**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


Washington,
      D.C.  20549





**FORM
      10-Q**





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


**SECURITIES
      EXCHANGE ACT OF 1934**


For
      the
      quarterly period ended March 31, 2007




£******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  S  No  £





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 £
                        Accelerated
                            filer S
                        Non-accelerated
                            filer £





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


Yes £No S





The
      number of shares outstanding of the issuer’s common stock as of April 16, 2007
      was 87,924,505.













**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
                        14Item
                            3.
                        Quantitative
                            and Qualitative Disclosures About Market
                            Risk
                        29Item
                            4.
                        Controls
                            and Procedures
                        30**PART
                          II – OTHER INFORMATION**Item
                            1.
                        Legal
                            Proceedings
                        31Item
                            1A.
                        Risk
                            Factors
                        31Item
                            6.
                        Exhibits
                        31**SIGNATURES**
                        32**EXHIBIT
                          INDEX**
                        3331.1
                        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**





**ITEM1.  FINANCIAL
      STATEMENTS**





**21ST
      CENTURY INSURANCE GROUP**


**CONDENSED
      CONSOLIDATED BALANCE SHEETS**


Unaudited


*AMOUNTS
                              IN THOUSANDS, EXCEPT SHARE DATA*
                          
                          **March
                              31,**
                            **2007**
                          
                          December
                              31,
                            2006**Assets**Investments
                              available-for-saleFixed
                              maturity securities, at fair value (amortized cost:
                              $1,444,354 and
                              $1,453,468)
                          
                          **$**
                          **1,431,213**
                          
                          
                          $
                          1,435,016Other
                              long-term investments, equity method
                          
                          ****
                          **14,528**
                          
                          
                          
                          14,705Total
                              investments
                          
                          ****
                          **1,445,741**
                          
                          
                          
                          1,449,721Cash
                              and cash equivalents
                          
                          ****
                          **86,051**
                          
                          
                          
                          51,999Accrued
                              investment income
                          
                          ****
                          **16,722**
                          
                          
                          
                          17,215Premiums
                              receivable
                          
                          ****
                          **118,763**
                          
                          
                          
                          110,115Reinsurance
                              receivables and recoverables
                          
                          ****
                          **6,401**
                          
                          
                          
                          6,338Prepaid
                              reinsurance premiums
                          
                          ****
                          **2,060**
                          
                          
                          
                          2,095Deferred
                              income taxes
                          
                          ****
                          **41,807**
                          
                          
                          
                          48,437Deferred
                              policy acquisition costs
                          
                          ****
                          **69,181**
                          
                          
                          
                          63,581Leased
                              property under capital leases, net of deferred gain
                              of $982 and $1,092 and
                              net of accumulated amortization of $42,913 and $42,149
                          
                          ****
                          **18,164**
                          
                          
                          
                          19,281Property
                              and equipment, at cost less accumulated depreciation
                              of $108,881 and
                              $104,279
                          
                          ****
                          **156,996**
                          
                          
                          
                          154,966Other
                              assets
                          
                          ****
                          **29,375**
                          
                          
                          
                          27,949Total
                              assets
                          
                          **$**
                          **1,991,261**
                          
                          
                          $
                          1,951,697**Liabilities
                              and stockholders’ equity**Unpaid
                              losses and loss adjustment expenses
                          
                          **$**
                          **465,810**
                          
                          
                          $
                          482,269Unearned
                              premiums
                          
                          ****
                          **341,632**
                          
                          
                          
                          321,927Debt
                          
                          ****
                          **112,551**
                          
                          
                          
                          115,895Claims
                              checks payable
                          
                          ****
                          **41,759**
                          
                          
                          
                          42,931Reinsurance
                              payable
                          
                          ****
                          **639**
                          
                          
                          
                          680Other
                              liabilities
                          
                          ****
                          **99,596**
                          
                          
                          
                          89,446Total
                              liabilities
                          
                          ****
                          **1,061,987**
                          
                          
                          
                          1,053,148Commitments
                              and contingenciesStockholders’
                              equity:Common
                              stock, par value $0.001 per share; 110,000,000 shares
                              authorized; shares
                              issued 87,918,687 and 86,489,082
                          
                          ****
                          **88**
                          
                          
                          
                          86Additional
                              paid-in capital
                          
                          ****
                          **467,358**
                          
                          
                          
                          441,969Treasury
                              stock; at cost shares: 29,419 and 17,328
                          
                          ****
                          **(443**
                          **)**
                          
                          
                          (259
                          )Retained
                              earnings
                          
                          ****
                          **486,417**
                          
                          
                          
                          484,539Accumulated
                              other comprehensive loss
                          
                          ****
                          **(24,146**
                          **)**
                          
                          
                          (27,786
                          )Total
                              stockholders’ equity
                          
                          ****
                          **929,274**
                          
                          
                          
                          898,549Total
                              liabilities and stockholders’ equity
                          
                          **$**
                          **1,991,261**
                          
                          
                          $
                          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





*AMOUNTS
                              IN THOUSANDS, EXCEPT SHARE DATA*
                            *Three
                              Months Ended March 31,*
                          
                          **2007**
                          
                          2006**Revenues**Net
                              premiums earned
                          
                          **$**
                          **329,282**
                          
                          
                          $
                          325,824Net
                              investment income
                          
                          ****
                          **16,925**
                          
                          
                          
                          17,755Net
                              realized investment gains (losses)
                          
                          ****
                          **287**
                          
                          
                          
                          (1,067
                          )Total
                              revenues
                          
                          ****
                          **346,494**
                          
                          
                          
                          342,512**Losses
                              and expenses**Net
                              losses and loss adjustment expenses
                          
                          ****
                          **233,457**
                          
                          
                          
                          236,496Policy
                              acquisition costs
                          
                          ****
                          **68,652**
                          
                          
                          
                          59,333Other
                              underwriting expenses
                          
                          ****
                          **11,725**
                          
                          
                          
                          12,600Other
                              expense
                          
                          ****
                          **4,194**
                          
                          
                          ****
                          **—**Interest
                              and fees expense
                          
                          ****
                          **1,726**
                          
                          
                          
                          1,898Total
                              losses and expenses
                          
                          ****
                          **319,754**
                          
                          
                          
                          310,327Income
                              before provision for income taxes
                          
                          ****
                          **26,740**
                          
                          
                          
                          32,185Provision
                              for income taxes
                          
                          ****
                          **8,394**
                          
                          
                          
                          10,868Net
                              income
                          
                          **$**
                          **18,346**
                          
                          
                          $
                          21,317**Earnings
                              per share:**Basic
                              and diluted
                          
                          **$**
                          **0.21**
                          
                          
                          $
                          0.25**Cash
                              dividends declared per share**
                          
                          **$**
                          **0.16**
                          
                          
                          $
                          0.08**Weighted-average
                              shares outstanding:**Basic
                          
                          ****
                          **87,108,898**
                          
                          
                          
                          85,868,878Additional
                              common shares assumed issued under treasury stock method
                          
                          ****
                          **1,057,931**
                          
                          
                          
                          648,285Diluted
                          
                          ****
                          **88,166,829**
                          
                          
                          
                          86,517,163




*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
                    )Comprehensive
                        income
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    18,346
                    (1)
                    
                    
                    3,640
                    (2)
                    
                    
                    21,986Cash
                        dividends declared on common stock
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    (14,046
                    )
                    
                    
                    
                    
                    
                    
                    (14,046
                    )Exercise
                        of stock options
                    
                    
                    1,310,455
                    
                    
                    
                    2
                    
                    
                    
                    21,080
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    21,082Issuance
                        of restricted stock
                    
                    
                    119,150
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    —Forfeiture
                        of 12,091shares
                        of restricted
                        stock
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    184
                    
                    
                    
                    (184
                    )
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    —Stock-based
                        compensation cost
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,924
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    1,924Excess
                        tax benefit of stock-based compensation
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2,201
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    2,201Balance
                        – March 31, 2007
                    
                    
                    87,918,687
                    
                    
                    $
                    88
                    
                    
                    $
                    467,358
                    
                    
                    $
                    (443
                    )
                    
                    $
                    486,417
                    
                    
                    $
                    (24,146
                    )
                    
                    $
                    929,274


(1)
                        Net
                            income for the three months ended March 31,
                            2007.
 
