
                    and Procedures
                32**PART
                    II – OTHER INFORMATION**Item
                    1.
                Legal
                    Proceedings
                33Item
                    1A.
                Risk
                    Factors
                33Item
                    6.
                Exhibits
                34**SIGNATURES**
                35**EXHIBIT
                    INDEX**
                3631.1
                Certification
                    of principal executive officer pursuant to Rule 13a-14(a) under
                    the
                    Securities
                  Exchange
                    Act of 193431.2
                Certification
                    of principal financial officer pursuant to Rule 13a-14(a) under
                    the
                    Securities
                  Exchange
                    Act of 193432.1
                Certification
                    Pursuant to 18 U.S.C. Section 1350





1
 ***Table
            of Contents***





**PART
      I – FINANCIAL INFORMATION**





**ITEM
      1.  FINANCIAL STATEMENTS**





**21ST
      CENTURY INSURANCE GROUP**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


Unaudited





**June
                  30,**
              
              December
                  31,*AMOUNTS
                  IN THOUSANDS, EXCEPT SHARE DATA*
              
              **2007**
              
              2006**Assets**Investments
                  available-for-saleFixed
                  maturity securities, at fair value (amortized cost: $1,427,975
                  and
                  $1,453,468)
              
              **$**
              **1,398,237**
              
              
              $
              1,435,016Other
                  long-term investments, equity method
              
              ****
              **18,440**
              
              
              
              14,705Total
                  investments
              
              ****
              **1,416,677**
              
              
              
              1,449,721Cash
                  and cash equivalents
              
              ****
              **89,578**
              
              
              
              51,999Accrued
                  investment income
              
              ****
              **16,965**
              
              
              
              17,215Premiums
                  receivable
              
              ****
              **112,993**
              
              
              
              110,115Reinsurance
                  receivables and recoverables
              
              ****
              **6,411**
              
              
              
              6,338Prepaid
                  reinsurance premiums
              
              ****
              **2,051**
              
              
              
              2,095Deferred
                  income taxes
              
              ****
              **45,970**
              
              
              
              48,437Deferred
                  policy acquisition costs
              
              ****
              **63,621**
              
              
              
              63,581Leased
                  property under capital leases, net of deferred gain of $871 and
                  $1,092 and
                  net of accumulated amortization of $43,801 and $42,149
              
              ****
              **17,048**
              
              
              
              19,281Property
                  and equipment, at cost less accumulated depreciation of $111,819
                  and
                  $104,279
              
              ****
              **153,608**
              
              
              
              154,966Other
                  assets
              
              ****
              **33,070**
              
              
              
              27,949Total
                  assets
              
              **$**
              **1,957,992**
              
              
              $
              1,951,697**Liabilities
                  and stockholders’ equity**Unpaid
                  losses and loss adjustment expenses
              
              **$**
              **451,254**
              
              
              $
              482,269Unearned
                  premiums
              
              ****
              **328,793**
              
              
              
              321,927Debt
              
              ****
              **109,197**
              
              
              
              115,895Claims
                  checks payable
              
              ****
              **41,155**
              
              
              
              42,931Reinsurance
                  payable
              
              ****
              **636**
              
              
              
              680Other
                  liabilities
              
              ****
              **94,575**
              
              
              
              89,446Total
                  liabilities
              
              ****
              **1,025,610**
              
              
              
              1,053,148Commitments
                  and contingenciesStockholders’
                  equity:Common
                  stock, par value $0.001 per share; 110,000,000 shares authorized;
                  shares
                  issued 88,102,464 and 86,489,082
              
              ****
              **88**
              
              
              
              86Additional
                  paid-in capital
              
              ****
              **472,404**
              
              
              
              441,969Treasury
                  stock; at cost shares: 33,841 and 17,328
              
              ****
              **(530**
              **)**
              
              
              (259
              )Retained
                  earnings
              
              ****
              **495,168**
              
              
              
              484,539Accumulated
                  other comprehensive loss
              
              ****
              **(34,748**
              **)**
              
              
              (27,786
              )Total
                  stockholders’ equity
              
              ****
              **932,382**
              
              
              
              898,549Total
                  liabilities and stockholders’ equity
              
              **$**
              **1,957,992**
              
              
              $
              1,951,697




*See
      accompanying Notes to Condensed Consolidated Financial
      Statements.*





2
 ***Table
            of Contents***





**21ST
      CENTURY INSURANCE GROUP**


**CONDENSED
      CONSOLIDATED STATEMENTS OF OPERATIONS**


Unaudited




*Three
                Months Ended*
              *June
                30,*
            
            *Six
                Months Ended*
              *June
                30,**AMOUNTS
                IN THOUSANDS, EXCEPT SHARE DATA*
            
            **2007**
            
            2006
            
            **2007**
            
            2006**Revenues**Net
                premiums earned
            
            **$**
            **334,424**
            
            
            $
            325,512
            
            
            **$**
            **663,706**
            
            
            $
            651,336Net
                investment income
            
            ****
            **17,582**
            
            
            
            17,174
            
            
            ****
            **34,507**
            
            
            
            34,929Other
                income
            
            ****
            **—**
            
            
            
            10
            
            
            ****
            **—**
            
            
            
            10Net
                realized investment gains (losses)
            
            ****
            **64**
            
            
            
            30
            
            
            ****
            **351**
            
            
            
            (1,037
            )Total
                revenues
            
            ****
            **352,070**
            
            
            
            342,726
            
            
            ****
            **698,564**
            
            
            
            685,238**Losses
                and expenses**Net
                losses and loss adjustment expenses
            
            ****
            **235,221**
            
            
            
            223,094
            
            
            ****
            **468,678**
            
            
            
            459,590Policy
                acquisition costs
            
            ****
            **70,466**
            
            
            
            64,887
            
            
            ****
            **139,118**
            
            
            
            124,219Other
                underwriting expenses
            
            ****
            **9,795**
            
            
            
            9,504
            
            
            ****
            **21,520**
            
            
            
            22,104Other
                expense
            
            ****
            **2,436**
            
            
            
            923
            
            
            ****
            **6,613**
            
            
            
            923Interest
                and fees expense
            
            ****
            **1,677**
            
            
            
            1,854
            
            
            ****
            **3,403**
            
            
            
            3,752Total
                losses and expenses
            
            ****
            **319,595**
            
            
            
            300,262
            
            
            ****
            **639,332**
            
            
            
            610,588Income
                before provision for income taxes
            
            ****
            **32,475**
            
            
            
            42,464
            
            
            ****
            **59,232**
            
            
            
            74,650Provision
                for income taxes
            
            ****
            **9,637**
            
            
            
            14,143
            
            
            ****
            **18,048**
            
            
            
            25,011Net
                income
            
            **$**
            **22,838**
            
            
            $
            28,321
            
            
            **$**
            **41,184**
            
            
            $
            49,639**Earnings
                per share:**Basic
            
            **$**
            **0.26**
            
            
            $
            0.33
            
            
            **$**
            **0.47**
            
            
            $
            0.58Diluted
            
            **$**
            **0.25**
            
            
            $
            0.33
            
            
            **$**
            **0.46**
            
            
            $
            0.57**Cash
                dividends declared per share**
            
            **$**
            **0.16**
            
            
            $
            0.08
            
            
            **$**
            **0.32**
            
            
            $
            0.16**Weighted-average
                shares outstanding:**Basic
            
            ****
            **87,782,310**
            
            
            
            85,968,155
            
            
            ****
            **87,447,464**
            
            
            
            85,918,791Additional
                common shares assumed issued under treasury stock method
            
            ****
            **1,888,961**
            
            
            
            263,948
            
            
            ****
            **1,475,742**
            
            
            
            455,054Diluted
            
            ****
            **89,671,271**
            
            
            
            86,232,103
            
            
            ****
            **88,923,206**
            
            
            
            86,373,845




*See
      accompanying Notes to Condensed Consolidated Financial
      Statements.*





3
 ***Table
            of Contents***





**21ST
      CENTURY INSURANCE GROUP**


**CONDENSED
      CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY**


Unaudited





*Common
                    Stock**$0.001
                    par*
                  *value*
                
                
                
                
                
                
                
                
                
                
                *Accumulated**AMOUNTS
                    IN THOUSANDS,*
                  *EXCEPT
                    SHARE DATA*
                
                *Issued*
                  *Shares*
                
                *Amount*
                
                *Additional*
                  *Paid-in*
                  *Capital*
                
                *Treasury
                    Stock*
                
                *Retained
                    Earnings*
                
                *Other*
                  *Comprehensive*
                  *Loss*
                
                *Total*Balance
                    – January 1, 2007
                
                
                86,489,082
                
                
                $
                86
                
                
                $
                441,969
                
                
                $
                (259
                )
                
                $
                484,539
                
                
                $
                (27,786
                )
                
                $
                898,549Cumulative
                    effect of adopting FIN 48
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (2,422
                )
                
                
                
                
                
                
                (2,422
                )Adjusted
                    balance – January 1, 2007
                
                
                86,489,082
                
                
                $
                86
                
                
                $
                441,969
                
                
                $
                (259
                )
                
                $
                482,117
                
                
                $
                (27,786
                )
                
                $
                896,127Comprehensive
                    income (loss)
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                41,184
                (1)
                
                
                (6,962
                )(2)
                
                
                34,222Cash
                    dividends declared on common stock
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (28,133
                )
                
                
                
                
                
                
                (28,133
                )Exercise
                    of stock options
                
                
                1,494,232
                
                
                
                2
                
                
                
                24,063
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                24,065Issuance
                    of restricted stock
                
                
                119,150
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                —Forfeiture
                    of 16,513shares
                    of restricted
                    stock
                
                
                
                
                
                
                
                
                
                
                271
                
                
                
                (271
                )
                
                
                
                
                
                
                
                
                
                
                —Stock-based
                    compensation cost
                
                
                
                
                
                
                
                
                
                
                3,625
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                3,625Excess
                    tax benefit of stock-based compensation
                
                
                
                
                
                
                
                
                
                
                2,476
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                2,476Balance
                    – June 30, 2007
                
                
                88,102,464
                
                
                $
                88
                
                
                $
                472,404
                
                
                $
                (530
                )
                
                $
                495,168
                
                
                $
                (34,748
                )
                
                $
                932,382





(1)
            Net
                income for the six months ended June 30,
                2007.





*Six
                Months Ended*(2)
            Net
                change in accumulated other comprehensive loss follows:
            
            *June
                30, 2007*Unrealized
                holding losses arising during the period, net of tax benefit of
                $3,957
            
            $
            (7,350
            )Reclassification
                adjustment for investment losses included in net income, net of tax
                expense of $8
            
            
            14Amortization
                of prior service cost and net actuarial loss on defined benefit plans,
                net
                of deferred tax expense of $201
            
            
            374Total
                net other comprehensive loss
            
            $
            (6,962
            )




*See
      accompanying Notes to Condensed Consolidated Financial
      Statements.*





4
 ***Table
            of Contents***





**21ST
      CENTURY INSURANCE GROUP**


**CONDENSED
      CONSOLIDATED STATEMENTS OF CASH FLOWS**


Unaudited




*AMOUNTS
                IN THOUSANDS, EXCEPT SHARE DATA**Six
                Months Ended June 30,*
            
            **2007**
            
            2006**Operating
                activities**Net
                income
            
            **$**
            **41,184**
            
            
            $
            49,639Adjustments
                to reconcile net income to net cash provided by operating
                activities:Depreciation
                and amortization
            
            ****
            **12,742**
            
            
            
            13,304Net
                amortization of investment premiums and discounts
            
            ****
            **5,269**
            
            
            
            4,496Stock-based
                compensation cost
            
            ****
            **3,625**
            
            
            
            6,478Provision
                for deferred income taxes
            
            ****
            **4,816**
            
            
            
            9,431Provision
                for premiums receivable losses
            
            ****
            **1,086**
            
            
            
            1,151Net
                realized investment (gains) losses
            
            ****
            **(351**
            **)**
            
            
            1,037Equity
                loss of other long-term investment
            
            ****
            **187**
            
            
            ****
            **—**Changes
                in assets and liabilitiesPremiums
                receivable
            
            ****
            **(3,964**
            **)**
            
            
            862Deferred
                policy acquisition costs
            
            ****
            **(40**
            **)**
            
            
            (8,309
            )Reinsurance
                receivables and recoverables
            
            ****
            **(73**
            **)**
            
            
            (3
            )Federal
                income taxes
            
            ****
            **2,285**
            
            
            
            2,786Other
                assets
            
            ****
            **(3,216**
            **)**
            
            
            (1,866
            )Unpaid
                losses and loss adjustment expenses
            
            ****
            **(31,015**
            **)**
            
            
            (28,743
            )Unearned
                premiums
            
            ****
            **6,866**
            
            
            
            1,490Claims
                checks payable
            
            ****
            **(1,776**
            **)**
            
            
            (4,318
            )Other
                liabilities
            
            ****
            **2,216**
            
            
            
            16,983Net
                cash provided by operating activities
            
            ****
            **39,841**
            
            
            
            64,418**Investing
                activities**Purchases
                of:Fixed
                maturity securities available-for-sale
            
            ****
            **(22,848**
            **)**
            
            
            (180,179
            )Equity
                securities available-for-sale
            
            ****
            **—**
            
            
            
            (35,627
            )Other
                long-term investments, equity method
            
            ****
            **(4,045**
            **)**
            
            ****
            **—**Property
                and equipment
            
            ****
            **(8,570**
            **)**
            
            
            (13,346
            )Maturities
                and calls of fixed maturity securities available-for-sale
            
            ****
            **27,908**
            
            
            
            12,618Sales
                of:Fixed
                maturity securities available-for-sale
            
            ****
            **15,142**
            
            
            
            55,346Equity
                securities available-for-sale
            
            ****
            **—**
            
            
            
            84,836Other
                long-term investments, equity method
            
            ****
            **123**
            
            
            ****
            **—**Net
                cash provided by (used in) investing activities
            
            ****
            **7,710**
            
            
            
            (76,352
            )**Financing
                activities**Repayment
                of debt
            
            ****
            **(7,359**
            **)**
            
            
            (6,740
            )Dividends
                paid (per share: $0.32 and $0.16)
            
            ****
            **(28,133**
            **)**
            
            
            (13,763
            )Proceeds
                from the exercise of stock options
            
            ****
            **24,065**
            
            
            
            3,844Excess
                tax benefit from stock-based compensation
            
            ****
            **1,455**
            
            
            
            113Net
                cash used in financing activities
            
            ****
            **(9,972**
            **)**
            
            
            (16,546
            )Net
                increase (decrease) in cash and cash equivalents
            
            ****
            **37,579**
            
            
            
            (28,480
            )Cash
                and cash equivalents, beginning of period
            
            ****
            **51,999**
            
            
            
            68,668Cash
                and cash equivalents, end of period
            
            **$**
            **89,578**
            
            
            $
            40,188**Supplemental
                information:**Income
                taxes paid
            
            **$**
            **11,555**
            
            
            $
            12,863Interest
                paid
            
            ****
            **3,321**
            
            
            
            3,682




*See
      accompanying Notes to Condensed Consolidated Financial
      Statements.*





5
 ***Table
            of Contents***




**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**


**Unaudited**


**TABULAR
      DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**


**June
      30, 2007**





**NOTE1.  FINANCIAL STATEMENT
      PRESENTATION**





***General***





21st
      Century Insurance Group and
      subsidiaries (the “Company” or “21st Century”) 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, 2006.




These
      unaudited 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 six-month period ended June 30, 2007
      are not necessarily indicative of results that may be expected for the remaining
      interim period or the year as a whole.





***Other
      Expense***





In
      the
      first quarter of 2007, the Company reduced its workforce by approximately three
      percent in connection with efforts to streamline operations.  The
      Company incurred $3.4 million in severance and other benefits costs during
      the
      first quarter of 2007 and recognized an additional $0.2 million during the
      second quarter for differences between the original estimate and subsequent
      payments.  The undistributed severance and other benefits payments for
      this workforce reduction were $0.4 million at March 31 and June 30, 2007, due
      to
      payments of $0.2 million in the second quarter that were offset by the second
      quarter increase discussed above. The remaining payments are expected to be
      distributed by the end of 2007.





