##### Table of Contents



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 quarterly period ended September 30, 2008
 o
    
    Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the transition period from  to
 Commission file no. 000-50990
 Tower Group, Inc.
 
 (Exact name of registrant as specified in its charter)
 Delaware
    
    13-3894120(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)120 Broadway, 31st FloorNew York, NY
    
    10271(Address of principal executive offices)
    
    (Zip Code)
 (212) 655-2000
 (Registrants telephone number, including area code)
 þ o
  Large accelerated filer o
    
    Accelerated filer
þ
    
    Non-accelerated filer o
(Do not check if a smaller reporting company)
    
    Smaller Reporting Company o
 o þ




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##### 



INDEX
 PagePART I FINANCIAL INFORMATIONItem 1. Financial statementsConsolidated Balance Sheets  September 30, 2008 (unaudited)
and December 31, 2007
    
    
    1Consolidated Statements of Income and Comprehensive Income
three and nine months ended September 30, 2008 and 2007 (unaudited)
    
    
    2Consolidated Statements of Cash Flows
three and nine months ended September 30, 2008 and 2007 (unaudited)
    
    
    3Notes to Unaudited Consolidated Financial Statements
    
    
    4Item 2. Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    20Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    32Item 4. Controls and Procedures
    
    
    33PART II OTHER INFORMATIONItem 1A Risk Factors
    
    
    34Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    45Item 6. Exhibits
    
    
    45SIGNATURES
    
    
    46EX-31.1: CERTIFICATIONEX-31.2: CERTIFICATIONEX-32: CERTIFICATION




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##### Table of Contents



Part I  FINANCIAL INFORMATION
 
 Item 1. Financial Statements
Tower Group, Inc.
 
 Consolidated Balance Sheets
 (Unaudited)September 30,
    
    December 31,($ in thousands, except par value and share amounts)
    
    2008
    
    2007AssetsFixed-maturity securities, available-for-sale, at fair value (amortized cost of
$608,677 and $616,757)
    
    $
    554,138
    
    
    $
    606,488Equity securities, available-for-sale, at fair value (cost of $7,051 and $14,429)
    
    
    4,531
    
    
    
    12,580Total investments
    
    
    558,669
    
    
    
    619,068Cash and cash equivalents
    
    
    101,396
    
    
    
    77,679Investment income receivable
    
    
    6,860
    
    
    
    6,546Agents balances receivable
    
    
    130,143
    
    
    
    122,763Reinsurance recoverable
    
    
    245,507
    
    
    
    207,828Prepaid reinsurance premiums
    
    
    122,021
    
    
    
    124,834Deferred acquisition costs, net of deferred ceding commission revenue
    
    
    57,082
    
    
    
    39,271Deferred income taxes
    
    
    34,824
    
    
    
    22,802Intangible assets
    
    
    20,765
    
    
    
    21,670Goodwill
    
    
    18,962
    
    
    
    13,281Fixed assets, net of accumulated depreciation
    
    
    37,510
    
    
    
    32,337Investment in unconsolidated affiliate
    
    
    30,274
    
    
    
    32,615Other assets
    
    
    46,753
    
    
    
    34,955Total assets
    
    $
    1,410,766
    
    
    $
    1,355,649LiabilitiesLoss and loss adjustment expenses
    
    $
    525,123
    
    
    $
    501,183Unearned premium
    
    
    306,370
    
    
    
    272,774Reinsurance balances payable
    
    
    75,878
    
    
    
    58,740Payable to issuing carriers
    
    
    28,106
    
    
    
    42,855Funds held under reinsurance agreements
    
    
    26,119
    
    
    
    36,841Accounts payable, accrued liabilities and other liabilities
    
    
    29,947
    
    
    
    32,833Subordinated debentures
    
    
    101,036
    
    
    
    101,036Total liabilities
    
    
    1,092,579
    
    
    
    1,046,262Stockholders EquityCommon stock ($0.01 par value; 40,000,000 shares authorized, 23,386,731 and
23,225,039 shares issued, and 23,307,939 and 23,185,173 shares outstanding)
    
    
    234
    
    
    
    232Treasury stock (78,792 and 39,866 shares)
    
    
    (1,074
    )
    
    
    (493
    )Paid-in-capital
    
    
    207,498
    
    
    
    205,435Accumulated other comprehensive net loss
    
    
    (39,288
    )
    
    
    (8,322
    )Retained earnings
    
    
    150,817
    
    
    
    112,535Total stockholders equity
    
    
    318,187
    
    
    
    309,387Total liabilities and stockholders equity
    
    $
    1,410,766
    
    
    $
    1,355,649
 See accompanying notes to the consolidated financial statements.
 1




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##### Table of Contents



Tower Group, Inc.
 
 Consolidated Statements of Income and Comprehensive Income
(Unaudited)
 Three Months Ended
    
    Nine Months Ended($ in thousands, except
    
    September 30,
    
    September 30,per share and share amounts)
    
    2008
    
    2007
    
    2008
    
    2007RevenuesNet premiums earned
    
    $
    88,249
    
    
    $
    73,124
    
    
    $
    226,793
    
    
    $
    207,542Ceding commission revenue
    
    
    18,432
    
    
    
    19,601
    
    
    
    60,577
    
    
    
    50,867Insurance services revenue
    
    
    17,993
    
    
    
    9,137
    
    
    
    41,896
    
    
    
    12,236Net investment income
    
    
    8,174
    
    
    
    9,615
    
    
    
    26,335
    
    
    
    27,016Net realized gains (losses) on investments
    
    
    (2,684
    )
    
    
    (62
    )
    
    
    (9,280
    )
    
    
    10Policy billing fees
    
    
    583
    
    
    
    599
    
    
    
    1,716
    
    
    
    1,444Total revenues
    
    
    130,747
    
    
    
    112,014
    
    
    
    348,037
    
    
    
    299,115ExpensesLoss and loss adjustment expenses
    
    
    43,907
    
    
    
    40,007
    
    
    
    118,127
    
    
    
    114,528Direct and ceding commission expense
    
    
    35,406
    
    
    
    26,422
    
    
    
    92,040
    
    
    
    66,865Other operating expenses
    
    
    23,060
    
    
    
    21,311
    
    
    
    66,917
    
    
    
    55,832Interest expense
    
    
    2,110
    
    
    
    2,313
    
    
    
    6,593
    
    
    
    6,843Total expenses
    
    
    104,483
    
    
    
    90,053
    
    
    
    283,677
    
    
    
    244,068Other IncomeEquity income (loss) in unconsolidated affiliate
    
    
    (820
    )
    
    
    746
    
    
    
    700
    
    
    
    2,169Gain from issuance of common stock by
unconsolidated affiliate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,705Income before income taxes
    
    
    25,444
    
    
    
    22,707
    
    
    
    65,060
    
    
    
    59,921Income tax expense
    
    
    8,728
    
    
    
    8,323
    
    
    
    23,321
    
    
    
    21,530Net income
    
    $
    16,716
    
    
    $
    14,384
    
    
    $
    41,739
    
    
    $
    38,391Gross unrealized investment holding losses
arising during period
    
    
    (31,732
    )
    
    
    (9,140
    )
    
    
    (54,201
    )
    
    
    (20,169
    )Equity in net unrealized losses in investment in
unconsolidated affiliates investment portfolio
    
    
    (1,615
    )
    
    
    (236
    )
    
    
    (2,722
    )
    
    
    (658
    )Less: reclassification adjustment for (gains) losses
included in net income
    
    
    2,684
    
    
    
    62
    
    
    
    9,280
    
    
    
    (10
    )Income tax benefit related to items of other
comprehensive income
    
    
    10,732
    
    
    
    3,260
    
    
    
    16,675
    
    
    
    7,293Comprehensive net income (loss)
    
    $
    (3,215
    )
    
    $
    8,330
    
    
    $
    10,771
    
    
    $
    24,847Basic and diluted earnings per shareBasic
    
    $
    0.73
    
    
    $
    0.63
    
    
    $
    1.81
    
    
    $
    1.67Diluted
    
    $
    0.72
    
    
    $
    0.62
    
    
    $
    1.80
    
    
    $
    1.65Weighted average common shares outstandingBasic
    
    
    23,054,860
    
    
    
    22,983,325
    
    
    
    23,029,541
    
    
    
    22,622,672Diluted
    
    
    23,251,173
    
    
    
    23,189,031
    
    
    
    23,244,577
    
    
    
    22,885,001Dividends declared and paid per common shareCommon stock
    
    $
    0.05
    
    
    $
    0.05
    
    
    $
    0.15
    
    
    $
    0.10
 See accompanying notes to the consolidated financial statements.
 2




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##### Table of Contents



Tower Group, Inc.
 