 (2)
                        Net
                            change in accumulated other comprehensive loss
                            follows:


*Three
                              Months Ended*
                            *March
                              31, 2007*Unrealized
                              holding gains arising during the period, net of tax
                              expense of
                              $1,857
                          
                          $
                          3,450Reclassification
                            adjustment for investment losses included in net income,
                            net of tax
                            expense of $1
                          
                          
                          3Amortization
                              of prior service cost and net actuarial loss on defined
                              benefit plans, net
                              of deferred tax expense of $100
                          
                          
                          187Total
                              net other comprehensive income
                          
                          $
                          3,640




*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*
                            *Three
                              Months Ended March 31,*
                          
                          **2007**
                          
                          2006**Operating
                              activities**Net
                              income
                          
                          **$**
                          **18,346**
                          
                          
                          $
                          21,317Adjustments
                              to reconcile net income to net cash provided by operating
                              activities:Depreciation
                              and amortization
                          
                          ****
                          **6,218**
                          
                          
                          
                          6,661Net
                              amortization of investment premiums and discounts
                          
                          ****
                          **2,585**
                          
                          
                          
                          2,007Stock-based
                              compensation cost
                          
                          ****
                          **1,924**
                          
                          
                          
                          4,099Provision
                              for deferred income taxes
                          
                          ****
                          **3,179**
                          
                          
                          
                          2,820Provision
                              for premiums receivable losses
                          
                          ****
                          **545**
                          
                          
                          
                          612Net
                              realized investment (gains) losses
                          
                          ****
                          **(287**
                          **)**
                          
                          
                          1,067Equity
                              loss of other long-term investment
                          
                          ****
                          **187**
                          
                          
                          
                          —Changes
                              in assets and liabilitiesPremiums
                              receivable
                          
                          ****
                          **(9,193**
                          **)**
                          
                          
                          (6,943
                          )Deferred
                              policy acquisition costs
                          
                          ****
                          **(5,600**
                          **)**
                          
                          
                          (2,980
                          )Reinsurance
                              receivables and recoverables
                          
                          ****
                          **(69**
                          **)**
                          
                          
                          352Federal
                              income taxes
                          
                          ****
                          **4,389**
                          
                          
                          
                          4,529Other
                              assets
                          
                          ****
                          **(3,280**
                          **)**
                          
                          
                          (2,880
                          )Unpaid
                              losses and loss adjustment expenses
                          
                          ****
                          **(16,459**
                          **)**
                          
                          
                          (15,407
                          )Unearned
                              premiums
                          
                          ****
                          **19,705**
                          
                          
                          
                          11,476Claims
                              checks payable
                          
                          ****
                          **(1,172**
                          **)**
                          
                          
                          (2,072
                          )Other
                              liabilities
                          
                          ****
                          **8,695**
                          
                          
                          
                          14,079Net
                              cash provided by operating activities
                          
                          ****
                          **29,713**
                          
                          
                          
                          38,737**Investing
                              activities**Purchases
                              of:Fixed
                              maturity securities available-for-sale
                          
                          ****
                          **(3,404**
                          **)**
                          
                          
                          (146,738
                          )Equity
                              securities available-for-sale
                          
                          ****
                          **—**
                          
                          
                          
                          (35,627
                          )Other
                              long-term investments, equity method
                          
                          ****
                          **(133**
                          **)**
                          
                          
                          —Property
                              and equipment
                          
                          ****
                          **(6,820**
                          **)**
                          
                          
                          (6,627
                          )Maturities
                              and calls of fixed maturity securities available-for-sale
                          
                          ****
                          **8,207**
                          
                          
                          
                          8,299Sales
                              of:Fixed
                              maturity securities available-for-sale
                          
                          ****
                          **1,722**
                          
                          
                          
                          33,862Equity
                              securities available-for-sale
                          
                          ****
                          **—**
                          
                          
                          
                          83,989Other
                              long-term investments, equity method
                          
                          ****
                          **123**
                          
                          
                          
                          —Net
                              cash used in investing activities
                          
                          ****
                          **(305**
                          **)**
                          
                          
                          (62,842
                          )**Financing
                              activities**Repayment
                              of debt
                          
                          ****
                          **(3,662**
                          **)**
                          
                          
                          (3,352
                          )Dividends
                              paid (per share: $0.16 and $0.08)
                          
                          ****
                          **(14,046**
                          **)**
                          
                          
                          (6,872
                          )Proceeds
                              from the exercise of stock options
                          
                          ****
                          **21,082**
                          
                          
                          
                          718Excess
                              tax benefit from stock-based compensation
                          
                          ****
                          **1,270**
                          
                          
                          
                          89Net
                              cash provided by (used in) financing activities
                          
                          ****
                          **4,644**
                          
                          
                          
                          (9,417
                          )Net
                              increase (decrease) in cash and cash equivalents
                          
                          ****
                          **34,052**
                          
                          
                          
                          (33,522
                          )Cash
                              and cash equivalents, beginning of period
                          
                          ****
                          **51,999**
                          
                          
                          
                          68,668Cash
                              and cash equivalents, end of period
                          
                          **$**
                          **86,051**
                          
                          
                          $
                          35,146**Supplemental
                              information:**Income
                              taxes paid
                          
                          **$**
                          **1,209**
                          
                          
                          $
                          3,519Interest
                              paid
                          
                          ****
                          **210**
                          
                          
                          
                          388




*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**


**March
      31, 2007**








**NOTE1.  FINANCIAL STATEMENT
      PRESENTATION**





***General***





21st
      Century Insurance Group and subsidiaries (the “Company”) prepared the
      accompanying unaudited condensed consolidated financial statements in accordance
      with the rules and regulations of the Securities and Exchange Commission for
      interim reporting. As permitted under those rules and regulations, certain
      notes
      or other information that are normally required by accounting principles
      generally accepted in the United States of America (“GAAP”) have been condensed
      or omitted if they substantially duplicate the disclosures contained in the
      annual audited consolidated financial statements. The unaudited condensed
      consolidated financial statements should be read in conjunction with the audited
      consolidated financial statements and notes thereto included in the Company’s
      Annual Report on Form 10-K for the year ended December 31, 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 three-month period
      ended March 31, 2007 are not necessarily indicative of results that may be
      expected for the remaining interim period or the year as a whole.





***Other
      Expense***





The
      Company incurred $3.4 million in severance and other benefits costs for an
      approximate three percent reduction of its work force during the first quarter
      of 2007 in connection with efforts to streamline operations.  As of
      March 31, 2007, $0.4 million of severance-related benefits had not been paid,
      and are expected to be distributed by the end of 2007.  The Company
      also incurred $0.7 million in connection with a proposal from 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.