The
      Company also incurred $2.3 million and $3.0 million for the three and six months
      ended June 30, 2007, respectively, for costs associated with the Special
      Committee of the Board of Directors and its advisors’ evaluation and negotiation
      of the merger proposal by the majority shareholder, as discussed in Note 2
      of
      the *Notes to Condensed Consolidated Financial Statements*.





***Earnings
      Per Share (“EPS”)***





The
      numerator for the calculation of both basic and diluted EPS is equal to net
      income reported for that period. The difference between basic and diluted EPS
      denominators is due to dilutive common stock equivalents (stock options and
      restricted stock). Basic EPS excludes dilution and reflects net income divided
      by the weighted-average shares of common stock outstanding during the periods
      presented.  Diluted EPS is based upon the weighted-average shares of
      common stock and dilutive common stock equivalents outstanding during the
      periods presented. Common stock equivalents arising from dilutive stock options
      and restricted common stock were computed using the treasury stock
      method.





The
      following shares attributable to outstanding stock options and restricted shares
      were excluded from the calculation of diluted earnings per share because their
      inclusion would have been anti-dilutive (i.e., their inclusion under the
      treasury stock method would have increased EPS):




*Three
                Months Ended*
              *June
                30,*
            
            *Six
                Months Ended*
              *June
                30,***2007**
            
            2006
            
            **2007**
            
            2006Common
                stock equivalents excluded from calculation of diluted EPS
            
            ****
            **845,008**
            
            
            
            6,157,293
            
            
            ****
            **2,141,139**
            
            
            
            5,359,356





***Recent
      Accounting Pronouncements***





In
      February 2007, the Financial Accounting Standards Board (“FASB”) issued
      Financial Accounting Standard No. (“FAS”) 159, *The Fair Value Option for
      Financial Assets and Financial Liabilities – including an amendment of FASB
      Statement No. 115*, (“FAS 159”), which permits an entity to choose to
      measure many financial instruments and certain other items at fair value that
      are not currently required to be measured at fair value. The objective is to
      provide entities with an opportunity to mitigate volatility in reported earnings
      caused by measuring related assets and liabilities differently without having
      to
      apply complex hedge accounting provisions. Entities that choose to measure
      eligible items at fair value will report unrealized gains and losses in earnings
      at each subsequent reporting date. The fair value option may be elected at
      specified election dates on an instrument-by-instrument basis, with few
      exceptions. The Statement also establishes presentation and disclosure
      requirements designed to facilitate comparisons between entities that choose
      different measurement attributes for similar types of assets and liabilities.
      FAS 159 is effective at the beginning of the first fiscal year beginning after
      November 15, 2007. The Company is currently evaluating the impact of adopting
      FAS 159.





6
 ***Table
            of Contents***







**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**


**Unaudited**


**TABULAR
      DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**


**June
      30, 2007**





In
      September 2006, the FASB issued FAS 157, *Fair Value Measurements*(“FAS
      157”). FAS 157 clarifies the principle that fair value should be based on the
      assumptions market participants would use when pricing an asset or liability
      and
      establishes a fair value hierarchy that prioritizes the information used to
      develop those assumptions. Under the standard, fair value measurements would
      be
      separately disclosed by level within the fair value hierarchy. FAS 157 is
      effective for financial statements issued for fiscal years beginning after
      November 15, 2007 and interim periods within those fiscal years, with early
      adoption permitted. The Company has not yet determined the effect, if any,
      that
      the implementation of FAS 157 will have on its results of operations or
      financial condition.





In
      June
      2006, the FASB issued Financial Interpretation No. 48, *Accounting for
      Uncertainty in Income Taxes – an Interpretation of FAS No. 109* (“FIN
      48”). This interpretation clarifies the accounting for uncertainty in income
      taxes recognized in an enterprise’s financial statements in accordance with FAS
      109, *Accounting for Income Taxes*. FIN 48 prescribes a recognition
      threshold and measurement attribute for the financial statement recognition
      and
      measurement of a tax position taken or expected to be taken in a tax return.
      This interpretation also provides guidance on derecognition, classification,
      interest and penalties, accounting in interim periods, disclosure, and
      transition.  The effect of this adoption on January 1, 2007, resulted
      in a $2.4 million decrease to opening retained earnings.  Adoption of
      FIN 48 had no impact on net income in the six months ended June 30,
      2007.





As
      permitted by FIN 48, the Company also adopted a policy of including interest
      and
      penalties related to income taxes with the provision for income taxes in the
      consolidated statements of operations.  As required by FIN 48, this
      change was done prospectively.  Previously, penalties and interest
      were classified as *Other Income* or *Other
      Expense*.  The Company had no accrued penalties and no material
      interest receivable or interest payable at the date of adoption or at June
      30,
      2007.





At
      January 1, 2007, the Company had unrecognized tax benefits for all jurisdictions
      of approximately $9.1 million, which would favorably impact the effective tax
      rate if recognized.  For the three and six months ended June 30, 2007,
      the total amount of unrecognized tax benefits declined by approximately $1.8
      million and $3.5 million, respectively, representing the proportionate amount
      deemed utilized for tax purposes in the first quarter and second quarter of
      the
      year, respectively, and the Company established an estimated liability for
      uncertain tax position of the same amount.  Absent changes in
      profitability or other facts and circumstances, the Company currently
      anticipates that the unrecognized tax benefits will decline to zero by the
      end
      of 2007 as the benefits are used for tax purposes, in which case the estimated
      liability for uncertain tax position would total approximately $9.1
      million.





Tax
      years
      2003 to 2006 and 2002 to 2006 are subject to examination by Federal and
      California jurisdictions, respectively.





Statement
      of Position 05-1*, Accounting by Insurance Enterprises for Deferred
      Acquisition Costs in Connection with Modifications or Exchanges of Insurance
      Contracts*(“SOP 05-1”) was adopted January 1, 2007. SOP
      05-1**provides guidance on accounting for deferred policy
      acquisition costs on internal replacements of insurance and investment contracts
      other than those specifically described in FAS No. 97, *Accounting and
      Reporting by Insurance Enterprises for Certain Long-Duration Contracts and
      for
      Realized Gains and Losses from the Sale of Investments*. The SOP defines an
      internal replacement as a modification in product benefits, features, rights,
      or
      coverage that occurs by the exchange of a contract for a new contract, or by
      amendment, endorsement, or rider to a contract, or by the election of a feature
      or coverage within a contract. The Company’s prospective application of SOP 05-1
      since January 1, 2007 resulted in a $3.8 million reduction in deferred policy
      acquisition costs as of June 30, 2007, and a corresponding increase in policy
      acquisition costs during the six months ended June 30, 2007.





***Reclassifications***





Certain
      prior year amounts have been reclassified to conform to the current year
      presentation.




7
 ***Table
            of Contents***




**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**


**Unaudited**


**TABULAR
      DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**


**June
      30, 2007**





**NOTE
      2.  AGREEMENT AND PLAN OF MERGER**





On May
      15, 2007, 21st Century Insurance Group and American International Group,
      Inc. (”AIG”) entered into a merger agreement (the “Merger Agreement”)
      providing for the acquisition by AIG of all of the outstanding shares of common
      stock of 21st Century not currently owned by AIG for $22.00 per share in
      cash.  The Company’s Board of Directors unanimously approved the
      Merger Agreement following the recommendation and approval of a Special
      Committee comprised of directors of 21st Century who are independent of
      AIG.  AIG currently owns approximately 60.8% of the outstanding shares of
      21st Century.  The transaction represents a 32.6% premium over 21st
      Century’s closing price on January 24, 2007, the day of AIG’s unsolicited merger
      proposal, and an 11.4% premium over AIG's original proposal price of $19.75
      per
      share.  Upon completion of the transaction, 21st Century will become a
      wholly owned subsidiary of AIG.




The
      Merger is expected to be completed in the third quarter of calendar year 2007,
      subject to customary conditions and approvals.  The exact timing is
      dependent on the review and clearance of necessary filings with the Securities
      and Exchange Commission.  The transaction is subject to the affirmative
      vote of the holders of a majority of the outstanding shares of 21st
      Century.  However, AIG has agreed to vote all of its 21st Century shares in
      favor of the Merger, thereby assuring that approval will be obtained at the
      21st
      Century stockholders’ meeting relating to the Merger.





Provisions
      in certain agreements, including the supplemental executive retirement plan
      and
      stock-based compensation plans, will be accelerated as a result of
      provisions in the Merger Agreement, resulting in the accelerated recognition
      of
      expense on the date of the Merger that could materially impact the Company’s
      future results of operations.  The Company’s stock option and
      retirement valuation assumptions have not been altered for provisions in
      the Merger Agreement.




The
      following items will occur upon the Merger:




·
            Expected
                payment of equity awards of approximately $47.2 million, which will
                reduce
                stockholders’ equity on the date of
                payment;




·
            Accelerated
                recognition of stock-based compensation of $2.7 million, which will
                increase other expense and additional paid-in
                capital;




·
            Payment
                of retention bonuses to certain employees of $2.1 million, including
                $0.9
                million of retention bonus that will be accelerated by the Merger
                Agreement and borne by AIG; and




·
            Payment
                of supplemental employee retirement plan benefits of $14.5 million,
                including $2.2 million that will be accelerated by the Merger Agreement
                and borne by AIG.





**NOTE
      3.  COMMITMENTS AND CONTINGENCIES**




***Legal
      Proceedings***





In
      the
      normal course of business, the Company is named as a defendant in lawsuits
      related to its insurance operations and 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 the possibility
      of 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. In addition, 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.





8
 ***Table
            of Contents***




**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**


**Unaudited**


**TABULAR
      DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**


**June
      30, 2007**





*Poss
      v. 21st Century Insurance Company***was filed on June 13,
      2003, in Los Angeles Superior Court and *Axen v. 21st Century Insurance
      Company* was filed on April 14, 2004, in Alameda County Superior Court.
      Both complaints seek injunctive and unspecified restitutionary relief against
      the Company under Business and Professions Code (“B&P”) Sec. 17200 for
      alleged unfair business practices in violation of California Insurance Code
      Sec.
      1861.02(c) relating to Company rating practices. The court in the
*Poss* case granted the Company’s motion to dismiss the complaint,
      based on California’s Proposition 64, but allowed the addition of a second
      plaintiff, Leacy. Discovery has been stayed in both cases and, because these
      matters are 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. In January of 2007, a settlement for an immaterial amount
      was reached with the Axen plaintiff, which the Company has now
      finalized.





*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 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 could not 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 concluded on December 9, 2005, on his
      claims for bad faith, emotional distress, punitive damages and attorney fees.
      A
      jury found he sustained no damages as to these claims. The Company’s exposure in
      this case includes the aforementioned $10.5 million judgment plus post-judgment
      interest, which currently totals $2.9 million. This matter is now subject to
      three separate appeals by the parties. The Company’s Motion to Consolidate the
      three appeals was recently denied by the Court of Appeal.





*Thomas
      Theis, on his own behalf and on behalf of all others similarly situated v.
      21st
      Century Insurance Company* 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 and the adjusted amount is “predetermined” and
“biased.” This case is consolidated with similar actions against other insurers
      for discovery and pre-trial motions. On January 11, 2007, Plaintiff’s motion to
      certify a “med-pay” class was granted.  The Company filed a writ of
      mandate with the Court of Appeal, challenging the trial court’s certification,
      which was subsequently denied. The matter is now in the discovery
      phase.





*Silvia
      Quintana, on her own behalf and on behalf of all others similarly situated
      v.
      21st Century Insurance Company* was filed on November 16, 2005. This
      purported class action, filed in San Diego, names the Company in four causes
      of
      action: 1) violation of B&P Section 17200, 2) conversion, 3) unjust
      enrichment and, 4) declaratory relief.  Silvia Quintana alleges that
      the Company’s demand for reimbursement of the medical payments it made to her
      pursuant to her insurance contract violates the “make-whole rule.” The Company
      anticipates that if the matter survives the initial pleading stage, it will
      be
      consolidated, for discovery and pre-trial motions, with actions alleging similar
      facts against other insurers.  This matter is in the pleading stage
      and no reasonable estimate of potential losses in the event of a negative
      outcome can be made at this time.  In July 2006, the trial court
      denied the Company’s demurrer and motion to strike and the Company has filed a
      writ to the Court of Appeal for review of this decision. The court, in a
      published opinion entitled *Delanzo v. Allstate,*held that in
      California, the make-whole rule does not require insurance companies to deduct
      an insured’s attorney fees and costs before recovering medical payments made to
      an insured.  The trial court in the *Qunitana* case was
      ordered to enter judgment consistent with the *Delanzo*
      decision.




9
 ***Table
            of Contents***




**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**


**Unaudited**


**TABULAR
      DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**


**June
      30, 2007**





*Ronald
      A. Katz Technology Licensing, L.P. v. American International Group, Inc. et
      al***was filed on September 1, 2006, in the United States
      District Court for the District of Delaware. The defendants include American
      International Group, Inc., its subsidiaries and affiliates, including 21st
      Century Insurance Group, 21st Century Insurance Company, and 21st Century
      Casualty Company. The complaint alleges infringement of various patents relating
      to automated call processing applications. The matter is in the initial pleading
      stage and no reasonable estimate of potential losses in the event of a negative
      outcome can be made at this time.





*Edward
      Bronstein v. 21st Century Insurance Group, et al* and companion cases,
*Francis A. Sliwinski v. 21st Century Insurance Group, et
      al* and
*Paul Roberts v. 21st Century Insurance*, all allege the
      Company, its directors and AIG have, or will, breach fiduciary duties as a
      result of AIG’s January 24, 2007 merger proposal to acquire the remaining shares
      of Company common stock which AIG does not yet own. Both actions were filed
      in
      the Los Angeles Superior Court in January 2007 and seek class action
      certification and equitable relief. The Company formed a Special Committee
      of
      the Company’s Board of Directors, independent of AIG, to evaluate the terms of
      any merger proposal. The Company believes these actions are without
      merit.




**NOTE
      4.ACCUMULATEDOTHER COMPREHENSIVE
      LOSS**





Accumulated
      other comprehensive loss is a component of stockholders’ equity and includes all
      net changes in the unrealized appreciation and depreciation in value of
      available-for-sale investments and changes in unamortized prior service cost
      and
      actuarial loss of defined benefit pension plans.





A
      summary
      of accumulated other comprehensive loss follows:





**June
                30,**
              **2007**
            
            December
                31,
              2006Net
                unrealized losses on
                available-for-sale investments, net of deferred income tax benefit
                of $10,408and
                $6,458
            
            **$**
            **(19,330**
            **)**
            
            $
            (11,994
            )Unamortized
                prior service cost and net actuarial loss of defined benefit pension
                plans, net of deferred income tax benefit of $8,302 and
                $8,503
            
            ****
            **(15,418**
            **)**
            
            
            (15,792
            )Total
                accumulated other comprehensive loss
            
            **$**
            **(34,748**
            **)**
            
            $
            (27,786
            )





**NOTE5.  EMPLOYEE BENEFIT PLANS**





The
      Company has a qualified defined benefit pension plan, which covers essentially
      all employees who have completed at least one year of service. The pension
      benefits under the qualified plan are based on employees’ compensation during
      all years of service. For certain key employees designated by the Board of
      Directors, the Company sponsors a non-qualified supplemental executive
      retirement plan (“SERP”). The SERP 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. The SERP has “change in control” provisions
      that could immediately vest benefits for certain
      individuals.  However, the retirement assumptions used to determine
      the SERP benefit obligations have not been altered by these “change in control”
provisions in response to the offer by AIG to purchase the remaining Company
      common stock.





