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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington D.C. 20549** **Form 10-Q**   þ     **QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE    SECURITIES EXCHANGE ACT OF 1934**   **For the quarter ended June 30, 2005** **or** **o** **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE    SECURITIES EXCHANGE ACT OF 1934****Commission File Number 1-14094****Meadowbrook Insurance Group, Inc.***(Exact name of Registrant as specified in its charter)*   **Michigan** **38-2626206***(State of Incorporation)* *(IRS Employer Identification No.)***26255 American Drive, Southfield, Michigan 48034***(Address, zip code of principal executive offices)***(248) 358-1100***(Registrant’s telephone number, including area code)*     Indicate by check mark whether the Registrant (1) has filedall reports required to be filed by Section 13 or 15(d) ofthe Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the Registrantwas required to file such reports), and (2) has beensubject to such filing requirements for the past90 days.     Yes þ          No o     Indicate by check mark whether the Registrant is an acceleratedfiler (as defined in Rule 12b-2 of the ExchangeAct).     Yes þ          No o     The aggregate number of shares of the Registrant’s CommonStock, $.01 par value, outstanding on August 2, 2005was 29,017,772.  

**TABLE OF CONTENTS**           **Page**                **PART I — FINANCIAL INFORMATION**     ITEM 1 —      FINANCIAL STATEMENTS  2        Consolidated Statements of Income    (unaudited)  2-3        Consolidated Statements of Comprehensive    Income (unaudited)  4-5        Consolidated Balance Sheets (unaudited)  6        Consolidated Statement of Cash Flows    (unaudited)  7        Notes to Consolidated Financial Statements    (unaudited)  8-20      ITEM 2 —      MANAGEMENT’S DISCUSSION AND ANALYSIS    OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS  21-40      ITEM 3 —      QUANTITATIVE AND QUALITATIVE DISCLOSURES    ABOUT MARKET RISK  40-41      ITEM 4 —      CONTROLS AND PROCEDURES  41      **PART II — OTHER    INFORMATION**     ITEM 1 —      LEGAL PROCEEDINGS  42      ITEM 2 —      UNREGISTERED SALES OF EQUITY SECURITIES AND    USE OF PROCEEDS  42      ITEM 4 —      SUBMISSION OF MATTERS TO A VOTE OF SECURITY    HOLDERS  42      ITEM 6 —      EXHIBITS  43                SIGNATURES  44  First Modification to the Amended and Restated Loan and Security Agreement Reciprocal Easement and Operation Agreement First Amendment to Land Contract Amendment to Credit Agreement Demand Note Certification of Robert S Cubbin, CEO Certification of Karen M. Spaun, Senior VP and CFO Certification to Section 906, by Robert S. Cubbin, CEO Certification to Section 906, by Karen M. Spaun, Senior VP and CFO
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**PART 1 — FINANCIAL INFORMATION****ITEM 1*     FinancialStatements*****MEADOWBROOK INSURANCE GROUP, INC.****CONSOLIDATED STATEMENTS OF INCOME**             **For the Six Months Ended**  **June 30,**     **2005** **2004**       **(Unaudited)**  **(In thousands,**  **except share data)****Revenues**             Premiums earned              Gross $161,550  $136,100       Ceded  (37,399)  (33,304)            Net earned premiums  124,151   102,796      Net commissions and fees  18,133   20,125      Net investment income  8,568   7,144      Net realized losses  (10)  (152)             Total revenues  150,842   129,913        **Expenses**             Losses and loss adjustment expenses  117,864   101,411      Reinsurance recoveries  (43,002)  (36,076)            Net losses and loss adjustment expenses  74,862   65,335      Salaries and employee benefits  26,253   25,133      Policy acquisition and other underwriting expenses  21,793   16,416      Other administrative expenses  13,831   12,565      Interest expense  1,579   843              Total expenses  138,318   120,292            Income before taxes and equity earnings  12,524   9,621             Federal and state income tax expense  4,202   3,534      Equity earnings (losses), of affiliates  1   (35)           Net income $8,323  $6,052            Earnings Per Share              Basic $0.29  $0.21       Diluted $0.28  $0.21     Weighted average number of common shares              Basic  29,101,484   29,030,836       Diluted  29,419,606   29,427,512 The accompanying notes are an integral part of the ConsolidatedFinancial Statements.
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**MEADOWBROOK INSURANCE GROUP, INC.****CONSOLIDATED STATEMENTS OF INCOME**             **For the Three Months Ended**  **June 30,**     **2005** **2004**       **(Unaudited)**  **(In thousands,**  **except share data)****Revenues**             Premiums earned              Gross $80,745  $69,922       Ceded  (17,381)  (16,839)            Net earned premiums  63,364   53,083      Net commissions and fees  8,034   8,844      Net investment income  4,477   3,547      Net realized gains (losses)  104   (32)             Total revenues  75,979   65,442        **Expenses**             Losses and loss adjustment expenses  61,522   49,997      Reinsurance recoveries  (23,794)  (17,171)            Net losses and loss adjustment expenses  37,728   32,826      Salaries and employee benefits  13,648   12,325      Policy acquisition and other underwriting expenses  10,971   8,870      Other administrative expenses  6,046   6,469      Interest expense  806   528              Total expenses  69,199   61,018            Income before taxes and equity earnings  6,780   4,424             Federal and state income tax expense  2,250   1,546      Equity earnings (losses), of affiliates  50   (58)           Net income $4,580  $2,820            Earnings Per Share              Basic $0.16  $0.10       Diluted $0.16  $0.10     Weighted average number of common shares              Basic  29,130,033   29,036,164       Diluted  29,443,933   29,459,390 The accompanying notes are an integral part of the ConsolidatedFinancial Statements.
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**MEADOWBROOK INSURANCE GROUP, INC.****CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME**              **For the Six**  **Months Ended**  **June 30,**     **2005** **2004**       **(Unaudited)**  **(In thousands)**    Net income $8,323  $6,052      Other comprehensive income, net of tax:              Unrealized losses on securities  (1,211)  (4,671)      Less: reclassification adjustment for losses included in net    income  79   60               Other comprehensive loss, net of tax  (1,132)  (4,611)              Comprehensive income $7,191  $1,441        The accompanying notes are an integral part of the ConsolidatedFinancial Statements.
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**MEADOWBROOK INSURANCE GROUP, INC.****CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME**              **For the Three**  **Months Ended**  **June 30,**     **2005** **2004**       **(Unaudited)**  **(In thousands)**    Net income $4,580  $2,820      Other comprehensive income, net of tax:              Unrealized gains (losses) on securities  3,252   (6,405)      Less: reclassification adjustment for (gains) losses    included in net income  2   (13)              Other comprehensive gain (loss), net of tax  3,254   (6,418)              Comprehensive income (loss) $7,834  $(3,598)       The accompanying notes are an integral part of the ConsolidatedFinancial Statements.
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**MEADOWBROOK INSURANCE GROUP, INC.****CONSOLIDATED BALANCE SHEETS**             **June 30,** **December 31,**  **2005** **2004**       **(Unaudited)**    **(In thousands,**  **except share data)****ASSETS**    Investments             Debt securities available for sale, at fair value (amortized    cost of $368,969 and $324,966) $374,570  $332,242      Equity securities available for sale, at fair value (cost of $0)  —   39              Total investments  374,570   332,281      Cash and cash equivalents  32,835   69,875      Accrued investment income  4,704   4,331      Premiums and agent balances receivable, net  100,180   84,094      Reinsurance recoverable on:              Paid losses  18,685   17,908       Unpaid losses  170,120   151,161      Prepaid reinsurance premiums  25,350   26,075      Deferred policy acquisition costs  26,168   25,167      Deferred federal income taxes  15,188   14,956      Goodwill  28,997   28,997      Other assets  43,225   46,851              Total assets $840,022  $801,696         **LIABILITIES AND SHAREHOLDERS’ EQUITY**     Liabilities             Losses and loss adjustment expenses $418,069  $378,157      Unearned premiums  139,704   134,302      Debt  9,918   12,144      Debentures  35,310   35,310      Accounts payable and accrued expenses  28,182   38,837      Reinsurance funds held and balances payable  19,285   17,832      Payable to insurance companies  2,969   6,990      Other liabilities  11,590   10,614              Total liabilities  665,027   634,186            Commitments and contingencies (Note 6)            Shareholders’ Equity             Common stock, $0.01 stated value; authorized    50,000,000 shares; 29,172,892 and 29,074,832 shares    issued and outstanding  292   290      Additional paid-in capital  126,558   126,085      Retained earnings  45,310   37,175      Note receivable from officer  (861)  (868)     Accumulated other comprehensive income  3,696   4,828              Total shareholders’ equity  174,995   167,510              Total liabilities and shareholders’ equity $840,022  $801,696        The accompanying notes are an integral part of the ConsolidatedFinancial Statements.
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**MEADOWBROOK INSURANCE GROUP, INC.****CONSOLIDATED STATEMENTS OF CASH FLOWS**              **For the Six Months**  **Ended June 30,**     **2005** **2004**       **(Unaudited)**  **(In thousands)****Cash Flows From Operating Activities**             Net income $8,323  $6,052             Adjustments to reconcile net income to net cash provided by    (used in) operating activities:              Amortization of other intangible assets  185   191       Amortization of deferred debenture issuance costs  75   35       Depreciation of furniture, equipment, and building  1,248   656       Net accretion of discount and premiums on bonds  1,180   822       Loss on sale of investments, net  121   92       Gain on sale of fixed assets  (126)  —       Stock-based employee compensation  23   44       Long-term incentive plan expense  390   309       Deferred income tax expense  351   137      Changes in operating assets and liabilities:             Decrease (increase) in:              Premiums and agent balances receivable  (16,086)  (17,295)      Reinsurance recoverable on paid and unpaid losses  (19,737)  (1,118)      Prepaid reinsurance premiums  725   (2,645)      Deferred policy acquisition costs  (1,000)  (2,958)      Other assets  4,060   1,457      Increase (decrease) in:              Losses and loss adjustment expenses  39,912   20,673       Unearned premiums  5,401   15,825       Payable to insurance companies  (4,021)  (4,541)      Reinsurance funds held and balances payable  1,454   3,466       Other liabilities  542   5,096               Total adjustments  14,697   20,246              Net cash provided by operating activities  23,020   26,298        **Cash Flows From Investing Activities**             Purchase of debt securities available for sale  (152,612)  (62,411)     Proceeds from sales and maturities of debt securities available    for sale  106,298   25,944      Proceeds from sales of equity securities available for sale  8   —      Capital expenditures  (12,915)  (1,673)     Purchase of books of business  (149)  (272)     Proceeds from sale of assets  633   —      Deconsolidation of subsidiary  —   (4,218)     Other investing activities  399   1,775              Net cash used in investing activities  (58,338)  (40,855)       **Cash Flows From Financing Activities**             Proceeds from lines of credit  2,654   9,829      Payment of lines of credit  (4,880)  (11,131)     Net proceeds from debentures  —   24,250      Book overdraft  757   (343)     Issuance of common stock  952   45      Share repurchases of common stock  (1,094)  —      Other financing activities  (111)  10              Net cash (used in) provided by financing activities  (1,722)  22,660             Net (decrease) increase in cash and cash equivalents  (37,040)  8,103      Cash and cash equivalents, beginning of period  69,875   50,647             Cash and cash equivalents, end of period $32,835  $58,750        The accompanying notes are an integral part of the ConsolidatedFinancial Statements.
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**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS****Note 1 — Summary of Significant AccountingPolicies*****Basis of Presentation and Management Representation***     The consolidated financial statements include accounts, afterelimination of intercompany accounts and transactions, ofMeadowbrook Insurance Group, Inc. (the “Company”), itswholly owned subsidiary Star Insurance Company(“Star”), and Star’s wholly owned subsidiaries,Savers Property and Casualty Insurance Company, WilliamsburgNational Insurance Company, and Ameritrust Insurance Corporation(which are collectively referred to as the “InsuranceCompany Subsidiaries”), and Preferred Insurance Company,Ltd. The consolidated financial statements also includeMeadowbrook, Inc., Crest Financial Corporation, and theirsubsidiaries. In addition, the consolidated financial statementsinclude the equity earnings of the Company’s wholly ownedunconsolidated subsidiaries, American Indemnity InsuranceCompany, Ltd. and Meadowbrook Capital Trust I.     In the opinion of management, the consolidated financialstatements reflect all normal recurring adjustments necessary topresent a fair statement of the results for the interim period.Preparation of financial statements under generally acceptedaccounting principles requires management to make estimates.Actual results could differ from those estimates. The results ofoperations for the three months and six months endedJune 30, 2005, are not necessarily indicative of theresults expected for the full year.     These financial statements and the notes thereto should be readin conjunction with the Company’s audited financialstatements and accompanying notes included in its annual reporton Form 10-K, as filed with the United States Securitiesand Exchange Commission, for the year ended December 31,2004.     Certain amounts in the 2004 financial statements and notes toconsolidated financial statements have been reclassified toconform to the 2005 presentation. These amounts specificallyrelate to state income tax expense, the allocation of corporateoverhead, and a reclassification of revenue and net incomerelated to a specific subsidiary. State income tax expense hasbeen reclassified from total expenses to federal and stateincome tax expense. The Company’s segment information hasbeen reclassified to include an allocation of corporate overheadfrom the specialty risk management operations segment to theagency operations segment. Previously, 100% of corporateoverhead was allocated to specialty risk management operations.In addition, the Company reclassified revenues and the overallnet income related to a specific subsidiary from the agencyoperations segment to the specialty risk management operationssegment. Refer to Note 7 — *Segment Information*for additional information.***Revenue Recognition***     Premiums written are recognized as earned on a pro rata basisover the life of the policy term. Unearned premiums representthe portion of premiums written that are applicable to theunexpired terms of policies in force. Provisions for unearnedpremiums on reinsurance assumed from others are made on thebasis of ceding reports when received and actuarial estimates.Certain premiums are subject to retrospective premiumadjustments. Premiums are recognized over the term of theinsurance policy.     Fee income, which includes risk management consulting, losscontrol, and claims services, is recognized during the periodthe services are provided. Claims processing fees are recognizedas revenue over the estimated life of the claims, or theestimated life of the contract. For those contracts that provideservices beyond the expiration or termination of the contract,fees are deferred in an amount equal to management’sestimate of the Company’s obligation to continue to provideservices.     Commission income, which includes reinsurance placement, isrecorded on the later of the effective date or the billing dateof the policies on which they are earned. Commission income isreported net of sub-producer commission expense. Profit sharingcommissions from insurance companies are recognized whendeterminable, which is when such commissions are received.