Common
      stock equivalents excluded from the calculation of diluted EPS because their
      inclusion would have been anti-dilutive (i.e., their inclusion under the
      treasury stock method would have increased EPS) were 2,422,342 and 4,552,553
      at
      March 31, 2007 and 2006, respectively.




***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**
 **Unaudited**
 **TABULAR
            DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**
 **March
            31, 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. We have not yet determined the effect, if any, that the
      implementation of FAS 157 will have on our 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 three months ended March 31,
      2007.





As
      permitted by FIN 48, the Company also adopted a policy of classifying interest
      and penalties related to income taxes as elements of income tax expense in
      the
      consolidated financial statements.  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 during the next 12 months.





The
      Company had no accrued penalties and no material interest receivable or interest
      payable at the date of adoption or at March 31, 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 $1.7 million
      reduction in deferred policy acquisition costs as of March 31, 2007, and a
      corresponding increase in policy acquisition costs during the quarter ended
      March 31, 2007.





**Reclassifications**





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





**NOTE
      2.  PROPOSAL FOR OFFER**





On
      January 24, 2007, the owner of approximately 61% of the outstanding shares
      of
      Company common stock, American International Group, Inc. (“AIG”), submitted an
      unsolicited proposal to the Company’s Board of Directors to acquire the
      remaining shares of the Company common stock it does not own. The proposal
      is
      subject to several conditions, including the approval of the transaction by
      a
      Special Committee of the Company’s Board of Directors who are independent of
      AIG.  Provisions in certain agreements, including the supplemental
      executive retirement plan and stock-based compensation plans, could be triggered
      by an offer or acquisition, resulting in the accelerated recognition of expense
      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 the proposal made by AIG.




7
 *Table
            of Contents*




**21ST
            CENTURY INSURANCE GROUP**
 **NOTES
            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **Unaudited**
 **TABULAR
            DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**
 **March
            31, 2007**





**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.





*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 agreement for an
      immaterial amount was reached with the Axen plaintiff, which the Company is
      finalizing.





*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 $2.6 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.





8
 *Table
            of Contents*




**21ST
            CENTURY INSURANCE GROUP**
 **NOTES
            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **Unaudited**
 **TABULAR
            DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**
 **March
            31, 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. Plaintiff seeks California class action certification,
      injunctive relief, and unspecified actual and punitive damages. The complaint
      contended that the Company uses “biased” software in determining the value of
      total-loss automobiles. Specifically, Plaintiff alleged that database providers
      use improper methodology to establish comparable auto values, that the providers
      populate their databases with biased figures, and that the Company and other
      carriers allegedly subscribe to the programs to unfairly reduce claims costs.
      This case is consolidated with similar actions against other insurers for
      discovery and pre-trial motions.  A court-ordered appraisal of Speck’s
      vehicle was favorable to the Company and Ramona Goldenberg was substituted
      as a
      Plaintiff, replacing Speck, and a new appraisal was ordered. On October 13,
      2006, Plaintiff’s counsel offered to dismiss this case, with prejudice, in
      exchange for the Company waiving its costs. The Company has accepted the offer
      from the Plaintiff’s counsel to dismiss the matter and will support a motion,
      containing the agreed terms.





*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.  In March 2007, the Court of Appeal stayed the trial
      court’s order and requested briefs from the parties.





*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 “made-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. In November 2006,
      the
      Court of Appeal ordered the trial court to show cause why the relief the Company
      requested should not be granted. Oral arguments have been concluded and the
      Company is awaiting the Court’s decision.





*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 a companion case,
*Francis A. Sliwinski v. 21st Century Insurance Group, et
      al*
      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 has 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.





9
 *Table
            of Contents*




**21ST
            CENTURY INSURANCE GROUP**
 **NOTES
            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **Unaudited**
 **TABULAR
            DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**
 **March
            31, 2007**


**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:





**March
                              31,**
                            **2007**
                          
                          December
                              31,
                            2006Net
                              unrealized losses on available-for-sale investments,
                              net of deferred
                              income taxes of $(4,600) and $(6,458)
                          
                          **$**
                          **(8,541**
                          **)**
                          
                          $
                          (11,994
                          )Unamortized
                              prior service cost and net actuarial loss of defined
                              benefit pension
                              plans, net of deferred income taxes of $8,403 and $8,503
                          
                          ****
                          **(15,605**
                          **)**
                          
                          
                          (15,792
                          )Total
                              accumulated other comprehensive loss
                          
                          **$**
                          **(24,146**
                          **)**
                          
                          $
                          (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. 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. 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. Because 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.  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 proposed 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*
                            *March
                              31,***2007**
                          
                          2006Service
                              cost
                          
                          **$**
                          **1,771**
                          
                          
                          $
                          1,872Interest
                              cost
                          
                          ****
                          **2,105**
                          
                          
                          
                          1,971Expected
                              return on plan assets
                          
                          ****
                          **(2,360**
                          **)**
                          
                          
                          (2,108
                          )Amortization
                              of prior service cost
                          
                          ****
                          **36**
                          
                          
                          
                          34Amortization
                              of net loss
                          
                          ****
                          **251**
                          
                          
                          
                          678Total
                          
                          **$**
                          **1,803**
                          
                          
                          $
                          2,447





***Pension
      Plan Contributions***





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.





10
 *Table
            of Contents*




**21ST
            CENTURY INSURANCE GROUP**
 **NOTES
            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **Unaudited**
 **TABULAR
            DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**
 **March
            31, 2007**


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 $0.2 million in the first quarter
      2007.





**NOTE
      6.  STOCK–BASED AWARDS**





***Stock
      Option Plans***





No
      stock
      options were granted during the quarter ended March 31, 2007. The quarter ended
      March 31, 2006 results 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. As compensation costs for
      certain employees are included in deferred policy acquisition costs, pre-tax
      compensation cost related to stock-based compensation of $0.4 million and $0.5
      million was deferred at March 31, 2007 and 2006, respectively. The remaining
      unrecognized compensation cost related to unvested awards was $6.9 million
      and
      $14.6 million at March 31, 2007 and 2006, respectively.





The
      impact of stock options expense is as follows:





*Three
                              Months Ended*
                            *March
                              31,**AMOUNTS
                              IN THOUSANDS, EXCEPT PER SHARE DATA*
                          
                          **2007**
                          
                          2006Net
                              losses and loss adjustment expenses
                          
                          **$**
                          **228**
                          
                          
                          $
                          1,134Policy
                              acquisition costs
                          
                          ****
                          **149**
                          
                          
                          
                          487Other
                              underwriting expenses
                          
                          ****
                          **929**
                          
                          
                          
                          1,835Income
                              before provision for income taxes
                          
                          ****
                          **(1,306**
                          **)**
                          
                          
                          (3,456
                          )Provision
                              for income taxes
                          
                          ****
                          **355**
                          
                          
                          
                          757Net
                              income
                          
                          **$**
                          **(951**
                          **)**
                          
                          $
                          (2,699
                          )Basic
                              and diluted earnings per share
                          
                          **$**
                          **(0.01**
                          **)**
                          
                          $
                          (0.03
                          )





*Outstanding
      Options*





The
      following table summarizes information about stock options outstanding at March
      31, 2007:





*AMOUNTS
                              IN THOUSANDS*
                          
                          *Number
                              of*
                            *Options*
                          
                          *Aggregate*
                            *Intrinsic
                              Value*
                          
                          *Weighted-*
                            *Average*
                            *Exercise
                              Price*Outstanding
                          
                          
                          8,570
                          
                          
                          $
                          44,490
                          
                          
                          $
                          16.40Exercisable
                          
                          
                          6,752
                          
                          
                          
                          34,557
                          
                          
                          
                          16.58





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 March 31, 2007.