***Components
      of Net Periodic Benefit Cost***





The
      following table presents the
      components of net periodic benefit costs for all plans:




*Three
                Months Ended*
              *June
                30,*
            
            *Six
                Months Ended*
              *June
                30,***2007**
            
            2006
            
            **2007**
            
            2006Service
                cost
            
            **$**
            **1,771**
            
            
            $
            1,693
            
            
            **$**
            **3,542**
            
            
            $
            3,565Interest
                cost
            
            ****
            **2,105**
            
            
            
            1,898
            
            
            ****
            **4,210**
            
            
            
            3,869Expected
                return on plan assets
            
            ****
            **(2,360**
            **)**
            
            
            (2,112
            )
            
            ****
            **(4,721**
            **)**
            
            
            (4,220
            )Amortization
                of prior service cost
            
            ****
            **36**
            
            
            
            39
            
            
            ****
            **72**
            
            
            
            73Amortization
                of net loss
            
            ****
            **251**
            
            
            
            628
            
            
            ****
            **503**
            
            
            
            1,306Total
            
            **$**
            **1,803**
            
            
            $
            2,146
            
            
            **$**
            **3,606**
            
            
            $
            4,593




10
 ***Table
            of Contents***




**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**


**Unaudited**


**TABULAR
      DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**


**June
      30, 2007**





***Pension
      Plan Contributions***





The
      Company’s funding policy for the qualified plan is to make annual contributions
      as required by applicable regulations; employees may not make contributions
      to
      this plan. The amount and timing of future contributions to the Company’s
      qualified defined benefit pension plan depends on a number of assumptions
      including statutory funding requirements, the market performance of the plan’s
      assets and future changes in interest rates that affect the actuarial
      measurement of the plan’s obligations. The Company did not make any
      contributions to its qualified defined benefit pension plan in 2006. Based
      on
      current assumptions, the Company does not expect to be required to contribute
      to
      its qualified defined benefit pension plan in 2007.





As
      the
      Internal Revenue Code does not allow current deductions for advance funding
      of a
      non-qualified plan, the Company’s funding policy with respect to this plan is to
      make contributions as benefits become payable to participants. Contributions
      to
      our 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 2007. Contributions to our non-qualified defined
      benefit pension plan totaled $0.3 million and $0.5 million for the three and
      six
      months ended June 30, 2007, respectively, and $0.2 million and $0.5 million
      for
      the three and six months ended June 30, 2006, respectively.





**NOTE
      6.  STOCK–BASED AWARDS**





***Stock
      Option Plans***





No
      stock
      options were granted during the six months ended June 30, 2007. Results for
      the
      six months ended June 30, 2006 include $0.7 million of accelerated costs
      incurred to recognize the effect of retirement eligibility in accordance with
      the non-substantive vesting period approach and $1.4 million of actual vesting
      in accordance with an executive retention agreement. Unrecognized compensation
      cost for unvested stock option awards was $5.5 million and $8.7 million at
      June
      30, 2007 and December 31, 2006, respectively. The unrecognized cost as of June
      30, 2007, is scheduled to be recognized over a weighted-average period of 1.4
      years.





Stock-based
      compensation recognized for our stock option awards is as follows:





*Three
                  Months Ended*
                *June
                  30,*
              
              *Six
                  Months Ended*
                *June
                  30,**AMOUNTS
                  IN THOUSANDS, EXCEPT PER SHARE DATA*
              
              **2007**
              
              2006
              
              **2007**
              
              2006Net
                  losses and loss adjustment expenses
              
              **$**
              **184**
              
              
              $
              759
              
              
              **$**
              **412**
              
              
              $
              1,893Policy
                  acquisition costs
              
              ****
              **561**
              
              
              
              448
              
              
              ****
              **710**
              
              
              
              935Other
                  underwriting expenses
              
              ****
              **638**
              
              
              
              434
              
              
              ****
              **1,567**
              
              
              
              2,269Income
                  before provision for income taxes
              
              ****
              **(1,383**
              **)**
              
              
              (1,641
              )
              
              ****
              **(2,689**
              **)**
              
              
              (5,097
              )Provision
                  for income taxes
              
              ****
              **311**
              
              
              
              288
              
              
              ****
              **666**
              
              
              
              1,045Net
                  income
              
              **$**
              **(1,072**
              **)**
              
              $
              (1,353
              )
              
              **$**
              **(2,023**
              **)**
              
              $
              (4,052
              )Basic
                  and diluted earnings per share
              
              **$**
              **(0.01**
              **)**
              
              $
              (0.02
              )
              
              **$**
              **(0.02**
              **)**
              
              $
              (0.05
              )





*Outstanding
      Options*





The
      following table summarizes information about stock options outstanding at June
      30, 2007:





*AMOUNTS
                IN THOUSANDS, EXCEPT FOR PRICE DATA*
            
            *Number
                of*
              *Options*
            
            *Aggregate*
              *Intrinsic
                Value*
            
            *Weighted-*
              *Average*
              *Exercise
                Price*Outstanding
            
            
            8,320
            
            
            $
            45,699
            
            
            $
            16.37Exercisable
            
            
            6,739
            
            
            
            36,220
            
            
            
            16.48





The
      aggregate intrinsic value in the preceding table represents the pre-tax amount
      that would have been received by the option holders had all option holders
      exercised their options at June 30, 2007.




11
 ***Table
            of Contents***




**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**


**Unaudited**


**TABULAR
      DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**


**June
      30, 2007**





*Current
      Activity*





A
      summary
      of the Company’s stock option activity and related information
      follows:





*Three
                Months Ended*
              *June
                30,*
            
            *Six
                Months Ended*
              *June
                30,**AMOUNTS
                IN THOUSANDS*
            
            **2007**
            
            2006
            
            **2007**
            
            
            2006Fair
                value of stock options granted
            
            **$**
            **—**
            
            
            $
            900
            
            
            **$**
            **—**
            
            
            $
            9,994Intrinsic
                value of options exercised
            
            ****
            **941**
            
            
            
            266
            
            
            ****
            **7,510**
            
            
            
            483Grant
                date fair value of options vested
            
            ****
            **967**
            
            
            
            884
            
            
            ****
            **7,614**
            
            
            
            7,399Proceeds
                from exercise of stock options
            
            ****
            **2,911**
            
            
            
            3,126
            
            
            ****
            **23,992**
            
            
            
            3,844Tax
                benefit realized as a result of stock option exercises
            
            ****
            **334**
            
            
            
            53
            
            
            ****
            **2,633**
            
            
            
            97





***Restricted
      Shares Plan***





Total
      compensation expense relating to the Restricted Shares Plan was $0.4 million
      and
      $0.7 million for the three and six months ended June 30, 2007, respectively,
      and
      $0.4 million and $0.5 million for the three and six months ended June 30, 2006,
      respectively. The Company granted 119,150 and 108,550 restricted shares with
      a
      total fair value of $2.6 million and $1.8 million during the six months ended
      June 30, 2007 and 2006, respectively. Unrecognized compensation cost for
      restricted stock grants totaled $3.3 million and $1.7 million at June 30, 2007
      and December 31, 2006, respectively. The unrecognized cost as of June 30, 2007,
      is scheduled to be recognized over a weighted-average period of 2.3
      years.





***Accelerated
      Vesting Provisions***





The
      Merger Agreement discussed in Note 2 of the *Notes to Condensed Consolidated
      Financial Statements* provides for the immediate vesting of certain stock
      option awards and restricted share awards on the effective date of the Merger.
      The assumptions used to recognize expense over the service period have not
      been
      altered by the acceleration provisions contained in the Merger
      Agreement.





**NOTE
      7.  SEGMENT INFORMATION**





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





The
      Company evaluates segment performance based on pre-tax underwriting profit
      or
      loss.  The Company does not allocate assets, net investment income,
      net realized investment gains or 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, 2006. All revenues are
      generated from external customers and the Company does not rely on any major
      customer.




12
 ***Table
            of Contents***




**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**


**Unaudited**


**TABULAR
      DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**


**June
      30, 2007**





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




*Homeowner
                and**Personal*
            
            *Earthquake**Auto
                Lines*
            
            *Lines
                in Runoff*
            
            *Total**Three
                Months Ended June 30, 2007*Net
                premiums earned
            
            **$**
            **334,424**
            
            
            **$**
            **—**
            
            
            **$**
            **334,424**Depreciation
                and amortization expense
            
            ****
            **6,524**
            
            
            ****
            **—**
            
            
            ****
            **6,524**Segment
                profit (loss)
            
            ****
            **19,108**
            
            
            ****
            **(166**
            **)**
            
            ****
            **18,942***Three
                Months Ended June 30, 2006*Net
                premiums earned
            
            $
            325,512
            
            
            $
            —
            
            
            $
            325,512Depreciation
                and amortization expense
            
            
            6,642
            
            
            
            1
            
            
            
            6,643Segment
                profit (loss)
            
            
            28,293
            
            
            
            (266
            )
            
            
            28,027*Six
                Months Ended June 30, 2007*Net
                premiums earned
            
            **$**
            **663,706**
            
            
            **$**
            **—**
            
            
            **$**
            **663,706**Depreciation
                and amortization expense
            
            ****
            **12,741**
            
            
            ****
            **1**
            
            
            ****
            **12,742**Segment
                profit (loss)
            
            ****
            **34,618**
            
            
            ****
            **(228**
            **)**
            
            ****
            **34,390***Six
                Months Ended June 30, 2006*Net
                premiums earned
            
            $
            651,336
            
            
            $
            —
            
            
            $
            651,336Depreciation
                and amortization expense
            
            
            13,301
            
            
            
            3
            
            
            
            13,304Segment
                profit (loss)
            
            
            45,765
            
            
            
            (342
            )
            
            
            45,423








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





*Three
                  Months Ended*
              
              *Six
                  Months Ended**June
                  30,*
              
              *June
                  30,***2007**
              
              2006
              
              **2007**
              
              2006Segment
                  profit
              
              **$**
              **18,942**
              
              
              $
              28,027
              
              
              **$**
              **34,390**
              
              
              $
              45,423Net
                  investment income
              
              ****
              **17,582**
              
              
              
              17,174
              
              
              ****
              **34,507**
              
              
              
              34,929Other
                  income
              
              ****
              **—**
              
              
              
              10
              
              
              ****
              **—**
              
              
              
              10Net
                  realized investment gains (losses)
              
              ****
              **64**
              
              
              
              30
              
              
              ****
              **351**
              
              
              
              (1,037
              )Other
                  expense
              
              ****
              **(2,436**
              **)**
              
              
              (923
              )
              
              ****
              **(6,613**
              **)**
              
              
              (923
              )Interest
                  and fees expense
              
              ****
              **(1,677**
              **)**
              
              
              (1,854
              )
              
              ****
              **(3,403**
              **)**
              
              
              (3,752
              )Consolidated
                  income before provision for income taxes
              
              **$**
              **32,475**
              
              
              $
              42,464
              
              
              **$**
              **59,232**
              
              
              $
              74,650




**NOTE
      8.  VARIABLE INTEREST ENTITIES**





In
      January 2003, the 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.





13
 ***Table
            of Contents***




**21ST
      CENTURY INSURANCE GROUP**


**NOTES
      TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)**


**Unaudited**


**TABULAR
      DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**


**June
      30, 2007**





The
      Company has decided to purchase investments that provide housing and other
      services to economically disadvantaged communities. To that end, the Company
      is
      a voluntary member, along with other participating insurance organizations,
      of
      Impact Community Capital, LLC (“Impact”). Impact’s charter is to facilitate
      loans and other investments in such communities.





The
      VIE
      structure provides a wider range of investment options through which insurance
      companies and other institutional investors can address the investment needs
      of
      these communities. The Company’s maximum participation in Impact C.I.L.,
      LLC (“Impact C.I.L.”), a subsidiary of Impact and a VIE, is for up to 11.1%
      ($52.8 million) of $475.0 million of the entity’s funding activities. These
      commitments consist of a $10.6 million minimum investment and a $42.2 million
      guarantee of a warehouse lending facility.  Potential losses are
      limited to the Company’s participation as well as associated operating
      fees.  The Company’s pro rata share of these advances to Impact
      C.I.L., which in turn makes housing investments in economically disadvantaged
      communities, was approximately 11.1%, or $8.3 million and $8.6 million at June
      30, 2007 and December 31, 2006, respectively.  The revolving member
      loan and the warehouse financing agreement do not significantly impact the
      Company’s liquidity or capital.





The
      Company is not the primary beneficiary of any of the VIEs as the Company has
      a
      non-controlling interest with voting rights, beneficiary rights, obligations,
      and ownership in proportion to each of its Impact related
      investments.





In
      addition to the above, the Company held $8.2 million in other Impact related
      fixed-income investments at June 30, 2007 and December 31, 2006. The Company
      also held $0.3 million in other Impact related private equity investments
      classified as other long-term investments at June 30, 2007 and December 31,
      2006. Total Impact related investment income was $0.2 million and $0.5 million
      for the three and six months ended June 30, 2007, respectively, and $0.2 million
      and $0.5 million for the same periods in 2006, respectively.




14
 ***Table
            of Contents***





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





Management’s
      Discussion and Analysis of Financial Condition and Results of Operations
      (“MD&A”) is intended to help the reader understand the Company, our
      operations and our present business environment.  MD&A should be
      read in conjunction with the accompanying condensed consolidated financial
      statements. MD&A includes the following sections:




·
            Overview




·
            Results
                of
                Operations




·
            Financial
                Condition




·
            Liquidity
                and Capital
                Resources




·
            Contractual
                Obligations and
                Commitments




·
            Critical
                Accounting
                Estimates




·
            Recent
                Accounting
                Pronouncements




·
            Forward-Looking
                Statements





**OVERVIEW**





***General***





21st
      Century Insurance Group is an insurance holding company registered on the New
      York Stock Exchange. For convenience, the terms “Company”, “21st”, “21st Century”,
“we”, “us”
or “our”
are used
      to refer collectively to the parent company and its
      subsidiaries.





Founded
      in 1958, we are a direct-to-consumer provider of personal auto
      insurance.  With $1.4 billion of revenue in 2006, we insure over 1.6
      million vehicles in Arizona, California, Florida, Georgia, Illinois, Indiana,
      Nevada, New Jersey, Ohio, Oregon, Pennsylvania, Texas, Washington, Colorado,
      Minnesota, Missouri, New York, and Wisconsin. We provide superior policy
      features and customer service at a competitive price. Customers can receive
      a
      quote, purchase a policy, service their policy, or report a claim at
*www.21st.com* or over the phone with our licensed insurance
      professionals at 1-800-211-SAVE.  Service is offered in English and
      Spanish, both over the phone and on the web, 24 hours a day, 365 days a year.
      Our insurance subsidiaries, 21st Century Insurance Company (our primary
      insurance subsidiary), 21st Century Casualty Company, and 21st Century Insurance
      Company of the Southwest (“21st of the Southwest”), are rated A+ by A.M. Best,
      Fitch Ratings and Standard & Poor’s.





Our
      long-term financial goals include achieving a 96% or lower combined ratio,
      15%
      annual growth in direct premiums written, 15% return on stockholders’ equity,
      and strong financial ratings.





***Agreement
      and Plan of Merger***





On May
      15, 2007, 21st Century Insurance Group and American International Group,
      Inc. (“AIG”) entered into a merger agreement (the “Merger Agreement”)
      providing for the acquisition by AIG of all of the outstanding shares of common
      stock of 21st Century not currently owned by AIG for $22.00 per share in
      cash.  The Company’s Board of Directors unanimously approved the
      Merger Agreement following the recommendation and approval of a Special
      Committee comprised of directors of 21st Century who are independent of
      AIG.  AIG currently owns approximately 60.8% of the outstanding shares of
      21st Century.  The transaction represents a 32.6% premium over 21st
      Century’s closing price on January 24, 2007, the day of AIG’s unsolicited merger
      proposal, and an 11.4% premium over AIG’s original proposal price of $19.75 per
      share.  Upon completion of the transaction, 21st Century will become a
      wholly owned subsidiary of AIG.




The
      Merger is expected to be completed in the third quarter of calendar year 2007,
      subject to customary conditions and approvals.  The exact timing is
      dependent on the review and clearance of necessary filings with the Securities
      and Exchange Commission.  The transaction is subject to the affirmative
      vote of the holders of a majority of the outstanding shares of 21st
      Century.  However, AIG has agreed to vote all of its 21st Century shares in
      favor of the Merger, thereby assuring that approval will be obtained at the
      21st
      Century stockholders’ meeting relating to the Merger.




In
      connection with the Merger, AIG estimates the total amount of funds required
      to
      purchase all of the outstanding common stock of the Company not currently owned
      by AIG and its subsidiaries and to pay estimated fees and expenses will be
      approximately $825.0 million.