 Consolidated Statements of Cash Flows
(Unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,($ in thousands)
    
    2008
    
    
    2007
    
    
    2008
    
    
    2007Cash flows provided by (used in) operating activities:Net income
    
    $
    16,716
    
    
    $
    14,384
    
    
    $
    41,739
    
    
    $
    38,391Adjustments to reconcile net income to net cash provided by
(used in) operations:Gain from IPO of common shares of unconsolidated affiliate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,705
    )(Gain) loss on sale of investments
    
    
    (2,922
    )
    
    
    62
    
    
    
    (7,055
    )
    
    
    (10
    )Impairment write-downs
    
    
    5,606
    
    
    
    
    
    
    
    16,335
    
    
    
    Depreciation and amortization
    
    
    2,882
    
    
    
    2,171
    
    
    
    8,541
    
    
    
    6,132Amortization of bond premium or discount
    
    
    (5,240
    )
    
    
    42
    
    
    
    (5,593
    )
    
    
    396Amortization of restricted stock
    
    
    614
    
    
    
    503
    
    
    
    1,767
    
    
    
    1,504Deferred income taxes
    
    
    1,787
    
    
    
    (249
    )
    
    
    3,398
    
    
    
    (900
    )Excess tax benefits from share-based payment arrangements
    
    
    (115
    )
    
    
    (76
    )
    
    
    (195
    )
    
    
    (1,035
    )(Increase) decrease in assets:Investment income receivable
    
    
    132
    
    
    
    (229
    )
    
    
    (314
    )
    
    
    (670
    )Agents balances receivable
    
    
    (7,345
    )
    
    
    (32
    )
    
    
    (7,379
    )
    
    
    (3,365
    )Reinsurance recoverable
    
    
    (14,204
    )
    
    
    (12,890
    )
    
    
    (37,680
    )
    
    
    (44,429
    )Prepaid reinsurance premiums
    
    
    20,274
    
    
    
    3,369
    
    
    
    2,813
    
    
    
    (34,710
    )Deferred acquisition costs, net
    
    
    (9,580
    )
    
    
    709
    
    
    
    (17,811
    )
    
    
    10,356Equity in unconsolidated affiliate
    
    
    821
    
    
    
    (684
    )
    
    
    (699
    )
    
    
    (2,107
    )Other assets
    
    
    (874
    )
    
    
    2,072
    
    
    
    (3,015
    )
    
    
    (2,859
    )Increase (decrease) in liabilities:Loss and loss adjustment expenses
    
    
    5,546
    
    
    
    18,718
    
    
    
    23,941
    
    
    
    70,739Unearned premium
    
    
    6,592
    
    
    
    (7,942
    )
    
    
    33,596
    
    
    
    12,329Reinsurance balances payable
    
    
    (4,538
    )
    
    
    (6,839
    )
    
    
    17,139
    
    
    
    10,850Payable to issuing carriers
    
    
    984
    
    
    
    7,401
    
    
    
    (14,749
    )
    
    
    12,658Accounts payable and accrued expenses
    
    
    6,351
    
    
    
    1,771
    
    
    
    (1,283
    )
    
    
    (9,077
    )Funds held under reinsurance agreement
    
    
    (4,349
    )
    
    
    (3,922
    )
    
    
    (11,764
    )
    
    
    (12,916
    )Other
    
    
    (177
    )
    
    
    (232
    )
    
    
    319
    
    
    
    27Net cash flows provided by operations
    
    
    18,961
    
    
    
    18,107
    
    
    
    42,051
    
    
    
    48,599Cash flows provided by (used in) investing activities:Acquisition of Preserver Group Inc.
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (66,233
    )Acquisition related transaction costs
    
    
    (2,892
    )
    
    
    
    
    
    
    (7,058
    )
    
    
    (4,729
    )Purchase of fixed assets
    
    
    (3,799
    )
    
    
    (3,493
    )
    
    
    (12,809
    )
    
    
    (10,045
    )Purchase  fixed-maturity securities
    
    
    (79,761
    )
    
    
    (42,282
    )
    
    
    (298,008
    )
    
    
    (177,594
    )Purchase  equity securities
    
    
    
    
    
    
    (499
    )
    
    
    
    
    
    
    (14,386
    )Sale or maturity  fixed-maturity securities
    
    
    69,635
    
    
    
    16,796
    
    
    
    298,019
    
    
    
    87,314Sale  equity securities
    
    
    
    
    
    
    
    
    
    
    5,066
    
    
    
    3,776Net cash flows provided by (used in) investing activities
    
    
    (16,817
    )
    
    
    (29,478
    )
    
    
    (14,790
    )
    
    
    (181,897
    )Cash flows provided by (used in) financing activities:Equity offering and over allotment, net of issuance costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    89,366Purchase of common trust securities  statutory business trusts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (619
    )Redemption of preferred stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (40,000
    )Proceeds from issuance of subordinated debentures
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,619Exercise of stock options & warrants
    
    
    65
    
    
    
    17
    
    
    
    296
    
    
    
    1,027Excess tax benefits from share-based payment arrangements
    
    
    115
    
    
    
    76
    
    
    
    195
    
    
    
    1,035Treasury stock acquired-net employee share-based compensation
    
    
    (33
    )
    
    
    (16
    )
    
    
    (578
    )
    
    
    39Dividends paid
    
    
    (1,153
    )
    
    
    (1,149
    )
    
    
    (3,457
    )
    
    
    (2,804
    )Net cash flows provided by (used in) financing activities
    
    
    (1,006
    )
    
    
    (1,072
    )
    
    
    (3,544
    )
    
    
    68,663Increase in cash and cash equivalents
    
    
    1,138
    
    
    
    (12,443
    )
    
    
    23,717
    
    
    
    (64,635
    )Cash and cash equivalents, beginning of period
    
    
    100,258
    
    
    
    64,969
    
    
    
    77,679
    
    
    
    117,161Cash and cash equivalents, end of period
    
    $
    101,396
    
    
    $
    52,526
    
    
    $
    101,396
    
    
    $
    52,526Supplemental disclosures of cash flow information:Cash paid for income taxes
    
    $
    9,582
    
    
    $
    6,574
    
    
    $
    26,475
    
    
    $
    21,746Cash paid for interest
    
    
    1,908
    
    
    
    2,772
    
    
    
    5,956
    
    
    
    6,264
 See accompanying notes to the consolidated financial statements.
 3




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##### Table of Contents



Tower Group, Inc.
 
 Notes to Unaudited Interim Consolidated Financial Statements
 Note 1Nature of Business
   Insurance Segment:
 Insurance Services Segment:
 Note 2Accounting Policies and Basis of Presentation
 Basis of Presentation
   Accounting Pronouncements
 Determining the Fair Value
of a Financial Asset When the Market for That Asset Is Not Active. Fair Value Measurements Accounting Changes and Error
Corrections.
 The Hierarchy of Generally Accepted Accounting
Principles
 4




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##### Table of Contents



Determination of the Useful Life of Intangible
Assets Goodwill and Other Intangible Assets.
 Effective Date of FASB Statement No. 157
 Business Combinations
 
    
    Transaction costs of approximately $12 million would be expensed rather than being
considered part of the purchase price;
    
    The purchase price would be calculated based on the fair value of the Companys common
stock on the date the acquisition closed rather than being set on the date of the announcement
of the acquisition assuming certain criteria are met; and
    
    The fair value of the CastlePoint common shares currently owned by the Company would be
determined on the closing date of the acquisition and any gain (loss) would be recognized in
the Companys income statement.
 Noncontrolling Interests in Consolidated Financial
Statements-an Amendment of ARB No. 51
 Accounting for
Income Tax Benefits of Dividends on Share-Based Payment Awards
 The Fair Value Option for Financial Assets and
Financial Liabilities  Including an Amendment of SFAS No. 115
 5




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##### Table of Contents



Fair Value Measurements,
 Note 3Acquisition of Preserver Group, Inc.
   Note 4Other Assets
  September 30,
    
    December 31,($ in thousands)
    
    2008
    
    2007Assumed premiums receivable
    
    $
    1,501
    
    
    $
    1,299Ceding commission receivable
    
    
    3,306
    
    
    
    3,852Receivable  claims paid by agency
    
    
    4,104
    
    
    
    2,726Federal and state taxes recoverable
    
    
    1,346
    
    
    
    125Investment in statutory business trusts, equity method
    
    
    3,036
    
    
    
    3,036Receivable for securities
    
    
    9,221
    
    
    
    8,755Deferred merger and acquisition expenses
    
    
    7,058
    
    
    
    1,488Prepaids, deposits and advances
    
    
    3,867
    
    
    
    3,694Receivable from residual market plans
    
    
    2,964
    
    
    
    2,723Commission receivable from issuing carriers
    
    
    6,132
    
    
    
    3,739Other
    
    
    4,218
    
    
    
    3,518Other assets
    
    $
    46,753
    
    
    $
    34,955
 Note 5Investment in Unconsolidated AffiliateCastlePoint
  6




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##### Table of Contents



For the Nine
    
    For the YearMonths Ended
    
    EndedSeptember 30,
    
    December 31,($ in millions)
    
    2008
    
    2007Carrying value of equity investment, beginning of year
    
    $
    32.6
    
    
    $
    27.9Equity in net income of CastlePoint
    
    
    0.7
    
    
    
    2.4Gain from initial public offering of common stock of CastlePoint
    
    
    0.0
    
    
    
    2.7Equity in net unrealized gain / (loss) of the CastlePoint investment portfolio
    
    
    (2.7
    )
    
    
    (0.1
    )Dividends received from CastlePoint
    
    
    (0.3
    )
    
    
    (0.3
    )Carrying value of equity investment, end of period
    
    $
    30.3
    
    
    $
    32.6
    Affiliated Agreements with CastlePoint
  Master Agreement
  Reinsurance Agreements
   7