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**     The Company reviews, on an ongoing basis, the collectibility ofits receivables and establishes an allowance for estimateduncollectible accounts.     Realized gains or losses on sale of investments are determinedon the basis of specific costs of the investments. Dividend andinterest income are recognized when earned. Discount or premiumon debt securities purchased at other than par value isamortized using the constant yield method. Investments withother than temporary declines in fair value are written down totheir estimated net fair value and the related realized lossesare recognized in income.***Earnings Per Share***     Basic earnings per share are based on the weighted averagenumber of common shares outstanding during the period, whilediluted earnings per share includes the weighted average numberof common shares and potential dilution from shares issuablepursuant to stock options using the treasury stock method.     Outstanding options of 622,592 and 1,035,796 for the six monthsended June 30, 2005 and 2004, respectively, have beenexcluded from the diluted earnings per share, as they wereanti-dilutive. Shares issuable pursuant to stock optionsincluded in diluted earnings per share were 318,122 and 340,659for the six months ended June 30, 2005 and 2004,respectively. In addition, shares issuable pursuant tooutstanding warrants included in diluted earnings per share were82,567 for the six months ended June 30, 2004. There wereno outstanding warrants as of June 30, 2005.     Outstanding options of 622,592 and 1,035,796 for the threemonths ended June 30, 2005 and 2004, respectively, havebeen excluded from the diluted earnings per share, as they wereanti-dilutive. Shares issuable pursuant to stock optionsincluded in diluted earnings per share were 313,901 and 319,358for the three months ended June 30, 2005 and 2004,respectively. In addition, shares issuable pursuant tooutstanding warrants included in diluted earnings per share were77,318 for the three months ended June 30, 2004. There wereno outstanding warrants as of June 30, 2005.***Stock Options***     Effective January 1, 2003, the Company adopted therequirements of Statement of Financial Accounting Standards(“SFAS”) No. 148, *“Accounting forStock-Based Compensation — Transition andDisclosure — an amendment of FASB StatementNo. 123”*, utilizing the prospective method. Underthe prospective method, stock-based compensation expense isrecognized for awards granted after the beginning of the fiscalyear in which the change is made. Upon implementation ofSFAS No. 148 in 2003, the Company is recognizingstock-based compensation expense for awards granted afterJanuary 1, 2003.     Prior to the adoption of SFAS No. 148, the Companyapplied the intrinsic value-based provisions set forth in APBOpinion No. 25. Under the intrinsic value method,compensation expense is determined on the measurement date,which is the first date when both the number of shares theemployee is entitled to receive, and the exercise price areknown. Compensation expense, if any, resulting from stockoptions granted by the Company is determined based upon thedifference between the exercise price and the fair market valueof the underlying common stock at the date of grant. TheCompany’s Stock Option Plan requires the exercise price ofthe grants to be at the current fair market value of theunderlying common stock.     The Company, through its 1995 and 2002 Amended and RestatedStock Option Plans (the “Plans”), may grant options tokey executives and other members of management of the Companyand its subsidiaries in amounts not to exceed2,000,000 shares of the Company’s common stockallocated for each plan. The Plans are administered by theCompensation Committee (the “Committee”) of the Boardof Directors. Option shares may be exercised subject to theterms of the Plans and the terms prescribed by the Committee atthe time of grant. Currently, the Plans’ options haveeither five or ten-year terms and are exercisable and vest inequal increments over the option term.
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**     In 2004, the Company’s Board of Directors approved theadoption of a Long Term Incentive Plan (the “LTIP”).The LTIP provides participants with the opportunity to earn cashand stock awards based upon the achievement of specifiedfinancial goals over a three-year performance period with thefirst performance period commencing January 1, 2004. At theend of the three-year performance period, and if the performancetarget is achieved, the Committee shall determine the amount ofLTIP awards that are payable to participants in the LTIP.One-half of any LTIP award will be payable in cash and one-halfof the award will be payable in the form of a restricted stockaward. If the Company achieves the three-year performancetarget, payment of the award would be made in three annualinstallments. The number of shares of Company’s commonstock subject to the restricted stock award shall equal thedollar amount of one-half of the LTIP award divided by the fairmarket value of Company’s common stock on the first date ofthe performance period. The restricted stock awards shall bemade subject to the terms and conditions of the LTIP and Plans.The Company accrues awards based upon the criteria set-forth andapproved by the Committee, as included in the LTIP. AtJune 30, 2005 and December 31, 2004, the Company had$2.1 million and $1.3 million accrued under the LTIP,respectively.     If compensation cost for stock option grants had been determinedbased on a fair value method, net income and earnings per shareon a pro forma basis for the periods ending June 30, 2005and 2004 would be as follows (in thousands):            **For the Six Months**  **Ended June 30,**     **2005** **2004**         Net income, as reported $8,323  $6,052     Add: Stock-based employee compensation expense included in    reported income, net of related tax effects  15   29     Deduct: Total stock-based employee compensation expense    determined under fair-value-based methods for all awards, net of    related tax effects  (121)  (251)           Pro forma net income $8,217  $5,830            Earnings per share:             Basic — as reported $0.29  $0.21      Basic — pro forma $0.28  $0.20      Diluted — as reported $0.28  $0.21      Diluted — pro forma $0.28  $0.20             **For the Three Months**  **Ended June 30,**     **2005** **2004**         Net income, as reported $4,580  $2,820     Add: Stock-based employee compensation expense included in    reported income, net of related tax effects  6   11     Deduct: Total stock-based employee compensation expense    determined under fair-value-based methods for all awards, net of    related tax effects  (55)  (117)           Pro forma net income $4,531  $2,714            Earnings per share:             Basic — as reported $0.16  $0.10      Basic — pro forma $0.16  $0.09      Diluted — as reported $0.16  $0.10      Diluted — pro forma $0.15  $0.09 
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**     No options were granted during the six months and three monthsending June 30, 2005 or 2004.     Compensation expense of $23,000 and $44,000 has been recorded inthe six months ended June 30, 2005 and 2004, respectively,under SFAS 148. Compensation expense of $9,000 and $17,000has been recorded in the three months ended June 30, 2005and 2004, respectively.***Recent Accounting Pronouncements***     In December 2004, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 123 (revised 2004),*“Share-Based Payment”*(“SFAS 123R”), which replacesSFAS No. 123, *“Accounting for Stock Issued toEmployees.”*SFAS 123R requires all share-basedpayments to employees to be recognized in the financialstatements based on their fair values. The pro forma disclosurespreviously permitted under SFAS 123, will no longer be analternative to financial statement recognition. Commencing inthe first quarter of 2003, the Company began expensing the fairvalue of all stock options granted since January 1, 2003under the prospective method. Under SFAS 123R, the Companymust determine the appropriate fair value model to be used forvaluing share-based payments, the amortization method forcompensation cost and the transition method to be used at thedate of adoption. The transition methods include prospective andretroactive adoption options. Under the retroactive options,prior periods may be restated either as of the beginning of theyear of adoption or for all periods presented. The prospectivemethod requires that compensation expense be recorded at thebeginning of the first quarter of adoption of SFAS 123R forall unvested stock options and restricted stock based upon thepreviously disclosed SFAS 123 methodology and amounts. Theretroactive methods would record compensation expense beginningwith the first period restated for all unvested stock optionsand restricted stock. On April 14, 2005, the Securities andExchange Commission adopted a new rule that delays thecompliance dates for SFAS 123R. Under the new rule,SFAS 123R is effective for public companies for annual,rather than interim periods, that begin after June 15,2005. Therefore, the Company is required to adopt SFAS 123Rin the first quarter of 2006, or beginning January 1, 2006.The Company is currently evaluating the requirements ofSFAS 123R and has not yet determined the method of adoptionor impact SFAS 123R will have on its financial statements.     In May 2005, the FASB issued SFAS No. 154,*“Accounting Changes and Error Corrections, a replacementof APB Opinion No. 20 and FASB StatementNo. 3.”* SFAS No. 154 replaces thementioned pronouncements and changes the requirements for theaccounting and reporting of a change in an accounting principle.This Statement applies to all voluntary changes in accountingprinciple, as well as changes required by an accountingpronouncement in the unusual instance that the pronouncementdoes not include specific transition provisions. However, when apronouncement includes specific transition provisions, thoseprovisions should be followed. SFAS No. 154 requiresretrospective application to prior period financial statementsfor changes in accounting principle, unless it is impracticableto determine either the period-specific effects or thecumulative effect of the change. SFAS No. 154 alsorequires that retrospective application of a change inaccounting principle be limited to the direct effects of thechange. Indirect effects of a change in accounting principleshould be recognized in the period of the accounting change.SFAS No. 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning afterDecember 15, 2005. However, early adoption is permitted foraccounting changes and corrections of errors made in fiscalyears beginning after the date this Statement was issued. TheCompany is required to adopt the provisions ofSFAS No. 154, as applicable, beginning in 2006.Management believes the adoption of SFAS No. 154 willnot have a material impact on its consolidated financialstatements.     In July 2005, the FASB issued an exposure draft of a proposedinterpretation on accounting for uncertain tax positions underSFAS No. 109 *“Accounting for IncomeTaxes”.* If adopted as proposed, the pronouncement willbe effective December 31, 2005 and only those tax benefitsthat meet the probable recognition threshold may be recognizedor continue to be recognized as of the effective date. TheCompany is currently evaluating the impact this proposedinterpretation will have on its financial statements.
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)****Note 2 —****Reinsurance**     The Insurance Company Subsidiaries cede insurance to otherinsurers under pro-rata and excess-of-loss contracts. Thesereinsurance arrangements diversify the Company’s businessand minimize its exposure to large losses or from hazards of anunusual nature. The ceding of insurance does not discharge theoriginal insurer from its primary liability to its policyholder.In the event that all or any of the reinsuring companies areunable to meet their obligations, the Insurance CompanySubsidiaries would be liable for such defaulted amounts.Therefore, the Company is subject to credit risk with respect tothe obligations of its reinsurers. In order to minimize itsexposure to significant losses from reinsurer insolvencies, theCompany evaluates the financial condition of its reinsurers andmonitors the economic characteristics of the reinsurers on anongoing basis. The Company also assumes insurance from otherinsurers and reinsurers, both domestic and foreign, underpro-rata and excess-of-loss contracts. Based upon managementevaluation’s, they have concluded the reinsuranceagreements entered into by the Company transfer both significanttiming and underwriting risk to the reinsurer and, accordingly,are accounted for as reinsurance under the provisions of SFAS.No. 113 *“Accounting and Reporting for Reinsurancefor Short-Duration and Long-Duration Contracts”.*     Intercompany pooling agreements are commonly entered intobetween affiliated insurance companies, so as to allow thecompanies to utilize the capital and surplus of all of thecompanies, rather than each individual company. Under poolingarrangements, companies share in the insurance business that isunderwritten and allocate the combined premium, losses andrelated expenses between the companies within the poolingarrangement. Effective January 1, 2005, the InsuranceCompany Subsidiaries entered into an Inter-Company ReinsuranceAgreement (the “Reinsurance Agreement”). ThisReinsurance Agreement includes Star, Ameritrust InsuranceCorporation (“Ameritrust”), Savers Property andCasualty Insurance Company (“Savers”) and WilliamsburgNational Insurance Company (“Williamsburg”). Pursuantto the Reinsurance Agreement, Savers, Ameritrust andWilliamsburg have agreed to cede to Star and Star has agreed toreinsure 100% of the liabilities and expenses of Savers,Ameritrust and Williamsburg, relating to all insurance andreinsurance policies issued by them. In return, Star agrees tocede and Savers, Ameritrust and Williamsburg have agreed toreinsure Star for their respective percentages of theliabilities and expenses of Star. The Reinsurance Agreement wasfiled with the applicable regulatory authorities and was notdisapproved. Any changes to the Reinsurance Agreement must besubmitted to the applicable regulatory authorities for reviewand approval.     At June 30, 2005, the Company had reinsurance recoverablesfor paid and unpaid losses of $188.8 million. The Companycustomarily collateralizes reinsurance balances due fromnon-admitted reinsurers through funds withheld trusts or lettersof credit. The largest unsecured reinsurance recoverable is duefrom an admitted reinsurer with an “A” A.M. Bestrating and accounts for 34.1% of the total recoverable for paidand unpaid losses.     The Company maintains an excess-of-loss reinsurance treatydesigned to protect against large or unusual loss and lossadjustment expense activity. The Company determines theappropriate amount of reinsurance based on the Company’sevaluation of the risks accepted and analysis prepared byconsultants and reinsurers and on market conditions includingthe availability and pricing of reinsurance. To date, there havebeen no material disputes with the Company’s excess-of-lossreinsurers. No assurance can be given, however, regarding thefuture ability of any of the Company’s excess-of-lossreinsurers to meet their obligations.     Under the workers’ compensation reinsurance treaty,reinsurers are responsible for 100% of each loss in excess of$350,000, up to $5.0 million for each claimant on lossesoccurring prior to April 1, 2005. The Company increased itsretention from $350,000 to $750,000, for losses occurring on orafter April 1, 2005. In addition, there is coverage forloss events involving more than one claimant up to$50.0 million per occurrence. In a loss event involvingmore than one claimant, the per claimant coverage is$10.0 million.     Under the core liability reinsurance treaty, the reinsurers areresponsible for 100% of each loss in excess of $350,000, up to$2.0 million per occurrence on policies effective prior toJune 1, 2005. The Company increased its retention from$350,000 to $500,000, for losses occurring on policies effectiveon or after June 1,
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**2005. The Company also purchased an additional $3.0 millionof reinsurance clash coverage in excess of the $2.0 millionto cover amounts that may be in excess of the $2.0 millionpolicy limit, such as expenses associated with the settlement ofclaims or awards in excess of policy limits. Reinsurance clashcoverage reinsures a loss when two or more policies are involvedin a common occurrence.     The Company has a separate treaty to cover liabilityspecifically related to commercial trucking, where reinsurersare responsible for 100% of each loss in excess of $350,000, upto $1.0 million. In addition, the Company purchased anadditional $1.0 million of reinsurance clash coverage. TheCompany also established a separate treaty to cover liabilityrelated to chemical distributors and repackagers, wherereinsurers are responsible for 100% of each loss in excess of$500,000, up to $1.0 million, applied separately to generalliability and auto liability.     Under the property reinsurance treaty, reinsurers areresponsible for 100% of the amount of each loss in excess of$500,000, up to $5.0 million per location for anoccurrence. In addition, there is coverage for loss eventsinvolving multiple locations up to $20.0 million after theCompany has incurred $750,000 in loss.     Under the semi-automatic facultative umbrella reinsurancetreaties, the reinsurers are responsible for a minimum of 85% ofthe first million in coverage and 100% of each of the secondthrough fifth million of coverage, up to $5.0 million. Thereinsurers provide a ceding commission allowance to cover theCompany’s expenses.     Effective September 30, 2004, the Company amended anexisting reinsurance agreement that provided reinsurancecoverage for policies with effective dates from August 1,2003 to July 31, 2004, which were written in theCompany’s public entity excess liability program. Thisreinsurance agreement provided coverage on an excess-of-lossbasis for each occurrence in excess of the policyholder’sself-insured and the Company’s retained limit. Thisreinsurance agreement was amended by revising premium rate andloss coverage terms, which effected the transfer of risk to thereinsurer and reduced the net estimated costs of reinsurance tothe Company. The amended reinsurance cost for this coverage is aflat percentage of premium subject to this treaty and providesreinsurance coverage of $4.0 million in excess of$1.0 million for each occurrence in excess of thepolicyholder’s self-insured retention. These amended termswere applicable to the renewal of this reinsurance agreement forthe period August 1, 2004 to January 31, 2006.     In addition, the Company purchased $10.0 million in excessof $5.0 million for each occurrence, which is above theunderlying $5.0 million of coverage for the Company’spublic entity excess liability program. Under this agreement,reinsurers are responsible for 100% of each loss in excess of$5.0 million for all lines, except workers’compensation, which is covered by the Company’s corecatastrophic workers’ compensation treaty structure up to$50.0 million per occurrence.     Additionally, several small programs have separate reinsurancetreaties in place, which limit the Company’s exposure to$350,000 or less.     Facultative reinsurance is purchased for property values inexcess of $5.0 million, casualty limits in excess of$2.0 million, or for coverage not covered by a treaty.     In its risk-sharing programs, the Company is also subject tocredit risk with respect to the payment of claims by itsclients’ captive, rent-a-captive, large deductibleprograms, indemnification agreements, and on the portion of riskexposure either ceded to the captives, or retained by theclients. The capitalization and credit worthiness of prospectiverisk-sharing partners is one of the factors considered by theCompany in entering into and renewing risk-sharing programs. TheCompany collateralizes balances due from its risk-sharingpartners through funds withheld trusts or letters of credit. AtJune 30, 2005, the Company had risk exposure in excess ofcollateral in the amount of $10.2 million, on theseprograms, of which the Company has an allowance of$8.3 million, related to these exposures. As ofJune 30, 2005, the Company increased its exposure allowancerelated to reinsurance recoverables for a specific discontinuedsurety program. During the quarter, the Company received anupdated financial report, which included an updated financialstatement, from the Liquidator of the reinsurer on that program.Based upon this information, the Company increased the