Acceleration
      provisions in certain agreements, including the supplemental executive
      retirement plan and stock-based compensation plans, will be triggered
      as a result of provisions in the Merger Agreement, resulting in the accelerated
      recognition of expense on the date of the Merger that could materially impact
      the Company’s future results of operations.  The Company's retirement
      and stock option valuation assumptions have not been altered for provisions
      in the Merger Agreement.**** See further discussion in Note 2
      of the *Notes to Condensed Consolidated Financial
      Statements.*





15
 ***Table
            of Contents***





***National
      Expansion***





The
      Company is implementing a multi-year strategy for national expansion to realize
      benefits from economies of scale, lower unit marketing costs due to the cost
      efficiency of buying advertising on a national basis, less dependency on any
      single market and the operating flexibility to focus resources on attractive
      markets and deemphasize less attractive markets. In execution of this strategy,
      21st expanded its operations into the Midwest (2004); Texas (2005); Florida,
      Georgia and Pennsylvania (second quarter of 2006); New Jersey (October 2006);
      Colorado, Minnesota, Missouri, and Wisconsin (fourth quarter 2006); and New
      York
      (April 2007). The Company increased the share of total U.S. personal auto market
      in which it operates from approximately 18% in 2003 to 66% in 2007. Growth
      in
      direct premiums written in non-California markets in the three months and six
      months ended June 30, 2007 was 143.4% and 153.9%, respectively, as compared
      to
      51.8% and 189.1% in the same period in 2006, respectively, and we wrote
      approximately 22% of the first half of 2007’s direct premiums outside of
      California, versus 9% for the same period of 2006. Continued implementation
      of
      our geographic expansion strategy could be affected by a number of factors
      beyond our control, such as increased competition, judicial, regulatory,
      legislative developments, general economic conditions, increased operating
      costs, or change in control of the Company.





***Highlights***





The
      following table summarizes our
      underwriting profit, which is reconciled to net income in *Results of
      Operations*:





*Three
                Months Ended*
              *June
                30,*
            
            *Six
                Months Ended*
              *June
                30,**AMOUNTS
                IN THOUSANDS*
            
            **2007**
            
            2006
            
            *%
                Change*
              *’07
                vs.‘06*
            
            **2007**
            
            2006
            
            *%
                Change*
              *’07
                vs.‘06*Direct
                premiums written
            
            **$**
            **323,122**
            
            
            $
            316,838
            
            
            
            2.0
            %
            
            **$**
            **673,652**
            
            
            $
            655,406
            
            
            
            2.8
            %Net
                premiums written
            
            ****
            **321,594**
            
            
            
            315,477
            
            
            
            1.9
            
            
            ****
            **670,616**
            
            
            
            652,699
            
            
            
            2.7Net
                premiums earned
            
            **$**
            **334,424**
            
            
            $
            325,512
            
            
            
            2.7
            
            
            **$**
            **663,706**
            
            
            $
            651,336
            
            
            
            1.9Net
                losses and loss adjustment expenses (“LAE”)
            
            ****
            **(235,221**
            **)**
            
            
            (223,094
            )
            
            
            5.4
            
            
            ****
            **(468,678**
            **)**
            
            
            (459,590
            )
            
            
            2.0Underwriting
                expenses
            
            ****
            **(80,261**
            **)**
            
            
            (74,391
            )
            
            
            7.9
            
            
            ****
            **(160,638**
            **)**
            
            
            (146,323
            )
            
            
            9.8Underwriting
                profit
            
            **$**
            **18,942**
            
            
            $
            28,027
            
            
            
            (32.4
            )
            
            **$**
            **34,390**
            
            
            $
            45,423
            
            
            
            (24.3
            )





Financial
      highlights for the three months ended June 30, 2007 and 2006:




·
            California
                direct premiums written decreased 12.5% to $251.4 million for the
                quarter
                ended June 30, 2007, compared to $287.4 million for the same period
                in
                2006.




·
            Non-California
                direct premiums written increased 143.4% to $71.7 million for the
                quarter
                ended June 30, 2007, compared to $29.4 million for the same period
                in
                2006.




·
            Consolidated
                combined ratio was 94.3% for the quarter ended June 30, 2007, versus
                91.4%
                for the same period in 2006.  The consolidated combined ratios
                for the three months ended June 30, 2007 and 2006 were both favorably
                impacted by 5.6 points of prior accident year loss and LAE reserve
                development.





Financial
      highlights for the six months ended June 30, 2007 and 2006:




·
            California
                direct premiums written decreased 11.4% to $531.0 million for the
                six
                months ended June 30, 2007, compared to $599.2 million for the same
                period
                in 2006.




·
            Non-California
                direct premiums written increased 153.9% to $142.7 million for the
                six
                months ended June 30, 2007, compared to $56.2 million for the same
                period
                in 2006.




·
            Consolidated
                combined ratio was 94.8% for the six months ended June 30, 2007,
                versus
                93.0% for the same period in 2006.  2007 was favorably impacted
                by 5.5 points of prior accident year loss and LAE reserve development,
                while 2006 was favorably impacted by 3.9 points of prior accident
                year
                development.





For
      the
      three months and six months ended June 30, 2007, 21st’s insurance subsidiaries
      achieved underwriting profitability and realized growth in total direct premiums
      written in spite of developments in the California market. In recent quarters,
      the California market, which represented approximately 78% of our total direct
      premiums written during the first half of 2007, compared to 91% for the first
      half of 2006, has seen stable to declining rates from competitors and a reduced
      level of shopping behavior by consumers. Both of these factors reduced our
      opportunities for profitable growth in this state, but this was offset by growth
      realized in non-California markets as a result of our national expansion
      efforts.





The
      underwriting expense (policy acquisition costs and other underwriting expenses)
      to net premiums earned ratio increased to 24.0% for the three months ended
      June
      30, 2007 from 22.9% for the same period in 2006.  For the six months
      ended June 30, 2007, the underwriting expense to net premiums earned ratio
      increased to 24.2% from 22.4% for the same period in 2006.  These
      increases are primarily the result of expenses associated with the Company’s
      national expansion efforts.




16
 ***Table
            of Contents***





Net
      income decreased 19.4% to $22.8million, or $0.26per
      basic share, for the
      three months ended June 30, 2007, compared to $28.3 million, or $0.33 per basic
      share, for the same period in 2006.  This was primarily due to higher
      underwriting expenses discussed above.  Also, net income during the
      second quarter 2007 was impacted by $2.4 million ($1.7 million after-tax, or
      $0.02 per basic share) of costs associated with the Special Committee of the
      Board of Directors and its advisors’ evaluation and negotiation of the merger
      proposal from AIG. Net income decreased 17.0% to $41.2million, or $0.47per
      basic share, for the
      six months ended June 30, 2007, compared to $49.6 million, or $0.58 per basic
      share, for the same six-month period in 2006. This was primarily due to lower
      underwriting profit realized as a result of the California rate decrease
      discussed below, and higher underwriting expenses discussed above. Additionally,
      2007 results were impacted by $6.6 million ($4.4 million after-tax, or $0.05
      per
      basic share) of non-operational items comprised of $3.6 million of severance
      costs associated with the Company’s efforts to streamline operations and $3.0
      million of costs associated with the Special Committee of the Board of Directors
      and its advisors’ evaluation and negotiation of the merger proposal from
      AIG.




In
      July
      2006, the California Department of Insurance (the “CDI”) obtained approval for
      changes to regulations (the “Auto Rating Factor Regulations”) relating to
      automobile insurance rating factors, particularly concerning territorial
      rating.  Because the new Auto Rating Factor Regulations required every
      personal auto insurance company operating in California to make a class plan
      and
      rate filing in the third quarter of 2006, competitive rate levels have changed
      and consumer shopping behavior may increase in the future.  The
      Company has filed for a personal automobile overall rate decrease in California
      of approximately 5%. The CDI approved the Company’s class plan and rate filings
      and the new rates took effect January 3, 2007. Most of the Company’s main
      competitors have also received approval of overall rate decreases of varying
      amounts, while some have not substantially changed overall rate levels while
      attempting to comply with the new regulations. It is not possible at this time
      to predict the ultimate impact of these changes, which could have either a
      materially favorable or materially adverse impact on the Company.





Also
      in
      July 2006, the CDI proposed new amended rate approval regulations (the “Rate
      Approval Regulations”) affecting personal auto, homeowners and most lines of
      commercial property and casualty insurance written in California. The
      regulations became effective on April 3, 2007. These regulations could have
      a
      materially adverse impact on the Company’s California results.





***Non-GAAP
      Measures***





Information
      concerning premiums written, underwriting profit, combined ratio and statutory
      surplus have been presented to enhance readers’ understanding of the Company’s
      operations.  These widely used financial measures in the insurance
      industry do not have formal definitions currently under accounting principles
      generally accepted in the United States of America (“GAAP”).





Premiums
      written represent the premiums charged on policies issued during a fiscal
      period. We use premiums written as a measure of the underlying growth of our
      insurance business from period to period. The most directly comparable GAAP
      measure, premiums earned, represents the portion of premiums written that is
      recognized as income on a pro rata basis over the terms of the
      policies.





Underwriting
      profit consists of net premiums earned less losses from claims, loss adjustment
      expenses and underwriting expenses. 21st believes that underwriting profit
      (loss) provides investors with financial information that is not only
      meaningful, but critically important to understanding the results of property
      and casualty insurance operations. The results of operations of a property
      and
      casualty insurance company include three components: underwriting profit (loss),
      net investment income and realized capital gains (losses).  Without
      disclosure of underwriting profit (loss), it is difficult to determine how
      successful an insurance company is in its core business activity of assessing
      and underwriting risk, as including investment income and realized capital
      gains
      (losses) in the results of operations without disclosing underwriting profit
      (loss) can mask underwriting losses.





Statutory
      surplus represents equity at 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 to statutory surplus.





**The
      reconciliations of these financial measures to the most directly comparable
      GAAP
      measures are in the following locations: premiums written and underwriting
      profit are located in *Results of Operations* and statutory surplus is
      located in *Liquidity and Capital Resources*. These financial measures
      are not intended to replace, and should be read in conjunction with, the GAAP
      financial measures.





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





17
 ***Table
            of Contents***





**RESULTS
      OF OPERATIONS**





***Consolidated
      Results***





The
      following table summarizes our segment results of operations and reconciles
      underwriting profit to consolidated net income:





*Three
                Months Ended*
              *June
                30,*
            
            *Six
                Months Ended*
              *June
                30,**AMOUNTS
                IN THOUSANDS,*
              *EXCEPT
                SHARE DATA*
            
            **2007**
            
            2006
            
            *%
                Change*
              *’07
                vs.‘06*
            
            **2007**
            
            2006
            
            *%
                Change*
              *’07
                vs.‘06*Personal
                auto lines underwritingprofit
            
            **$**
            **19,108**
            
            
            $
            28,293
            
            
            
            (32.5
            )%
            
            **$**
            **34,618**
            
            
            $
            45,765
            
            
            
            (24.4
            )%Homeowner
                and earthquake lines inrunoff,
                underwriting loss
            
            ****
            **(166**
            **)**
            
            
            (266
            )
            
            
            (37.6
            )
            
            ****
            **(228**
            **)**
            
            
            (342
            )
            
            
            (33.3
            )Net
                investment income
            
            ****
            **17,582**
            
            
            
            17,174
            
            
            
            2.4
            
            
            ****
            **34,507**
            
            
            
            34,929
            
            
            
            (1.2
            )Other
                income
            
            
            —
            
            
            
            10
            
            
            N/M1
            
            
            
            —
            
            
            
            10
            
            
            N/M1Net
                realized investment gains (losses)
            
            ****
            **64**
            
            
            
            30
            
            
            
            113.3
            
            
            ****
            **351**
            
            
            
            (1,037
            )
            
            
            133.8Other
                expense
            
            ****
            **(2,436**
            **)**
            
            
            (923
            )
            
            
            163.9
            
            
            ****
            **(6,613**
            **)**
            
            
            (923
            )
            
            
            616.5Interest
                and fees expense
            
            ****
            **(1,677**
            **)**
            
            
            (1,854
            )
            
            
            (9.5
            )
            
            ****
            **(3,403**
            **)**
            
            
            (3,752
            )
            
            
            (9.3
            )Provision
                for income taxes
            
            ****
            **(9,637**
            **)**
            
            
            (14,143
            )
            
            
            (31.9
            )
            
            ****
            **(18,048**
            **)**
            
            
            (25,011
            )
            
            
            (28.0
            )Net
                income
            
            **$**
            **22,838**
            
            
            $
            28,321
            
            
            
            (19.4
            )
            
            **$**
            **41,184**
            
            
            $
            49,639
            
            
            
            (17.0
            )Basic
                earnings per share
            
            **$**
            **0.26**
            
            
            $
            0.33
            
            
            
            (21.2
            )
            
            **$**
            **0.47**
            
            
            $
            0.58
            
            
            
            (19.0
            )Diluted
                earnings per share
            
            **$**
            **0.25**
            
            
            $
            0.33
            
            
            
            (24.2
            )
            
            **$**
            **0.46**
            
            
            $
            0.57
            
            
            
            (19.3
            )





Underwriting
      results above include the effect of prior accident years’ reserve development
      recorded in the current year. The following table summarizes losses and LAE
      incurred, net of applicable reinsurance, for the periods indicated:





*Three
                Months Ended*
              *June
                30,*
            
            *Six
                Months Ended*
              *June
                30,**AMOUNTS
                IN THOUSANDS*
            
            **2007**
            
            2006
            
            **2007**
            
            2006Net
                losses and LAE incurred related to insured events in:Current
                accident year personal auto lines
            
            **$**
            **253,905**
            
            
            $
            241,215
            
            
            **$**
            **505,245**
            
            
            $
            484,726Prior
                accident years:Personal
                auto lines
            
            ****
            **(18,850**
            **)**
            
            
            (18,387
            )
            
            ****
            **(36,795**
            **)**
            
            
            (25,479
            )Homeowner
                and earthquake lines in runoff
            
            ****
            **166**
            
            
            
            266
            
            
            ****
            **228**
            
            
            
            343Total
                prior years’ development recorded in current year
            
            ****
            **(18,684**
            **)**
            
            
            (18,121
            )
            
            ****
            **(36,567**
            **)**
            
            
            (25,136
            )Total
                net losses and LAE incurred
            
            **$**
            **235,221**
            
            
            $
            223,094
            
            
            **$**
            **468,678**
            
            
            $
            459,590





We
      perform quarterly reviews of the adequacy of carried unpaid losses and LAE.
      These estimates depend on many assumptions about the outcome of future events.
      Consequently, 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 at June 30, 2007 and 2006.  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. See *Critical Accounting Estimates – Losses and Loss
      Adjustment**Expenses* for additional discussion of our reserving
      policy.





***Personal
      Auto Lines Underwriting Results***





Personal
      automobile insurance is our primary line of business.  Non-California
      states accounted for 22.2% of our direct premiums written for the three months
      ended June 30, 2007, compared to 9.3% for the same period in
      2006.  For the six months ended June 30, 2007, non-California states
      accounted for 21.2% of our direct premiums written, compared to 8.6% for the
      same period in 2006.  This increase is due to our ongoing national
      expansion program. The Company currently plans to expand into additional states
      to further its national expansion strategy.






1Ratio
      is not
      meaningful.