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##### Table of Contents



Ceded
    
    Ceded
    
    Ceding
    
    CedingPremiums
    
    Premiums
    
    Commissions
    
    Commission($ in thousands)
    
    Written
    
    Earned
    
    Revenue
    
    PercentageNine Months Ending September 30, 2008Brokerage business (1)
    
    $
    90,055
    
    
    $
    129,960
    
    
    $
    46,996
    
    
    
    36.2
    %Traditional program business
    
    
    6,055
    
    
    
    4,635
    
    
    
    1,487
    
    
    
    32.1
    %Specialty program business and insurance
risk-sharing business
    
    
    43,753
    
    
    
    21,506
    
    
    
    8,014
    
    
    
    37.3
    %Total
    
    $
    139,863
    
    
    $
    156,101
    
    
    $
    56,497
    
    
    
    36.2
    %Nine Months Ending September 30, 2007Brokerage business
    
    $
    165,064
    
    
    $
    132,663
    
    
    $
    45,745
    
    
    
    34.5
    %Traditional program business
    
    
    583
    
    
    
    534
    
    
    
    160
    
    
    
    30.0
    %Specialty program business and insurance
risk-sharing business
    
    
    4,065
    
    
    
    2,169
    
    
    
    651
    
    
    
    30.0
    %Total
    
    $
    169,712
    
    
    $
    135,366
    
    
    $
    46,556
    
    
    
    34.4
    %Three Months Ending September 30, 2008Brokerage business (1)
    
    $
    (2,482
    )
    
    $
    30,246
    
    
    $
    10,910
    
    
    
    36.1
    %Traditional program business
    
    
    1,767
    
    
    
    1,843
    
    
    
    601
    
    
    
    32.6
    %Specialty program business and insurance
risk-sharing business
    
    
    22,600
    
    
    
    12,617
    
    
    
    4,871
    
    
    
    38.6
    %Total
    
    $
    21,885
    
    
    $
    44,706
    
    
    $
    16,382
    
    
    
    36.6
    %Three Months Ending September 30, 2007Brokerage business
    
    $
    46,439
    
    
    $
    51,343
    
    
    $
    17,938
    
    
    
    34.9
    %Traditional program business
    
    
    583
    
    
    
    219
    
    
    
    66
    
    
    
    30.0
    %Specialty program business and insurance
risk-sharing business
    
    
    2,013
    
    
    
    921
    
    
    
    276
    
    
    
    30.0
    %Total
    
    $
    49,035
    
    
    $
    52,483
    
    
    $
    18,280
    
    
    
    34.8
    %
 (1)
    
    Ceded premiums written with CastlePoint Reinsurance were reduced by $31.7 million in the
third quarter of 2008 as a result of the reduction of the quota share ceding percentage under
the brokerage business quota share reinsurance agreement to 25% on all unearned premiums on
policies in force as of July 1, 2008.  CededDates
    
    Quota Share Reinsurance Agreement With
    
    AmountApril 6, 2006 - June 30, 2006 (1)
    
    CastlePoint Reinsurance
    
    
    30
    %July 1, 2006 - December 31, 2006
    
    CastlePoint Reinsurance
    
    
    40
    %January 1, 2007 - March 31, 2007
    
    CastlePoint Reinsurance
    
    
    49
    %April 1 2007 - June 30, 2007
    
    CastlePoint Reinsurance
    
    
    40
    %April 1 2007 - June 30, 2007
    
    CastlePoint Insurance Company
    
    
    9
    %July 1, 2007 - December 31, 2007 (2)
    
    CastlePoint Reinsurance
    
    
    40
    %January 1, 2008 - March 31, 2008 (2)
    
    CastlePoint Reinsurance
    
    
    40
    %April 1, 2008 - June 30, 2008 (2)
    
    CastlePoint Reinsurance
    
    
    35
    %July 1, 2008 - September 30, 2008
    
    CastlePoint Reinsurance
    
    
    25
    %April 1, 2008 - September 30, 2008
    
    Swiss Re America Corporation
    
    
    5
    %
 
 (1)
    
    Multi year quota share reinsurance agreements with CastlePoint Reinsurance began April 6, 2006.(2)
    
    On July 1, 2008, we reduced the ceding percentage under our brokerage business quota share reinsurance agreement
with CastlePoint Reinsurance to 25% applicable to both the ceded unearned premium reserve as of July 1, 2008
and new and renewal premiums written in the third quarter of 2008. 8




---



##### Table of Contents



CastlePoint($ in thousands)
    
    CastlePoint
    
    InsuranceReceivable/(payable) due to/from
    
    Reinsurance
    
    CompanyShown in balance sheet:September 30, 2008Assumed premium receivable
    
    $
    
    
    
    $
    Reinsurance recoverable
    
    
    23,245
    
    
    
    855Reinsurance balances payable
    
    
    (59,717
    )
    
    
    150Payable to issuing carriers
    
    
    
    
    
    
    (25,460
    )Total
    
    $
    (36,472
    )
    
    $
    (24,455
    )December 30, 2007Assumed premium receivable
    
    $
    5
    
    
    $
    Reinsurance recoverable
    
    
    8,998
    
    
    
    470Reinsurance balances payable
    
    
    (43,158
    )
    
    
    (5,531
    )Payable to issuing carriers
    
    
    
    
    
    
    (41,664
    )Total
    
    $
    (34,155
    )
    
    $
    (46,725
    )
 Program Management Agreement
  9




---



##### Table of Contents



Management Agreement
  TICNY Service and Expense Sharing Agreements
  TRM Service and Expense Sharing Agreement
  Note 6Investments
  10




---



##### Table of Contents



Cost or
    
    Gross
    
    Gross Unrealized Losses
    
    
    
    
    
    % ofAmortized
    
    Unrealized
    
    Less than 12
    
    More than 12
    
    Fair
    
    Fair($ in thousands)
    
    Cost
    
    Gains
    
    Months
    
    Months
    
    Value
    
    ValueSeptember 30, 2008U.S. Treasury securities
    
    $
    26,401
    
    
    $
    116
    
    
    $
    (60
    )
    
    $
    
    
    
    $
    26,457
    
    
    
    5
    %U.S. Agency securities
    
    
    2,363
    
    
    
    15
    
    
    
    
    
    
    
    
    
    
    
    2,378
    
    
    
    0
    %Municipal bonds
    
    
    183,490
    
    
    
    275
    
    
    
    (4,622
    )
    
    
    
    
    
    
    179,143
    
    
    
    32
    %Corporate and other bonds
    
    
    217,164
    
    
    
    51
    
    
    
    (17,862
    )
    
    
    (8,850
    )
    
    
    190,503
    
    
    
    34
    %Commercial mortgage-backed securities
    
    
    52,939
    
    
    
    5
    
    
    
    (2,101
    )
    
    
    (12,885
    )
    
    
    37,958
    
    
    
    7
    %Residential mortgage-backed securities
    
    
    112,658
    
    
    
    444
    
    
    
    (2,752
    )
    
    
    (3,367
    )
    
    
    106,983
    
    
    
    19
    %Asset-backed securities
    
    
    13,662
    
    
    
    81
    
    
    
    (1,842
    )
    
    
    (1,185
    )
    
    
    10,716
    
    
    
    2
    %Total fixed maturity securities
    
    
    608,677
    
    
    
    987
    
    
    
    (29,239
    )
    
    
    (26,287
    )
    
    
    554,138
    
    
    
    99
    %Preferred stocks
    
    
    5,551
    
    
    
    
    
    
    
    
    
    
    
    (2,464
    )
    
    
    3,087
    
    
    
    1
    %Common stocks
    
    
    1,500
    
    
    
    
    
    
    
    (56
    )
    
    
    
    
    
    
    1,444
    
    
    
    0
    %Total
    
    $
    615,728
    
    
    $
    987
    
    
    $
    (29,295
    )
    
    $
    (28,751
    )
    
    $
    558,669
    
    
    
    100
    %December 31, 2007U.S. Treasury securities
    
    $
    25,837
    
    
    $
    827
    
    
    $
    
    
    
    $
    
    
    
    $
    26,664
    
    
    
    4
    %U.S. Agency securities
    
    
    19,709
    
    
    
    162
    
    
    
    
    
    
    
    
    
    
    
    19,871
    
    
    
    3
    %Municipal bonds
    
    
    155,296
    
    
    
    1,167
    
    
    
    (78
    )
    
    
    (24
    )
    
    
    156,361
    
    
    
    25
    %Corporate and other bonds
    
    
    201,501
    
    
    
    1,219
    
    
    
    (3,164
    )
    
    
    (817
    )
    
    
    198,739
    
    
    
    32
    %Commercial mortgage-backed securities
    
    
    49,475
    
    
    
    262
    
    
    
    (5,015
    )
    
    
    (162
    )
    
    
    44,560
    
    
    
    7
    %Residential mortgage-backed securities
    
    
    144,028
    
    
    
    1,083
    
    
    
    (2,511
    )
    
    
    (2,733
    )
    
    
    139,867
    
    
    
    23
    %Asset-backed securities
    
    
    20,911
    
    
    
    88
    
    
    
    (573
    )
    
    
    
    
    
    
    20,426
    
    
    
    3
    %Total fixed maturity securities
    
    
    616,757
    
    
    
    4,808
    
    
    
    (11,341
    )
    
    
    (3,736
    )
    