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**allowance in relation to this program to 100% of theuncollateralized exposure as of June 30, 2005. TheCompany’s total net exposure, after collateral andallowances, for uncollectible reinsurance at June 30, 2005,was $1.9 million, down from $2.5 million atMarch 31, 2005.     The Company has historically maintained an allowance for thepotential uncollectibility of certain reinsurance balances duefrom some risk-sharing partners, some of which are in litigationwith the Company. At the end of each quarter, an analysis ofthese exposures is conducted to determine the potential exposureto uncollectibility. As of June 30, 2005, managementbelieves that this allowance is adequate. To date, the Companyhas not, in the aggregate, experienced material difficulties incollecting balances from its risk-sharing partners. No assurancecan be given, however, regarding the future ability of any ofthe Company’s risk-sharing partners to meet theirobligations.**Note 3 — Debt*****Lines of Credit***     In November 2004, the Company entered into a revolving line ofcredit for up to $25.0 million. The revolving line ofcredit replaced the Company’s previous term loan and lineof credit and expires on November 11, 2007. The Company haddrawn approximately $9.0 million on this new revolving lineof credit to pay off its former term loan. The Company will usethe revolving line of credit to meet short-term working capitalneeds. Under the revolving line of credit, the Company andcertain of its non-regulated subsidiaries pledged securityinterests in certain property and assets of the Company andnamed subsidiaries.     At June 30, 2005 and December 31, 2004, the Companyhad an outstanding balance of $7.0 million and$9.0 million on the revolving line of credit, respectively.     The revolving line of credit provides for interest at a variablerate based, at the Company’s option, upon either a primebased rate or LIBOR-based rate. On prime based borrowings, theapplicable margin ranges from 75 to 25 basis points belowprime. On LIBOR-based borrowings, the applicable margin rangesfrom 125 to 175 basis points above LIBOR. The margin forall loans is dependent on the sum of non-regulated earningsbefore interest, taxes, depreciation, amortization, and non-cashimpairment charges related to intangible assets for thepreceding four quarters, plus dividends paid or payable to theCompany from subsidiaries during such period (“AdjustedEBITDA”). As of June 30, 2005, the average interestrate for LIBOR-based borrowings outstanding was 4.4%.     Debt covenants consist of: (1) maintenance of the ratio ofAdjusted EBITDA to interest expense of 2.0 to 1.0,(2) minimum net worth of $130.0 million and increasingannually, commencing June 30, 2005, by fifty percent of theprior year’s positive net income, (3) minimum A.M.Best rating of “B”, and (4) on an annual basis, aminimum Risk Based Capital Ratio for Star of 1.75 to 1.00. As ofJune 30, 2005, the Company was in compliance with thesecovenants.     In addition, a non-insurance premium finance subsidiary of theCompany maintains a line of credit with a bank, which permitsborrowings up to 75% of the accounts receivable, whichcollateralize the line of credit. At June 30, 2005, thisline of credit had an outstanding balance of $2.9 million.On April 26, 2005, the terms of this line of credit weremodified. The modification to this line of credit included adecrease in the line of credit from $8.0 million to$6.0 million. The interest terms of this line of creditprovide for interest at the prime rate minus 0.5%, or aLIBOR-based rate option, plus 2.0%. At June 30, 2005, theLIBOR-based option was 5.1% and the average interest rate was5.0%.**     *Senior Debentures***     In April 2004, the Company issued senior debentures in theamount of $13.0 million. The senior debentures mature inthirty years and provide for interest at the three-month LIBOR,plus 4.00%, which is non-deferrable. The senior debentures arecallable by the Company at par after five years from the date ofissuance. Associated with this transaction, the Company incurred$390,000 of commissions paid to the
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**placement agents. These issuance costs have been capitalized andare included in other assets on the balance sheet, which will beamortized over seven years as a component of interest expense.     In May 2004, the Company issued senior debentures in the amountof $12.0 million. The senior debentures mature in thirtyyears and provide for interest at the three-month LIBOR, plus4.20%, which is non-deferrable. The senior debentures arecallable by the Company at par after five years from the date ofissuance. Associated with this transaction, the Company incurred$360,000 of commissions paid to the placement agents. Theseissuance costs have been capitalized and are included in otherassets on the balance sheet, which will be amortized over sevenyears as a component of interest expense.     The Company contributed $9.9 million of the proceeds to itsInsurance Company Subsidiaries in December 2004. The remainingproceeds from the issuance of the senior debentures may be usedto support future premium growth through further contributionsto the Insurance Company Subsidiaries and general corporatepurposes.***Junior Subordinated Debentures***     In September 2003, Meadowbrook Capital Trust (the“Trust”), an unconsolidated subsidiary trust of theCompany, issued $10.0 million of mandatorily redeemabletrust preferred securities (“TPS”) to a trust formedby an institutional investor. Contemporaneously, the Companyissued $10.3 million in junior subordinated debentures,which includes the Company’s investment in the trust of$310,000. These debentures have financial terms similar to thoseof the TPS, which includes the deferral of interest payments atany time, or from time-to-time, for a period not exceeding fiveyears, provided there is no event of default. These debenturesmature in thirty years and provide for interest at thethree-month LIBOR, plus 4.05%, which started in December 2003.These debentures are callable by the Company at par beginning inOctober 2008.     The Company received a total of $9.7 million in netproceeds, after the deduction of approximately $300,000 ofcommissions paid to the placement agents in the transaction.These issuance costs have been capitalized and are included inother assets on the balance sheet, which will be amortized overseven years as a component of interest expense. The Companyestimates that the fair value of these debentures issuedapproximates the gross proceeds of cash received at the time ofissuance.     These debentures are unsecured obligations of the Company andare junior to the right of payment to all senior indebtedness ofthe Company. The Company has guaranteed that the payments madeto the Trust will be distributed by the Trust to the holders ofthe TPS.     The Company contributed $6.3 million of the proceeds fromthe issuance of these debentures to its Insurance CompanySubsidiaries and the remaining balance has been used for generalcorporate purposes.**Note 4 —****Shareholders’ Equity**     At June 30, 2005, shareholders’ equity was$175.0 million, or a book value of $6.00 per commonshare, compared to $167.5 million, or a book value of$5.76 per common share, at December 31, 2004.     In September 2002, the Company’s Board of Directorsauthorized management to repurchase up to 1,000,000 sharesof the Company’s common stock in market transactions for aperiod not to exceed twenty-four months. In August 2003, theCompany’s Board of Directors authorized management torepurchase up to an additional 1,000,000 shares of theCompany’s common stock under the existing share repurchaseplan. The original share repurchase plan expired in September2004. In November 2004, the Company’s Board of Directorsauthorized management to repurchase up to 1,000,000 sharesof its common stock in market transactions for a period not toexceed twenty-four months. For the six months and three monthsended June 30, 2005, the Company purchased and retired208,790 and 149,390 shares of common stock for a total costof approximately $1.1 million and $786,000, respectively.The Company did not repurchase any common stock during 2004. Asof June 30, 2005, the cumulative amount the Companyrepurchased and retired under
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**the current share repurchase plan was 208,790 shares ofcommon stock for a total cost of approximately$1.1 million. As of June 30, 2005, the Company hasavailable up to 791,210 shares remaining to be purchased.**Note 5 —****Regulatory Matters and Rating Agencies**     A significant portion of the Company’s consolidated assetsrepresent assets of the Insurance Company Subsidiaries that atthis time, without prior approval of the State of MichiganOffice of Financial and Insurance Services (“OFIS”),cannot be transferred to the holding company in the form ofdividends, loans or advances. The restriction on thetransferability to the holding company from its InsuranceCompany Subsidiaries is regulated by Michigan insuranceregulatory statutes which, in general, are as follows: themaximum discretionary dividend that may be declared, based ondata from the preceding calendar year, is the greater of eachinsurance company’s net income (excluding realized capitalgains) or ten percent of the insurance company’s surplus(excluding unrealized gains). These dividends are furtherlimited by a clause in the Michigan law that prohibits aninsurer from declaring dividends, except from surplus earningsof the company. Earned surplus balances are calculated on aquarterly basis. Since Star is the parent insurance company, itsmaximum dividend calculation represents the combined InsuranceCompany Subsidiaries’ surplus. Based upon the 2004statutory financial statements, Star may only pay dividends tothe Company during 2005 with the prior approval of OFIS.Star’s earned surplus position at December 31, 2004was negative $13.7 million. At June 30, 2005, earnedsurplus was negative $8.5 million. No statutory dividendswere paid in 2004 or 2005.     Insurance operations are subject to various leverage tests (e.g.premium to statutory surplus ratios), which are evaluated byregulators and rating agencies. The Company’s targets forgross and net written premium to statutory surplus are 3.0 to1.0 and 2.5 to 1.0, respectively. As of June 30, 2005, on astatutory consolidated basis, the gross and net premium leverageratios were 2.6 to 1.0 and 2.0 to 1.0, respectively.     The National Association of Insurance Commissioners(“NAIC”) has adopted a risk-based capital(“RBC”) formula to be applied to all property andcasualty insurance companies. The formula measures requiredcapital and surplus based on an insurance company’sproducts and investment portfolio and is used as a tool toevaluate the capital of regulated companies. The RBC formula isused by state insurance regulators to monitor trends instatutory capital and surplus for the purpose of initiatingregulatory action. In general, an insurance company must submita calculation of its RBC formula to the insurance department ofits state of domicile as of the end of the previous calendaryear. These laws require increasing degrees of regulatoryoversight and intervention as an insurance company’s RBCdeclines. The level of regulatory oversight ranges fromrequiring the insurance company to inform and obtain approvalfrom the domiciliary insurance commissioner of a comprehensivefinancial plan for increasing its RBC to mandatory regulatoryintervention requiring an insurance company to be placed underregulatory control in a rehabilitation or liquidation proceeding.     At December 31, 2004, all of the Insurance CompanySubsidiaries were in compliance with RBC requirements. Starreported statutory surplus of $120.7 million atDecember 31, 2004, compared to the threshold requiring theminimum regulatory involvement of $56.9 million in 2004. AtJune 30, 2005, Star’s statutory surplus was$126.2 million.**Note 6 —****Commitments and Contingencies**     In June 2003, the Company entered into a Guaranty Agreement witha bank. The Company is guaranteeing payment of a$1.5 million term loan issued by the bank to anunaffiliated insurance agency. In the event of default on theterm loan by the insurance agency, the Company is obligated topay any outstanding principal (up to a maximum of$1.5 million), as well as any accrued interest on the loan,and any costs incurred by the bank in the collection process. Inexchange for the Company’s guaranty, the president andmember of the unaffiliated insurance agency pledged 100% of thecommon stock of two insurance agencies that he wholly owns. Inthe event of default of the term loan by the unaffiliatedinsurance agency, the
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**Company has the right to sell all or a portion of the pledgedassets (the common stock of the two insurance agencies) and usethe proceeds from the sale to recover any amounts paid under theGuaranty Agreement. Any excess proceeds would be paid to theshareholder. As of June 30, 2005, no liability has beenrecorded with respect to the Company’s obligations underthe Guaranty Agreement, since the collateral is in excess of theguaranteed amount.     The Company, and its subsidiaries, are subject at times tovarious claims, lawsuits and proceedings relating principally toalleged errors or omissions in the placement of insurance,claims administration, consulting services and other businesstransactions arising in the ordinary course of business. Whereappropriate, the Company vigorously defends such claims,lawsuits and proceedings. Some of these claims, lawsuits andproceedings seek damages, including consequential, exemplary orpunitive damages, in amounts that could, if awarded, besignificant. Most of the claims, lawsuits and proceedingsarising in the ordinary course of business are covered by errorsand omissions insurance or other appropriate insurance. In termsof deductibles associated with such insurance, the Company hasestablished provisions against these items, which are believedto be adequate in light of current information and legal advice.In accordance with SFAS No. 5, *“Accounting forContingencies,”* if it is probable that an asset hasbeen impaired or a liability has been incurred as of the date ofthe financial statements and the amount of loss is estimable; anaccrual for the costs to resolve these claims is recorded by theCompany in its consolidated balance sheets. Period expensesrelated to the defense of such claims are included in otheroperating expenses in the accompanying consolidated statementsof income. Management, with the assistance of outside counsel,adjusts such provisions according to new developments or changesin the strategy in dealing with such matters. On the basis ofcurrent information, the Company does not expect the outcome ofthe claims, lawsuits and proceedings to which the Company issubject to, either individually, or in the aggregate, will havea material adverse effect on the Company’s financialcondition. However, it is possible that future results ofoperations or cash flows for any particular quarter or annualperiod could be materially affected by an unfavorable resolutionof any such matters.**Note 7 —****Segment Information**     The Company defines its operations as specialty risk managementoperations and agency operations based upon differences inproducts and services. The separate financial information ofthese segments is consistent with the way results are regularlyevaluated by management in deciding how to allocate resourcesand in assessing performance. Intersegment revenue is eliminatedin consolidation. It would be impracticable for the Company todetermine the allocation of assets between the two segments.***Specialty Risk Management Operations***     The specialty risk management operations segment focuses onspecialty or niche insurance business in which it providesvarious services and coverages tailored to meet specificrequirements of defined client groups and their members. Theseservices include; risk management consulting, claimsadministration and handling, loss control and prevention, andreinsurance placement, along with various types of property andcasualty insurance coverage, including workers’compensation, commercial multiple peril, general liability,commercial auto liability, and inland marine. Insurance coverageis provided primarily to associations or similar groups ofmembers and to specified classes of business of theCompany’s agent-partners. The Company recognizes revenuerelated to the services and coverages the specialty riskmanagement operations provides within seven categories: netearned premiums, management fees, claims fees, loss controlfees, reinsurance placement, investment income, and net realizedgains (losses).***Agency Operations***     The Company earns commissions through the operation of itsretail property and casualty insurance agency, which was formedin 1955. The agency is one of the largest agencies in Michiganand, with
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**acquisitions, has expanded into California. The agencyoperations produce commercial, personal lines, life, andaccident and health insurance, for more than fifty unaffiliatedinsurance carriers.     The following table sets forth the segment results (inthousands):             **For the Six Months**  **Ended June 30,**     **2005** **2004**         Revenues             Net earned premiums $124,151  $102,796      Management fees  8,296   8,609      Claims fees  3,518   5,429      Loss control fees  1,128   1,077      Reinsurance placement  439   117      Investment income  8,554   7,133      Net realized losses  (92)  (152)             Specialty risk management  145,994   125,009      Agency operations(2)  5,942   4,989      Reconciling items(3)  96   11      Intersegment revenue(2)  (1,190)  (96)             Consolidated revenue $150,842  $129,913            Pre-tax income:             Specialty risk management(1) and (2) $13,983  $10,382      Agency operations(1) and (2)  1,982   1,602      Reconciling items  (3,441)  (2,363)             Consolidated pre-tax income $12,524  $9,621        
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**             **For the Three Months**  **Ended June 30,**     **2005** **2004**         Revenues             Net earned premiums $63,364  $53,083      Management fees  4,100   3,898      Claims fees  1,766   2,728      Loss control fees  555   532      Reinsurance placement  94   (30)     Investment income  4,470   3,542      Net realized gains (losses)  22   (32)             Specialty risk management  74,371   63,721      Agency operations(2)  1,982   1,770      Reconciling items(3)  89   5      Intersegment revenue(2)  (463)  (54)             Consolidated revenue $75,979  $65,442            Pre-tax income:             Specialty risk management(1) and (2) $8,583  $5,775      Agency operations(1) and (2)  69   161      Reconciling items  (1,872)  (1,512)             Consolidated pre-tax income $6,780  $4,424         (1)     The Company’s agency operations include an allocation of    corporate overhead, which includes expenses associated with    accounting, information services, legal, and other corporate    services. The corporate overhead allocation excludes those    expenses specific to the holding company. In prior years,    corporate overhead was only reflected in the specialty risk    management operations segment. This reclassification for the    allocation of corporate overhead more accurately presents the    Company’s segments as a result of improved cost allocation    information. As a result, the segment information for the    periods ended June 30, 2004, have been adjusted to reflect    this allocation. For the six months ended June 30, 2005 and    2004, the allocation of corporate overhead to the agency    operations segment was $1.7 million and $1.6 million,    respectively. For the three months ended June 30, 2005 and    2004, the allocation of corporate overhead to the agency    operations segment was $983,000 and $891,000, respectively. (2)     In addition to the reclassification for the allocation of    corporate overhead as described above, the Company also    reclassified revenues related to the conversion of a west-coast    commercial transportation program, which was converted to a    specialty risk program with one of its subsidiaries, from the    agency operations segment to the specialty risk management    operations segment. Accordingly, the agency operations revenue    and intersegment revenue have been reclassified. As a result,    $3.8 million and $2.2 million was reclassified within    the agency operations segment and the intersegment revenue for    the six months and three months ended June 30, 2004,    respectively. In addition, the overall net income related to    this subsidiary was reclassified from the agency operations to    the specialty risk management operations segment. As a result,    pre-tax net income of $1.3 million and $848,000 related to    this subsidiary was reclassified to the specialty risk    management operations pre-tax income from the agency operations    segment for the six months and three months ended June 30,    2004, respectively. (3)     On December 4, 2003, the Company had entered into a    Purchase and Sale Agreement with an unaffiliated third party for    the sale of land. In July 2004, a land contract was executed and    the transaction closed in escrow subject to the conveyance of    certain land by the city to both parties. On May 18, 2005,    the settlement of the land contract was completed. The sale of    this land resulted in a total gain of
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**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS — (Continued)**    approximately $464,000. In accordance with SFAS No. 66    *“Accounting for Sales of Real Estate”*, the    Company recorded this transaction based on the installment    method of accounting. Accordingly, the Company recorded a gain    of $82,000, which reflects a portion of the total gain in    proportion to the down payment to the total purchase price. The    remaining $382,000 will be deferred until the land contract is    paid in full, or as principal payments are received.     The reconciling item included in the revenue relates to interestincome and the above mentioned gain in the holding company. Thefollowing table sets forth the pre-tax income reconciling items(in thousands):           **For the Six Months**  **Ended June 30,**     **2005** **2004**         Holding company expenses $(1,678) $(1,329)    Amortization  (184)  (191)    Interest expense  (1,579)  (843)         $(3,441) $(2,363)                  **For the Three Months**  **Ended June 30,**     **2005** **2004**         Holding company expenses $(974) $(892)    Amortization  (92)  (92)    Interest expense  (806)  (528)         $(1,872) $(1,512)       **Note 8 —****Subsequent Events**     Effective July 1, 2005, the Company made a$2.5 million loan, at an effective interest rate equal tothe three-month LIBOR, plus 5.2%, to an unaffiliated insuranceagency. This agency has been a producer for the Company for overten years. Under the terms of the agreement, the Company maydemand repayment of the principal, plus accrued interest at anytime. As security for the loan, the shareholder has pledged 100%of the common shares of the unaffiliated insurance agency andthree other insurance agencies, as well as executed a personalguaranty.