*Current
      Activity*





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





*Three
                              Months Ended*
                            *March
                              31,**AMOUNTS
                              IN THOUSANDS*
                          
                          **2007**
                          
                          2006Fair
                              value of stock options granted
                          
                          **$**
                          —
                          
                          
                          $
                          9,093Intrinsic
                              value of options exercised
                          
                          ****
                          **6,568**
                          
                          
                          
                          217Grant
                              date fair value of options vested
                          
                          ****
                          **6,647**
                          
                          
                          
                          6,519Proceeds
                              from exercise of stock options
                          
                          ****
                          **21,082**
                          
                          
                          
                          718Tax
                              benefit realized as a result of stock option exercises
                          
                          ****
                          **2,299**
                          
                          
                          
                          76




11
 *Table
            of Contents*




**21ST
            CENTURY INSURANCE GROUP**
 **NOTES
            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **Unaudited**
 **TABULAR
            DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**
 **March
            31, 2007**


***Restricted
      Shares Plan***





Total
      compensation expense relating to the Restricted Shares Plan was $0.2 million
      and
      $0.1 million for the three months ended March 31, 2007 and 2006, respectively.
      Unrecognized compensation cost in connection with restricted stock grants
      totaled $3.8 million and $2.4 million at March 31, 2007 and 2006, respectively.
      The cost is expected to be recognized over a weighted-average period of 2.5
      years.





***Accelerated
      Vesting Provisions***





The
      stock
      option plans contain "change in control" provisions that could immediately
      vest
      certain options. As permitted under the Restricted Shares Plan, restricted
      shares granted during 2007 contain a provision that would immediately vest
      shares that would otherwise vest within one year from the date of an offer
      from
      AIG. The Company granted 119,150 and 103,500 restricted shares with a total
      fair
      value of $2.6 million and $1.6 million during the three months ended March
      31,
      2007 and 2006, respectively. The assumptions used to recognize expense over
      the
      service period have not been altered by these "change in control" provisions
      in
      response to the proposed offer by AIG to purchase the remaining Company
      common stock.








**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.





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




*Personal*
                            *Auto
                              Lines*
                          
                          *Homeowner
                              and*
                            *Earthquake*
                            *Lines
                              in Runoff*
                          
                          *Total**Three
                              Months Ended March 31, 2007*Net
                              premiums earned
                          
                          **$**
                          **329,282**
                          
                          
                          **$**
                          **—**
                          
                          
                          **$**
                          **329,282**Depreciation
                              and amortization expense
                          
                          ****
                          **6,218**
                          
                          
                          
                          —
                          
                          
                          ****
                          **6,218**Segment
                              profit (loss)
                          
                          ****
                          **15,510**
                          
                          
                          ****
                          **(62**
                          **)**
                          
                          ****
                          **15,448***Three
                              Months Ended March 31, 2006*Net
                              premiums earned
                          
                          $
                          325,824
                          
                          
                          $
                          —
                          
                          
                          $
                          325,824Depreciation
                              and amortization expense
                          
                          
                          6,659
                          
                          
                          
                          2
                          
                          
                          
                          6,661Segment
                              profit (loss)
                          
                          
                          17,472
                          
                          
                          
                          (77
                          )
                          
                          
                          17,395





12
 *Table
            of Contents*




**21ST
            CENTURY INSURANCE GROUP**
 **NOTES
            TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS**
 **Unaudited**
 **TABULAR
            DOLLAR AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA**
 **March
            31, 2007**





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





*Three
                              Months Ended*
                            *March
                              31,***2007**
                          
                          2006Segment
                              profit
                          
                          **$**
                          **15,448**
                          
                          
                          $
                          17,395Net
                              investment income
                          
                          ****
                          **16,925**
                          
                          
                          
                          17,755Net
                              realized investment gains (losses)
                          
                          ****
                          **287**
                          
                          
                          
                          (1,067
                          )Other
                              expense
                          
                          ****
                          **(4,194**
                          **)**
                          
                          
                          —Interest
                              and fees expense
                          
                          ****
                          **(1,726**
                          **)**
                          
                          
                          (1,898
                          )Consolidated
                              income before provision for income taxes
                          
                          **$**
                          **26,740**
                          
                          
                          $
                          32,185




**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.





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 $8.5 million and $8.6 million at March
      31, 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 $8.3 million and $8.2 million in other
      Impact related fixed-income investments at March 31, 2007 and December 31,
      2006,
      respectively. The Company also held $0.3 million in other Impact related private
      equity investments classified as other long-term investments at March 31, 2007.
      Total Impact related investment income was $0.3 million for the three months
      ended March 31, 2007 and $0.2 million for the same period in 2006.




13
 *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”, “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 1.5
      million vehicles in Arizona, California, Florida, Georgia, Illinois, Indiana,
      Nevada, New Jersey, Ohio, Oregon, Pennsylvania, Texas, Washington, Colorado,
      Minnesota, Missouri, 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. The Company’s A+ rating was affirmed by A.M. Best on
      June 13, 2006.





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.





***Proposal
      from Majority Shareholder***





On
      January 24, 2007, the owner of approximately 61% of the outstanding shares
      of
      Company common stock, American International Group, Inc. (“AIG”), submitted an
      unsolicited proposal to the Company’s Board of Directors to acquire the
      remaining shares of the Company common stock it does not own. The proposal
      is
      subject to several conditions, including the approval of the transaction by
      a
      Special Committee of the Company’s Board of Directors who are independent of
      AIG.  Provisions in certain agreements, including the supplemental
      executive retirement plan and stock-based compensation plans, could be triggered
      by an offer or acquisition, resulting in the accelerated recognition of expense
      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 the proposal made by AIG.  The
      proposal could have a negative impact on the Company’s ability to carry out its
      business plans.





***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);
      and Colorado, Minnesota, Missouri, and Wisconsin (fourth quarter 2006). The
      Company increased the share of total U.S. personal auto market in which it
      operates from approximately 18% in 2003 to 60% in 2006. The Company has further
      increased the share of the total market in which it operates to 66% with the
      entry into the New York market in April 2007. Growth in direct premiums written
      in non-California markets in the first quarter of 2007 was 165.4% as compared
      to
      the same period in 2006 and we wrote 20.2% of the first quarter’s direct
      premiums outside of California, versus 7.9% for the same period in 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.





14
 *Table
            of Contents*





***Highlights***





The
      following table summarizes our condensed consolidated results of
      operations:





*AMOUNTS
                              IN THOUSANDS*
                            *Three
                              Months Ended March 31,*
                          
                          **2007**
                          
                          2006
                          
                          *%
                              Change*
                            *’07
                              vs.‘06*Direct
                              premiums written
                          
                          **$**
                          **350,530**
                          
                          
                          $
                          338,569
                          
                          
                          
                          3.5
                          %Net
                              premiums written
                          
                          ****
                          **349,022**
                          
                          
                          
                          337,223
                          
                          
                          
                          3.5Net
                              premiums earned
                          
                          **$**
                          **329,282**
                          
                          
                          $
                          325,824
                          
                          
                          
                          1.1Net
                              losses and loss adjustment expenses (“LAE”)
                          
                          ****
                          **(233,457**
                          **)**
                          
                          
                          (236,496
                          )
                          
                          
                          (1.3
                          )Underwriting
                              expenses
                          
                          ****
                          **(80,377**
                          **)**
                          
                          
                          (71,933
                          )
                          
                          
                          11.7Underwriting
                              profit
                          
                          **$**
                          **15,448**
                          
                          
                          $
                          17,395
                          
                          
                          
                          (11.2
                          )





Financial
      highlights for the three months ended March 31, 2007 and 2006:




·
            California
                direct premiums written decreased 10.3% to $279.5 million in 2007,
                compared to $311.8 million for the same period in
                2006.