    
    606,488
    
    
    
    98
    %Preferred stocks
    
    
    5,551
    
    
    
    
    
    
    
    (1,849
    )
    
    
    
    
    
    
    3,702
    
    
    
    1
    %Common stocks
    
    
    8,878
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,878
    
    
    
    1
    %Total
    
    $
    631,186
    
    
    $
    4,808
    
    
    $
    (13,190
    )
    
    $
    (3,736
    )
    
    $
    619,068
    
    
    
    100
    %
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,($ in thousands)
    
    2008
    
    2007
    
    2008
    
    2007Fixed-maturity securitiesGross realized gains
    
    $
    1,276
    
    
    $
    96
    
    
    $
    6,301
    
    
    $
    561Gross realized losses
    
    
    (177
    )
    
    
    (136
    )
    
    
    (1,139
    )
    
    
    (527
    )1,099
    
    
    
    (40
    )
    
    
    5,162
    
    
    
    34Equity securitiesGross realized gains (1)
    
    
    1,823
    
    
    
    (22
    )
    
    
    1,968
    
    
    
    319Gross realized losses
    
    
    
    
    
    
    
    
    
    
    (75
    )
    
    
    (343
    )1,823
    
    
    
    (22
    )
    
    
    1,893
    
    
    
    (24
    )Impairment write-down
    
    
    (5,606
    )
    
    
    
    
    
    
    (16,335
    )
    
    
    Net realized gains/losses
    
    $
    (2,684
    )
    
    $
    (62
    )
    
    $
    (9,280
    )
    
    $
    10
 
 (1)
    
    Includes a gain of $1.8 million for the three months ended September 30, 2008, on the sale of
the Companys investment in AgencyPort Insurance Services, Inc., a privately held company that
provides web-based solutions for property and casualty insurers. Impairment Review
  11




---



##### Table of Contents



Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets
  QuarterThird
    
    Second
    
    First
    

    Total($ in thousands)
    
    No.
    
    Amount
    
    No.
    
    Amount
    
    No.
    
    Amount
    
    No.
    
    AmountCategoryCorporate and other bonds
    
    
    3
    
    
    $
    (3,276
    )
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    
    
    
    
    3
    
    
    $
    (3,276
    )Residential mortgage-backed securities
    
    
    8
    
    
    
    (2,175
    )
    
    
    15
    
    
    
    (8,295
    )
    
    
    
    
    
    
    
    
    
    
    23
    
    
    
    (10,470
    )Asset-backed securities
    
    
    1
    
    
    
    (153
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1
    
    
    
    (153
    )Equities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7
    
    
    
    (2,436
    )
    
    
    7
    
    
    
    (2,436
    )12
    
    
    $
    (5,604
    )
    
    
    15
    
    
    $
    (8,295
    )
    
    
    7
    
    
    $
    (2,436
    )
    
    
    34
    
    
    $
    (16,335
    )
  Unrealized LossPercent of
    
    Fair Value by Security RatingFair
    
    
    
    
    
    Amortized
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    BB or($ in thousands)
    
    Count
    
    Value
    
    Amount
    
    Cost
    
    AAA
    
    AA
    
    A
    
    BBB
    
    LowerCategoryCorporate and other bonds
    
    
    171
    
    
    $
    183,953
    
    
    $
    (26,711
    )
    
    
    13
    %
    
    
    2
    %
    
    
    12
    %
    
    
    43
    %
    
    
    31
    %
    
    
    12
    %Commercial mortgage-backed securities
    
    
    38
    
    
    
    36,954
    
    
    
    (14,985
    )
    
    
    29
    %
    
    
    84
    %
    
    
    2
    %
    
    
    0
    %
    
    
    9
    %
    
    
    5
    %Residential mortgage-backed securities
    
    
    70
    
    
    
    51,865
    
    
    
    (6,118
    )
    
    
    11
    %
    
    
    80
    %
    
    
    1
    %
    
    
    2
    %
    
    
    4
    %
    
    
    13
    %Asset-backed securities
    
    
    18
    
    
    
    8,581
    
    
    
    (3,027
    )
    
    
    26
    %
    
    
    11
    %
    
    
    41
    %
    
    
    32
    %
    
    
    16
    %
    
    
    0
    %Equities
    
    
    7
    
    
    
    4,531
    
    
    
    (2,520
    )
    
    
    36
    %
    
    
    0
    %
    
    
    0
    %
    
    
    14
    %
    
    
    23
    %
    
    
    63
    %
  Note 7Fair Value Measurements
   12




---



##### Table of Contents



Level 1
 Level 2
 Level 3
    ($ in thousands)
    
    Level 1
    
    Level 2
    
    Level 3
    
    TotalFixed-maturity investments
    
    $
    
    
    
    $
    537,365
    
    
    $
    16,773
    
    
    $
    554,138Equity investments
    
    
    1,444
    
    
    
    3,087
    
    
    
    
    
    
    
    4,531Totals
    
    $
    1,444
    
    
    $
    540,452
    
    
    $
    16,773
    
    
    $
    558,669
   For the Three Months EndedMarch 31,
    
    June 30,
    
    September 30,($ in thousands)
    
    2008
    
    2008
    
    2008
    
    TotalBeginning balance
    
    $
    
    
    
    $
    10,707
    
    
    $
    8,904
    
    
    $
    Total gains (losses)-realized / unrealizedIncluded in net income
    
    
    278
    
    
    
    (6,740
    )
    
    
    (1,882
    )
    
    
    (8,344
    )Included in other comprehensive income (loss)
    
    
    (2,599
    )
    
    
    4,957
    
    
    
    (327
    )
    
    
    2,017Purchases, issuances and settlements
    
    
    (441
    )
    
    
    (20
    )
    
    
    (14
    )
    
    
    (461
    )Net transfers into (out of) Level 3
    
    
    13,469
    
    
    
    
    
    
    
    10,092
    
    
    
    23,561Ending balance
    
    $
    10,707
    
    
    $
    8,904
    
    
    $
    16,773
    
    
    $
    16,773
 13




---



##### Table of Contents



Note 8Goodwill
   ($ in thousands)Purchase PriceBase purchase price paid
    
    $
    68,250Preserver direct transaction costs, net of tax benefit
    
    
    (3,547
    )Total purchase price paid to Preserver
    
    
    64,703Direct transaction costs
    
    
    1,305Total purchase consideration
    
    
    66,008Allocation of Purchase PriceBook value of Preserver at date of acquisition
    
    
    7,106Preserver shareholder debt repayment
    
    
    30,754Estimated fair value adjustments
    
    
    9,186Estimated fair value of assets acquired
    
    
    47,046Goodwill as of September 30, 2008
    
    $
    18,962
   Note 9Other Liabilities
  September 30,
    
    December 31,($ in thousands)
    
    2008
    
    2007Accounts payable and accrued expenses
    
    $
    11,697
    
    
    $
    14,205Funds held as agent
    
    
    3,731
    
    
    
    4,772Deferred rent liability
    
    
    7,152
    
    
    
    7,386Other
    
    
    7,367
    
    
    
    6,470Other liabilities
    
    $
    29,947
    
    
    $
    32,833
 Note 10Dividends Declared
   14




---



##### Table of Contents



Note 11Stock Based Compensation
 Restricted Stock Awards
   WeightedAverageNumber of
    
    Grant DateShares
    
    Fair ValueOutstanding, beginning of year
    
    
    195,468
    
    
    $
    24.97Granted
    
    
    138,326
    
    
    
    24.75Vested
    
    
    (79,983
    )
    
    
    19.28Forfeitures
    
    
    (14,891
    )
    
    
    26.88Outstanding, end of year
    
    
    238,920
    
    
    $
    26.40
 Stock Options
  AverageNumber of
    
    ExerciseShares
    
    PriceOutstanding, beginning of year
    
    
    281,896
    
    
    $
    5.57Exercised
    
    
    (23,366
    )
    
    
    6.65Outstanding, end of period
    
    
    258,530
    
    
    $
    5.47Exercisable, end of period
    
    
    234,230
    
    
    $
    5.15
  Note 12Income Taxes
 Accounting for Uncertainty in
Income Taxes, an Interpretation of FASB Statement No. 109
   Note 13Earnings per Share
  15




---



##### Table of Contents



Income
    
    Shares
    
    Per Share($ in thousands, except share and per share amounts)
    
    (Numerator)
    
    (Denominator)
    
    AmountThree months ended September 30, 2008Net Income
    
    $
    16,716Basic earnings per share
    
    $
    16,716
    
    
    
    23,054,860
    
    
    $
    0.73Effect of dilutive securities:Stock options
    
    
    
    
    
    
    129,934Unvested restricted stock and restricted stock units
    
    
    
    
    
    
    44,607Warrants
    
    
    
    
    
    
    21,772Diluted earnings per share
    
    $
    16,716
    
    
    
    23,251,173
    
    
    $
    0.72Three months ended September 30, 2007Net Income
    
    $
    14,384Basic earnings per share
    
    
    14,384
    
    
    
    22,983,325
    
    
    $
    0.63Effect of dilutive securities:Stock options
    
    
    
    
    
    
    149,331Unvested restricted stock
    
    
    
    
    
    
    31,490Warrants
    
    
    
    
    
    
    24,885Diluted earnings per share
    
    $
    14,384
    
    
    