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**ITEM 2****MANAGEMENT’S DISCUSSION AND ANALYSIS OF****FINANCIAL CONDITION AND RESULTS OF OPERATIONS****For the Periods ended June 30, 2005 and 2004*****Forward-Looking Statements***     *This quarterly report may provide information includingcertain statements which constitute forward-looking statementswithin the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the SecuritiesExchange Act of 1934, as amended. These include statementsregarding the intent, belief, or current expectations ofmanagement, including, but not limited to, those statements thatuse the words “believes”, “expects”,“anticipates”, “estimates”, or similarexpressions. You are cautioned that any such forward-lookingstatements are not guarantees of future performance and involvea number of risks and uncertainties, and results could differmaterially from those indicated by such forward-lookingstatements. Among the important factors that could cause actualresults to differ materially from those indicated by suchforward-looking statements are: the frequency and severity ofclaims; uncertainties inherent in reserve estimates;catastrophic events; a change in the demand for, pricing of,availability or collectibility of reinsurance; increased ratepressure on premiums; obtainment of certain rate increases incurrent market conditions; investment rate of return; changes inand adherence to insurance regulation; actions taken byregulators, rating agencies or lenders; obtainment of certainprocessing efficiencies; changing rates of inflation; generaleconomic conditions and other risks identified in our reportsand registration statements filed with the Securities andExchange Commission. We are not under any obligation to (andexpressly disclaim any such obligation to) update or alter ourforward-looking statements whether as a result of newinformation, future events or otherwise***Description of Business**     We are a publicly traded specialty risk management company, withan emphasis on alternative market insurance and risk managementsolutions for agents, professional and trade associations, andinsureds of all sizes. The alternative market includes a widerange of approaches to financing and managing risk exposures,such as captives, rent-a-captives, risk retention and riskpurchasing groups, governmental pools and trusts, andself-insurance plans. The alternative market developed as aresult of the historical volatility in the cost and availabilityof traditional commercial insurance coverages, and usuallyinvolves some form of self-insurance or risk-sharing on the partof the client. We develop and manage alternative risk managementprograms for defined client groups and their members. We alsooperate as an insurance agency representing unaffiliatedinsurance companies in placing insurance coverages forpolicyholders. We define our business segments as specialty riskmanagement operations and agency operations.**Critical Accounting Estimates**     In certain circumstances, we are required to make estimates andassumptions that affect amounts reported in our consolidatedfinancial statements and related footnotes. We evaluate theseestimates and assumptions on an on-going basis based on avariety of factors. There can be no assurance, however, thatactual results will not be materially different than ourestimates and assumptions, and that reported results ofoperation will not be affected by accounting adjustments neededto reflect changes in these estimates and assumptions. Theaccounting estimates and related risks described in our annualreport on Form 10-K as filed with the United StatesSecurities and Exchange Commission on March 16, 2005, arethose that we consider to be our critical accounting estimates.As of the three months and six months ended June 30, 2005,there have been no material changes in regard to any of ourcritical accounting estimates.
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**RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30,2005 AND 2004****     *Executive Overview***     During the first half of 2005, underwriting results continued toimprove over 2004. This improvement is primarily the result ofthe earning pattern from our controlled growth of premiumswritten in the last two quarters of 2004 and the first quarterof 2005, as well as the impact of rate increases achieved in2004. Net income for the first half of 2005 continued todemonstrate our commitment to strong underwriting discipline,our consistent focus on growing our profitable specialty andfee-for-service programs, along with our on-going plan toleverage fixed costs. As a result, our generally acceptedaccounting principles (“GAAP”) combined ratio improved3.4 percentage points to 98.2% in the six months endedJune 30, 2005, from 101.6% in the comparable period in 2004.     On April 19, 2005, we announced an upgrade from A.M. Bestof certain of our Insurance Company Subsidiaries from B+ (VeryGood), with a positive outlook to B++ (Very Good). The ratingsupgrade applies to Star Insurance Company (“Star”),Savers Property and Casualty Insurance Company, and WilliamsburgNational Insurance Company. Additionally, A.M. Best reaffirmedthe rating for Ameritrust Insurance Corporation as B+ (VeryGood), with a positive outlook.**     *Results of Operations***     Net income for the six months ended June 30, 2005, was$8.3 million, or $0.28 per dilutive share, up 37.5%,compared to net income of $6.1 million, or $0.21 perdilutive share, for the comparable period of 2004. As previouslyindicated, this improvement is primarily the result of theearning pattern from our controlled growth of premiums writtenin the last two quarters of 2004 and the first quarter of 2005,the impact from rate increases achieved in 2004, and thecontinued leveraging of fixed costs. In addition, net income wasfavorably impacted by approximately $820,000 from profit-sharingcommissions, which were offset by an increase in expensesprimarily related to the implementation of Section 404 ofthe Sarbanes-Oxley Act.     Revenues for the six months ended June 30, 2005, increased$20.9 million, or 16.1%, to $150.8 million, from$129.9 million for the comparable period in 2004. Thisincrease reflects a $21.4 million, or 20.8%, increase innet earned premiums. The increase in net earned premiums is theresult of the earning pattern from our controlled growth inwritten premiums experienced in 2004 and the first quarter of2005. This increase was attributable to growth in existingprograms, which included new programs implemented in 2004 thatwere historically profitable. The growth in net earned premiumswas also attributable to a west-coast commercial transportationprogram and other various programs. The impact of an overall8.4% rate increase achieved in 2004 also contributed to theincrease in net earned premiums, as well as an increase in auditrelated premiums. This increase in revenues also reflects a$1.4 million increase in investment income, primarily theresult of an increase in average invested assets. Partiallyoffsetting these increases in revenue was the anticipatedreduction in managed fee revenue from two limited durationadministrative services and multi-state claims run-offcontracts, terminated in 2004. Due to the earlier thananticipated termination of these contracts, the revenues that weanticipated earning in the first six months of 2005 wereaccelerated into the third quarter of 2004.
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**Specialty Risk Management Operations**     The following table sets forth the revenues and results fromoperations for our specialty risk management operations (inthousands):            **For the Six Months**  **Ended June 30,**     **2005** **2004**         Revenue:             Net earned premiums $124,151  $102,796      Management fees  8,296   8,609      Claims fees  3,518   5,429      Loss control fees  1,128   1,077      Reinsurance placement  439   117      Investment income  8,554   7,133      Net realized losses  (92)  (152)            Total revenue $145,994  $125,009            Pre-tax income             Specialty risk management operations(1) and (2) $13,983  $10,382  (1)     Our specialty risk management operations now exclude an    allocation of corporate overhead, which is attributable to our    agency operations. In prior years, corporate overhead was only    reflected in the specialty risk management operations segment.    This reclassification for the allocation of corporate overhead    more accurately presents our segments as a result of improved    cost allocation information. As a result, the segment    information for the six months ended June 30, 2004, has    been adjusted to reflect this allocation. For the six months    ended June 30, 2005 and 2004, the allocation of corporate    overhead from the specialty risk management operations to the    agency operations segment was $1.7 million and    $1.6 million, respectively. (2)     We reclassified revenues related to the conversion of a    west-coast commercial transportation program, which was    converted to a specialty risk program with one of our    subsidiaries, from the agency operations segment to the    specialty risk management operations segment. Accordingly, the    agency operations revenue and intersegment revenue have been    reclassified. In addition, the overall net income related to    this subsidiary was reclassified from the agency operations to    the specialty risk management operations segment. As a result,    pre-tax net income of $1.3 million related to this    subsidiary was reclassified to the specialty risk management    operations pre-tax income from the agency operations segment for    the six months ended June 30, 2004.    Revenues from specialty risk management operations increased$21.0 million, or 16.8%, to $146.0 million for the sixmonths ended June 30, 2005, from $125.0 million forthe comparable period in 2004.     Net earned premiums increased $21.4 million, or 20.8%, to$124.2 million in the six months ended June 30, 2005,from $102.8 million in the comparable period in 2004. Thisincrease primarily reflects the earning pattern resulting fromthe controlled growth of premiums written in the last twoquarters of 2004 and the first quarter of 2005, as well as anincrease in audit related premiums.     Management fees decreased $313,000, or 3.6%, to$8.3 million for the six months ended June 30, 2005,from $8.6 million for the comparable period in 2004. Thedecrease in management fees reflects an anticipated shift infee-for-service revenue previously generated from a third partycontract to internally generated fee revenue from a specificrenewal rights agreement that is eliminated upon consolidation.Due to the earlier than anticipated termination of this thirdparty contract, the revenues that we anticipated earning in thefirst six months of 2005 were accelerated into the third quarterof 2004. Excluding revenue generated from this third partycontract, management fee revenue increased approximately$685,000 in comparison to 2004. This increase is primarily theresult of growth in a specific New England based program.     Claim fees decreased $1.9 million, or 35.2%, to$3.5 million, from $5.4 million for the comparableperiod in 2004. This decrease reflects a similar anticipatedshifting of revenue previously generated from a multi-stateclaims run-off service contract, to internally generated feerevenue from a specific renewal rights agreement that iseliminated upon consolidation. As previously indicated, due tothe earlier than anticipated termination of this third partycontract, the revenues that we anticipated earning in the firstsix months of 2005 were
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accelerated into the third quarter of 2004. Excluding revenuegenerated from this third party contract, claim fee revenueremained relatively consistent in comparison to 2004.     Net investment income increased $1.4 million, or 19.9%, to$8.5 million in 2005, from $7.1 million in 2004.Average invested assets increased $68.7 million, or 20.4%,to $404.8 million in 2005, from $336.1 million in2004. The increase in average invested assets reflects cashflows from underwriting activities and growth in gross writtenpremiums during 2004 and 2005, as well as net proceeds fromcapital raised in 2004 through the issuances of debentures. Theaverage investment yield for June 30, 2005, was 4.2%,compared to 4.3% for the comparable period in 2004. The currentpre-tax book yield was 4.1% and current after-tax book yield was3.1%. The investment yield reflects the accelerated prepaymentsin mortgage-backed securities and the reinvestment of cash flowsin municipal bonds.     Specialty risk management operations generated pre-tax income of$14.0 million for the six months ended June 30, 2005,compared to pre-tax income of $10.4 million for thecomparable period in 2004. This increase in pre-tax incomedemonstrates a continued improvement in underwriting results asa result of our controlled growth in premium volume and ourcontinued focus on leveraging of fixed costs. The GAAP combinedratio was 98.2% for the six months ended June 30, 2005,compared to 101.6% for the same period in 2004.     Net loss and loss adjustment expenses (“LAE”)increased $9.5 million, or 14.6%, to $74.8 million forthe six months ended June 30, 2005, from $65.3 millionfor the same period in 2004. Our loss and LAE ratio decreased3.3 percentage points to 65.0% for the six months endedJune 30, 2005, from 68.3% for the same period in 2004. Thisratio is the unconsolidated net loss and LAE in relation to netearned premiums. The improvement in the loss and LAE ratioreflects a 0.8 percentage point decrease in the change innet ultimate loss estimates for prior accident years in 2005 ascompared to 2004. Development on prior accident year reservesadded $2.0 million, or 1.6 percentage points, to netloss and LAE in 2005, compared to $2.5 million, or2.4 percentage points in 2004. In addition, there was a0.8 percentage point decrease in the net loss and LAE ratioas a result of efficiencies realized within our claims handlingactivities. This overall improvement in the loss and LAE ratioalso reflects the impact of earned premiums from the controlledgrowth of profitable programs which have had favorableunderwriting experience, as well as our intended shift in thebalance between workers’ compensation and general liabilityline of business. Historically, the general liability line ofbusiness has a lower loss ratio and a higher external producercommission. Additional discussion of our reserve activity isdescribed below within the *Other Items — Reserves*section.     Our expense ratio for the six months ended June 30, 2005was 33.2%, compared to 33.3% for the same period in 2004. Thisratio is the unconsolidated policy acquisition and otherunderwriting expenses in relation to net earned premiums. Ourexpense ratio was impacted by an anticipated increase in grossexternal commissions, due to a shift in the balance betweenworkers’ compensation and general liability. The generalliability line of business has a higher external producercommission rate and, as previously indicated, a lower lossratio. Offsetting these increases to the expense ratio was theimpact of the leveraging of fixed costs and a reduction in netceded excess reinsurance rates.