·
            Non-California
                direct premiums written increased 165.4% to $71.0 million in 2007,
                compared to $26.8 million for the same period in
                2006.




·
            First
                quarter 2007 consolidated combined ratio was 95.3%, versus 94.7%
                for the
                same period in 2006. First quarter 2007 was favorably impacted by
                5.5
                points of prior accident year loss and LAE reserve development, while
                2006
                was favorably impacted by 2.2 points of prior accident year
                development.




In
      recent
      quarters, the California market, which represented 79.8% of our total direct
      premiums written during the first quarter, 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 to net premiums earned ratio increased to 24.4% for the
      three months ended March 31, 2007 from 22.1% for the same period in 2006. This
      increase is primarily the result of expenses associated with the Company’s
      national expansion efforts.




Net
      income decreased 13.9% to $18.3million for the three
      months ended March 31, 2007, or $0.21per basic share, compared
      to $21.3 million, or $0.25 per basic share, for the same period in
      2006.  This was primarily due to $3.4 million of severance costs
      associated with the Company’s efforts to streamline operations and $0.7 million
      of Special Committee costs, for a total of $4.1 million in other expenses ($2.7
      million after tax, or $0.03 per share).  This decrease was also due to
      lower underwriting profit resulting from higher underwriting expenses, discussed
      above, partially offset by increases in net premiums earned and decreases in
      net
      losses and LAE summarized above.




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.  As of this
      date, 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. 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.





15
 *Table
            of Contents*





***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 (loss) 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 located in the following: 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.





**RESULTS
      OF OPERATIONS**





***Consolidated
      Results***





The
      following table summarizes our condensed consolidated results of operations
      and
      reconciles personal auto lines underwriting profit to net income:





*AMOUNTS
                              IN THOUSANDS,*
                          
                          *Three
                              Months Ended*
                            *March
                              31,*
                          
                          *%
                              Change**EXCEPT
                              SHARE DATA*
                          
                          **2007**
                          
                          2006
                          
                          *’07
                              vs.‘06*Personal
                              auto lines underwriting profit
                          
                          **$**
                          **15,510**
                          
                          
                          $
                          17,472
                          
                          
                          
                          (11.2
                          )%Homeowner
                              and earthquake lines in runoff, underwriting loss
                          
                          ****
                          **(62**
                          **)**
                          
                          
                          (77
                          )
                          
                          
                          (18.7
                          )Net
                              investment income
                          
                          ****
                          **16,925**
                          
                          
                          
                          17,755
                          
                          
                          
                          (4.7
                          )Net
                              realized investment gains (losses)
                          
                          ****
                          **287**
                          
                          
                          
                          (1,067
                          )
                          
                          N/M
                          1Other
                              expense
                          
                          ****
                          **(4,194**
                          **)**
                          
                          
                          —
                          
                          
                          
                          0.0Interest
                              and fees expense
                          
                          ****
                          **(1,726**
                          **)**
                          
                          
                          (1,898
                          )
                          
                          
                          (9.1
                          )Provision
                              for income taxes
                          
                          ****
                          **(8,394**
                          **)**
                          
                          
                          (10,868
                          )
                          
                          
                          (22.8
                          )Net
                              income
                          
                          **$**
                          **18,346**
                          
                          
                          $
                          21,317
                          
                          
                          
                          (13.9
                          )Basic
                              and diluted earnings per share
                          
                          **$**
                          **0.21**
                          
                          
                          $
                          0.25
                          
                          
                          
                          (16.0
                          )





1Ratio
      is not
      meaningful.





16
 *Table
            of Contents*








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





*Three
                              Months Ended*
                            *March
                              31,**AMOUNTS
                              IN THOUSANDS*
                          
                          **2007**
                          
                          2006Net
                              losses and LAE incurred related to insured events in:Current
                              accident year personal auto lines
                          
                          **$**
                          **251,340**
                          
                          
                          $
                          243,511Prior
                              accident years:Personal
                              auto lines
                          
                          ****
                          **(17,945**
                          **)**
                          
                          
                          (7,092
                          )Homeowner
                              and earthquake lines in runoff
                          
                          ****
                          **62**
                          
                          
                          
                          77Total
                              prior years’ redundancy recorded in current year
                          
                          ****
                          **(17,883**
                          **)**
                          
                          
                          (7,015
                          )Total
                              net losses and LAE incurred
                          
                          **$**
                          **233,457**
                          
                          
                          $
                          236,496





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 March 31, 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 vehicles
      accounted for 20.2% of our direct premiums written for the three months ended
      March 31, 2007, compared to 7.9% 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.





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




*Three
                              Months Ended**March
                              31,*
                          
                          *$
                              Change*
                          
                          *%
                              Change**AMOUNTS
                            IN THOUSANDS*
                          
                          **2007**
                          
                          2006
                          
                          *’07
                              vs.‘06*
                          
                          *’07
                              vs.‘06*Direct
                              premiums written
                          
                          **$**
                          **350,530**
                          
                          
                          $
                          338,569
                          
                          
                          $
                          11,961
                          
                          
                          
                          3.5
                          %Net
                              premiums written
                          
                          **$**
                          **349,022**
                          
                          
                          $
                          337,223
                          
                          
                          
                          11,799
                          
                          
                          
                          3.5Net
                              premiums earned
                          
                          **$**
                          **329,282**
                          
                          
                          $
                          325,824
                          
                          
                          
                          3,458
                          
                          
                          
                          1.1Net
                              losses and LAE
                          
                          ****
                          **(233,395**
                          **)**
                          
                          
                          (236,419
                          )
                          
                          
                          (3,024
                          )
                          
                          
                          (1.3
                          )Underwriting
                              expenses
                          
                          ****
                          **(80,377**
                          **)**
                          
                          
                          (71,933
                          )
                          
                          
                          8,444
                          
                          
                          
                          11.7Underwriting
                              profit
                          
                          **$**
                          **15,510**
                          
                          
                          $
                          17,472
                          
                          
                          
                          (1,962
                          )
                          
                          
                          (11.2
                          )Ratios:Loss
                              and LAE ratio
                          
                          ****
                          **70.9**
                          **%**
                          
                          
                          72.6
                          %
                          
                          
                          (1.7
                          )Underwriting
                              expense ratio
                          
                          ****
                          **24.4**
                          
                          
                          
                          22.1
                          
                          
                          
                          2.4Combined
                              ratio
                          
                          ****
                          **95.3**
                          **%**
                          
                          
                          94.7
                          %
                          
                          
                          0.7





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




*Three
                              Months Ended*
                            *March
                              31,**AMOUNTS
                              IN THOUSANDS*
                          
                          **2007**
                          
                          2006Direct
                              premiums written
                          
                          **$**
                          **350,530**
                          
                          
                          $
                          338,569Ceded
                              premiums written
                          
                          ****
                          **(1,508**
                          **)**
                          
                          
                          (1,346
                          )Net
                              premiums written
                          
                          ****
                          **349,022**
                          
                          
                          
                          337,223Net
                              change in unearned premiums
                          
                          ****
                          **(19,740**
                          **)**
                          
                          
                          (11,399
                          )Net
                              premiums earned
                          
                          **$**
                          **329,282**
                          
                          
                          $
                          325,824




17
 *Table
            of Contents*





California
      direct premiums written decreased in the three months ended March 31, 2007,
      as
      compared to the same period 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, 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, 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
      decline in the loss and LAE ratios for the three months ended March 31, 2007
      of
      1.7 points is primarily due to the effect of favorable development related
      to
      prior accident years and lower accident frequency. The loss and LAE ratios
      for
      the three months ended March 31, 2007, included 5.5 points ($17.9 million)
      of
      favorable reserve development compared to 2.2 points ($7.1 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,
      usually in conjunction with our quarterly actuarial review.