    23,189,031
    
    
    $
    0.62Nine months ended September 30, 2008Net Income
    
    $
    41,739Basic earnings per share
    
    $
    41,739
    
    
    
    23,029,541
    
    
    $
    1.81Effect of dilutive securities:Stock options
    
    
    
    
    
    
    137,864Unvested restricted stock and restricted stock units
    
    
    
    
    
    
    53,326Warrants
    
    
    
    
    
    
    23,846Diluted earnings per share
    
    $
    41,739
    
    
    
    23,244,577
    
    
    $
    1.80Nine months ended September 30, 2007Net Income
    
    $
    38,391Less: Preferred stock dividends
    
    
    (298
    )Less: Preferred stock excess consideration
    
    
    (400
    )Basic earnings per share
    
    $
    37,693
    
    
    
    22,622,672
    
    
    $
    1.67Effect of dilutive securities:Stock options
    
    
    
    
    
    
    178,445Unvested restricted stock
    
    
    
    
    
    
    54,195Warrants
    
    
    
    
    
    
    29,689Diluted earnings per share
    
    $
    37,693
    
    
    
    22,885,001
    
    
    $
    1.65
 Note 14Changes in Estimates
   Note 15Segment Information
  16




---



##### Table of Contents



Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,($ in thousands)
    
    2008
    
    2007
    
    2008
    
    2007Insurance SegmentRevenuesNet premiums earned
    
    $
    88,249
    
    
    $
    73,124
    
    
    $
    226,793
    
    
    $
    207,542Ceding commission revenue
    
    
    18,432
    
    
    
    19,601
    
    
    
    60,577
    
    
    
    50,867Policy billing fees
    
    
    485
    
    
    
    599
    
    
    
    1,445
    
    
    
    1,444Total revenues
    
    
    107,166
    
    
    
    93,324
    
    
    
    288,815
    
    
    
    259,853ExpensesNet loss and loss adjustment expenses
    
    
    43,907
    
    
    
    40,007
    
    
    
    118,127
    
    
    
    114,528Underwriting expenses
    
    
    46,468
    
    
    
    41,165
    
    
    
    130,717
    
    
    
    113,674Total expenses
    
    
    90,375
    
    
    
    81,172
    
    
    
    248,844
    
    
    
    228,202Underwriting profit
    
    $
    16,791
    
    
    $
    12,152
    
    
    $
    39,971
    
    
    $
    31,651Insurance Services SegmentRevenuesDirect commission revenue from managing
general agency
    
    $
    15,287
    
    
    $
    8,028
    
    
    $
    35,353
    
    
    $
    9,093Claims administration revenue
    
    
    1,606
    
    
    
    524
    
    
    
    3,576
    
    
    
    1,624Other administration revenue
    
    
    846
    
    
    
    326
    
    
    
    2,426
    
    
    
    924Reinsurance intermediary fees
    
    
    254
    
    
    
    254
    
    
    
    541
    
    
    
    595Policy billing fees
    
    
    99
    
    
    
    5
    
    
    
    271
    
    
    
    Total revenues
    
    
    18,092
    
    
    
    9,137
    
    
    
    42,167
    
    
    
    12,236ExpensesDirect commission expense paid to producers
    
    
    6,857
    
    
    
    3,807
    
    
    
    15,382
    
    
    
    3,959Other insurance services expenses:Underwriting expenses reimbursed to TICNY
    
    
    3,225
    
    
    
    1,687
    
    
    
    7,970
    
    
    
    2,302Claims expense reimbursement to TICNY
    
    
    1,606
    
    
    
    520
    
    
    
    3,576
    
    
    
    1,618Total expenses
    
    
    11,688
    
    
    
    6,014
    
    
    
    26,928
    
    
    
    7,879Insurance services pretax income
    
    $
    6,404
    
    
    $
    3,123
    
    
    $
    15,239
    
    
    $
    4,357
  17




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##### Table of Contents



Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,($ in thousands)
    
    2008
    
    2007
    
    2008
    
    2007Insurance segment
    
    $
    107,166
    
    
    $
    93,324
    
    
    $
    288,815
    
    
    $
    259,853Insurance services segment
    
    
    18,092
    
    
    
    9,137
    
    
    
    42,167
    
    
    
    12,236Total segment revenues
    
    
    125,258
    
    
    
    102,461
    
    
    
    330,982
    
    
    
    272,089Net investment income
    
    
    8,174
    
    
    
    9,615
    
    
    
    26,335
    
    
    
    27,016Net realized gains (losses) on investments
    
    
    (2,684
    )
    
    
    (62
    )
    
    
    (9,280
    )
    
    
    10Consolidated revenues
    
    $
    130,747
    
    
    $
    112,014
    
    
    $
    348,037
    
    
    $
    299,115
  Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,($ in thousands)
    
    2008
    
    2007
    
    2008
    
    2007Insurance segment underwriting profit
    
    $
    16,791
    
    
    $
    12,152
    
    
    $
    39,971
    
    
    $
    31,651Insurance services segment pretax income
    
    
    6,404
    
    
    
    3,123
    
    
    
    15,239
    
    
    
    4,357Net investment income
    
    
    8,174
    
    
    
    9,615
    
    
    
    26,335
    
    
    
    27,016Net realized gains (losses) on investments
    
    
    (2,684
    )
    
    
    (62
    )
    
    
    (9,280
    )
    
    
    10Corporate expenses
    
    
    (311
    )
    
    
    (554
    )
    
    
    (1,312
    )
    
    
    (1,144
    )Interest expense
    
    
    (2,110
    )
    
    
    (2,313
    )
    
    
    (6,593
    )
    
    
    (6,843
    )Other Income*
    
    
    (820
    )
    
    
    746
    
    
    
    700
    
    
    
    4,874Income before taxes
    
    $
    25,444
    
    
    $
    22,707
    
    
    $
    65,060
    
    
    $
    59,921
 *
    
    See note on investment in unconsolidated affiliate-CastlePoint
 Note 16Pending Acquisitions
    18




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##### Table of Contents



Note 17Subsequent Event
 Dividends
  Investment Performance
  19




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Note on Forward-Looking Statements
   
    
    ineffectiveness or obsolescence of our business strategy due to changes in current or
future market conditions;
    
    developments that may delay or limit our ability to enter new markets as quickly as we
anticipate;
    
    increased competition on the basis of pricing, capacity, coverage terms or other factors;
    
    greater frequency or severity of claims and loss activity, including as a result of natural
or man-made catastrophic events, than our underwriting, reserving or investment practices
anticipate based on historical experience or industry data;
    
    the effects of acts of terrorism or war;
    
    developments in the worlds financial and capital markets that adversely affect the
performance of our investments;
    
    changes in regulations or laws applicable to us, our subsidiaries, brokers or customers;
    
    changes in acceptance of our products and services, including new products and services;
    
    changes in the availability, cost or quality of reinsurance and failure of our reinsurers
to pay claims timely or at all;
    
    changes in the percentage of our premiums written that we cede to reinsurers;
    
    decreased demand for our insurance or reinsurance products;
    
    loss of the services of any of our executive officers or other key personnel;
    
    the effects of mergers, acquisitions and divestitures;
    
    changes in rating agency policies or practices;
    
    changes in legal theories of liability under our insurance policies;
    
    changes in accounting policies or practices;
    
    changes in general economic conditions, including inflation, interest rates and other
factors;
    
    the possibility that the proposed merger with CastlePoint or CastlePoints proposed
acquisition of Hermitage may not be completed or may be delayed;
    
    the risk that governmental and other consents needed to complete the merger with
CastlePoint and the acquisition of Hermitage may be delayed, not granted or granted with
unacceptable conditions;
    
    unanticipated difficulties in combining Tower, CastlePoint and Hermitage;
    
    disruptions in Towers, CastlePoints and Hermitages respective businesses arising from
the anticipation of the transactions and the integration of Tower, CastlePoint and Hermitage;
    
    increases in Towers exposure to risk of loss arising from the merger;
    
    the possibility that Tower will incur significant charges to write down the good will to be
established in the CastlePoint merger or the Hermitage acquisition if CastlePoints or
Hermitages businesses do not perform well or Tower does not integrate CastlePoints and
Hermitages business successfully;
 20




---



##### Table of Contents




    
    the requirement for Tower and CastlePoint to expense their transaction expenses in 2009 if
the merger or the Hermitage acquisition is completed after December 31, 2008;
    
    potential payments made to dissenting CastlePoint shareholders in respect of their shares,
which could exceed the amount of consideration otherwise due to them under the terms of the
merger agreement or permit Tower to terminate the merger agreement in certain circumstances;
and
    
    the absence at Hermitage of the internal control over financial reporting meeting the
standard that is required of a publicly traded company.
  Consolidated Results of Operations
  Transactions with CastlePoint
     21




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##### Table of Contents



Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,($ in millions)
    
    2008
    
    2007
    
    Change
    
    Percent
    
    2008
    
    2007
    
    Change
    
    PercentRevenuesPremiums earnedGross premiums earned
    
    $
    150.5
    
    
    $
    138.8
    
    
    $
    11.8
    
    
    
    8.5
    %
    
    $
    424.3
    
    
    $
    378.0
    
    
    $
    46.3
    
    
    
    12.2
    %Less: Ceded premiums earned
    
    
    (62.3
    )
    