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**Agency Operations**     The following table sets forth the revenues and results fromoperations for our agency operations (in thousands):           **For the Six Months**  **Ended June 30,**     **2005** **2004**         Net commission(1) $5,942  $4,989     Pre-tax income(1) and (2) $1,982  $1,602  (1)     We reclassified revenues related to the conversion of a    west-coast commercial transportation program, which was    converted to a specialty risk program with one of our    subsidiaries, from the agency operations segment to the    specialty risk management operations segment. Accordingly, the    agency operations revenue and intersegment revenue have been    reclassified. As a result, $3.8 million was reclassified    within the agency operations segment and the intersegment    revenue for the six months ended June 30, 2004. In    addition, the overall net income related to this subsidiary was    reclassified from the agency operations to the specialty risk    management operations segment. As a result, pre-tax net income    of $1.3 million related to this subsidiary was reclassified    to the specialty risk management operations pre-tax income from    the agency operations segment for the six months ended    June 30, 2004. (2)     Our agency operations include an allocation of corporate    overhead, which includes expenses associated with accounting,    information services, legal, and other corporate services. The    corporate overhead allocation excludes those expenses specific    to the holding company. In prior years, corporate overhead was    only reflected in the specialty risk management operations    segment. This reclassification for the allocation of corporate    overhead more accurately presents our segments as a result of    improved cost allocation information. As a result, the segment    information for the six months ended June 30, 2004, has    been adjusted to reflect this allocation. For the six months    ended June 30, 2005 and 2004, the allocation of corporate    overhead to the agency operations segment was $1.7 million    and $1.6 million, respectively.    Revenue from agency operations, which consists primarily ofagency commission revenue, increased $953,000, or 19.1%, to$5.9 million for the six months ended June 30, 2005,from $5.0 million for the comparable period in 2004. Thisincrease is primarily the result of profit sharing commissionsreceived in the first quarter of 2005. In addition, the agencyoperations experienced an increase in new business and renewalretentions in comparison to 2004, which was partially offset bya reduction in renewal rates.     Agency operations generated pre-tax income, after the allocationof corporate overhead, of $2.0 million for the six monthsended June 30, 2005, compared to $1.6 million for thecomparable period in 2004. The improvement in the pre-tax marginis primarily attributable to the overall increase in commissionsand leveraging of fixed costs. Excluding fixed costs and theallocation of corporate overhead, all other expenses remainedrelatively consistent.**Other Items****     Reserves**     At June 30, 2005, our best estimate for the ultimateliability for loss and LAE reserves, net of reinsurancerecoverables, was $247.9 million. We established areasonable range of reserves of approximately$230.8 million to $264.3 million. This range wasestablished primarily by considering the various indicationsderived from standard actuarial techniques and other appropriatereserve considerations. The following table sets forth thisrange by line of business (in thousands):               **Minimum** **Maximum**    **Reserve** **Reserve** **Selected****Line of Business** **Range** **Range** **Reserves**           Workers’ Compensation(1) $133,639  $151,952  $142,560     Commercial Multiple Peril/ General Liability  43,462   50,038   46,579     Commercial Automobile  35,384   42,021   39,521     Other  18,284   20,319   19,289               Total Net Reserves $230,769  $264,330  $247,949            (1)     Includes Residual Markets
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    Reserves are reviewed by internal and independent actuaries foradequacy on a quarterly basis. When reviewing reserves, weanalyze historical data and estimate the impact of numerousfactors such as (1) per claim information;(2) industry and our historical loss experience;(3) legislative enactments, judicial decisions, legaldevelopments in the imposition of damages, and changes inpolitical attitudes; and (4) trends in general economicconditions, including the effects of inflation. This processassumes that past experience, adjusted for the effects ofcurrent developments and anticipated trends, is an appropriatebasis for predicting future events. There is no precise methodfor subsequently evaluating the impact of any specific factor onthe adequacy of reserves, because the eventual deficiency orredundancy is affected by multiple factors.     The key assumptions used in our selection of ultimate reservesincluded the underlying actuarial methodologies, a review ofcurrent pricing and underwriting initiatives, an evaluation ofreinsurance costs and retention levels, and a detailed claimsanalysis with an emphasis on how aggressive claims handling maybe impacting the paid and incurred loss data trends embedded inthe traditional actuarial methods. With respect to the ultimateestimates for losses and LAE, the key assumptions remainedconsistent for the six months ended June 30, 2005 and theyear ended December 31, 2004.     For the six months ended June 30, 2005, we reported anincrease in net ultimate loss estimates for accident years 2004and prior to be $2.0 million, or 0.9% of$227.0 million of net loss and LAE reserves atDecember 31, 2004. The increase in net ultimate lossestimates reflected revisions in the estimated reserves as aresult of actual claims activity in calendar year 2005 thatdiffered from the projected activity. There were no significantchanges in the key assumptions utilized in the analysis andcalculations of our reserves during 2005. The major componentsof this change in ultimate loss estimates are as follows (inthousands):                                     **Incurred Losses** **Paid Losses**    **Reserves at**     **Reserves**  **December 31,** **Current** **Prior** **Total** **Current** **Prior** **Total** **at June 30,****Line of Business** **2004** **Year** **Years** **Incurred** **Year** **Years** **Paid** **2005**                     Workers’ Compensation $112,086  $32,038  $(199) $31,839  $1,366  $22,724  $24,090  $119,835     Residual Markets  19,391   5,919   934   6,853   886   2,633   3,519   22,725     Commercial Multiple Peril/ General Liability  44,217   10,596   (904)  9,692   19   7,311   7,330   46,579     Commercial Automobile  33,235   16,965   1,392   18,357   2,730   9,341   12,071   39,521     Other  18,067   7,296   825   8,121   1,103   5,796   6,899   19,289                              Net Reserves  226,996  $72,814  $2,048  $74,862  $6,104  $47,805  $53,909   247,949                              Reinsurance Recoverable  151,161                           170,120                              Consolidated $378,157                          $418,069                                           **Re-estimated** **Development**  **Reserves at** **Reserves at** **as a Percentage**  **December 31,** **June 30, 2005** **of Prior Year****Line of Business** **2004** **on Prior Years** **Reserves**           Workers’ Compensation $112,086  $111,887   (0.2%)    Commercial Multiple Peril/ General Liability  44,217   43,313   (2.0%)    Commercial Automobile  33,235   34,628   4.2%    Other  18,067   18,892   4.6%              Sub-total  207,605   208,720   0.5%    Residual Markets  19,391   20,325   4.8%              Total Net Reserves $226,996  $229,045   0.9%          
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**Workers’ Compensation Excluding Residual Markets**     The projected net ultimate loss estimate for the workers’compensation line of business, excluding residual markets,decreased $199,000, or 0.2% of net workers’ compensationreserves. This net overall decrease reflects reductions of$1.4 million, $3.4 million, and $762,000 in theultimate loss estimate for accident years 2004, 2001, and 1999,respectively. The decrease in the ultimate loss estimatereflects better than expected experience on most of ourworkers’ compensation programs. Average severity onreported claims did not increase as much as anticipated in theprior actuarial projections; therefore ultimate loss estimateswere reduced. In addition, there was a reallocation of lossreserves of $2.6 million from accident year 2001 toaccident year 2000 to align the incurred but not reported(“IBNR”) reserves with the case reserves for aspecific Tennessee program. The net overall decrease was offsetby increases of $1.8 million, $423,000, and$2.5 million in accident years 2003, 2002, and 2000,respectively. These increases are the result of higher thanexpected emergence of claim activity primarily related to aSoutheastern U.S. based program and the aforementionedreallocation in the Tennessee program. The change in ultimateloss estimates for all other accident years was insignificant.**Commercial Multiple Peril/ General Liability**     The commercial multiple peril and general liability lines ofbusiness had a decrease in net ultimate loss estimates of$904,000, or 2.0% of net commercial multiple peril and generalliability reserves. The net decrease reflects a reduction of$701,000 in the ultimate loss estimate for accident year 2004.The improvement in the accident year reflected better thanexpected claim emergence on several programs. The decrease inthe 2003 and 2002 accident years were $1.0 million and$209,000, respectively. The decreases in accident years 2003 and2002 reflect the impact of a reclassification from the generalliability line of business to the commercial automobile line ofbusiness. This reclassification totaled $1.2 million andwas the result of actual claims emergence on three commercialautomobile claims that are subject to our core casualtyreinsurance program. Prior to the actual claims emergence thereserves for this exposure was carried in the general liabilityreinsurance line of business as IBNR. These decreases werepartially offset by an increase of $555,000 in accident year2001. This increase in the 2001 accident year loss ratioreflects slightly higher than expected emergence of claimactivity in several different programs. The change in ultimateloss estimates for all other accident years was insignificant.**Commercial Automobile**     The projected net ultimate loss estimate for the commercialautomobile line of business increased $1.4 million, or 4.2%of net commercial automobile reserves. This increase reflectsincreases of $571,000, $363,000, and $869,000, in accident years2003, 2002, and 2001, respectively. These increases reflect theimpact from the three automobile line of business claimsmentioned in the above commercial multiple peril and generalliability section. These increases also reflect higher thanexpected emergence of claim activity in an inactive program.Partially offsetting these increases were reductions of $345,000and $370,000, in the ultimate loss estimates for accident years2004 and 2000, respectively. The accident year 2004 reductionreflected better than expected claim emergence from a truckingprogram in California. Average severity on reported claims didnot increase as much as anticipated in the prior actuarialprojections; therefore ultimate loss estimates were reduced. Theaccident year 2000 reduction reflects the reallocation in IBNRon a discontinued program mentioned above. The change inultimate loss estimates for all other accident years wasinsignificant.**Other**     The other lines of business had an increase in net ultimate lossestimates of $825,000, or 4.6% of net reserves on the otherlines of business. This net increase reflects an increase in theexposure allowance for unrecoverable reinsurance of $548,000related to a specific discontinued surety program. During thequarter, we received updated financial information from theLiquidator of the reinsurer on that program. Based upon thisinformation, we increased the allowance to cover 100% of theuncollateralized exposure as of June 30, 2005. The changein ultimate loss estimates for all other accident years wasinsignificant.
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**Residual Markets**     The workers’ compensation residual market line of businesshad an increase in net ultimate loss estimates of $934,000, or4.8% of net reserves on the workers’ compensation residualmarket line of business. The change reflects an increase of$965,000 in accident year 2003, offset by a $260,000 decrease inaccident year 2002. We record loss reserves as reported by theNational Council on Compensation Insurance (“NCCI”),plus an estimate for the reserves incurred but not yet analyzedand reported to us due to a two quarter lag in reporting. Thesechanges reflect a difference between our estimate of the lagincurred but not reported and the amounts reported by the NCCIin the quarter. The change in ultimate loss estimates for allother accident years was insignificant.**     Salary and Employee Benefitsand Other Administrative Expenses**     Salary and employee benefits for the six months endedJune 30, 2005, increased $1.1 million, or 4.5%, to$26.2 million, from $25.1 million for the comparableperiod in 2004. This increase primarily reflects both anincrease in variable compensation, which is directly related toperformance and profitability, as well as, merit increases forassociates. Theses increases were partially offset by a slightdecrease in staffing levels in comparison to 2004.     Other administrative expenses increased $1.3 million, or10.1%, to $13.8 million, from $12.5 million for thecomparable period in 2004. This increase is primarilyattributable to consulting and audit expenses associated withSection 404 of the Sarbanes-Oxley Act. In addition, thisincrease in other administrative expenses is the result ofinformation technology enhancements. Offsetting these increaseswas the favorable impact of overall expense initiatives.     Salary and employee benefits and other administrative expensesinclude both corporate overhead and the holding company expensesincluded in the reconciling items of our segment information.**     Interest Expense**     Interest expense for the six months ended June 30, 2005,increased $736,000, or 87.3%, to $1.6 million, from$843,000 for the comparable period in 2004. Interest expense isprimarily attributable to our debentures, which are describedwithin the *Liquidity and Capital Resources* section ofManagement’s Discussion and Analysis, as well as ourcurrent lines of credit. Interest expense increased $797,000primarily as a result of the senior debentures issued in thesecond quarter of 2004. Interest expense related to our lines ofcredit remained relatively consistent in comparison to 2004.This is the result of a decrease in the average outstandingbalance, offset by an increase in the average interest rate. Theaverage outstanding balance during the six months endingJune 30, 2005, was $10.7 million, compared to$16.9 million for the same period in 2004. The averageinterest rate, excluding the debentures, in 2005 was 5.1%,compared to 4.1% in 2004.**     Income Taxes**     Income tax expense, which includes both federal and state taxes,for the six months ended June 30, 2005, was$4.2 million, or 33.6% of income before taxes. For the sameperiod last year, we reflected an income tax expense of$3.5 million, or 36.7% of income before taxes. Oureffective tax rate differs from the 35% statutory rate primarilydue to a shift towards increasing investments in tax-exemptsecurities in an effort to maximize after-tax investment yields.Our current taxes are calculated using a 35% statutory ratebased on taxable income greater than $18.3 million.Deferred taxes are calculated based on a 34% statutory rate. Weare currently evaluating the expected tax rate for therealization of the deferred taxes.**     Other than TemporaryImpairments**     Our policy for the valuation of temporarily impaired securitiesis to determine impairment based on analysis of the followingfactors: (1) market value less than amortized cost for asix month period; (2) rating downgrade or other creditevent (e.g., failure to pay interest when due);(3) financial condition and near-term prospects of theissuer, including any specific events which may influence theoperations of the issuer such as
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changes in technology or discontinuance of a business segment;(4) prospects for the issuer’s industry segment; and(5) our intent and ability to retain the investment for aperiod of time sufficient to allow for anticipated recovery inmarket value. We evaluate our investments in securities todetermine other than temporary impairment, no less thanquarterly. Investments which are deemed impaired are writtendown to their estimated net fair value and the related lossesrecognized in income.     At June 30, 2005, we had 147 securities that were in anunrealized loss position. These investments all had unrealizedlosses of less than ten percent. At June 30, 2005, fifteenof those investments, with an aggregate $14.0 million and$408,000 fair value and unrealized loss, respectively, have beenin an unrealized loss position for more than eighteen months.Positive evidence considered in reaching our conclusion that theinvestments in an unrealized loss position are not other thantemporarily impaired consisted of: 1) there were nospecific events which caused concerns; 2) there were nopast due interest payments; 3) there has been a rise inmarket prices; 4) our ability and intent to retain theinvestment for a sufficient amount of time to allow ananticipated recovery in value; and 5) we also determinedthat the changes in market value were considered normal inrelation to overall fluctuations in interest rates.     The fair value and amount of unrealized losses segregated by thetime period the investment has been in an unrealized lossposition is as follows (in thousands):                    **June 30, 2005**     **Less than 12 Months** **Greater than 12 Months**       **Fair Value of** **Gross** **Fair Value of** **Gross**  **Investments with** **Unrealized** **Investments with** **Unrealized**  **Unrealized Losses** **Losses** **Unrealized Losses** **Losses**         **Debt Securities:**                    Debt securities issued by U.S. government and agencies $12,591  $(117) $11,912  $(281)    Obligations of states and political subdivisions  27,339   (175)  16,068   (169)    Corporate securities  21,913   (317)  17,853   (471)    Mortgage and asset backed securities  23,257   (96)  16,372   (258)                  Totals $85,100  $(705) $62,205  $(1,179)                  As of June 30, 2005, gross unrealized gains and (losses) onsecurities were $7.5 million and ($1.9 million),respectively.                    **December 31, 2004**     **Less than 12 Months** **Greater than 12 Months**       **Fair Value of** **Gross** **Fair Value of** **Gross**  **Investments with** **Unrealized** **Investments with** **Unrealized**  **Unrealized Losses** **Losses** **Unrealized Losses** **Losses**         **Debt Securities:**                    Debt securities issued by U.S. government and agencies $18,480  $(138) $4,871  $(150)    Obligations of states and political subdivisions  28,581   (257)  551   (14)    Corporate securities  23,323   (220)  7,450   (226)    Mortgage and asset backed securities  19,583   (167)  6,442   (129)                  Totals $89,967  $(782) $19,314  $(519)                  As of December 31, 2004, gross unrealized gains and(losses) on securities were $8.6 million and($1.3 million), respectively.