The
      underwriting expense to net premiums earned ratios increased in the three months
      ended March 31, 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 $0.1
      million for the three months ended March 31, 2007 and 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.





***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 March 31, 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:




*AMOUNTS
                              IN THOUSANDS*
                          
                          *Net
                              Investment Income**Three
                              Months Ended March 31,*
                          
                          **2007**
                          
                          2006Interest
                              on fixed maturity securities, at fair value
                          
                          **$**
                          **16,824**
                          
                          
                          $
                          16,867Interest
                              on cash and cash equivalents
                          
                          ****
                          **527**
                          
                          
                          
                          334Interest
                              on other long-term investments, equity method
                          
                          ****
                          **(187**
                          **)**
                          
                          
                          —Dividends
                              on equity securities
                          
                          
                          —
                          
                          
                          
                          810Total
                              investment income
                          
                          ****
                          **17,164**
                          
                          
                          
                          18,011Investment
                              expense
                          
                          ****
                          **(239**
                          **)**
                          
                          
                          (256
                          )Net
                              investment income
                          
                          **$**
                          **16,925**
                          
                          
                          $
                          17,755





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




*Average
                            Annual Yields*
                          *on
                            Fixed Maturity Securities**Three
                            Months Ended March 31,*
                        
                        **2007**
                        
                        2006Pre-tax
                            – fixed maturity securities
                        
                        ****
                        **4.5**
                        **%**
                        
                        
                        4.8
                        %After-tax
                            – fixed maturity securities
                        
                        ****
                        **3.3**
                        **%**
                        
                        
                        3.5
                        %





At
      March
      31, 2007, $375.7 million, or 26.3%, 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 March 31, 2007,
      no
      investments were rated below investment grade, except for a $3.0 million
      position in KN Energy that had a BB- rating.





18
 *Table
            of Contents*





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




*AMOUNTS
                              IN THOUSANDS*
                          
                          *Net
                              Realized Gains*
                            *(Losses)
                              on Investments**Three
                              Months Ended March 31,*
                          
                          **2007**
                          
                          2006Gross
                              realized gains
                          
                          **$**
                          **384**
                          
                          
                          $
                          1,492Gross
                              realized losses
                          
                          ****
                          **(97**
                          **)**
                          
                          
                          (2,559
                          )Net
                              realized gains (losses) on investments
                          
                          **$**
                          **287**
                          
                          
                          $
                          (1,067
                          )





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 months ended March 31, 2007 or
      2006.
      See discussion under *Critical Accounting Estimates – Investments* for
      further information.





***Other
      Expense***





The
      Company incurred $3.4 million in severance and other benefits costs for an
      approximate three percent reduction of its work force during the first quarter
      of 2007 in connection with efforts to streamline operations.  The
      entire cost of the reduction in force was recognized during the first quarter
      of
      2007.  As of March 31, 2007, $0.4 million of severance-related
      benefits had not been paid, and are expected to be distributed by the end of
      2007.  Annual savings from this reduction in work force are estimated
      to be primarily offset by merit increases and costs associated with national
      expansion efforts.  The Company also incurred $0.7 million in
      connection with a proposal from the majority shareholder as discussed in Note
      2
      of the *Notes to Condensed Consolidated Financial
      Statements*.





**FINANCIAL
      CONDITION**





Investments
      and cash were $1.5 billion at March 31, 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 March 31, 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 $14.2 million and
      $14.4 million at March 31, 2007 and December 31, 2006,
      respectively.





The
      Company also has unrated, community investments representing 1.4% 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.





Increased
      advertising, sales and
      customer service costs due to the Company’s national expansion efforts in the
      first quarter of 2007, partially offset by a $1.7 million decrease in deferred
      policy acquisition costs (“DPAC”) resulting from the adoption of Statement of
      Position 05-1 discussed in *Recent Accounting Pronouncements*,
      contributed to a net increase in DPAC of $5.6million to $69.2million,
      compared to $63.6
      million at December 31, 2006.  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:





**March
                              31, 2007**
                          
                          December
                              31, 2006*AMOUNTS
                              IN THOUSANDS*
                          
                          **Gross**
                          
                          **Net**
                          
                          Gross
                          
                          NetUnpaid
                              losses and LAEPersonal
                              auto lines
                          
                          **$**
                          **464,416**
                          
                          
                          **$**
                          **459,389**
                          
                          
                          $
                          480,731
                          
                          
                          $
                          475,261Homeowner
                              and earthquake lines in runoff
                          
                          ****
                          **1,394**
                          
                          
                          ****
                          **690**
                          
                          
                          
                          1,538
                          
                          
                          
                          808Total
                          
                          **$**
                          **465,810**
                          
                          
                          **$**
                          **460,079**
                          
                          
                          $
                          482,269
                          
                          
                          $
                          476,069





At
      March
      31, 2007, gross unpaid losses and LAE decreased $16.5 million, primarily due
      to
      a reserve decrease of $16.3 million in the personal auto lines as a result
      of
      $17.9 million of favorable prior year loss development recorded during the
      three
      months ended March 31, 2007. The gross unpaid losses and LAE in the homeowner
      and earthquake lines decreased $0.1 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
      $112.6 million at March 31, 2007, compared to $115.9 million at December 31,
      2006, consists of $12.7 million of capital lease obligations and $99.9 million
      of Senior Notes, net of discount. The decrease in debt of $3.3 million during
      the three months ended March 31, 2007 is primarily attributable to principal
      payments on the capital leases.





19
 *Table
            of Contents*





Stockholders’
equity
      and book value per
      share increased to $929.3 million and $10.57, respectively, at March 31, 2007,
      compared to $898.5 million and $10.39 at December 31, 2006,
      respectively.  The increase in stockholders’ equity for the three
      months ended March 31, 2007 was primarily due to net income of $18.3 million,
      stock-based compensation cost of $1.9 million, $23.3 million from the exercise
      of stock options, and other comprehensive income of $3.6
      million.****This
      was partially offset by dividends
      to stockholders of $14.0 million and an adjustment of $2.4 million as the result
      of adopting Financial Interpretation No. 48,*Accounting for
      Uncertainty in
      Income Taxes – an Interpretation of FAS No. 109*.





**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;
                and





·
            Any
                dividends to stockholders that our directors may
                declare.





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 $38.8 million
      at March 31, 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 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 increases, there
      can be no assurance that insurance regulators will grant future rate increases
      that may be necessary to offset possible future increases in claims cost
      trends.





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, subsequently amended in October of 2006, could have a
      materially adverse impact on the Company’s California results.  The
      regulations became effective on April 3, 2007. If the newly elected insurance
      commissioner does not modify, suspend or withdraw the regulations before they
      become effective, an industry lawsuit could be brought to challenge the
      regulations as contrary to current law.  Also, the Company could
      consider bringing its own legal action once the regulations are applied to
      it.





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.