    
    (65.6
    )
    
    
    3.4
    
    
    
    -5.1
    %
    
    
    (197.5
    )
    
    
    (170.5
    )
    
    
    (27.0
    )
    
    
    15.9
    %Net premiums earned
    
    
    88.2
    
    
    
    73.1
    
    
    
    15.1
    
    
    
    20.7
    %
    
    
    226.8
    
    
    
    207.5
    
    
    
    19.3
    
    
    
    9.3
    %Total commission and fee income
    
    
    37.0
    
    
    
    29.3
    
    
    
    7.7
    
    
    
    26.2
    %
    
    
    104.2
    
    
    
    64.5
    
    
    
    39.6
    
    
    
    61.4
    %Net investment income
    
    
    8.2
    
    
    
    9.6
    
    
    
    (1.4
    )
    
    
    -15.0
    %
    
    
    26.3
    
    
    
    27.0
    
    
    
    (0.7
    )
    
    
    -2.5
    %Net realized investment (losses) gains
    
    
    (2.7
    )
    
    
    (0.1
    )
    
    
    (2.6
    )
    
    NM
    
    
    
    (9.3
    )
    
    
    0.0
    
    
    
    (9.3
    )
    
    NMTotal
    
    
    130.7
    
    
    
    112.0
    
    
    
    18.7
    
    
    
    16.7
    %
    
    
    348.0
    
    
    
    299.1
    
    
    
    48.9
    
    
    
    16.4
    %ExpensesNet loss and loss adjustment expenses
    
    
    43.9
    
    
    
    40.0
    
    
    
    3.9
    
    
    
    9.7
    %
    
    
    118.1
    
    
    
    114.5
    
    
    
    3.6
    
    
    
    3.1
    %Operating expenses
    
    
    58.5
    
    
    
    47.7
    
    
    
    10.7
    
    
    
    22.5
    %
    
    
    159.0
    
    
    
    122.7
    
    
    
    36.3
    
    
    
    29.6
    %Interest expense
    
    
    2.1
    
    
    
    2.3
    
    
    
    (0.2
    )
    
    
    -8.8
    %
    
    
    6.6
    
    
    
    6.8
    
    
    
    (0.2
    )
    
    
    -3.7
    %Total expenses
    
    
    104.5
    
    
    
    90.1
    
    
    
    14.4
    
    
    
    16.0
    %
    
    
    283.7
    
    
    
    244.1
    
    
    
    39.6
    
    
    
    16.2
    %Equity in income (loss) of unconsolidated
affiliate
    
    
    (0.8
    )
    
    
    0.7
    
    
    
    (1.6
    )
    
    
    -210.2
    %
    
    
    0.7
    
    
    
    2.2
    
    
    
    (1.5
    )
    
    
    -67.7
    %Gain from issuance of common stock
by unconsolidated affiliate
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2.7
    
    
    
    (2.7
    )
    
    
    -100.0
    %Income before taxes
    
    
    25.4
    
    
    
    22.7
    
    
    
    2.7
    
    
    
    12.1
    %
    
    
    65.1
    
    
    
    59.9
    
    
    
    5.1
    
    
    
    8.6
    %Federal and state income taxes
    
    
    8.7
    
    
    
    8.3
    
    
    
    0.4
    
    
    
    4.9
    %
    
    
    23.3
    
    
    
    21.5
    
    
    
    1.8
    
    
    
    8.3
    %Net Income
    
    $
    16.7
    
    
    $
    14.4
    
    
    $
    2.3
    
    
    
    16.2
    %
    
    $
    41.7
    
    
    $
    38.4
    
    
    $
    3.3
    
    
    
    8.7
    %Key MeasuresPercent of total revenues:Net premiums earned
    
    
    67.5
    %
    
    
    65.3
    %
    
    
    
    
    
    
    
    
    
    
    65.2
    %
    
    
    69.4
    %Commission and fee income
    
    
    28.3
    %
    
    
    26.2
    %
    
    
    
    
    
    
    
    
    
    
    29.9
    %
    
    
    21.6
    %Net investment income
    
    
    6.3
    %
    
    
    8.6
    %
    
    
    
    
    
    
    
    
    
    
    7.6
    %
    
    
    9.0
    %Net realized investment gains (losses)
    
    
    -2.1
    %
    
    
    -0.1
    %
    
    
    
    
    
    
    
    
    
    
    -2.7
    %
    
    
    0.0
    %Return on average equity (1)
    
    
    20.9
    %
    
    
    19.6
    %
    
    
    
    
    
    
    
    
    
    
    17.7
    %
    
    
    20.4
    %
 
 (1)
    
    Excluding net realized losses on investments, net of tax, return on average equity
would have higher by 2.2% for the third quarter of 2008 and 2.6% for the nine months ended
September 30, 2008. Consolidated Results of Operations Three and Nine months ended September 30, 2008 and 2007
 Total revenues .
  22




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##### Table of Contents



Premiums earned .
  CededDates
    
    Quota Share Reinsurance Agreement With
    
    AmountApril 6, 2006 - June 30, 2006 (1)
    
    CastlePoint Reinsurance
    
    
    30
    %July 1, 2006 - December 31, 2006
    
    CastlePoint Reinsurance
    
    
    40
    %January 1, 2007 - March 31, 2007
    
    CastlePoint Reinsurance
    
    
    49
    %April 1 2007 - June 30, 2007
    
    CastlePoint Reinsurance
    
    
    40
    %April 1 2007 - June 30, 2007
    
    CastlePoint Insurance Company
    
    
    9
    %July 1, 2007 - December 31, 2007 (2)
    
    CastlePoint Reinsurance
    
    
    40
    %January 1, 2008 - March 31, 2008 (2)
    
    CastlePoint Reinsurance
    
    
    40
    %April 1, 2008 - June 30, 2008 (2)
    
    CastlePoint Reinsurance
    
    
    35
    %July 1, 2008 - September 30, 2008
    
    CastlePoint Reinsurance
    
    
    25
    %April 1, 2008 - September 30, 2008
    
    Swiss Re America Corporation
    
    
    5
    %
 
 (1)
    
    Multi year quota share reinsurance agreements with CastlePoint Reinsurance began April 6,
2006.(2)
    
    On July 1, 2008, we reduced the ceding percentage under our brokerage business quota share
reinsurance agreement with CastlePoint Reinsurance to 25% applicable to both the ceded
unearned premium reserve as of July 1, 2008 and new and renewal premiums written in the third
quarter of 2008.  Commission and fee income .
 Net investment income and net realized investment gains (losses) . Accounting for
Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct
Costs of Leases
   23




---



##### Table of Contents



Losses and loss adjustment expenses .
 Operating expenses .
 Interest expense .
 Equity in income (loss) of unconsolidated affiliate.
 Income tax expense .
 Net income and return on average equity .
   24




---



##### Table of Contents



Insurance Segment Results of Operations
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,($ in millions)
    
    2008
    
    2007
    
    Change
    
    Percent
    
    2008
    
    2007
    
    Change
    
    PercentRevenuesPremiums earnedGross premiums earned
    
    $
    150.5
    
    
    $
    138.8
    
    
    $
    11.8
    
    
    
    8.5
    %
    
    $
    424.3
    
    
    $
    378.0
    
    
    $
    46.3
    
    
    
    12.2
    %Less: ceded premiums earned
    
    
    (62.3
    )
    
    
    (65.6
    )
    
    
    3.4
    
    
    
    -5.1
    %
    
    
    (197.5
    )
    
    
    (170.5
    )
    
    
    (27.0
    )
    
    
    15.9
    %Net premiums earned
    
    
    88.2
    
    
    
    73.1
    
    
    
    15.1
    
    
    
    20.7
    %
    
    
    226.8
    
    
    
    207.5
    
    
    
    19.3
    
    
    
    9.3
    %Ceding commission revenue
    
    
    18.4
    
    
    
    19.6
    
    
    
    (1.2
    )
    
    
    -6.0
    %
    
    
    60.6
    
    
    
    50.9
    
    
    
    9.7
    
    
    
    19.1
    %Policy billing fees
    
    
    0.5
    
    
    
    0.6
    
    
    
    (0.1
    )
    
    
    -19.1
    %
    
    
    1.4
    
    
    
    1.4
    
    
    
    0.0
    
    
    NMTotal
    
    
    107.2
    
    
    
    93.3
    
    
    
    13.8
    
    
    
    14.8
    %
    
    
    288.8
    
    
    
    259.9
    
    
    
    29.0
    
    
    
    11.1
    %ExpensesLoss and loss adjustment expensesGross loss and loss adjustment expenses
    
    
    70.1
    
    
    
    69.9
    
    
    
    0.2
    
    
    
    0.3
    %
    
    
    207.2
    
    
    
    194.1
    
    
    
    13.1
    
    
    
    6.8
    %Less: ceded loss and loss adjustment expen
    
    
    (26.2
    )
    
    
    (29.9
    )
    
    
    3.7
    
    
    
    -12.3
    %
    
    
    (89.1
    )
    
    
    (79.5
    )
    
    
    (9.5
    )
    
    
    12.0
    %Net loss and loss adjustment expenses
    
    
    43.9
    
    
    
    40.0
    
    
    
    3.9
    
    
    
    -19.1
    %
    
    
    118.1
    
    
    
    114.5
    
    
    