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**RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDEDJUNE 30, 2005 AND 2004*****     Results of Operations***     Net income for the three months ended June 30, 2005, was$4.6 million, or $0.16 per dilutive share, up 62.4%,compared to net income of $2.8 million, or $0.10 perdilutive share, for the comparable period of 2004. Thisimprovement primarily reflects the earning pattern from ourcontrolled growth of premiums written in the last two quartersof 2004 and the first quarter of 2005, the impact from rateincreases achieved in 2004, and the continued leveraging offixed costs. In addition, this improvement was the result of theabsence of unfavorable development on prior accident years inrelation to our loss reserves.     Revenues for the three months ended June 30, 2005,increased $10.6 million, or 16.1%, to $76.0 million,from $65.4 million for the comparable period in 2004. Thisincrease reflects a $10.3 million, or 19.4%, increase innet earned premiums. The increase in net earned premiums is theresult of the earning pattern from the controlled growth inwritten premiums experienced in 2004 and the first quarter of2005. This growth was attributable to growth in existingprograms, which included new programs implemented in 2004 thathad been historically profitable. The growth in net earnedpremiums was also attributable to a west-coast commercialtransportation program and other various programs. The impact ofan overall 8.4% rate increase achieved in 2004 also contributedto the increase in net earned premiums. This increase inrevenues also reflects a $930,000, increase in investmentincome, primarily the result of an increase in average investedassets. Partially offsetting these increases in revenue was theanticipated reduction in a limited duration multi-state claimsrun-off contract, terminated in 2004. Due to the earlier thananticipated termination of this third party contract, therevenues that we anticipated earning in the second quarter of2005 were accelerated into the third quarter of 2004.**Specialty Risk Management Operations**     The following table sets forth the revenues and results fromoperations for our specialty risk management operations (inthousands):            **For the Three Months**  **Ended June 30,**     **2005** **2004**         Revenue:             Net earned premiums $63,364  $53,083      Management fees  4,100   3,898      Claims fees  1,766   2,728      Loss control fees  555   532      Reinsurance placement  94   (30)     Investment income  4,470   3,542      Net realized gains (losses)  22   (32)            Total revenue $74,371  $63,721            Pre-tax income             Specialty risk management operations(1) and (2) $8,583  $5,775  (1)     Our specialty risk management operations now exclude an    allocation of corporate overhead, which is attributable to our    agency operations. In prior years, corporate overhead was only    reflected in the specialty risk management operations segment.    This reclassification for the allocation of corporate overhead    more accurately presents our segments as a result of improved    cost allocation information. As a result, the segment    information for the three months ended June 30, 2004, has    been adjusted to reflect this allocation. For the three months    ended June 30, 2005 and 2004, the allocation of corporate    overhead from the specialty risk management operations to the    agency operations segment was $983,000 and $891,000,    respectively. (2)     We reclassified revenues related to the conversion of a    west-coast commercial transportation program, which was    converted to a specialty risk program with one of our    subsidiaries, from the agency operations segment to the    specialty risk management operations segment. Accordingly, the    agency operations revenue and intersegment revenue have been    reclassified. In addition, the overall net income related to    this subsidiary was reclassified from the agency operations to    the specialty risk management operations segment. As a result,    pre-tax net income of $848,000 related to this subsidiary was    reclassified to the specialty risk management operations pre-tax    income from the agency operations segment for the three months    ended June 30, 2004.
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    Revenues from specialty risk management operations increased$10.7 million, or 16.7%, to $74.4 million for thethree months ended June 30, 2005, from $63.7 millionfor the comparable period in 2004.     Net earned premiums increased $10.3 million, or 19.4%, to$63.4 million in the three months ended June 30, 2005,from $53.1 million in the comparable period in 2004. Thisincrease primarily reflects the earning pattern resulting fromthe controlled growth of programs written in the last twoquarters of 2004 and the first quarter of 2005, which includednew programs implemented in 2004. In addition, this growthincludes the impact from the increase in the net retention onour workers’ compensation reinsurance treaty from $350,000to $750,000.     Management fees increased $202,000, or 5.2%, to$4.1 million for the three months ended June 30, 2005,from $3.9 million for the comparable period in 2004. Theincrease in management fees is primarily attributable to growthin a specific New England based program.     Claim fees decreased $962,000, or 35.3%, to $1.8 million,from $2.7 million for the comparable period in 2004. Thedecrease in claim fees reflects an anticipated shift in feerevenue previously generated from a multi-state claims run-offservice contract, to internally generated fee revenue from aspecific renewal rights agreement that is eliminated uponconsolidation. Due to the earlier than anticipated terminationof this third party contract, the revenues that we anticipatedearning in the second quarter of 2005 were accelerated into thethird quarter of 2004. Excluding revenue generated from thisthird party contract, claim fee revenue remained consistent incomparison to 2004.     Net investment income increased $928,000, or 26.2%, to$4.4 million in 2005, from $3.5 million in 2004.Average invested assets increased $66.9 million, or 19.5%,to $409.8 million in 2005, from $343.0 million in2004. The increase in average invested assets reflects cashflows from underwriting activities and growth in gross writtenpremiums during 2004 and 2005, as well as net proceeds fromcapital raised in 2004 through the issuances of debentures. Theaverage investment yield for June 30, 2005, was 4.4%,compared to 4.1% for the comparable period in 2004. The currentpre-tax book yield is 4.1% and current after-tax book yield is3.1%. The investment yield reflects the accelerated prepaymentsin mortgage-backed securities and the reinvestment of cash flowsin municipal bonds.     Specialty risk management operations generated pre-tax income of$8.6 million for the three months ended June 30, 2005,compared to pre-tax income of $5.8 million for thecomparable period in 2004. This increase in pre-tax incomedemonstrates a continued improvement in underwriting results asa result of our controlled growth in premium volume and ourcontinued focus on leveraging of fixed costs. In addition, theabsence of unfavorable development on prior accident years inrelation to our loss reserves contributed to this improvement.The GAAP combined ratio was 97.1% for the three months endedJune 30, 2005, compared to 101.2% for the same period in2004.     Net loss and loss adjustment expenses increased$4.9 million, or 14.9%, to $37.7 million for the threemonths ended June 30, 2005, from $32.8 million for thesame period in 2004. Our loss and LAE ratio decreased2.1 percentage points to 64.4% for the three months endedJune 30, 2005, from 66.5% for the same period in 2004. Thisratio is the unconsolidated net loss and LAE in relation to netearned premiums. The improvement in the loss and LAE ratioreflects a 0.3 percentage point decrease in the change innet ultimate loss estimates for prior accident years in 2005 ascompared to 2004. Development on prior accident year reservesadded $577,000, or 0.9 percentage points, to net loss andLAE in 2005, compared to $647,000, or 1.2 percentage pointsin 2004. The development in the second quarter of 2005 primarilyreflects the impact of an increase to an exposure allowancespecific to reinsurance recoverables for a discontinued suretyprogram. During the quarter, we received updated financialinformation from the Liquidator of the reinsurer on thatprogram. Based upon this information, which included an updatedfinancial statement, we increased the allowance to 100% of theuncollateralized exposure as of June 30, 2005. In addition,there was a 0.4 percentage point decrease in the net lossand LAE ratio as a result of efficiencies within our claimshandling activities. This overall improvement in the loss andLAE ratio also reflects the impact of earned premiums from thecontrolled growth of profitable programs which have hadfavorable underwriting experience, as well as our intended shiftin the balance between workers’ compensation and generalliability line of business. Historically, the general liabilityline of business has a lower loss ratio and a higher externalproducer commission.
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     Our expense ratio decreased 2.0 percentage points to 32.7%for the three months ended June 30, 2005, from 34.7% forthe same period in 2004. This ratio is the unconsolidated policyacquisition and other underwriting expenses in relation to netearned premiums. Our continued leveraging of fixed costs and areduction in net ceded excess reinsurance costs resulted in adecrease to our overall expense ratio. As a result of theincrease in our net retention on our excess of lossworkers’ compensation treaty from $350,000 to $750,000, ourceded excess reinsurance costs decreased due to a lower excessreinsurance rate. In addition, ceded excess reinsurance costsdecreased on the reinsurance treaty for our public entity excessliability program. The lower overall expense ratio also reflectsthe favorable impact of a settlement with a department ofinsurance authority related to insurance related assessmentsfrom old policy years. These decreases were partially offset bythe anticipated increase in gross external commissions, due to ashift in the balance between workers’ compensation andgeneral liability. The general liability line of business has ahigher external producer commission rate and, as previouslyindicated, a lower loss ratio.**Agency Operations**     The following table sets forth the revenues and results fromoperations for our agency operations (in thousands):           **For the Three Months**  **Ended June 30,**     **2005** **2004**         Net commission(1) $1,982  $1,770     Pre-tax income(1) and (2) $69  $161  (1)     We reclassified revenues related to the conversion of a    west-coast commercial transportation program, which was    converted to a specialty risk program with one of our    subsidiaries, from the agency operations segment to the    specialty risk management operations segment. Accordingly, the    agency operations revenue and intersegment revenue have been    reclassified. As a result, $2.2 million was reclassified    within the agency operations segment and the intersegment    revenue for the three months ended June 30, 2004. In    addition, the overall net income related to this subsidiary was    reclassified from the agency operations to the specialty risk    management operations segment. As a result, pre-tax net income    of $848,000 related to this subsidiary was reclassified to the    specialty risk management operations pre-tax income from the    agency operations segment for the three months ended    June 30, 2004. (2)     Our agency operations include an allocation of corporate    overhead, which includes expenses associated with accounting,    information services, legal, and other corporate services. The    corporate overhead allocation excludes those expenses specific    to the holding company. In prior years, corporate overhead was    only reflected in the specialty risk management operations    segment. This reclassification for the allocation of corporate    overhead more accurately presents our segments as a result of    improved cost allocation information. As a result, the segment    information for the three months ended June 30, 2004, has    been adjusted to reflect this allocation. For the three months    ended June 30, 2005 and 2004, the allocation of corporate    overhead to the agency operations segment was $983,000 and    $891,000, respectively.    Revenue from agency operations, which consists primarily ofagency commission revenue, increased $212,000, or 12.0%, to$2.0 million for the three months ended June 30, 2005,from $1.8 million for the comparable period in 2004. Thisincrease is primarily the result of an increase in new businessand renewal retention in comparison to 2004.     Agency operations generated pre-tax income, after the allocationof corporate overhead, of $69,000 for the three months endedJune 30, 2005, compared to $161,000 for the comparableperiod in 2004. This decrease is primarily the result of thetiming of revenue, as well as an increase in the allocation offixed overhead costs in comparison to 2004, primarily related toinformation technology enhancements.**Other Items****     Reserves**     For the three months ended June 30, 2005, we reported anincrease in net ultimate loss estimates for accident years 2004and prior to be $577,000, or 0.3% of $227.0 million of netloss and LAE reserves at December 31, 2004. There were nosignificant changes in the key assumptions utilized in theanalysis and calculations of our reserves during 2005.
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**     Salary and Employee Benefitsand Other Administrative Expenses**     Salary and employee benefits for the three months endedJune 30, 2005, increased $1.3 million, or 10.7%, to$13.6 million, from $12.3 million for the comparableperiod in 2004. This increase primarily reflects both anincrease in variable compensation, which is directly related toperformance and profitability, as well as merit increases forassociates. Theses increases were partially offset by a slightdecrease in staffing levels in comparison to 2004.     Other administrative expenses decreased $423,000, or 6.5%, to$6.0 million, from $6.4 million for the comparableperiod in 2004. This decrease is primarily attributable to adecrease in expenses related to outside third partyadministrators for the handling of claims and decrease inoutside legal expenses in comparison to 2004. Otheradministrative expenses were also favorably impacted incomparison to 2004 as the result of overall expense initiatives.These decreases were partially offset by increases in expensesas a result of information technology enhancements.     Salary and employee benefits and other administrative expensesinclude both corporate overhead and the holding company expensesincluded in the reconciling items of our segment information.**     Interest Expense**     Interest expense for the three months ended June 30, 2005,increased $278,000, or 52.7%, to $806,000, from $528,000 for thecomparable period in 2004. Interest expense is primarilyattributable to our debentures, which are described within the*Liquidity and Capital Resources*section ofManagement’s Discussion and Analysis, as well as ourcurrent lines of credit. Interest expense increased $320,000primarily as a result of the senior debentures issued in thesecond quarter of 2004. Interest expense related to our lines ofcredit remained relatively consistent in comparison to 2004.This is the result of a decrease in the average outstandingbalance, offset by an increase in the average interest rate. Theaverage outstanding balance during the three months endingJune 30, 2005, was $9.9 million, compared to$16.9 million for the same period in 2004. The averageinterest rate, excluding the debentures, in 2005 was 5.4%,compared to 4.2% in 2004.**     Income Taxes**     Income tax expense, which includes both federal and state taxes,for the three months ended June 30, 2005, was$2.3 million, or 33.2% of income before taxes. For the sameperiod last year, we reflected an income tax expense of$1.5 million, or 34.9% of income before taxes. Oureffective tax rate differs from the 35% statutory rate primarilydue to a shift towards increasing investments in tax-exemptsecurities in an effort to maximize after-tax investment yields.Our current taxes are calculated using a 35% statutory ratebased on taxable income greater than $18.3 million.Deferred taxes are calculated based on a 34% statutory rate. Weare currently evaluating the expected tax rate for therealization of the deferred taxes.