20
 *Table
            of Contents*





At
      March
      31, 2007, our insurance subsidiaries had a combined statutory surplus of $785.8
      million compared to $771.0 million at December 31, 2006. The increase in
      statutory surplus was primarily due to statutory net income of $18.5 million
      and
      a decrease in nonadmitted assets of $9.9 million, partially offset by dividends
      to the holding company of $14.0 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 March 31, 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 March 31, 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*
                          
                          **March
                              31,**
                            **2007**
                          
                          December
                              31,
                            2006Stockholders’
                              equity – GAAP
                          
                          **$**
                          **929,274**
                          
                          
                          $
                          898,549Condensed
                              adjustments to reconcile GAAP shareholders’ equity to statutory
                              surplus:Net
                              book value of fixed assets under capital leases
                          
                          ****
                          **(19,146**
                          **)**
                          
                          
                          (20,373
                          )Deferred
                              loss (gain) under capital lease transactions
                          
                          ****
                          **130**
                          
                          
                          
                          (79
                          )Capital
                              lease obligation
                          
                          ****
                          **12,638**
                          
                          
                          
                          15,985Nonadmitted
                              net deferred tax assets
                          
                          ****
                          **(15,752**
                          **)**
                          
                          
                          (17,419
                          )Difference
                              in net deferred tax assets reported under Statutory
                              Accounting
                              Principles
                          
                          ****
                          **31,545**
                          
                          
                          
                          24,200Intercompany
                              receivables
                          
                          ****
                          **(1,433**
                          **)**
                          
                          
                          (11,488
                          )Fixed
                              assets
                          
                          ****
                          **(22,920**
                          **)**
                          
                          
                          (22,955
                          )Equity
                              in non-insurance entities
                          
                          ****
                          **(67,643**
                          **)**
                          
                          
                          (47,006
                          )Net
                              unrealized losses on investments
                          
                          ****
                          **12,611**
                          
                          
                          
                          17,881Deferred
                              policy acquisition costs
                          
                          ****
                          **(69,181**
                          **)**
                          
                          
                          (63,581
                          )Pension
                              related liabilities (assets)
                          
                          ****
                          **17,174**
                          
                          
                          
                          15,648Other
                              prepaid expenses
                          
                          ****
                          **(18,623**
                          **)**
                          
                          
                          (14,195
                          )FIN
                              48 liability
                          
                          ****
                          **1,750**
                          
                          
                          
                          —Other,
                              net
                          
                          ****
                          **(4,650**
                          **)**
                          
                          
                          (4,158
                          )Statutory
                              surplus
                          
                          **$**
                          **785,774**
                          
                          
                          $
                          771,009





***Cash
      Flows***





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




*AMOUNTS
                              IN THOUSANDS*
                            *Three
                              Months Ended March 31,*
                          
                          **2007**
                          
                          2006
                          
                          *‘07
                              vs.‘06*
                            *Increase/*
                            *(Decrease)*Net
                              cash and cash equivalents provided by operating activities
                          
                          **$**
                          **29,713**
                          
                          
                          $
                          38,737
                          
                          
                          $
                          (9,024
                          )Net
                              cash and cash equivalents used in investing activities
                          
                          ****
                          **(305**
                          **)**
                          
                          
                          (62,842
                          )
                          
                          
                          62,537Net
                              cash and cash equivalents provided by (used in) financing
                              activities
                          
                          ****
                          **4,644**
                          
                          
                          
                          (9,417
                          )
                          
                          
                          14,061Net
                              increase (decrease) in cash and cash equivalents
                          
                          **$**
                          **34,052**
                          
                          
                          $
                          (33,522
                          )
                          
                          $
                          67,574





*Operating
      Activities*





Net
      cash
      provided by operating activities decreased primarily due to an increase in
      expenses as a result of the Company’s national expansion strategy, expenditures
      related to the 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.





Net
      cash
      used in investing activities decreased due to a decrease in net acquisitions
      (purchases, net of maturities, calls and sales) of investments, primarily as
      a
      result of a decline in the redeployment of cash from operating cash flows to
      the
      investment portfolio.  Operating cash was instead invested in more
      liquid cash equivalents that have similar returns as a result of the flat yield
      curve.





21
 *Table
            of Contents*





*Financing
      Activities*





Net
      cash
      provided by financing activities increased due to a $20.4 million increase
      in
      cash receipts provided by 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 $7.2 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 three-month period ended March 31, 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 March 31, 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
      March 31, 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.





22
 *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 first 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.





23
 *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 first quarter 2007 loss and LAE reserve analysis will range
      from negative 13% to positive 6%, or approximately 12% lower and 7% higher
      than
      the assumptions utilized in the first quarter 2007 reserve
      analysis.  These changes in the assumed loss cost trend would cause
      approximately a $78 million decrease or a $49 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.





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 1.3 percent lower than those
      actually utilized in the first quarter 2007 loss and LAE reserve analysis to
      approximately 1.0 percent higher than those actually utilized.  If the
      loss development factor assumptions were reduced by 1.3 percent and increased
      by
      1.0 percent, the loss and LAE reserves would decrease by approximately $70
      million under the lower assumptions or increase by approximately $53 million
      under the higher assumptions.  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 are not assumed to be other-than-temporary. Where declines
      in values of securities below cost or amortized cost are considered to be
      other-than-temporary, 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 months ended March 31, 2007 or for
      the
      same period 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.





24
 *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”):





**March
                              31, 2007**
                          
                          December
                              31, 2006*AMOUNTS
                              IN THOUSANDS,*
                            *EXCEPT
                              NUMBER OF ISSUES*
                          
                          ***#
                              issues***
                          
                          ***Fair
                              Value***
                          
                          *#
                              issues*
                          
                          *Fair
                              Value*AAA
                          
                          ****
                          **321**
                          
                          
                          **$**
                          **724,717**
                          
                          
                          
                          322
                          
                          
                          $
                          728,033AA
                          
                          ****
                          **112**
                          
                          
                          ****
                          **205,227**
                          
                          
                          
                          106
                          
                          
                          
                          165,216A
                          
                          ****
                          **99**
                          
                          
                          ****
                          **361,947**
                          
                          
                          
                          109
                          
                          
                          
                          423,429BBB
                          
                          ****
                          **40**
                          
                          
                          ****
                          **131,053**
                          
                          
                          
                          42
                          
                          
                          
                          113,162BB
                          
                          ****
                          **3**
                          
                          
                          ****
                          **3,036**
                          
                          
                          ****
                          **—**
                          
                          
                          ****
                          **—**Unrated
                          
                          ****
                          **4**
                          
                          
                          ****
                          **5,233**
                          
                          
                          
                          4
                          
                          
                          
                          5,176Total
                              fixed maturity securities
                          
                          ****
                          **579**
                          
                          
                          **$**
                          **1,431,213**
                          
                          
                          
                          583
                          
                          
                          $
                          1,435,016





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





*AMOUNTS
                              IN THOUSANDS*
                          
                          **March
                              31,**
                            **2007**
                          
                          December
                              31,
                            2006Unrated
                              fixed maturity securities (fair value):Impact
                              Community Capital, LLC 2
                          
                          **$**
                          **1,999**
                          
                          
                          $
                          1,999Impact
                              Healthcare, LLC 2
                          
                          ****
                          **567**
                          
                          
                          
                          510Impact
                              Childcare, LLC 2
                          
                          ****
                          **810**
                          
                          
                          
                          810Impact
                              Commercial Opportunities, LLC 2
                          
                          ****
                          **1,857**
                          
                          
                          
                          1,857Total
                              unrated fixed maturity securities
                          
                          ****
                          **5,233**
                          
                          
                          