    3.6
    
    
    
    3.1
    %Underwriting expensesDirect commission expense
    
    
    28.5
    
    
    
    22.6
    
    
    
    5.9
    
    
    
    26.2
    %
    
    
    76.7
    
    
    
    62.9
    
    
    
    13.8
    
    
    
    21.9
    %Other underwriting expenses
    
    
    17.9
    
    
    
    18.6
    
    
    
    (0.6
    )
    
    
    -3.4
    %
    
    
    54.1
    
    
    
    50.8
    
    
    
    3.3
    
    
    
    6.5
    %Total underwriting expenses
    
    
    46.5
    
    
    
    41.2
    
    
    
    5.3
    
    
    
    12.9
    %
    
    
    130.7
    
    
    
    113.7
    
    
    
    17.0
    
    
    
    15.0
    %Underwriting profit
    
    $
    16.8
    
    
    $
    12.2
    
    
    $
    4.6
    
    
    
    38.2
    %
    
    $
    40.0
    
    
    $
    31.7
    
    
    $
    8.3
    
    
    
    26.3
    %Key MeasuresPremiums writtenGross premiums written
    
    $
    157.2
    
    
    $
    127.7
    
    
    $
    29.5
    
    
    
    23.1
    %
    
    $
    458.3
    
    
    
    387.4
    
    
    $
    70.9
    
    
    
    18.3
    %Less: ceded premiums written
    
    
    (42.6
    )
    
    
    (60.9
    )
    
    
    18.3
    
    
    
    -30.1
    %
    
    
    (192.7
    )
    
    
    (202.9
    )
    
    
    10.2
    
    
    
    -5.0
    %Net premiums written
    
    $
    114.6
    
    
    $
    66.8
    
    
    $
    47.9
    
    
    
    71.7
    %
    
    $
    265.6
    
    
    $
    184.5
    
    
    $
    81.1
    
    
    
    44.0
    %Ceded premiums as a percent of gross premiumsWritten
    
    
    27
    %
    
    
    48
    %
    
    
    
    
    
    
    
    
    
    
    42
    %
    
    
    52
    %Earned
    
    
    41
    %
    
    
    47
    %
    
    
    
    
    
    
    
    
    
    
    47
    %
    
    
    45
    %Loss RatiosGross
    
    
    46.5
    %
    
    
    50.4
    %
    
    
    
    
    
    
    
    
    
    
    48.8
    %
    
    
    51.3
    %Net
    
    
    49.8
    %
    
    
    54.7
    %
    
    
    
    
    
    
    
    
    
    
    52.1
    %
    
    
    55.2
    %Accident Year Loss RatiosGross
    
    
    52.4
    %
    
    
    50.5
    %
    
    
    
    
    
    
    
    
    
    
    51.6
    %
    
    
    51.7
    %Net
    
    
    53.3
    %
    
    
    55.4
    %
    
    
    
    
    
    
    
    
    
    
    54.1
    %
    
    
    55.4
    %Underwriting Expense RatiosGross
    
    
    30.6
    %
    
    
    29.2
    %
    
    
    
    
    
    
    
    
    
    
    30.5
    %
    
    
    29.7
    %Net
    
    
    31.2
    %
    
    
    28.7
    %
    
    
    
    
    
    
    
    
    
    
    30.3
    %
    
    
    29.6
    %Combined RatiosGross
    
    
    77.1
    %
    
    
    79.6
    %
    
    
    
    
    
    
    
    
    
    
    79.3
    %
    
    
    81.0
    %Net
    
    
    81.0
    %
    
    
    83.4
    %
    
    
    
    
    
    
    
    
    
    
    82.4
    %
    
    
    84.8
    %
 Insurance Segment Results of Operations Three and Nine months ended September 30, 2008 and 2007
 Gross premiums .
 25




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##### Table of Contents



Ceded premiums .
  Ceding commission revenue.
 26




---



##### Table of Contents



Loss and loss adjustment expenses and loss ratio .
    Underwriting expenses and underwriting expense ratio
    Underwriting profit and combined ratio .
 27




---



##### Table of Contents



Insurance Services Segment Results of Operations
 Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,($ in millions)
    
    2008
    
    2007
    
    Change
    
    Percent
    
    2008
    
    2007
    
    Change
    
    PercentRevenueDirect commission revenue from
managing general agency
    
    $
    15.3
    
    
    $
    8.0
    
    
    $
    7.3
    
    
    
    90.4
    %
    
    $
    35.4
    
    
    $
    9.1
    
    
    $
    26.3
    
    
    
    289.0
    %Claims administration revenue
    
    
    1.6
    
    
    
    0.5
    
    
    
    1.1
    
    
    
    206.5
    %
    
    
    3.6
    
    
    
    1.6
    
    
    
    2.0
    
    
    
    120.2
    %Other administration revenue (1)
    
    
    0.8
    
    
    
    0.3
    
    
    
    0.5
    
    
    
    160.3
    %
    
    
    2.4
    
    
    
    0.9
    
    
    
    1.5
    
    
    
    162.6
    %Reinsurance intermediary fees (2)
    
    
    0.3
    
    
    
    0.3
    
    
    
    0.0
    
    
    
    0.2
    %
    
    
    0.5
    
    
    
    0.6
    
    
    
    (0.1
    )
    
    
    -9.3
    %Policy billing fees
    
    
    0.1
    
    
    
    0.0
    
    
    
    0.1
    
    
    
    
    
    
    
    0.3
    
    
    
    
    
    
    
    0.3Total
    
    
    18.1
    
    
    
    9.1
    
    
    
    9.0
    
    
    
    98.0
    %
    
    
    42.2
    
    
    
    12.2
    
    
    
    29.9
    
    
    
    244.7
    %ExpensesDirect commission expense paid to producers
    
    
    6.9
    
    
    
    3.8
    
    
    
    3.0
    
    
    
    80.1
    %
    
    
    15.4
    
    
    
    4.0
    
    
    
    11.4
    
    
    
    288.5
    %Other insurance services expenses
    
    
    3.2
    
    
    
    1.7
    
    
    
    1.5
    
    
    
    91.2
    %
    
    
    8.0
    
    
    
    2.3
    
    
    
    5.7
    
    
    
    246.2
    %Claims expense reimbursement to TICNY (3)
    
    
    1.6
    
    
    
    0.5
    
    
    
    1.1
    
    
    
    208.9
    %
    
    
    3.6
    
    
    
    1.6
    
    
    
    2.0
    
    
    
    121.0
    %Total
    
    
    11.7
    
    
    
    6.0
    
    
    
    5.7
    
    
    
    94.3
    %
    
    
    26.9
    
    
    
    7.9
    
    
    
    19.0
    
    
    
    241.8
    %Insurance services pre-tax income (loss)
    
    $
    6.4
    
    
    $
    3.1
    
    
    $
    3.3
    
    
    
    105.2
    %
    
    $
    15.2
    
    
    $
    4.4
    
    
    $
    10.9
    
    
    
    250.1
    %Premiums produced by TRM on behalf
of issuing companies
    
    $
    46.6
    
    
    $
    23.4
    
    
    $
    23.2
    
    
    
    98.9
    %
    
    $
    106.0
    
    
    $
    24.1
    
    
    $
    81.9
    
    
    
    340.0
    %
 
 (1)
    
    Other administration revenue includes amounts reimbursed by CastlePoint
Reinsurance for services rendered pursuant to a service and expense sharing agreement.(2)
    
    Reinsurance intermediary fees include commissions earned for placement of
reinsurance on behalf of our insurance subsidiaries.(3)
    
    Consists of underwriting expenses reimbursed to TICNY pursuant to an expense sharing
agreement. Insurance Services Segment Results of OperationsThree and Nine months ended September 30, 2008
and 2007
 Total revenues.
  Direct commission expense .
 28




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##### Table of Contents



Other insurance services expenses .
 Claims expense reimbursement .
 Pre-tax income .
 Liquidity and Capital Resources
 Cash flows .
  Three Months Ended
    
    Nine Months EndedCash Flow Summary
    
    September 30,
    
    September 30,($ in thousands)
    
    2008
    
    2007
    
    2008
    
    2007Cash provided by (used in):Operating activities
    
    $
    18,961
    
    
    $
    18,107
    
    
    $
    42,050
    
    
    $
    48,599Investing activities
    
    
    (16,817
    )
    
    
    (29,478
    )
    
    
    (14,788
    )
    
    
    (181,897
    )Financing activities
    
    
    (1,006
    )
    
    
    (1,072
    )
    
    
    (3,544
    )
    
    
    68,663Net increase (decrease) in cash and cash equivalents
    
    $
    1,138
    
    
    $
    (12,443
    )
    
    $
    23,717
    
    
    $
    (64,635
    )
     29




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##### Table of Contents



Investments
 Credit Rating of Fixed Maturity Securities
  September 30, 2008
    
    December 31, 2007Percentage of
    
    
    
    
    
    Percentage ofFair Market
    
    Fair Market
    
    Fair Market
    
    Fair Market($ in thousands)
    
    Value
    
    Value
    
    Value
    
    ValueRatingU.S. Treasury securities
    
    $
    26,457
    
    
    
    4.8
    %
    
    $
    26,663
    
    
    
    4.4
    %AAA
    
    
    211,456
    
    
    
    38.2
    %
    
    
    286,528
    
    
    