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**Liquidity and Capital Resources**     Our principal sources of funds, which include both regulated andnon-regulated cash flows, are insurance premiums, investmentincome, proceeds from the maturity and sale of invested assets,risk management fees, and agency commissions. Funds areprimarily used for the payment of claims, commissions, salariesand employee benefits, other operating expenses, shareholderdividends, share repurchases, and debt service. Our regulatedsources of funds are insurance premiums, investment income, andproceeds from the maturity and sale of invested assets. Theseregulated funds are used for the payment of claims, policyacquisition and other underwriting expenses, and taxes relatingto the regulated portion of net income. Our non-regulatedsources of funds are in the form of commission revenue, outsidemanagement fees, and intercompany management fees. Thesenon-regulated sources of funds are used to service debt,shareholders’ dividends, and other operating expenses ofthe holding company and non-regulated subsidiaries. Thefollowing table illustrates net income, excluding interest,depreciation, and amortization, between our regulated andnon-regulated subsidiaries, which reconciles to our consolidatedstatement of income and statement of cash flows (in thousands):             **For the Six Months**  **Ended June 30,**     **2005** **2004**         Net income $8,323  $6,052            Regulated Subsidiaries:              Net income $6,370  $3,015       Depreciation and amortization  —   —       Interest  —   —             Net income, excluding interest, depreciation, and amortization  6,370   3,015              Adjustments to reconcile net income to net cash provided by    operating activities  1,493   910       Changes in operating assets and liabilities  18,482   20,623             Total adjustments  19,975   21,533      Depreciation and amortization  —   —      Interest  —   —             Net cash provided by operating activities $26,345  $24,548            Non-regulated Subsidiaries:              Net income $1,953  $3,037       Depreciation and amortization  1,433   848       Interest  1,579   969             Net income, excluding interest, depreciation, and amortization  4,965   4,854              Adjustments to reconcile net income to net cash (used in)    provided by operating activities  1,954   1,376       Changes in operating assets and liabilities  (7,232)  (2,663)            Total adjustments  (5,278)  (1,287)     Depreciation and amortization  (1,433)  (848)     Interest  (1,579)  (969)            Net cash (used in) provided by operating activities $(3,325) $1,750            Consolidated total adjustments  14,697   20,246            Consolidated net cash provided by operating activities $23,020  $26,298        
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             **For the Three Months**  **Ended June 30,**     **2005** **2004**         Net income $4,580  $2,820            Regulated Subsidiaries:              Net income $3,752  $1,605       Depreciation and amortization  —   —       Interest  —   —             Net income, excluding interest, depreciation, and amortization  3,752   1,605              Adjustments to reconcile net income to net cash provided by    operating activities  786   12       Changes in operating assets and liabilities  6,469   7,465             Total adjustments  7,255   7,477      Depreciation and amortization  —   —      Interest  —   —             Net cash provided by operating activities $11,007  $9,082            Non-regulated Subsidiaries:              Net income $828  $1,215       Depreciation and amortization  756   474       Interest  806   591             Net income, excluding interest, depreciation, and amortization  2,390   2,280              Adjustments to reconcile net income to net cash (used in)    provided by operating activities  1,109   1,511       Changes in operating assets and liabilities  (4,093)  (1,667)            Total adjustments  (2,984)  (156)     Depreciation and amortization  (756)  (474)     Interest  (806)  (591)            Net cash (used in) provided by operating activities $(2,156) $1,059            Consolidated total adjustments  4,271   7,321            Consolidated net cash provided by operating activities $8,851  $10,141             Consolidated cash flow provided by operations for the six monthsended June 30, 2005, was $23.0 million, compared toconsolidated cash flow provided by operations of$26.3 million for the comparable period in 2004.     Regulated subsidiaries’ cash flow provided by operationsfor the six months ended June 30, 2005, was$26.3 million, compared to $24.5 million for thecomparable period in 2004. This increase is the result ofimproved underwriting results and an increase in investmentincome, offset by a tax benefit reduction from the utilizationof the net operating loss carryforward in 2004.     Non-regulated subsidiaries’ cash flow used in operationsfor the six months ended June 30, 2005, was$3.3 million, compared to $1.8 million provided byoperations for the comparable period in 2004. The decrease innon-regulated cash flow from operations primarily reflects thedecrease in net income as a result of an increase inadministrative costs associated with the implementation ofSection 404 of the Sarbanes-Oxley Act, offset by anincrease in revenue associated with profit-sharing commissions.In addition, the decrease in cash flow from operations is theresult of variable compensation payments made in the firstquarter of 2005, related to 2004 performance and profitabilityand a decrease in cash as a result of tax payments.
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     In addition to the changes described above in relation to ourcash provided by operations, we had an increase in cash used ininvesting activities as a result of an $11.6 cash payment forour new corporate headquarters in the first quarter of 2005. Theproceeds from the 2004 issuance of debentures, which aredescribed below, were used for the purchase of our new building.On January 1, 2005, we entered into a Lease Agreement forour furniture and phone system in relation to our new building.As of June 30, 2005, the total liability in relation tothis lease was $1.0 million. Total lease payments made forthe six months and three months ended June 30, 2005, wereapproximately $117,000 and $65,000, respectively.     We anticipate a temporary increase in cash outflows related toinvestments in technology as we continue to enhance ouroperating systems and controls.**Other Items**     In September 2003, an unconsolidated subsidiary trust of oursissued $10.0 million of mandatory redeemable trustpreferred securities (“TPS”) to a trust formed by aninstitutional investor. Contemporaneously, we issued$10.3 million in junior subordinated debentures, whichincludes our $310,000 investment in the trust. We received atotal of $9.7 million in net proceeds, after the deductionof approximately $300,000 of commissions paid to the placementagents in the transaction. These issuance costs have beencapitalized and are included in other assets on the balancesheet, which will be amortized over seven years as a componentof interest expense. We contributed $6.3 million of theproceeds to our Insurance Company Subsidiaries and the remainingbalance was used for general corporate purposes. The debenturesmature in thirty years and provide for interest at thethree-month LIBOR, plus 4.05%.     In April 2004, we issued senior debentures in the amount of$13.0 million. The senior debentures mature in thirty yearsand provide for interest at the three-month LIBOR, plus 4.00%,which is non-deferrable. The senior debentures are callable atpar after five years from the date of issuance. Associated withthis transaction, we incurred $390,000 of commissions paid tothe placement agents. These issuance costs have been capitalizedand are included in other assets on the balance sheet, whichwill be amortized over seven years as a component of interestexpense.     In May 2004, we issued senior debentures in the amount of$12.0 million. The senior debentures mature in thirty yearsand provide for interest at the three-month LIBOR, plus 4.20%,which is non-deferrable. The senior debentures are callable atpar after five years from the date of issuance. Associated withthis transaction, we incurred $360,000 of commissions paid tothe placement agents. These issuance costs have been capitalizedand are included in other assets on the balance sheet, whichwill be amortized over seven years as a component of interestexpense.     We contributed $9.9 million of the proceeds from the seniordebentures to our Insurance Company Subsidiaries in December2004. The remaining proceeds from the issuance of the seniordebentures may be used to support future premium growth throughfurther contributions to our Insurance Company Subsidiaries andgeneral corporate purposes.     In November 2004, we entered into a revolving line of credit forup to $25.0 million. The revolving line of credit replacedour previous term loan and line of credit and expires onNovember 11, 2007. We had drawn approximately$9.0 million on this new revolving line of credit to payoff our former term loan. We will use the revolving line ofcredit to meet short-term working capital needs. Under therevolving line of credit, we and certain of our non-regulatedsubsidiaries pledged security interests in certain property andassets of named subsidiaries.     At June 30, 2005 and December 31, 2004, we had anoutstanding balance of $7.0 million and $9.0 millionon the new revolving line of credit, respectively.     The revolving line of credit provides for interest at a variablerate based, at our option, upon either a prime based rate orLIBOR-based rate. On prime based borrowings, the applicablemargin ranges from 75 to 25 basis points below prime. OnLIBOR-based borrowings, the applicable margin ranges from 125 to175 basis points above LIBOR. The margin for all loans isdependent on the sum of non-regulated earnings before interest,taxes, depreciation, amortization, and non-cash impairmentcharges related to intangible assets for
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the preceding four quarters, plus dividends paid or payable tous from subsidiaries during such period (“AdjustedEBITDA”). As of June 30, 2005, the average interestrate for LIBOR-based borrowings outstanding was 4.4%.     Debt covenants consist of: (1) maintenance of the ratio ofAdjusted EBITDA to interest expense of 2.0 to 1.0,(2) minimum net worth of $130.0 million and increasingannually, commencing June 30, 2005, by fifty percent of theprior year’s positive net income, (3) minimum A.M.Best rating of “B”, and (4) on an annual basis, aminimum Risk Based Capital Ratio for Star of 1.75 to 1.00. As ofJune 30, 2005, we were in compliance with these covenants.     In addition, our non-insurance premium finance subsidiarymaintains a line of credit with a bank, which permits borrowingsup to 75% of the accounts receivable, which collateralize theline of credit. At June 30, 2005, this line of credit hadan outstanding balance of $2.9 million. On April 26,2005, the terms of this line of credit were modified. Themodification to this line of credit included a decrease in theline of credit from $8.0 million to $6.0 million. Theinterest terms of this line of credit provide for interest atthe prime rate minus 0.5%, or a LIBOR-based rate option, plus2.0%. At June 30, 2005, the LIBOR-based option was 5.1% andthe average interest was 5.0%.     At June 30, 2005, shareholders’ equity was$175.0 million, or $6.00 per common share, compared to$167.5 million, or $5.76 per common share, atDecember 31, 2004.     In September 2002, our Board of Directors authorized managementto repurchase up to 1,000,000 shares of our common stock inmarket transactions for a period not to exceed twenty-fourmonths. In August 2003, our Board of Directors authorizedmanagement to repurchase up to an additional1,000,000 shares of our common stock under the existingshare repurchase plan. The original share repurchase planexpired in September 2004. In November 2004, our Board ofDirectors authorized management to repurchase up to1,000,000 shares of our common stock in market transactionsfor a period not to exceed twenty-four months. For the sixmonths and three months ended June 30, 2005, we purchasedand retired 208,790 and 149,390 shares of common stock fora total cost of approximately $1.1 million and $786,000,respectively. We did not repurchase any common stock during2004. As of June 30, 2005, the cumulative amount we haverepurchased and retired under the current share repurchase planwas 208,790 shares of common stock for a total cost ofapproximately $1.1 million. As of June 30, 2005, wehave available up to 791,210 shares remaining to bepurchased.     A significant portion of our consolidated assets representassets of our Insurance Company Subsidiaries that at this time,without prior approval of the State of Michigan Office ofFinancial and Insurance Services (“OFIS”), cannot betransferred to us in the form of dividends, loans or advances.The restriction on the transferability to us from the InsuranceCompany Subsidiaries is regulated by Michigan insurance statuteswhich, in general, are as follows: the maximum discretionarydividend that may be declared, based on data from the precedingcalendar year, is the greater of each insurance company’snet income (excluding realized capital gains) or ten percent ofthe insurance company’s surplus (excluding unrealizedgains). These dividends are further limited by a clause in theMichigan law that prohibits an insurer from declaring dividendsexcept out of surplus earnings of the company. Earned surplusbalances are calculated on a quarterly basis. Since Star is theparent insurance company, its maximum dividend calculationrepresents the combined Insurance Company Subsidiaries’surplus. Based upon the 2004 statutory financial statements,Star may only pay dividends to us during 2005 with the priorapproval of OFIS. Star’s earned surplus position atDecember 31, 2004 was negative $13.7 million. AtJune 30, 2005, earned surplus was negative$8.5 million. No dividends were paid in 2004 or 2005.***     Contractual Obligations andCommitments***     There were no material changes outside the ordinary course ofour business in relation to our contractual obligations andcommitments for the three months and six months endedJune 30, 2005.