18
 ***Table
            of Contents***





The
      following table presents the components of our personal auto lines underwriting
      profit and the components of the combined ratio:




*Three
                Months Ended*
            
            *Six
                Months Ended**June
                30,*
            
            *June
                30,**AMOUNTS
                IN THOUSANDS*
            
            **2007**
            
            2006
            
            *Change*
              *’07
                vs.‘06*
            
            *%
                Change*
              *’07
                vs.‘06*
            
            **2007**
            
            2006
            
            *Change*
              *’07
                vs.‘06*
            
            *%
                Change*
              *’07
                vs.‘06*Direct
                premiums written
            
            **$**
            **323,122**
            
            
            $
            316,837
            
            
            $
            6,285
            
            
            
            2.0
            %
            
            **$**
            **673,652**
            
            
            $
            655,406
            
            
            $
            18,246
            
            
            
            2.8
            %Net
                premiums written
            
            **$**
            **321,594**
            
            
            $
            315,476
            
            
            $
            6,118
            
            
            
            1.9
            
            
            **$**
            **670,616**
            
            
            $
            652,700
            
            
            $
            17,916
            
            
            
            2.7Net
                premiums earned
            
            **$**
            **334,424**
            
            
            $
            325,512
            
            
            $
            8,912
            
            
            
            2.7
            
            
            **$**
            **663,706**
            
            
            $
            651,336
            
            
            $
            12,370
            
            
            
            1.9Net
                losses and LAE
            
            ****
            **(235,055**
            **)**
            
            
            (222,828
            )
            
            
            12,227
            
            
            
            5.5
            
            
            ****
            **(468,450**
            **)**
            
            
            (459,248
            )
            
            
            9,202
            
            
            
            2.0Underwriting
                expenses
            
            ****
            **(80,261**
            **)**
            
            
            (74,391
            )
            
            
            5,870
            
            
            
            7.9
            
            
            ****
            **(160,638**
            **)**
            
            
            (146,323
            )
            
            
            14,315
            
            
            
            9.8Underwriting
                profit
            
            **$**
            **19,108**
            
            
            $
            28,293
            
            
            $
            (9,185
            )
            
            
            (32.5
            )
            
            **$**
            **34,618**
            
            
            $
            45,765
            
            
            $
            (11,147
            )
            
            
            (24.4
            )Ratios:Loss
                and LAE ratio
            
            ****
            **70.3**
            **%**
            
            
            68.5
            %
            
            
            1.8
            
            
            
            
            
            
            ****
            **70.6**
            **%**
            
            
            70.5
            %
            
            
            0.1Underwriting
                expense ratio
            
            ****
            **24.0**
            
            
            
            22.9
            
            
            
            1.2
            
            
            
            
            
            
            ****
            **24.2**
            
            
            
            22.5
            
            
            
            1.7Combined
                ratio
            
            ****
            **94.3**
            **%**
            
            
            91.4
            %
            
            
            3.0
            
            
            
            
            
            
            ****
            **94.8**
            **%**
            
            
            93.0
            %
            
            
            1.8





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




*Three
                  Months Ended*
              
              *Six
                  Months Ended**June
                  30,*
              
              *June
                  30,**AMOUNTS
                  IN THOUSANDS*
              
              **2007**
              
              2006
              
              **2007**
              
              2006Direct
                  premiums written
              
              **$**
              **323,122**
              
              
              $
              316,837
              
              
              **$**
              **673,652**
              
              
              $
              655,406Ceded
                  premiums written
              
              ****
              **(1,528**
              **)**
              
              
              (1,361
              )
              
              ****
              **(3,036**
              **)**
              
              
              (2,706
              )Net
                  premiums written
              
              ****
              **321,594**
              
              
              
              315,476
              
              
              ****
              **670,616**
              
              
              
              652,700Net
                  change in unearned premiums
              
              ****
              **12,830**
              
              
              
              10,036
              
              
              ****
              **(6,910**
              **)**
              
              
              (1,364
              )Net
                  premiums earned
              
              **$**
              **334,424**
              
              
              $
              325,512
              
              
              **$**
              **663,706**
              
              
              $
              651,336





California
      direct premiums written decreased in the three months and six months ended
      June
      30, 2007, as compared to the same periods in 2006, primarily due to a 5% rate
      decrease and continued competitiveness in the California market. As discussed
      in
      the *Highlights*, the CDI issued changes to regulations relating to
      automobile insurance rating factors, particularly concerning territorial rating
      in July 2006.  It is not possible at this time to predict the impact
      of these changes, which could have either a favorable or adverse impact on
      the
      Company.  Also in July 2006, the CDI proposed new amended rate
      approval regulations affecting personal auto, homeowners and most lines of
      commercial property and casualty insurance written in California, subsequently
      amended in October of 2006 and approved in January of 2007 with an effective
      date of April 3, 2007. These regulations could have a materially adverse impact
      on the Company’s California results.





As
      the
      Company proceeds with its national expansion strategy, we believe that achieving
      our long-term growth goal will steadily depend less on the California
      marketplace.  The Company’s national expansion efforts will provide us
      with flexibility to use combinations of local and national marketing media,
      as
      appropriate, and the ability to focus our marketing expenditures and Company
      resources on attractive markets, while minimizing costs in less attractive
      markets.





The
      increase in the loss and LAE ratio for the three months ended June 30, 2007
      over
      the same period in 2006 of 1.8 points is primarily due to the California rate
      decrease discussed above. The loss and LAE ratios for the three months ended
      June 30, 2007 and 2006 were both favorably impacted by 5.6 points of prior
      accident year loss and LAE reserve development. The loss and LAE ratios included
      $18.9 million and $18.4 million of favorable reserve development for the three
      months ended June 30, 2007 and 2006, respectively. The loss and LAE ratio for
      the six months ended June 30, 2007 is consistent with the same period in
      2006.  For the six months ended June 30, 2007 loss and LAE ratio
      included 5.5 points ($36.8 million) of favorable reserve development compared
      to
      3.9 points ($25.5 million) in the same period of 2006.  In general,
      changes in estimates are recorded in the period in which new information becomes
      available indicating that a change is warranted.





The
      underwriting expense to net premiums earned ratios increased in the three months
      and six months ended June 30, 2007, as compared to the same period in the prior
      year.  This increase is primarily the result of expenses associated
      with the Company’s national expansion efforts.





***Homeowner
      and Earthquake Lines in Runoff***





We
      have
      not written any earthquake policies since 1994 and exited the voluntary
      homeowner insurance business in 2002. Underwriting results of the homeowner
      and
      earthquake lines, which are in runoff, include losses and LAE incurred of $0.2
      million for the three and six months ended June 30, 2007 and $0.3 million for
      the three and six months ended June 30, 2006. California Senate Bill 1899
      (“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 last remaining earthquake claim brought
      against the Company as a result of SB 1899 was resolved in the first quarter
      of
      2007.





19
 ***Table
            of Contents***





***Net
      Investment Income***





We
      utilize a conservative investment philosophy. Substantially the entire fixed
      maturity securities portfolio is investment grade, having a weighted-average
      Standard & Poor’s credit quality of “AA”.  No derivatives are held
      in our investment portfolio and there were no publicly traded equity securities
      at June 30, 2007.  The Company previously held publicly traded
      equities, but sold them in the first quarter of 2006, lowering the risk and
      yield of the overall investment portfolio. The components of net investment
      income were as follows:




*Three
                Months Ended*
            
            *Six
                Months Ended**June
                30,*
            
            *June
                30,**AMOUNTS
                IN THOUSANDS*
            
            **2007**
            
            2006
            
            **2007**
            
            2006Interest
                on fixed maturity securities, at fair value
            
            **$**
            **16,889**
            
            
            $
            17,087
            
            
            **$**
            **33,715**
            
            
            $
            33,954Interest
                on cash and cash equivalents
            
            ****
            **942**
            
            
            
            287
            
            
            ****
            **1,469**
            
            
            
            621Loss
                from other long-term investments, equity method
            
            
            —
            
            
            
            —
            
            
            ****
            **(187**
            **)**
            
            
            —Dividends
                on equity securities
            
            
            —
            
            
            
            —
            
            
            
            —
            
            
            
            811Total
                investment income
            
            ****
            **17,831**
            
            
            
            17,374
            
            
            ****
            **34,997**
            
            
            
            35,386Investment
                expense
            
            ****
            **(249**
            **)**
            
            
            (200
            )
            
            ****
            **(490**
            **)**
            
            
            (457
            )Net
                investment income
            
            **$**
            **17,582**
            
            
            $
            17,174
            
            
            **$**
            **34,507**
            
            
            $
            34,929





The
      fixed
      maturity securities portfolio comprised 99% of the total investment portfolio
      at
      June 30, 2007 and December 31, 2006.The average annual yields on fixed maturity
      securitieswere as
      follows:




*Three
                  Months Ended*
              
              *Six
                  Months Ended**June
                  30,*
              
              *June
                  30,***2007**
              
              2006
              
              **2007**
              
              2006Pre-tax
                  – fixed maturity securities
              
              ****
              **4.6**
              **%**
              
              
              4.6
              %
              
              ****
              **4.6**
              **%**
              
              
              4.7
              %After-tax
                  – fixed maturity securities
              
              ****
              **3.3**
              **%**
              
              
              3.3
              %
              
              ****
              **3.3**
              **%**
              
              
              3.4
              %





At
      June 30, 2007, $368.6 million, or
      26.4%, of our total fixed maturity securities at fair value were invested in
      tax-exempt bonds, compared to 26.4% at December 31, 2006, with the remainder
      invested in taxable securities. At June 30, 2007, no investments were rated
      below investment grade.





The
      net
      realized gains (losses) on investments were as follows:




*Three
                Months Ended*
              *June
                30,*
            
            *Six
                Months Ended*
              *June
                30,**AMOUNTS
                IN THOUSANDS*
            
            **2007**
            
            2006
            
            **2007**
            
            2006Gross
                realized gains
            
            **$**
            **239**
            
            
            $
            97
            
            
            **$**
            **621**
            
            
            $
            1,549Gross
                realized losses
            
            ****
            **(175**
            **)**
            
            
            (67
            )
            
            ****
            **(270**
            **)**
            
            
            (2,586
            )Net
                realized gains (losses) on investments
            
            **$**
            **64**
            
            
            $
            30
            
            
            **$**
            **351**
            
            
            $
            (1,037
            )





During
      the first quarter of 2006, the Company sold its investments in publicly held
      equity securities, contributing to the recognition of a $1.4 million loss on
      equity securities in the period. 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 six months ended June 30, 2007 or for the same periods in 2006. See
      discussion under *Critical Accounting Estimates – Investments* for
      further information.




20
 ***Table
            of Contents***





***Other
      Expense***





In
      the
      first quarter of 2007, the Company reduced its workforce by an approximate
      three
      percent in connection with efforts to streamline operations.  The
      Company incurred $3.4 million in severance and other benefits costs during
      the
      first quarter of 2007 and subsequently adjusted this estimate by $0.2 million
      during the second quarter for the differences between the original estimate
      and
      subsequent payments.  At March 31 and June 30, 2007, the undistributed
      severance and other benefits payments in connection with this workforce
      reduction was $0.4 million due to the payments of $0.2 million in the second
      quarter that were offset by the revision of the estimate. The remaining payments
      are expected to be distributed by the end of 2007. Annual savings from this
      reduction in workforce are estimated to be primarily offset by merit increases
      and costs associated with national expansion efforts.





The
      Company also incurred $2.3 million and $3.0 million for the three and six months
      ended June 30, 2007, respectively, in connection with the Merger Agreement,
      as
      discussed in Note 2 of the *Notes to Condensed Consolidated Financial
      Statements*.





**FINANCIAL
      CONDITION**





Investments
      and cash were $1.5 billion
      at June 30, 2007 and December 31, 2006.  The Company sold its
      investments in publicly held equity securities during the first quarter of
      2006,
      with the proceeds primarily reinvested in fixed maturity securities and did
      not
      hold any publicly held equity securities at June 30, 2007.  However,
      we executed a $35 million funding commitment for a private equity investment
      program during the second quarter of 2006. The Company’s funded commitment was
      $18.1 million and $14.4 million at June 30, 2007 and December 31, 2006,
      respectively.





The
      Company also has unrated, community
      investments representing 1.7% of total investments. These investments have
      been
      made in an effort to provide housing and other services to economically
      disadvantaged communities. See Note 8 of the *Notes to Condensed Consolidated
      Financial Statements* for additional information.




Deferred
      policy acquisition costs
      totaled $63.6 million at June 30, 2007 and December 31, 2006. This balance
      remained consistent between periods as increased advertising, sales and customer
      service costs due to the Company’s national expansion efforts during 2007 were
      offset by amortization, as spending was concentrated in the first quarter,
      and a
      $3.8 million decrease in deferred policy acquisition costs (“DPAC”) resulting
      from the adoption of Statement of Position 05-1 (see *Recent Accounting
      Pronouncements)*.  Our DPAC is estimated to be fully recoverable
      (see *Critical Accounting Estimates – Deferred Policy Acquisition
      Costs*).





The
      following table summarizes unpaid losses and LAE, gross and net of applicable
      reinsurance, with respect to our lines of business:





**June
                30, 2007**
            
            December
                31, 2006*AMOUNTS
                IN THOUSANDS*
            
            **Gross**
            
            **Net**
            
            Gross
            
            NetUnpaid
                losses and LAEPersonal
                auto lines
            
            **$**
            **449,893**
            
            
            **$**
            **444,433**
            
            
            $
            480,731
            
            
            $
            475,261Homeowner
                and earthquake lines in runoff
            
            ****
            **1,361**
            
            
            ****
            **680**
            
            
            
            1,538
            
            
            
            808Total
            
            **$**
            **451,254**
            
            
            **$**
            **445,113**
            
            
            $
            482,269
            
            
            $
            476,069





At
      June 30, 2007, gross unpaid losses
      and LAE decreased $31.0 million, primarily due to a reserve decrease of $30.8
      million in the personal auto lines as a result of $36.8 million of favorable
      prior year loss development recorded during the six months ended June 30, 2007.
      The gross unpaid losses and LAE in the homeowner and earthquake lines decreased
      $0.2 million as the result of continued runoff activity (see *Critical
      Accounting Estimates – Losses and Loss Adjustment Expenses*for a
      description of the Company’s reserving process).




Debt
      of
      $109.2 million at June 30, 2007, compared to $115.9 million at December 31,
      2006, consists of $9.3 million of capital lease obligations and $99.9 million
      of
      Senior Notes, net of discount. The decrease in debt of $6.7 million during
      the
      six months ended June 30, 2007 is primarily attributable to principal payments
      on the capital leases.





Stockholders’
equity
      and book value per
      share increased to $932.4 million and $10.59, respectively, at June 30, 2007,
      compared to $898.5 million and $10.39 at December 31, 2006,
      respectively.  The increase in stockholders’ equity for the six months
      ended June 30, 2007 was primarily due to net income of $41.2 million, $26.5
      million from the exercise of stock options, and stock-based compensation cost
      of
      $3.6 million.****This
      was partially offset by dividends
      to stockholders of $28.1 million, other comprehensive loss of $7.0 million
      and
      an adjustment of $2.4 million for the adoption of Financial Interpretation
      No.
      48,*Accounting for
      Uncertainty in Income Taxes – an Interpretation of FAS No. 109*.




21
 ***Table
            of Contents***





**LIQUIDITY
      AND CAPITAL RESOURCES**





***Holding
      Company***




Our
      holding company’s main sources of liquidity historically have been dividends
      received from our insurance subsidiaries, borrowing from our primary insurance
      subsidiary, 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 AIG exercised its warrants to purchase 16 million
      sharesofcommon stock for
      cash of $145.6 million. Our insurance subsidiaries did not pay any dividends
      to
      our holding company from 2001 to 2004 due to the previous uncertainty
      surrounding the taxability of dividends received by holding companies from
      their
      insurance subsidiaries in California, which was resolved in 2004. Our primary insurance
      subsidiary, 21st Century Insurance Company, declared and paid a $110.0 million
      dividend in December 2006.




Effective
      December 31, 2003, the CDI approved an intercompany lease whereby 21st Century
      Insurance Company leases certain computer software from our holding company.
      The
      monthly lease payment, currently $0.9 million, started in January 2004 and
      has
      been subject to upward adjustments based on the cost incurred by the holding
      company to enhance the software.




Our
      holding company’s significant cash obligations over the next several years
      consist of the following:




·
            Ongoing
                costs to enhance our computer
                software;




·
            The
                repayment of the $100 million principal on the Senior Notes due in
                2013;




·
            Related
                interest on the Senior Notes above;




·
            The
                repayment of the $60 million term loan due to subsidiary;
                and




·
            Any
                dividends to stockholders that our board of directors may
                declare.





The
      declaration and payment of dividends is subject to the discretion of our board
      of directors and will depend on our financial condition, results of operations,
      cash requirements, future prospects, and regulatory and contractual restrictions
      on the payment of dividends by our subsidiaries, and other factors deemed
      relevant by our board of directors. There is no requirement that we must, and
      we
      cannot assure you that we will, declare and pay any dividends in the future.
      Our
      board of directors may determine to retain such capital for general corporate
      or
      other purposes. The Merger Agreement among the Company and AIG limits the amount
      of dividends that the Company may declare to regular quarterly dividends on
      shares of no more than $0.16 per share (the record dates for which shall be
      the
      close of business, September 24, 2007, December 21, 2007 and March 5, 2008,
      respectively) which are payable after the last day of any quarter. If the Merger
      closes between record dates, the Merger Agreement allows for a special dividend
      equivalent up to $0.16 per share (adjusted on a pro rata basis for the passage
      of time since the last record date).