                          5,176Unrated
                              other long-term investments (equity method):Impact
                              Workforce, LLC 2
                          
                          ****
                          **320**
                          
                          
                          
                          320AIG
                              PEP3
                          
                          ****
                          **14,208**
                          
                          
                          
                          14,385Total
                              unrated other long-term investments
                          
                          ****
                          **14,528**
                          
                          
                          
                          14,705Total
                              unrated investments
                          
                          **$**
                          **19,761**
                          
                          
                          $
                          19,881Percentage
                              of total investments, at fair value
                          
                          ****
                          **1.4**
                          **%**
                          
                          
                          1.4
                          %Percentage
                              of total unrealized losses
                          
                          ****
                          **0.0**
                          **%**
                          
                          
                          0.0
                          %





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:





**March
                              31, 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
                          
                          ****
                          **—**
                          
                          
                          **$**
                          **—**
                          
                          
                          **$**
                          **—**
                          
                          
                          
                          2
                          
                          
                          $
                          12,075
                          
                          
                          **$**
                          2166-12
                              months
                          
                          ****
                          **3**
                          
                          
                          ****
                          **21,544**
                          
                          
                          ****
                          **947**
                          
                          
                          
                          1
                          
                          
                          
                          9,625
                          
                          
                          
                          375More
                              than 1 year
                          
                          ****
                          **79**
                          
                          
                          ****
                          **657,765**
                          
                          
                          ****
                          **20,204**
                          
                          
                          
                          88
                          
                          
                          
                          698,674
                          
                          
                          
                          25,919Less
                              than $0.1 million
                          
                          ****
                          **136**
                          
                          
                          ****
                          **290,836**
                          
                          
                          ****
                          **4,256**
                          
                          
                          
                          142
                          
                          
                          
                          304,838
                          
                          
                          
                          4,764Total
                              investments with unrealized losses4
                          
                          ****
                          **218**
                          
                          
                          **$**
                          **970,145**
                          
                          
                          **$**
                          **25,407**
                          
                          
                          
                          233
                          
                          
                          $
                          1,025,212
                          
                          
                          $
                          31,274





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.*




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


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


4 
Unrealized
        losses represent
        approximately 1.8% and 2.2% of the total fair value of investments at March
        31,
        2007 and December 31, 2006.




25
 *Table
            of Contents*





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





**March
                              31, 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
                          
                          **$**
                          **22,100**
                          
                          
                          **$**
                          **21,873**
                          
                          
                          **$**
                          **227**
                          
                          
                          $
                          3,040
                          
                          
                          $
                          2,983
                          
                          
                          $
                          57Due
                              after one year through five years
                          
                          ****
                          **586,932**
                          
                          
                          ****
                          **571,858**
                          
                          
                          ****
                          **15,074**
                          
                          
                          
                          602,148
                          
                          
                          
                          584,279
                          
                          
                          
                          17,869Due
                              after five years through ten years
                          
                          ****
                          **60,916**
                          
                          
                          ****
                          **59,433**
                          
                          
                          ****
                          **1,483**
                          
                          
                          
                          96,077
                          
                          
                          
                          93,043
                          
                          
                          
                          3,034Due
                              after ten years
                          
                          ****
                          **325,604**
                          
                          
                          ****
                          **316,981**
                          
                          
                          ****
                          **8,623**
                          
                          
                          
                          355,221
                          
                          
                          
                          344,907
                          
                          
                          
                          10,314Total
                              fixed maturity securities with unrealized losses
                          
                          **$**
                          **995,552**
                          
                          
                          **$**
                          **970,145**
                          
                          
                          **$**
                          **25,407**
                          
                          
                          $
                          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
      March
      31, 2007, our DTAs were $113.0 million and our DTLs were $71.2 million, for
      a
      net DTA of $41.8 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 $9.3 million,
      representing an unrealized tax benefit of $3.2 million at March 31, 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 March 31, 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: $1.3 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 March 31, 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.





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 to opening retained earnings and stockholders’ equity by $2.4
      million. Adoption of FIN 48 had no impact on net income in the three months
      ended March 31, 2007.





26
 *Table
            of Contents*





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 months
      ended March 31, 2007, the total amount of unrecognized tax benefits declined
      by
      approximately $1.8 million, representing the proportionate amount deemed
      utilized for tax purposes in the first quarter of the year, 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 March 31, 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, for which the final required regulatory approval was obtained 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.




***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 March
      31, 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
      March
      31, 2007, net property and equipment included $132.9 million in software, net
      of
      related accumulated depreciation. This amount represented 84.7% 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 first 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.





27
 *Table
            of Contents*





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. We have not yet determined the effect, if any, that the
      implementation of FAS 157 will have on our 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 three months ended March 31,
      2007.





As
      permitted by FIN 48, the Company also adopted a policy of classifying interest
      and penalties related to income taxes as elements of income tax expense in
      the
      consolidated financial statements.  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 March 31, 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”)*,*provides guidance on accounting for
      deferred 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 $1.7 million
      reduction in deferred policy acquisition costs as of March 31, 2007, and a
      corresponding increase in policy acquisition costs during the quarter ended
      March 31, 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.****




28
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            of Contents*





**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 may 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 3.8 at March 31,
      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*
                            *March
                              31, 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
                          
                          $
                          1,431.2
                          
                          
                          $
                          1,376.5
                          
                          
                          
                          (3.82
                          %)Debt,
                              at amortized cost
                          
                          
                          112.6
                          
                          
                          
                          118.6
                          
                          
                          
                          5.36
                          %





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.





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.”





29
 *Table
            of Contents*





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**March
                            31, 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
                        
                        
                        3.5%
                        
                        
                        
                        23.8%
                        
                        
                        
                        58.3%
                        
                        
                        
                        9.9%
                        
                        
                        
                        3.9%
                        
                        
                        
                        0.6%





***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 Global Investment Corp. (“AIGGIC”)
      managed fund of private equity investments and funded $14.4 million of the
      $35 million commitment in 2006. The funded commitment at March 31, 2007 was
      $14.2 million. The value of these private equity investments are calculated
      on a
      quarterly basis, as AIGGIC 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 AIGGIC’s 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.





***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
      March 31, 2007 that has materially affected, or is reasonably likely to
      materially affect, our internal control over financial reporting.





30
 *Table
            of Contents*





***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 become reportable
      during the quarter ended March 31, 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.





**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.





**ITEM6.  EXHIBITS**





See
      accompanying exhibit index.





31
 *Table
            of Contents*




**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:
                        May
                            2, 2007
                        
                        /s/
                            Bruce W. MarlowBRUCE
                            W. MARLOWPresident
                            and Chief Executive Officer(Principal
                            Executive Officer)Date:
                        May
                            2, 2007
                        
                        /s/
                            Steven P. ErwinSTEVEN
                            P. ERWINSenior
                            Vice President and Chief Financial Officer(Principal
                            Financial
                            Officer)




32
 *Table
            of Contents*




**EXHIBIT
      INDEX**







Exhibit
                          No.
                        Description
                            of Exhibit
                        
                        Location31.1
                        Certification
                            of principal executive officer pursuant to Rule 13a-14(a)
                            under the
                            Securities Exchange Act of 1934
                        
                        Filed
                            herewith31.2
                        Certification
                            of principal financial officer pursuant to Rule 13a-14(a)
                            under the
                            Securities Exchange Act of 1934
                        
                        Filed
                            herewith32.1
                        Certification
                            Pursuant to 18 U.S.C. Section 1350
                        
                        Filed
                            herewith







33