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**Regulatory and Rating Issues**     The National Association of Insurance Commissioners(“NAIC”) has adopted a risk-based capital(“RBC”) formula to be applied to all property andcasualty insurance companies. The formula measures requiredcapital and surplus based on an insurance company’sproducts and investment portfolio and is used as a tool toevaluate the capital of regulated companies. The RBC formula isused by state insurance regulators to monitor trends instatutory capital and surplus for the purpose of initiatingregulatory action. In general, an insurance company must submita calculation of its RBC formula to the insurance department ofits state of domicile as of the end of the previous calendaryear. These laws require increasing degrees of regulatoryoversight and intervention as an insurance company’s RBCdeclines. The level of regulatory oversight ranges fromrequiring the insurance company to inform and obtain approvalfrom the domiciliary insurance commissioner of a comprehensivefinancial plan for increasing its RBC to mandatory regulatoryintervention requiring an insurance company to be placed underregulatory control in a rehabilitation or liquidation proceeding.     At December 31, 2004, all of our Insurance CompanySubsidiaries were in compliance with RBC requirements. Starreported statutory surplus of $120.7 million atDecember 31, 2004, compared to the threshold requiring theminimum regulatory involvement of $56.9 million in 2004. AtJune 30, 2005, Star’s statutory surplus increased$5.5 million to $126.2 million.     Insurance operations are subject to various leverage tests (e.g.premium to statutory surplus ratios), which are evaluated byregulators and rating agencies. Our targets for gross and netwritten premium to statutory surplus are 3.0 to 1.0 and 2.5 to1.0, respectively. As of June 30, 2005, on a statutoryconsolidated basis, gross and net premium leverage ratios were2.6 to 1.0 and 2.0 to 1.0, respectively.**     Reinsurance**     Intercompany pooling agreements are commonly entered intobetween affiliated insurance companies, so as to allow thecompanies to utilize the capital and surplus of all of thecompanies, rather than each individual company. Under poolingarrangements, companies share in the insurance business that isunderwritten and allocate the combined premium, losses andrelated expenses between the companies within the poolingarrangement. Effective January 1, 2005, the InsuranceCompany Subsidiaries entered into an Inter-Company ReinsuranceAgreement (the “Reinsurance Agreement”). ThisReinsurance Agreement includes Star, Ameritrust InsuranceCorporation (“Ameritrust”), Savers Property andCasualty Insurance Company (“Savers”) and WilliamsburgNational Insurance Company (“Williamsburg”). Pursuantto the Reinsurance Agreement, Savers, Ameritrust andWilliamsburg have agreed to cede to Star and Star has agreed toreinsure 100% of the liabilities and expenses of Savers,Ameritrust and Williamsburg, relating to all insurance andreinsurance policies issued by them. In return, Star agrees tocede and Savers, Ameritrust and Williamsburg have agreed toreinsure Star for their respective percentages of theliabilities and expenses of Star. The Reinsurance Agreement wasfiled with the applicable regulatory authorities and was notdisapproved. Any changes to the Reinsurance Agreement must besubmitted to the applicable regulatory authorities for reviewand approval.**     Off-Balance SheetArrangements**     In June 2003, we entered into a Guaranty Agreement with a bank.We are guaranteeing payment of a $1.5 million term loanissued by the bank to an unaffiliated insurance agency. In theevent of default on the term loan by the insurance agency, weare obligated to pay any outstanding principal (up to a maximumof $1.5 million), as well as any accrued interest on theloan, and any costs incurred by the bank in the collectionprocess. In exchange for our guaranty, the president and memberof the unaffiliated insurance agency pledged 100% of the commonshares of two other insurance agencies that he wholly owns. Inthe event of default on the term loan by the unaffiliatedinsurance agency, we have the right to sell any or all of thepledged assets (the common stock of the two insurance agencies)and use the proceeds from the sale to recover any amounts paidunder the Guaranty Agreement. Any excess proceeds would be paidto the shareholder. As of June 30,
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2005, no liability has been recorded with respect to ourobligations under the Guaranty Agreement, since the collateralis in excess of the guaranteed amount.**Recent Accounting Pronouncements**     In December 2004, the Financial Accounting Standards Board(“FASB”) issued SFAS No. 123 (revised 2004),*“Share-Based Payment”*(“SFAS 123R”), which replacesSFAS No. 123, *“Accounting for Stock Issued toEmployees.”*SFAS 123R requires all share-basedpayments to employees to be recognized in the financialstatements based on their fair values. The pro forma disclosurespreviously permitted under SFAS 123, will no longer be analternative to financial statement recognition. Commencing inthe first quarter of 2003, we began expensing the fair value ofall stock options granted since January 1, 2003 under theprospective method. Under SFAS 123R, we must determine theappropriate fair value model to be used for valuing share-basedpayments, the amortization method for compensation cost and thetransition method to be used at the date of adoption. Thetransition methods include prospective and retroactive adoptionoptions. Under the retroactive options, prior periods may berestated either as of the beginning of the year of adoption orfor all periods presented. The prospective method requires thatcompensation expense be recorded at the beginning of the firstquarter of adoption of SFAS 123R for all unvested stockoptions and restricted stock based upon the previously disclosedSFAS 123 methodology and amounts. The retroactive methodswould record compensation expense beginning with the firstperiod restated for all unvested stock options and restrictedstock. On April 14, 2005, the Securities and ExchangeCommission adopted a new rule that delays the compliance datesfor SFAS 123R. Under the new rule, SFAS 123R iseffective for public companies for annual, rather than interimperiods, that begin after June 15, 2005. Therefore, we arerequired to adopt SFAS 123R in the first quarter of 2006,or beginning January 1, 2006. We are currently evaluatingthe requirements of SFAS 123R and have not yet determinedthe method of adoption or impact SFAS 123R will have on ourfinancial statements.     In May 2005, the FASB issued SFAS No. 154,*“Accounting Changes and Error Corrections, a replacementof APB Opinion No. 20 and FASB StatementNo. 3.”* SFAS No. 154 replaces thementioned pronouncements and changes the requirements for theaccounting and reporting of a change in an accounting principle.This Statement applies to all voluntary changes in accountingprinciple, as well as changes required by an accountingpronouncement in the unusual instance that the pronouncementdoes not include specific transition provisions. However, when apronouncement includes specific transition provisions, thoseprovisions should be followed. SFAS No. 154 requiresretrospective application to prior period financial statementsfor changes in accounting principle, unless it is impracticableto determine either the period-specific effects or thecumulative effect of the change. SFAS No. 154 alsorequires that retrospective application of a change inaccounting principle be limited to the direct effects of thechange. Indirect effects of a change in accounting principleshould be recognized in the period of the accounting change.SFAS No. 154 is effective for accounting changes andcorrections of errors made in fiscal years beginning afterDecember 15, 2005. However, early adoption is permitted foraccounting changes and corrections of errors made in fiscalyears beginning after the date this Statement was issued. We arerequired to adopt the provisions of SFAS No. 154, asapplicable, beginning in 2006. We believe the adoption ofSFAS No. 154 will not have a material impact on ourconsolidated financial statements.     In July 2005, the FASB issued an exposure draft of a proposedinterpretation on accounting for uncertain tax positions underSFAS No. 109 *“Accounting for IncomeTaxes”.* If adopted as proposed, the pronouncement willbe effective December 31, 2005 and only those tax benefitsthat meet the probable recognition threshold may be recognizedor continue to be recognized as of the effective date. We arecurrently evaluating the impact this proposed interpretationwill have on our financial statements.**Subsequent Events**     Effective July 1, 2005, we made a $2.5 million loan,at an effective interest rate equal to the three month LIBOR,plus 5.2%, to an unaffiliated insurance agency. This agency hasbeen a producer for us for over ten years. Under the terms ofthe agreement, we may demand repayment of the principal, plusaccrued interest at
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any time. As security for the loan, the shareholder has pledged100% of the common shares of the unaffiliated insurance agencyand three insurance agencies, as well as executed a personalguaranty.**Item 3.*****Quantitative and Qualitative Disclosures About Market    Risk***     Market risk is the risk of loss arising from adverse changes inmarket rates and prices, such as interest rates as well as otherrelevant market rate or price changes. The volatility andliquidity in the markets in which the underlying assets aretraded directly influence market risk. The following is adiscussion of our primary risk exposures and how those exposuresare currently managed as of June 30, 2005. Our market risksensitive instruments are primarily related to fixed incomesecurities, which are available for sale and not held fortrading purposes.     Interest rate risk is managed within the context of an asset andliability management strategy where the target duration for thefixed income portfolio is based on the estimate of the liabilityduration and takes into consideration our surplus. Theinvestment policy guidelines provide for a fixed incomeportfolio duration of between three and five years. AtJune 30, 2005, our fixed income portfolio had a modifiedduration of 3.75, compared to 3.46 at December 31, 2004.     At June 30, 2005, the fair value of our investmentportfolio was $374.6 million. Our market risk to theinvestment portfolio is interest rate risk associated with debtsecurities. Our exposure to equity price risk is notsignificant. Our investment philosophy is one of maximizingafter-tax earnings and has historically included significantinvestments in tax-exempt bonds. During 2003 and 2004, we beganto increase our holdings of tax-exempt securities based on ourreturn to profitability and our desire to maximize after-taxinvestment income. For our investment portfolio, there were nosignificant changes in our primary market risk exposures or inhow those exposures are managed compared to the year endedDecember 31, 2004. We do not anticipate significant changesin our primary market risk exposures or in how those exposuresare managed in future reporting periods based upon what is knownor expected to be in effect.     A sensitivity analysis is defined as the measurement ofpotential loss in future earnings, fair values, or cash flows ofmarket sensitive instruments resulting from one or more selectedhypothetical changes in interest rates and other market rates orprices over a selected period. In our sensitivity analysismodel, a hypothetical change in market rates is selected that isexpected to reflect reasonable possible near-term changes inthose rates. “Near term” means a period of up to oneyear from the date of the consolidated financial statements. Inour sensitivity model, we use fair values to measure ourpotential loss of debt securities assuming an upward parallelshift in interest rates to measure the hypothetical change infair values. The table below presents our model’s estimateof changes in fair values given a change in interest rates.Dollar values are rounded and in thousands.               **Rates Down** **Rates** **Rates Up**  **100bps** **Unchanged** **100bps**           Market Value $389,412  $374,570  $359,904     Yield to Maturity or Call  2.93%  3.93%  4.93%    Effective Duration  3.82   3.89   3.99      The other financial instruments, which include cash and cashequivalents, equity securities, premium receivables, reinsurancerecoverables, lines of credit and other assets and liabilities,when included in the sensitivity model, do not produce amaterial loss in fair values.     At June 30, 2005 and December 31, 2004, our$35.3 million of debentures are subject to variableinterest rates. Thus, our interest expense on these debenturesis directly correlated to market interest rates. At this level,a 1% change in market rates would change interest expense by$353,000.     In addition, our revolving line of credit under which we canborrow up to $25.0 million is subject to variable interestrates. Thus, our interest expense on the revolving line ofcredit is directly correlated to market interest rates. AtJune 30, 2005, we had $7.0 million outstanding. Atthis level, a one percent change in market
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rates would change interest expense by $70,000. AtDecember 31, 2004, we had $9.0 million outstanding. Atthis level, a one percent change in market rates would havechanged interest expense by $90,000.**Item 4.*****Controls and Procedures*****Evaluation of Disclosure Controls and Procedures.**     Our disclosure controls and procedures (as defined inRule 13a-15(e) under the Securities Exchange Act of 1934,the “Exchange Act”), which we refer to as disclosurecontrols, are controls and procedures that are designed with theobjective of ensuring that information required to be disclosedin our reports filed under the Exchange Act, such as thisForm 10-Q, is recorded, processed, summarized and reportedwithin the time periods specified in the Securities and ExchangeCommission’s rules and forms. Disclosure controls are alsodesigned with the objective of ensuring that such information isaccumulated and communicated to management, including our ChiefExecutive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosure. There areinherent limitations to the effectiveness of any control system.A control system, no matter how well conceived and operated, canprovide only reasonable assurance that its objectives are met.No evaluation of controls can provide absolute assurance thatall control issues and instances of fraud, if any, have beendetected.     As of June 30, 2005, an evaluation was carried out underthe supervision and with the participation of our management,including our Chief Executive Officer and Chief FinancialOfficer, of the effectiveness of the design and operation ofdisclosure controls. Based upon our evaluation, our ChiefExecutive Officer and Chief Financial Officer concluded that thedesign and operation of our disclosure controls were effectivein recording, processing, summarizing, and reporting, on atimely basis, material information required to be disclosed inthe reports we file under the Exchange Act and is accumulatedand communicated, as appropriate to allow timely decisionsregarding required disclosure.**Changes in Internal Control over Financial Reporting**     There were no significant changes in our internal control overfinancial reporting during the three month period endedJune 30, 2005, which have materially affected, or arereasonably likely to materially affect, our internal controlover financial reporting.
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**PART II — OTHER INFORMATION****Item 1.*****Legal Proceedings***     The information required by this item is included underNote 6 — *Commitments and Contingencies*ofthe Notes to the Consolidated Financial Statements of theCompany’s Form 10-Q for the six months endedJune 30, 2005, which is hereby incorporated by reference.**Item 2.*****Unregistered Sales of Equity Securities and Use of    Proceeds***     In November 2004, the Company’s Board of Directorsauthorized management to repurchase up to 1,000,000 sharesof its common stock in market transactions for a period not toexceed twenty-four months. For the three months endedJune 30, 2005, the Company purchased and retired149,390 shares of common stock for a total cost ofapproximately $786,000.                       **Total Number of** **Maximum**      **Shares** **Number of**      **Purchased as** **Shares that may**      **Part of Publicly** **yet be**  **Total** **Average** **Announced** **Repurchased**  **Number of** **Price Paid** **Plans or** **Under the Plans****Period** **Shares** **Per Share** **Programs** **or Programs**             April 1 — April 30, 2005  20,500  $5.19   20,500   920,100     May 1 — May 31, 2005  —   —   —   920,100     June 1 — June 30, 2005  128,890  $5.22   128,890   791,210                  Total  149,390  $5.21   149,390                  **Item 4.*****Submission of Matters to a Vote of Security Holders***     On May 10, 2005, the Company held its Annual Meeting ofShareholders (“Annual Meeting”) to consider and actupon the following proposals:          (1) The election of three (3) members to the Board of    Directors of the Company; and           (2) Ratification of the appointment of the Company’s    independent accountants, PricewaterhouseCoopers, LLP.     The following Directors stood for election at the AnnualMeeting: (1) Robert H. Naftaly; (2) Robert W. Sturgis;and (3) Bruce E. Thal. The shareholders re-elected theDirectors at the Annual Meeting and therefore, each shallcontinue in office. The vote tabulation for each Director was:(1) Robert H. Naftaly — 25,086,667 in favor and419,855 withheld; (2) Robert W. Sturgis —25,087,667 in favor and 418,855 withheld; and (3) Bruce E.Thal — 25,086,995 in favor and 419,527 withheld. OtherDirectors continuing in office after the meeting were asfollows: Robert S. Cubbin, Joseph S. Dresner, Hugh W. Greenberg,Florine Mark, David K. Page, Merton J. Segal, and Herbert Tyner.     The shareholders ratified the appointment ofPricewaterhouseCoopers, LLP by a vote of 25,477,379 in favor,22,857 against and 6,286 abstained.
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**Item 6.*****Exhibits***     The following documents are filed as part of this Report:     **Exhibit**  **No.** **Description**    10.1     First Modification to the Amended and Restated Loan and Security    Agreement between Liberty Premium Finance, Inc. and Comerica    Bank, dated April 26, 2005. 10.2     Reciprocal Easement and Operation Agreement between Meadowbrook    Insurance Group, Inc. and MB Center II, LLC, dated    May 9, 2005. 10.3     First Amendment to Land Contract between MB Center II, LLC    and Meadowbrook Insurance Group, Inc., dated May 20, 2005. 10.4     Amendment to Credit Agreement between Meadowbrook Insurance    Group, Inc. and Standard Federal Bank National Association,    dated May 20, 2005. 10.5     Demand Note between Meadowbrook Insurance Group, Inc. and    Renaissance Alliance Insurance Services, LLC, dated July 1,    2005. 31.1     Certification of Robert S. Cubbin, Chief Executive Officer of    the Corporation, pursuant to Securities Exchange Act    Rule 13a-14(a). 31.2     Certification of Karen M. Spaun, Senior Vice President and Chief    Financial Officer of the Corporation, pursuant to Securities    Exchange Act Rule 13a-14(a). 32.1     Certification pursuant to 18 U.S.C. Section 1350, as    adopted pursuant to Section 906 of the Sarbanes-Oxley Act    of 2002, signed by Robert S. Cubbin, Chief Executive Officer of    the Corporation. 32.2     Certification pursuant to 18 U.S.C. Section 1350, as    adopted pursuant to Section 906 of the Sarbanes-Oxley Act    of 2002, signed by Karen M. Spaun, Senior Vice President and    Chief Financial Officer of the Corporation.
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**SIGNATURES**     Pursuant to the requirements of the Securities and Exchange Actof 1934, the Registrant has duly caused this Report to be signedon its behalf by the undersigned, thereunto duly authorized. Meadowbrook Insurance    Group, Inc.     By:     /s/ Karen M. Spaun       *Senior Vice President and* *Chief Financial Officer*Dated: August 5, 2005
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**EXHIBIT INDEX**     **Exhibit**  **No.** **Description**    10.1     First Modification to the Amended and Restated Loan and Security    Agreement between Liberty Premium Finance, Inc. and Comerica    Bank, dated April 26, 2005. 10.2     Reciprocal Easement and Operation Agreement between Meadowbrook    Insurance Group, Inc. and MB Center II, LLC, dated    May 9, 2005. 10.3     First Amendment to Land Contract between MB Center II, LLC    and Meadowbrook Insurance Group, Inc., dated May 20, 2005. 10.4     Amendment to Credit Agreement between Meadowbrook Insurance    Group, Inc. and Standard Federal Bank National Association,    dated May 20, 2005. 10.5     Demand Note between Meadowbrook Insurance Group, Inc. and    Renaissance Alliance Insurance Services, LLC, dated July 1,    2005. 31.1     Certification of Robert S. Cubbin, Chief Executive Officer of    the Corporation, pursuant to Securities Exchange Act    Rule 13a-14(a). 31.2     Certification of Karen M. Spaun, Senior Vice President and Chief    Financial Officer of the Corporation, pursuant to Securities    Exchange Act Rule 13a-14(a). 32.1     Certification pursuant to 18 U.S.C. Section 1350, as    adopted pursuant to Section 906 of the Sarbanes-Oxley Act    of 2002, signed by Robert S. Cubbin, Chief Executive Officer of    the Corporation. 32.2     Certification pursuant to 18 U.S.C. Section 1350, as    adopted pursuant to Section 906 of the Sarbanes-Oxley Act    of 2002, signed by Karen M. Spaun, Senior Vice President and    Chief Financial Officer of the Corporation.