We
      expect
      to be able to meet these obligations from sources of cash currently available
      (i.e., cash and investments at the holding company, which totaled $94.0 million
      at June 30, 2007, dividends received from our insurance subsidiaries, payments
      received from the intercompany lease, and borrowing from our insurance
      subsidiary), or additional funds that may be obtainable from the capital
      markets. The effective California state income tax rate applicable to dividends
      received from our insurance subsidiaries is approximately 1.8%, or 1.2% net
      of
      federal benefit. In December 2007, our primary insurance subsidiary could pay
      $124.0 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 since 2001
      and have thereby enhanced our liquidity. Our cash flows 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. Our underwriting
      results are impacted by rate changes. Although in the past years we have been
      successful in gaining California regulatory approval for rate changes, there
      can
      be no assurance that insurance regulators will grant future rate changes that
      may be necessary to offset possible future increases in claims cost
      trends.




As
      discussed in the *Highlights*, in July 2006, the CDI issued changes to
      regulations relating to automobile insurance rating factors, particularly
      concerning territorial rating.  It is not possible at this time to
      predict the ultimate timing or impact of these changes, which could have either
      a materially favorable or materially adverse impact on the
      Company.  Also in July 2006, the CDI proposed new amended rate
      approval regulations affecting personal auto, homeowners and most lines of
      commercial property and casualty insurance written in California, subsequently
      amended in October of 2006, which could have a materially adverse impact on
      the
      Company’s California results.  The regulations became effective on
      April 3, 2007.




Also,
      in
      the event of adverse claims results, we could be forced 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.




22
 ***Table
            of Contents***





At
      June
      30, 2007, our insurance subsidiaries had a combined statutory surplus of $753.1
      million compared to $771.0 million at December 31, 2006. The decrease in
      statutory surplus was primarily due to an increase in nonadmitted assets of
      $49.7 million, dividends to the holding company of $14.0 million and an increase
      in deferred taxes of $7.0 million, partially offset by statutory net income
      of
      $52.2 million. The net premiums written to statutory surplus ratio, which is
      required to be below 3.0 by the insurance regulators, was 1.7 at June 30, 2007
      and December 31, 2006.





Certain
      of our subsidiaries must comply with minimum capital and surplus requirements
      under applicable state laws and regulations, and must have adequate reserves
      for
      claims. We believe that at June 30, 2007, all of our insurance subsidiaries
      met
      their respective regulatory requirements.





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




*AMOUNTS
                IN THOUSANDS*
            
            **June
                30,**
              **2007**
            
            December
                31,
              2006Stockholders’
                equity – GAAP
            
            **$**
            **932,382**
            
            
            $
            898,549Condensed
                adjustments to reconcile GAAP stockholders’ equity to statutory
                surplus:Net
                book value of fixed assets under capital leases
            
            ****
            **(17,919**
            **)**
            
            
            (20,373
            )Deferred
                loss (gain) under capital lease transactions
            
            ****
            **339**
            
            
            
            (79
            )Capital
                lease obligation
            
            ****
            **9,280**
            
            
            
            15,985Nonadmitted
                net deferred tax assets
            
            ****
            **(16,724**
            **)**
            
            
            (17,419
            )Difference
                in net deferred tax assets reported under Statutory Accounting
                Principles
            
            ****
            **21,557**
            
            
            
            24,200Intercompany
                receivables
            
            ****
            **(64,345**
            **)**
            
            
            (11,488
            )Fixed
                assets
            
            ****
            **(21,698**
            **)**
            
            
            (22,955
            )Equity
                in non-insurance entities
            
            ****
            **(54,053**
            **)**
            
            
            (47,006
            )Net
                unrealized losses on investments
            
            ****
            **28,989**
            
            
            
            17,881Deferred
                policy acquisition costs
            
            ****
            **(63,621**
            **)**
            
            
            (63,581
            )Pension
                related liabilities
            
            ****
            **18,481**
            
            
            
            15,648Other
                prepaid expenses
            
            ****
            **(18,214**
            **)**
            
            
            (14,195
            )FIN
                48 liability
            
            ****
            **3,500**
            
            
            
            —Other,
                net
            
            ****
            **(4,822**
            **)**
            
            
            (4,158
            )Statutory
                surplus
            
            **$**
            **753,132**
            
            
            $
            771,009





***Cash
      Flows***





Our
      net
      increase (decrease) in cash and cash equivalents were as follows:


*AMOUNTS
                  IN THOUSANDS*
                *Six
                  Months Ended June 30,*
              
              **2007**
              
              2006
              
              *‘07
                  vs.‘06*
                *Increase/*
                *(Decrease)*Net
                  cash and cash equivalents provided by operating activities
              
              **$**
              **39,841**
              
              
              $
              64,418
              
              
              $
              (24,577
              )Net
                  cash and cash equivalents provided by (used in) investing
                  activities
              
              
              **7,710**
              
              
              
              (76,352
              )
              
              
              84,062Net
                  cash and cash equivalents used in financing activities
              
              
              **(9,972**
              **)**
              
              
              (16,546
              )
              
              
              6,574Net
                  increase (decrease) in cash and cash equivalents
              
              **$**
              **37,579**
              
              
              $
              (28,480
              )
              
              $
              66,059


*Operating
      Activities*





Net
      cash
      provided by operating activities decreased primarily due to an increase in
      underwriting costs as a result of the Company’s national expansion strategy; an
      increase in payments for losses and LAE attributable to growth realized in
      the
      current quarter; expenditures related to the merger proposal from the majority
      owner, AIG, to acquire the remaining shares of the Company common stock it
      does
      not own; and severance costs in connection with the Company’s efforts to
      streamline operations. This was partially offset by an increase in direct
      premiums collected resulting from the increase in direct premiums written
      realized as a result of the Company’s national expansion efforts.





*Investing
      Activities*





Our
      cash
      flow from investing activities is primarily impacted by the sales, maturities
      and purchases of our available-for-sale investment securities.  Our
      investment objective is to maintain a low level of risk and to preserve
      principal by investing in high quality, investment grade securities while
      maintaining liquidity in each portfolio sufficient to meet our cash flow
      requirements.




23
 ***Table
            of Contents***





Our
      cash
      flows from investing activities changed from a net outflow in 2006 to a net
      inflow in 2007. This change is primarily a result of a decrease in investment
      purchases due to decline in operating cash flows. Additionally, the redeployment
      of cash from operating cash flows to the investment portfolio declined as
      available funds in the current year were instead invested in more liquid cash
      equivalents that have similar returns as a result of the relatively flat yield
      curve.





*Financing
      Activities*





Net
      cash
      used in financing activities decreased due to the favorable impact of a $20.2
      million increase in cash receipts for stock option exercises, partially offset
      by the doubling of the quarterly dividend since the prior year from $0.08 per
      share to $0.16 per share, resulting in a $14.4 million increase in dividends
      paid.





**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 six-month period ended June 30, 2007.





**CRITICAL
      ACCOUNTING ESTIMATES**





The
      preparation of financial statements
      in accordance with GAAP requires management to make estimates and assumptions
      that affect reported amounts and related disclosures.  Our significant
      accounting policies are essential to understanding Management’s Discussion and
      Analysis of Financial Condition and Results of Operations. Management considers
      an accounting estimate to be critical if:




·
            It
                requires assumptions to be made that were uncertain at the time the
                estimate was made; and




·
            Change
                in the estimate or different estimates that may have been selected
                could
                have a material impact on the Company’s consolidated results of operations
                or financial condition.





The
      following is a summary of the more
      critical accounting estimates. 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 the
      development and selection of our critical accounting estimates with the Audit
      Committee of our Board of Directors.





***Unpaid
      Losses and Loss Adjustment Expenses***




The
      estimated liabilities for unpaid
      losses and LAE include estimates of the ultimate resolution 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 variability of the ultimate
      settlement amount is likely to increase as the time between the occurrence
      and
      settlement of the claim increased.





The
      methods used to determine such estimates and to establish the resulting reserves
      are continually monitored, reviewed, and updated.  Any resulting
      adjustments are reflected in current operating income 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.





It
      is
      management’s belief that the reserves for losses and LAE are adequate to cover
      unpaid losses and LAE at June 30, 2007.  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 possibly differ materially from our unpaid losses and LAE
      at
      June 30, 2007.  In the future, if the unpaid losses and LAE develop
      redundancies or deficiencies, then such redundancy or deficiency would have
      a
      positive or adverse impact, respectively, on future results of
      operations.





Because
      these are unknown future events, there is uncertainty in the Company’s estimates
      of ultimate losses and LAE.  This uncertainty comes from various
      factors, both positive and negative, that may include changes in claims
      reporting and settlement patterns, changes in regulatory and legal environment,
      and inflation rates.  The Company does not make a specific provision
      for these uncertainties; however, they are considered in establishing the
      reserves by analyzing historical patterns and trends.





24
 ***Table
            of Contents***





The
      process of estimating unpaid losses and LAE begins with the review of the actual
      claims experience, 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. Based on this review,
      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 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 several commonly accepted actuarial methods
      utilizing paid and incurred loss histories, claim frequency and severity, and
      expected loss ratios.





The
      incurred loss development method analyzes historical case incurred loss (paid
      loss plus case reserves) development to estimate ultimate losses.  The
      Company applies loss development factors against case incurred losses by
      accident period to calculate ultimate losses.  The paid loss
      development method is similar to the incurred loss development method except
      only paid losses are used.





The
      claim
      count development method analyzes historical claim count development to estimate
      ultimate claim counts.  The Company applies these development factors
      against claim counts by accident period to calculate ultimate claim
      counts.  Severity is the amount of loss per claim.  The
      average severity method analyzes historical severity development to calculate
      an
      ultimate average cost per claim.  From this, the ultimate severity can
      be estimated.  The claim count development method coupled with the
      average severity method also provides useful information regarding frequency
      and
      inflationary trends that the Company believes is useful in setting
      reserves.  In states with little operating history the Company’s
      experience is supplemented with industry statistics.





The
      Company uses similar methods for LAE.  The Company estimates the loss
      IBNR reserves as the difference between its projection of ultimate losses and
      the sum of the payments and case reserves for losses.





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 the loss costs
      recognized.





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 months would require more judgment.  We do
      not believe disclosure of specific indicated point estimates as calculated
      by
      the various methods 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 estimate of ultimate severities exhibits greater variability
      at the same maturity. Generally, actual 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.




*Volatility
      of Reserve Estimates and Sensitivity Analysis*




The
      Company uses numerous assumptions
      in determining its best estimates of reserves for losses and LAE for each
      coverage of the personal auto business.  If actual experience differs
      from key assumptions used in establishing reserves, there is potential for
      significant variation in the development of loss and LAE
      reserves.  Set forth below is a sensitivity analysis that estimates
      the effect on the loss and LAE reserve position of using alternative loss cost
      trend or loss development factor assumptions rather than those actually used
      in
      determining the best estimates in the second quarter 2007 loss and LAE reserve
      analyses.  The analysis addresses the personal auto business in
      California for which a material deviation to the Company’s overall reserve
      position is believed reasonably possible, and uses what the Company believes
      is
      a reasonably likely range of potential deviation.  There can be no
      assurance, however, that actual reserve development will be consistent with
      either the original or the adjusted loss cost trend or loss development
      assumptions, or that other assumptions made in the reserving process will not
      materially affect reserve development for a particular coverage.




25
 ***Table
            of Contents***





After
      evaluating the historical loss
      cost trends from prior years since 1994, in Management’s judgment, it is
      reasonably likely that actual loss cost trends applicable to the second quarter
      2007 loss and LAE reserve analysis will range from negative 13% to positive
      6%,
      or approximately 10% lower and 9% higher than the assumptions utilized in the
      second quarter 2007 reserve analysis.  These changes in the assumed
      loss cost trend would cause approximately a $67 million decrease or a $56
      million increase in the loss and LAE reserves.  It should be
      emphasized that these deviations are not considered the highest possible
      deviations that might be expected, but rather what is considered by the Company
      to reflect a reasonably likely range of potential deviation as of June 30,
      2007.  The Company’s sensitivity analysis that estimated the effect on
      the loss and LAE reserve position of using alternative loss cost trend
      assumptions as of December 31, 2006 rather than those actually used in
      determining the best estimate in the year-end loss and LAE reserve analyses
      for
      2006 indicated an approximate $84 million decrease or a $47 million increase
      in
      the loss and LAE reserves.





The
      assumed loss development factors are also a key assumption.  After
      evaluating the historical loss development factors from prior accident years
      since 1999, in Management’s judgment, it is reasonably likely that actual loss
      development factors will range from approximately 1.2 percent lower than those
      actually utilized in the second quarter 2007 loss and LAE reserve analysis
      to
      approximately 1.1 percent higher than those actually utilized.  If the
      loss development factor assumptions were reduced by 1.2 percent and increased
      by
      1.1 percent, the loss and LAE reserves would decrease by approximately $64
      million under the lower assumptions or increase by approximately $62 million
      under the higher assumptions.  The Company’s sensitivity analysis that
      estimated the effect on the loss and LAE reserve position of using alternative
      loss development factors as of December 31, 2006 rather than those actually
      used
      in determining the best estimate in the year-end loss and LAE reserve analyses
      for 2006 indicated an approximate $86 million decrease or a $42 million increase
      in the loss and LAE reserves. Generally, historical loss development factors
      are
      used to project future loss development.  However, there can be no
      assurance that future loss development patterns will be the same as in the
      past,
      or that they will not deviate by more than the amounts illustrated
      above.  Thus, there is the potential for the reserves with respect to
      a number of accident years to be significantly affected by changes in the loss
      cost trends or loss development factors that were initially relied upon in
      setting the reserves.  These changes in loss cost trends or loss
      development factors could be attributable to changes in inflation or in the
      judicial environment, or in other social or economic conditions affecting
      claims.  Thus, there is the potential for variations greater than the
      amounts cited above, either negatively or positively.





The
      primary responsibility of an
      insurance company is paying the claims of its policyholders in a fair and timely
      manner.  Having adequate loss reserves, with special consideration for
      the upside potential of claims not yet paid is central to this responsibility.
      The Company experienced significant losses from the 1994 Northridge earthquake
      and the subsequent reopening of claims resulting from California Senate Bill
      1899 (“SB 1899”).  The costs related to both the original event and SB
      1899 illustrate the uncertainty that can result from estimating loss
      reserves.  The number and severity of claims far exceeded initial
      estimates of losses.  The two Northridge events point to the
      importance of the adequacy of loss reserves and the inherent estimating
      uncertainties of the loss reserving process.




***Investments***




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 at
      inception 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. The cost of investment
      securities sold is determined by the specific identification
      method.





We
      are
      obligated to assess, at each reporting date, whether there is an
“other-than-temporary” impairment to our investment securities.  In
      general, a security is considered a candidate for impairment if it meets any
      of
      the following criteria:




·
            Trading
                at a significant (25% or
                more) discount to par, amortized cost (if lower) or cost for an extended
                period of time (nine months or
                longer);




·
            The
                occurrence of a discrete
                credit event resulting in the debtor defaulting or seeking bankruptcy
                or
                insolvency protection or voluntary reorganization;
                and




·
            The
                probability of
                non-realization of a full recovery on our investment, irrespective
                of the
                occurrence of one of the foregoing
                events.




For
      investments with unrealized losses due to market conditions or industry-related
      events, where we have 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 or amortized cost are not assumed to be
      other-than-temporary. Where declines in fair values of securities below cost
      or
      amortized cost are considered to be other-than-temporary, such as when it is
      determined that an issuer is unable to repay the entire principal, 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
      necessarily a matter of subjective judgment. The Company’s intent is to hold all
      of its fixed securities with unrealized losses for a period of time sufficient
      to allow a market recovery or to maturity as long as these securities continue
      to be consistent with our investment strategy.  If our strategy were
      to change and these securities were impaired, we would recognize a write down
      in
      accordance with our stated policy. Additionally, it is possible that future
      information will become available about our current investments that would
      require accounting for them as realized losses due to other-than-temporary
      declines in value.No
      such charges were recorded in the three or six months ended June 30, 2007 or
      for
      the same periods in 2006. 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 at the end of the periods presented because
      any unrealized losses would have been already included in accumulated other
      comprehensive loss.





26
 ***Table
            of Contents***





Substantially
      the entire fixed maturity securities portfolio is investment
      grade.  The following is a summary of the Standard & Poor’s credit
      rating for the fixed maturity securities portfolio (the weighted-average is
      “AA”):





**June
                30, 2007**
            
            December
                31, 2006*AMOUNTS
                IN THOUSANDS,*
              *EXCEPT
                NUMBER OF ISSUES*
            
            ***#
                issues***
            
            ***Fair
                Value***
            
            *#
                issues*
            
            *Fair
                Value*AAA
            
            ****
            **315**
            
            
            **$**
            **708,024**
            
            
            
            322
            
            
            $
            728,033AA
            
            ****
            **114**
            
            
            ****
            **200,808**
            
            
            
            106
            
            
            
            165,216A
            
            ****
            **101**
            
            
            ****
            **372,793**
            
            
            
            109
            
            
            
            423,429BBB
            
            ****
            **39**
            
            
            ****
            **111,378**
            
            
            
            42
            
            
            
            113,162Unrated
            
            ****
            **7**
            
            
            ****
            **5,234**
            
            
            
            4
            
            
            
            5,176Total
                fixed maturity securities
            
            ****
            **576**
            
            
            **$**
            **1,398,237**
            
            
            
            583
            
            
            $
            1,435,016





The
      following is a summary by issuer of unrated securities held:





**June
                30,**
            
            December
                31,*AMOUNTS
                IN THOUSANDS*
            
            **2007**
            
            2006Unrated
                fixed maturity securities (fair value):Impact
                Community Capital, LLC 2
            
            **$**
            **1,999**
            
            
            $
            1,999Impact
                Healthcare, LLC 2
            
            ****
            **568**
            
            
            
            510Impact
                Childcare, LLC 2
            
            ****
            **810**
            
            
            
            810Impact
                Commercial Opportunities, LLC 2
            
            ****
            **1,857**
            
            
            
            1,857Total
                unrated fixed maturity securities
            
            ****
            **5,234**
            
            
            
            5,176Unrated
                other long-term investments (equity method):Impact
                Workforce, LLC 2
            
            ****
            **320**
            
            
            
            320AIG
                PEP 3
            
            ****
            **18,120**
            
            
            
            14,385Total
                unrated other long-term investments
            
            ****
            **18,440**
            
            
            
            14,705Total
                unrated investments
            
            **$**
            **23,674**
            
            
            $
            19,881Percentage
                of total investments, at fair value
            
            ****
            **1.7**
            **%**
            
            
            1.4
            %





At
      June
      30, 2007 and December 31, 2006, unrated securities had no unrealized gains
      and
      losses.





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:





**June
                30, 2007**
            
            December
                31, 2006*AMOUNTS
                IN THOUSANDS,*
              *EXCEPT
                NUMBER OF ISSUES*
            
            ***#
                issues***
            
            ***Fair
                Value***
            
            ***Unrealized
                Loss***
            
            *#*
              *issues*
            
            *Fair
                Value*
            
            *Unrealized
                Loss*Investments
                with unrealized losses:Fixed
                maturity securities:Exceeding
                $0.1 million and in a loss position for:Less
                than 6 months
            
            ****
            **1**
            
            
            **$**
            **10,339**
            
            
            **$**
            **117**
            
            
            
            2
            
            
            $
            12,075
            
            
            $
            2166-12
                months
            
            ****
            **11**
            
            
            ****
            **57,298**
            
            
            ****
            **2,189**
            
            
            
            1
            
            
            
            9,625
            
            
            
            375More
                than 1 year
            
            ****
            **88**
            
            
            ****
            **680,015**
            
            
            ****
            **30,535**
            
            
            
            88
            
            
            
            698,674
            
            
            
            25,919Less
                than $0.1 million
            
            ****
            **147**
            
            
            ****
            **304,484**
            
            
            ****
            **5,007**
            
            
            
            142
            
            
            
            304,838
            
            
            
            4,764Total
                investments with unrealized losses4
            
            ****
            **247**
            
            
            **$**
            **1,052,136**
            
            
            **$**
            **37,848**
            
            
            
            233
            
            
            $
            1,025,212
            
            
            $
            31,274




2
            Impact
                Community Capital is a limited partnership that was voluntarily
                established by a group of California insurers to make loans and other
                investments that providehousing
                and other services to economically disadvantaged communities. See
                further
                discussion in Note 8 of the *Notes to Condensed Consolidated
                Financial**Statements.*


3
              AIG
                  PEP is a private equity
                  investment program managed by AIG
                  Investments.


4
              Unrealizedlosses
                  represent approximately
                  2.7% and 2.2% of the total fair value of investments at June 30,
                  2007 and
                  December 31, 2006,
                  respectively.





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If
      our
      portfolio were to be impaired by market or issuer-specific conditions to a
      substantial degree, then our liquidity, financial position and financial results
      could be materially affected.  Further, our income from these
      investments could be materially reduced, and write-downs of the value of certain
      securities could further reduce our profitability.  In addition, a
      decrease in value of our investment portfolio could put our subsidiaries at
      risk
      of failing to satisfy regulatory capital requirements.  If we were not
      at that time able to supplement our capital by issuing debt or equity securities
      on acceptable terms, our ability to continue growing could be adversely
      affected.**See further discussion in*Item 3. Quantitative and
      Qualitative Disclosures About Market Risk.*





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





**June
                30, 2007**
            
            December
                31, 2006*AMOUNTS
                IN THOUSANDS*
            
            ***Amortized
                Cost***
            
            ***Fair
                Value***
            
            ***Unrealized***
              ***Loss***
            
            *Amortized*
              *Cost*
            
            *Fair
                Value*
            
            *Unrealized
                Loss*Fixed
                maturity securities:Due
                in one year or less
            
            **$**
            **28,079**
            
            
            **$**
            **27,764**
            
            
            **$**
            **315**
            
            
            $
            3,040
            
            
            $
            2,983
            
            
            $
            57Due
                after one year through five years
            
            ****
            **622,935**
            
            
            ****
            **601,544**
            
            
            ****
            **21,391**
            
            
            
            602,148
            
            
            
            584,279
            
            
            
            17,869Due
                after five years through ten years
            
            ****
            **111,190**
            
            
            ****
            **107,746**
            
            
            ****
            **3,444**
            
            
            
            96,077
            
            
            
            93,043
            
            
            
            3,034Due
                after ten years
            
            ****
            **327,780**
            
            
            ****
            **315,082**
            
            
            ****
            **12,698**
            
            
            
            355,221
            
            
            
            344,907
            
            
            
            10,314Total
                fixed maturity securities with unrealized losses
            
            **$**
            **1,089,984**
            
            
            **$**
            **1,052,136**
            
            
            **$**
            **37,848**
            
            
            $
            1,056,486
            
            
            $
            1,025,212
            
            
            $
            31,274





***Income
      Taxes***




Determining
      the consolidated provision
      for income tax expense, deferred tax assets and liabilities and any related
      valuation allowance requires the use of estimates and assumptions about the
      outcome of future events, as well as assessments of the likelihood that the
      tax
      positions taken by the Company ultimately will be sustained.




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 consolidated
      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 net operating losses (“NOLs”), which may be
      carried forward 20 years for losses incurred after 1998.




At
      June 30, 2007, our DTAs were $114.0
      million and our DTLs were $68.0 million, for a net DTA of $46.0 million.At December 31, 2006,
      our
      DTAs were $117.9 million and our DTLs were $69.5 million, for a net DTA of
      $48.4
      million. The net DTAs are classified as an asset, “Deferred income taxes,” 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.




The
      Company’s net deferred tax assets include a net operating loss (“NOL”)
      carryforward for regular federal corporate tax purposes of $9.2 million,
      representing an unrealized tax benefit of $3.2 million at June 30, 2007,
      compared to $3.3 million at December 31, 2006. As a result of taxable income
      since 2002, our NOL has been fully utilized through June 30, 2007 except for
      the
      amount relating to 21st of the Southwest that is subject to the Internal Revenue
      Service separate return limitation year provisions. The remaining NOL expires
      as
      follows: $1.2 million in 2017; $1.1 million in 2018; $1.5 million in 2019;
      $3.2
      million in 2020, and $2.2 million in 2021.





Our
      ability to fully utilize the NOL of
      21st of the Southwest and our other DTAs depends primarily on future taxable
      income from operations and tax planning strategies. Because of the Company’s
      profitable operating history and the availability of tax planning
      strategies, management believes it is reasonable to conclude that it is at
      least more likely than not that we will be able to realize the benefits of
      all
      of our DTAs. Accordingly, no valuation allowance has been recognized at June
      30,
      2007. 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. Implementation of tax planning strategies to effect
      realization of our remaining NOL may require regulatory approvals, which
      although reasonably expected cannot be assured by management. Future operating
      losses could possibly jeopardize our ability to realize our other DTAs. Future
      unfavorable regulatory actions or operating losses would lead management to
      reach a different conclusion about the likelihood of realizing the DTAs and,
      if
      so, to recognize a valuation allowance at that time for some or all of the
      DTAs.




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Effective
      January 1, 2007, as explained
      more fully in Note 1 of the *Notes to Condensed Consolidated Financial
      Statements*, the Company adopted Financial Interpretation No. 48,
*Accounting for Uncertainty in Income Taxes – an Interpretation of FAS No.
      109*(“FIN 48”), which had the effect of decreasing opening retained
      earnings and stockholders’ equity by $2.4 million. Adoption of FIN 48 had no
      impact on net income in the six months ended June 30, 2007.




At
      January 1, 2007, the Company had no liabilities for uncertain tax liabilities
      for uncertain tax positions and the total amount of unrecognized tax benefits
      for all jurisdictions was approximately $9.1 million, which would favorably
      affect the effective tax rate if recognized.  For the three and six
      months ended June 30, 2007, the total amount of unrecognized tax benefits
      declined by approximately $1.8 million and $3.5 million, respectively,
      representing the proportionate amount deemed utilized for tax purposes in the
      first and second quarters of the year, respectively, and the Company established
      an estimated liability for uncertain tax position of the same
      amount.  Absent changes in profitability or other facts and
      circumstances, the Company currently anticipates that the unrecognized tax
      benefits will decline to zero by the end of 2007 as the benefits are used for
      tax purposes, in which case the estimated liability for uncertain tax position
      would total approximately $9.1 million.





The
      Company had no accrued penalties
      and no material interest receivable or interest payable at the date of adoption
      or at June 30, 2007.




In
      the first quarter of 2005, the
      Company filed amended California tax returns and paid the State of California
      $6.8 million to cover all issues outstanding with the Franchise Tax
      Board  (“FTB”), including certain matters paid under protest as to
      which the Company reserved all its rights to file for refunds and appeal to
      the
      California State Board of Equalization (“SBE”) any adverse rulings by the
      California FTB. In September 2005, the FTB completed its audit and denied our
      refund claims. In December 2005, the Company filed an appeal with the SBE.
      In
      the fourth quarter of 2006, the Company executed a settlement agreement with
      the
      FTB. This settlement agreement received regulatory approval in February 2007.
      Accordingly, the tax refund and accrued interest totaling approximately $2.9
      million ($1.9 million net of federal tax effect) was recorded as a reduction
      of
      state income tax expense effective December 31, 2006. This amount was received
      in July 2007.




***Deferred
      Policy Acquisition Costs***





Deferred
      policy acquisition costs
      (“DPAC”) include premium taxes, advertising after it takes place, and other
      variable costs incurred with writing business. While our customers typically
      renew their policies numerous times and on average stay with us for over five
      years, these costs are deferred and amortized over the six-month policy period
      in which the related premiums are earned.




Management
      assesses the recoverability
      of DPAC 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 the DPAC costs are fully recoverable at June
      30, 2007.




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 it is a reasonable assumption,
      actual results could differ materially from such estimates.




***Property
      and Equipment***




At
      June 30, 2007, net property and
      equipment included $130.8 million in software, net of related accumulated
      depreciation. This amount represented 85.2% of total net property and equipment,
      with the remaining balance consisting of furniture and equipment, leasehold
      and
      building improvements, building, and land.




Management
      evaluates the recoverability
      of long-lived assets upon indication of possible impairment when events or
      changes in circumstances indicate that the carrying amount may not be
      recoverable by measuring the carrying amount of the assets against the related
      estimated undiscounted cash flows. For purposes of recognition and measurement
      of an impairment loss, long-lived 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. When an
      evaluation indicates that the future undiscounted cash flows are not sufficient
      to recover the carrying value of the assets, the assets are adjusted to their
      estimated fair value. The determination of what constitutes an indication of
      possible impairment, the estimation of future cash flows, and the determination
      of estimated fair value are all significant judgments.There have been no events
      or circumstances in the second quarter of 2007 that would require a reassessment
      of any asset group for impairment.





**RECENT
      ACCOUNTING PRONOUNCEMENTS**





In
      February 2007, the Financial Accounting Standards Board (“FASB”) issued
      Financial Accounting Standard No. (“FAS”) 159, *The Fair Value Option for
      Financial Assets and Financial Liabilities – including an amendment of FASB
      Statement No. 115*, (“FAS 159”), which permits an entity to choose to
      measure many financial instruments and certain other items at fair value that
      are not currently required to be measured at fair value. The objective is to
      provide entities with an opportunity to mitigate volatility in reported earnings
      caused by measuring related assets and liabilities differently without having
      to
      apply complex hedge accounting provisions. Entities that choose to measure
      eligible items at fair value will report unrealized gains and losses in earnings
      at each subsequent reporting date. The fair value option may be elected at
      specified election dates on an instrument-by-instrument basis, with few
      exceptions. The Statement also establishes presentation and disclosure
      requirements designed to facilitate comparisons between entities that choose
      different measurement attributes for similar types of assets and liabilities.
      FAS 159 is effective at the beginning of the first fiscal year beginning after
      November 15, 2007. The Company is currently evaluating the impact of adopting
      FAS 159.





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In
      September 2006, the FASB issued FAS 157, *Fair Value Measurements*(“FAS
      157”). FAS 157 clarifies the principle that fair value should be based on the
      assumptions market participants would use when pricing an asset or liability
      and
      establishes a fair value hierarchy that prioritizes the information used to
      develop those assumptions. Under the standard, fair value measurements would
      be
      separately disclosed by level within the fair value hierarchy. FAS 157 is
      effective for financial statements issued for fiscal years beginning after
      November 15, 2007 and interim periods within those fiscal years, with early
      adoption permitted.  The Company has not yet determined the effect, if
      any, that the implementation of FAS 157 will have on its results of operations
      or financial condition.





In
      June
      2006, the FASB issued Financial Interpretation No. 48, *Accounting for
      Uncertainty in Income Taxes – an Interpretation of FAS No. 109* (“FIN
      48”). This interpretation clarifies the accounting for uncertainty in income
      taxes recognized in an enterprise’s financial statements in accordance with FAS
      109, *Accounting for Income Taxes*. FIN 48 prescribes a recognition
      threshold and measurement attribute for the financial statement recognition
      and
      measurement of a tax position taken or expected to be taken in a tax return.
      This interpretation also provides guidance on derecognition, classification,
      interest and penalties, accounting in interim periods, disclosure, and
      transition.  The effect of this adoption on January 1, 2007, resulted
      in a $2.4 million decrease to opening retained earnings.  Adoption of
      FIN 48 had no impact on net income in the six months ended June 30,
      2007.





As
      permitted by FIN 48, the Company also adopted a policy of including interest
      and
      penalties related to income taxes with the provision for income taxes in the
      consolidated statements of operations.  As required by FIN 48, this
      change was done prospectively.  Previously, penalties and interest
      were classified as *Other Income* or *Other Expense*.





At
      January 1, 2007, the Company had unrecognized tax benefits for all jurisdictions
      of approximately $9.1 million, which would favorably impact the effective tax
      rate if recognized.  The Company does not anticipate any material
      changes in unrecognized tax benefits within 12 months of the date of
      adoption.





The
      Company had no accrued penalties and no material interest receivable or interest
      payable at the date of adoption or at June 30, 2007.





Tax
      years
      2003 to 2006 and 2002 to 2006 are subject to examination by Federal and
      California jurisdictions, respectively.





Statement
      of Position 05-1*, Accounting by Insurance Enterprises for Deferred
      Acquisition Costs in Connection with Modifications or Exchanges of Insurance
      Contracts*(“SOP 05-1”) was adopted January 1, 2007. SOP
      05-1**provides guidance on accounting for deferred policy
      acquisition costs on internal replacements of insurance and investment contracts
      other than those specifically described in FAS No. 97, *Accounting and
      Reporting by Insurance Enterprises for Certain Long-Duration Contracts and
      for
      Realized Gains and Losses from the Sale of Investments*. The SOP defines an
      internal replacement as a modification in product benefits, features, rights,
      or
      coverage that occurs by the exchange of a contract for a new contract, or by
      amendment, endorsement, or rider to a contract, or by the election of a feature
      or coverage within a contract. The Company’s prospective application of SOP 05-1
      since January 1, 2007 resulted in a $3.8 million reduction in deferred policy
      acquisition costs as of June 30, 2007, and a corresponding increase in policy
      acquisition costs during the six months ended June 30, 2007.





**FORWARD-LOOKING
      STATEMENTS**





The
      Private Securities Litigation Reform Act of 1995 provides a safe harbor for
      forward-looking statements made by or on behalf of the Company. This report
      contains statements that constitute “forward-looking” information. Readers 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. Forward-looking statements include,
      but are not limited to, discussions concerning our potential expectations,
      beliefs, estimates, forecasts, projections, and assumptions.




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. These
      statements are made on the basis of management’s views and assumptions at the
      time the statements are made. There can be no assurance, however, that our
      expectations will necessarily come to pass.




30
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**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 the financial instruments in which we
      invest, the underlying insurance risk related to our core business and the
      exposure of the personal automobile lines insurance business, as a regulated
      industry, to legal, legislative, judicial, political and regulatory action.
      Financial instruments are not used for trading purposes. The Company also
      obtained long-term fixed rate financing as a means of increasing the statutory
      surplus of the Company’s primary insurance subsidiary in 2002 and 2003. The
      following disclosure reflects estimated changes in value that result from
      selected hypothetical changes in market rates and prices. Actual results may
      differ.




Our
      cash
      flows from operations and short-term cash position generally have been 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 the Company to employ elaborate market risk management techniques involving
      complicated asset and liability duration matching or hedging
      strategies.




***Fixed
      Maturity Financial Instruments***




For
      all
      of our fixed maturity securities, which comprise the majority of the Company’s
      investment portfolio, we seek to provide for liquidity and diversification
      while
      maximizing income without sacrificing investment quality.  The value
      of the fixed maturity securities portfolio is subject to interest rate risk
      where the value of the fixed maturity securities portfolio decreases as market
      interest rates increase, and conversely, when market interest rates decrease,
      the value of the fixed maturity securities portfolio increases. Duration is
      a
      common measure of the sensitivity of a fixed maturity security’s value to
      changes in interest rates.  More specifically, it is the approximate
      percentage change in the value of a bond or bond portfolio due to a 100 basis
      point change 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, cash flow, and
      other items.




Since
      fixed maturity securities with longer remaining terms to maturity usually tend
      to realize higher yields, the Company’s past investment philosophy typically
      resulted in a portfolio with an effective duration of over 6.  Due to
      the changing interest rate environment in 2004, Management, in consultation
      with
      the Investment Committee, targeted a lower duration for the Company’s fixed
      maturity security portfolio to reduce the negative impact of potential increases
      in interest rates.As
      a result, the effective duration of the total fixed maturity security portfolio
      declined from approximately 5.4 at December 31, 2004 to 3.5 at June 30,
      2007.




The
      graphical depiction of the relationship between the yield on bonds of the same
      credit quality with different maturities is usually referred to as a yield
      curve. Because the yield on U.S. Treasury securities is the base rate (or “risk
      free rate”) from which non-government bond yields are normally benchmarked, the
      most commonly constructed yield curve is derived from the observation of prices
      and yields in the Treasury market. An upward sloping curve, where yield rises
      steadily as maturity increases, is referred to as a normal yield
      curve.




The
      following table shows the carrying values of our fixed maturity securities,
      which are reported at fair value, and our debt, which is reported at amortized
      cost. The table also presents estimated fair values at adjusted market rates
      assuming a parallel 100 basis point increase in market interest rates, given
      the
      effective duration noted above, for the fixed maturity security portfolio and
      a
      parallel 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*
              *June
                30, 2007*
            
            *Carrying
                Value*
            
            *Estimated
                Carrying Value at Adjusted Market Rates/Prices Indicated
                Above*
            
            *Change
                in Value as a Percentage of Carrying Value*Fixed
                maturity securities available-for-sale, at fair value
            
            $
            1,398.2
            
            
            $
            1,350.9
            
            
            
            (3.4
            %)Debt,
                at amortized cost
            
            
            109.2
            
            
            
            114.8
            
            
            
            5.2
            %





The
      discussion above provides only a limited, point-in-time view of the market
      risk
      sensitivity of our fixed rate financial instruments.  The actual
      impact of interest rate changes on our fixed maturity securities in particular
      may differ significantly from those shown, as the analysis assumes a parallel
      shift in market interest rates.  The analysis also does not consider
      any actions we could take in response to actual and/or anticipated changes
      in
      interest rates.





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The
      difference between long-term Treasury yields and short-term Treasury yields
      are
      usually referred as the “slope” of the yield curve. If the spread between the
      long end of the curve, where maturities are high, and the short end of the
      curve, where maturities are low, narrows, the yield curve is said to be
“flattening”. Conversely, if the spread between the long end of the curve and
      the short end of the curve widens, the yield curve is said to be “steepening”.
      If the yields on the long end of the curve fall below those of the short end
      of
      the curve, the yield curve is said to be “inverted.”





The
      analysis above assumes a parallel shift in interest rates. However, the curve
      may also steepen, flatten or become inverted. This type of behavior may affect
      certain sections of the curve in disproportionate amounts. For example, if
      short-term Treasury yields rise and the yield curve flattens, fixed maturity
      instruments with short duration may be impacted to a greater degree than fixed
      maturity instruments with longer duration. Conversely, if long-term Treasury
      yields rise and the yield curve steepens, fixed maturity instruments with long
      duration may be impacted to a greater degree than fixed maturity instruments
      with shorter duration.





The
      following summarizes the effective duration distribution of our fixed maturity
      securities portfolio.




*Duration
                  Ranges**June
                  30, 2007*
              
              Below
                  1
              
              1
                  to 3
              
              3
                  to 5
              
              5
                  to 7
              
              7
                  to 10
              
              10
                  to 20Fair
                  value percentage of fixed maturity security portfolio
              
              
              5.0
              %
              
              
              24.9
              %
              
              
              57.6
              %
              
              
              8.6
              %
              
              
              3.2
              %
              
              
              0.7
              %


***Equity
      Investments***





In
      an
      effort to enhance yield and provide some non-correlated diversification to
      our
      fixed income portfolio, the Company has invested in non-publicly held equity
      securities.  In the first quarter of 2006, the Company sold its
      publicly traded equity security portfolio and subsequently invested in a private
      equity portfolio.****The value of these privately held equity
      assets are less sensitive to interest rate risk and more subject to credit
      and
      liquidity risks.  However, interest rate risk still exists, just to a
      lesser extent.  A rise in interest rates may increase the rate on
      floating rate debt and, therefore, use an increasing proportion of a company's
      cash flow, or may raise market rates to a level that limits the underlying
      company's access to the capital markets.  In a fixed income portfolio,
      credit risk refers to the risk that an issuer of a fixed income security may
      default on principal or interest payments.  When evaluating private
      equity assets, the same financial and operating factors that can reduce cash
      flow and increase the likelihood of default can also have a real or perceived
      negative effect on the value of the equity asset.  Liquidity risk also
      may decrease private equity values if the assets have to be sold during a time
      of slack demand for the asset or if the multiples for recent comparable
      transactions have fallen.





The
      Company committed $35 million to an AIG Investments managed fund of private
      equity investments and funded $14.4 million of the $35 million commitment in
      2006. The funded commitment at June 30, 2007 was $18.1 million. The value of
      these private equity investments are calculated on a quarterly basis, as AIG
      Investments consolidates the performance of each fund partner and each
      particular investment.  The primary risk in this portfolio is
      event-driven risk.  This is managed via diversification across fund
      managers and styles, as well as by AIG Investments’ long history of experience
      in the asset class.  The Company also has a small portion, $0.3
      million, of its community-related investment portfolio invested in a single
      private equity transaction.




**ITEM
      4.  CONTROLS AND PROCEDURES**





***Evaluation
      of Disclosure Controls and Procedures***





The
      Company has established disclosure
      controls and procedures designed to ensure that material information relating
      to
      the Company, including its consolidated subsidiaries, is made known to the
      officers who certify the Company’s financial reports and to other members of
      senior management and the Board of Directors.





As
      required by Rule 13a-15(b) of the Securities Exchange Act of 1934 (the “Exchange
      Act”), our management, which includes our Principal Executive Officer and
      Principal Financial Officer, has evaluated the effectiveness of our disclosure
      controls and procedures (as defined in Rule 13a-15(e) under the Exchange
      Act).  Based on that evaluation the Principal Executive Officer and
      Principal Financial Officer have concluded that such disclosure controls and
      procedures are effective as of the end of the period covered by this report
      in
      providing a reasonable level of assurance that information we are required
      to
      disclose in reports that we file or submit under the Exchange Act is recorded,
      processed, summarized and reported within the time periods specified in
      Securities and Exchange Commission rules and forms, and a reasonable level
      of
      assurance that information required to be disclosed by us in such reports is
      accumulated and communicated to our management, including our Principal
      Executive Officer and Principal Financial Officer, as appropriate to allow
      timely decisions regarding required disclosure.




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***Changes
      in Internal Control Over Financial Reporting***





Management,
      with the participation of the Principal Executive Officer and Principal
      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 Principal
      Executive Officer and Principal 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
      June 30, 2007 that has materially affected, or is reasonably likely to
      materially affect, our internal control over financial reporting.




***Inherent
      Limitations on Effectiveness of Controls***





A
      control system, no matter how well
      designed and operated, can provide only reasonable, not absolute, assurance
      that
      the control system’s objectives will be met. Further, no evaluation of controls
      can provide absolute assurance that misstatements due to error or fraud will
      not
      occur or that all control issues and instances of fraud, if any, have been
      detected. These inherent limitations include the realities that judgments in
      decision-making can be faulty and that breakdowns can occur because of simple
      error or mistake. Controls can also be circumvented by the individual acts
      of
      some persons, or by collusion of two or more people.








**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 its insurance operations
      and business practices.  A description of the reportable legal
      proceedings to which the Company and its subsidiaries are a party is contained
      in Note 3 of the *Notes to Condensed Consolidated Financial Statements*,
      and is incorporated herein by reference. The description identifies legal
      proceedings, if any, that became reportable during the quarter ended June 30,
      2007, and amends and restates descriptions of previously reported legal
      proceedings in which there have been material developments during such quarter
      or which are otherwise updated due to other developments. The following claim
      was dismissed in March 2007:





*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. On October 13, 2006, Plaintiff’s counsel offered to dismiss this
      case, with prejudice, in exchange for the Company waiving its costs. The Company
      accepted the offer from the Plaintiff’s counsel to dismiss the matter in March
      2007 and no settlement was paid by the Company to the Plaintiffs or Plaintiffs’
counsel.





**ITEM
      1A. RISK FACTORS**





There
      are no material changes from the
      risk factors previously disclosed in Part I of Item 1A. in our Annual Report
      on
      Form 10-K for the fiscal year ended December 31, 2006, except for the
      following  risks related to the pending AIG merger:




***Business Uncertainties***





Uncertainty
      about the effect of the
      Agreement and Plan of Merger, dated as of May 15, 2007, among the Company,
      AIG,
      and AIG TW Corp. (“Merger Sub”), as amended pursuant to Amendment No. 1 to
      Agreement and Plan of Merger, dated as of June 8, 2007, among the Company,
      AIG
      and Merger Sub (the “Merger Agreement”), providing for the merger of Merger Sub
      with and into the Company (the “Merger”), on employees, suppliers, partners and
      customers may have an adverse effect on us.  These uncertainties may
      impair our ability to attract, retain and motivate key personnel until the
      Merger is consummated, and could cause suppliers, customers and others that
      deal
      with us to defer purchases or other decisions concerning us, or seek to change
      existing business relationships with us.





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***Failure
      to complete the proposed Merger could negatively impact stock price and
      financial results.***




Although
      our Board of Directors and the
      Special Committee of the Board of Directors has recommended that our
      stockholders approve and adopt the Merger Agreement, there is no assurance
      that
      all of the conditions to the completion of the Merger will be satisfied or
      waived.  If the Merger is not completed, we will be subject to several
      risks, including the following:




·
            Under
                certain circumstances, if the Merger is not completed, we may be
                required
                to pay AIG a termination fee of
                $24,300,000;




·
            The
                current market price of our common stock may reflect a market assumption
                that the Merger will occur, and a failure to complete the Merger
                could
                result in a negative perception by the stock market of us generally
                and a
                decline in the market price of our common
                stock;




·
            Certain
                costs relating to the Merger, such as legal, accounting and financial
                advisory fees, are payable by us whether or not the Merger is completed;
                and




·
            We
                would continue to face the risks that we currently face as an independent
                company.




***The
      Merger Agreement restricts our ability to take certain actions pending the
      closing of the Merger.***




In
      the
      Merger Agreement, we have agreed that, except as agreed to by AIG and subject
      to
      certain exceptions, we will not take certain actions pending the closing of
      the
      Merger.  Our inability to take certain actions that our management may
      deem desirable pending the Merger could have a negative impact on our business
      or the future prospects for our company.  For more information
      regarding the Merger, including the limitations on our ability to operate
      pending the Merger, please see the preliminary proxy statement we filed with
      the
      SEC on June 11, 2007.





**ITEM
      6.  EXHIBITS**





See
      accompanying exhibit index.





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**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:
            July
                31, 2007
            
            
            /s/
                Bruce W. MarlowBRUCE
                W. MARLOWPresident
                and Chief Executive Officer(Principal
                Executive Officer)Date:
            July
                31, 2007
            
            
            /s/
                Steven P. ErwinSTEVEN
                P. ERWINSenior
                Vice President and Chief Financial Officer(Principal
                Financial Officer)




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EXHIBIT
      INDEX







Exhibit
              No.
            Description
                of Exhibit
            Location2.1
            Agreement
                and Plan of Merger among Registrant, American International Group,
                Inc. and AIG TW Corp, dated as of May 15, 2007.
            Current
                Report on Form 8-K (filed with SEC on May 16, 2007; Exhibit 2.1
                therein).10.1
            Employment
                Agreement between Bruce W. Marlow, President and CEO, Registrant,
                and
                American International Group, Inc., dated May 14, 2007.
            Current
                Report on Form 8-K (filed with SEC on May 18, 2007; Exhibit 10.1
                therein).10.2
            Retention
                and Severance Agreement between Michael J. Cassanego and
                Registrant.
            Current
                Report on Form 8-K (filed with SEC on May 18, 2007; Exhibit 10.1
                therein).10.3
            Retention
                and Severance Agreement between Dean E. Stark and
                Registrant.
            Current
                Report on Form 8-K (filed with SEC on May 18, 2007; Exhibit 10.2
                therein).10.4
            Retention
                and Severance Agreement between Michael T. Ray and
                Registrant.
            Current
                Report on Form 8-K (filed with SEC on May 18, 2007; Exhibit 10.3
                therein).10.5
            Retention
                and Severance Agreement between Jesús C. Zaragoza and
                Registrant.
            Current
                Report on Form 8-K (filed with SEC on May 18, 2007; Exhibit 10.4
                therein).31.1
            Certification
                of principal executive officer pursuant to Rule 13a-14(a) under the
                Securities Exchange Act of 1934
            Filed
                herewith.31.2
            Certification
                of principal financial officer pursuant to Rule 13a-14(a) under the
                Securities Exchange Act of 1934
            Filed
                herewith.32.1
            Certification
                Pursuant to 18 U.S.C. Section 1350
            Filed
                herewith.






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