    47.2
    %AA
    
    
    112,088
    
    
    
    20.2
    %
    
    
    72,276
    
    
    
    11.9
    %A
    
    
    100,617
    
    
    
    18.1
    %
    
    
    80,426
    
    
    
    13.3
    %BBB
    
    
    69,272
    
    
    
    12.5
    %
    
    
    77,768
    
    
    
    12.8
    %Below BBB
    
    
    34,248
    
    
    
    6.2
    %
    
    
    62,827
    
    
    
    10.4
    %Total
    
    $
    554,138
    
    
    
    100.0
    %
    
    $
    606,488
    
    
    
    100.0
    %
 Fair Value Consideration
      30




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##### Table of Contents



Level 3 AssetsTotal Assets
    
    
    
    
    
    As a PercentageCarried at
    
    
    
    
    
    of Total AssetsFair Value at
    
    Fair Value of
    
    Carried at($ in thousands)
    
    September 30, 2008
    
    Level 3 Assets
    
    Fair ValueFixed-maturity investments
    
    $
    554,138
    
    
    $
    16,773
    
    
    
    3.0
    %Equity investments
    
    
    4,531
    
    
    
    
    
    
    
    0.0
    %Total invesments available for sale
    
    
    558,669
    
    
    
    16,773
    
    
    
    3.0
    %Cash and cash equivalents
    
    
    101,396
    
    
    
    
    
    
    
    0.0
    %Total
    
    $
    660,065
    
    
    $
    16,773
    
    
    
    2.5
    %
  Unrealized Losses
   Less than 12 Months
    
    12 Months or Longer
    
    TotalUnrealized
    
    
    
    
    
    Unrealized
    
    Aggregate
    
    Unrealized($ in thousands)
    
    Fair Value
    
    Losses
    
    Fair Value
    
    Losses
    
    Fair Value
    
    LossesSeptember 30, 2008U.S. Treasury securities
    
    $
    18,151
    
    
    $
    (60
    )
    
    $
    
    
    
    $
    
    
    
    $
    18,151
    
    
    $
    (60
    )U.S. Agency securities
    
    
    2,003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,003
    
    
    
    Municipal bonds
    
    
    136,682
    
    
    
    (4,622
    )
    
    
    
    
    
    
    
    
    
    
    136,682
    
    
    
    (4,622
    )Corporate and other bonds
    
    
    149,648
    
    
    
    (17,862
    )
    
    
    34,305
    
    
    
    (8,850
    )
    
    
    183,953
    
    
    
    (26,712
    )Commercial mortgage-backed securities
    
    
    19,310
    
    
    
    (2,101
    )
    
    
    17,644
    
    
    
    (12,885
    )
    
    
    36,954
    
    
    
    (14,986
    )Residential mortgage-backed securities
    
    
    40,195
    
    
    
    (2,752
    )
    
    
    11,670
    
    
    
    (3,367
    )
    
    
    51,865
    
    
    
    (6,119
    )Asset-backed securities
    
    
    6,824
    
    
    
    (1,842
    )
    
    
    1,756
    
    
    
    (1,185
    )
    
    
    8,580
    
    
    
    (3,027
    )Total fixed maturity securities
    
    
    372,812
    
    
    
    (29,239
    )
    
    
    65,375
    
    
    
    (26,287
    )
    
    
    438,187
    
    
    
    (55,526
    )Preferred stocks
    
    
    
    
    
    
    
    
    
    
    3,087
    
    
    
    (2,464
    )
    
    
    3,087
    
    
    
    (2,464
    )Common stocks
    
    
    1,444
    
    
    
    (56
    )
    
    
    
    
    
    
    
    
    
    
    1,444
    
    
    
    (56
    )Total
    
    $
    374,256
    
    
    $
    (29,296
    )
    
    $
    68,462
    
    
    $
    (28,751
    )
    
    $
    442,718
    
    
    $
    (58,046
    )December 31, 2007Municipal bonds
    
    $
    11,614
    
    
    $
    (78
    )
    
    $
    7,272
    
    
    $
    (24
    )
    
    $
    18,886
    
    
    $
    (102
    )Corporate and other bonds
    
    
    77,262
    
    
    
    (3,164
    )
    
    
    24,631
    
    
    
    (817
    )
    
    
    101,893
    
    
    
    (3,981
    )Commercial mortgage-backed securities
    
    
    24,146
    
    
    
    (5,015
    )
    
    
    8,325
    
    
    
    (162
    )
    
    
    32,471
    
    
    
    (5,177
    )Residential mortgage-backed securities
    
    
    17,263
    
    
    
    (2,511
    )
    
    
    46,196
    
    
    
    (2,733
    )
    
    
    63,459
    
    
    
    (5,244
    )Asset-backed securities
    
    
    2,898
    
    
    
    (573
    )
    
    
    
    
    
    
    
    
    
    
    2,898
    
    
    
    (573
    )Total fixed maturity securities
    
    
    133,183
    
    
    
    (11,341
    )
    
    
    86,424
    
    
    
    (3,736
    )
    
    
    219,607
    
    
    
    (15,077
    )Preferred stocks
    
    
    3,702
    
    
    
    (1,849
    )
    
    
    
    
    
    
    
    
    
    
    3,702
    
    
    
    (1,849
    )Total
    
    $
    136,885
    
    
    $
    (13,190
    )
    
    $
    86,424
    
    
    $
    (3,736
    )
    
    $
    223,309
    
    
    $
    (16,926
    )
  31




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##### Table of Contents



Fixed Maturity Investments with Third Party Guarantees
  September 30, 2008With
    
    Without($ in thousands)
    
    Guarantee
    
    GuaranteeAAA
    
    $
    32,126
    
    
    $
    1,966AA
    
    
    42,979
    
    
    
    50,503A
    
    
    26,677
    
    
    
    36,863BBB
    
    
    251
    
    
    
    1,561No underlying rating
    
    
    
    
    
    
    11,140Total
    
    $
    102,033
    
    
    $
    102,033
  Guaranteed
    
    Percent($ in thousands)
    
    Amount
    
    of TotalFinancial Security Assurance
    
    $
    27,996
    
    
    
    27
    %MBIA Inc.
    
    
    26,276
    
    
    
    26
    %FGIC Corp.
    
    
    20,641
    
    
    
    20
    %Ambac Financial Corp.
    
    
    18,116
    
    
    
    18
    %Others
    
    
    9,004
    
    
    
    9
    %Total
    
    $
    102,033
    
    
    
    100
    %
 
 Item 3. Quantitative and Qualitative Disclosures about Market Risk
  Interest Rate Risk
  32




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##### Table of Contents



Sensitivity Analysis
     Estimated Increase
    
    Estimated Percentage(Decrease) in Fair Value
    
    Increase (Decrease)Change in interest rate
    
    ($ in thousands)
    
    in Fair Value300 basis point rise
    
    
    (64,828
    )
    
    
    (12.9
    )%200 basis point rise
    
    
    (44,776
    )
    
    
    (8.9
    )%100 basis point rise
    
    
    (23,250
    )
    
    
    (4.6
    )%No change
    
    
    0
    
    
    
    0.0
    %50 basis point decline
    
    
    12,376
    
    
    
    2.5
    %100 basis point decline
    
    
    25,036
    
    
    
    5.0
    %
   
 Item 4. Controls and Procedures
  Changes in internal control over financial reporting
  33




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##### Table of Contents



Part II  OTHER INFORMATION
 
 Item 1A. Risk Factors
    Risk Factors Relating to the Proposed Merger with CastlePoint
 The proposed merger with CastlePoint may not be completed.
  
    
    approval by Tower stockholders of an amendment to its amended and restated certificate of
incorporation to increase the maximum number of authorized shares of Tower common stock;
    
    approval by Tower stockholders of the issuance of additional shares of Tower common stock
pursuant to the merger agreement;
    
    CastlePoint shareholders approval and adoption of the merger agreement and approval of the
merger;
    
    approvals by regulatory authorities;
    
    receipt by CastlePoint, as a result of distributions and/or dividends from certain of its
Bermuda subsidiaries, of an amount in immediately available cash of not less than $80,000,000;
    
    the absence of laws and regulatory actions by governmental authorities that impose terms,
conditions, obligations or restrictions upon Tower, Ocean I Corporation, an indirect
wholly-owned subsidiary of Tower, or their respective subsidiaries, that would, individually
or in the aggregate, reasonably be expected to have a material adverse effect (as defined in
the merger agreement) on Tower after the effective time of the merger; and
    
    other customary closing conditions.
   34




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##### Table of Contents



Combining Tower and CastlePoint may be more difficult than expected.
  The anticipation of the merger and the integration of Tower and CastlePoint may cause disruptions
in Towers and CastlePoints respective businesses, which could have an adverse effect on their
financial condition and operating results, as well as the market price of Tower common stock.
  
    
    current employees and producers of both Tower and CastlePoint may experience uncertainty
about their future roles with the combined company, which might adversely affect the parties
ability to retain key executives, managers and other employees and producers; and
 
    
    the attention of Towers and CastlePoints management may be directed toward the completion
of the merger or the integration of operations and not the ongoing business of Tower or
CastlePoint, as the case may be.
 The parties must obtain governmental and other consents to complete the merger. If these consents
are delayed, not granted or granted with unacceptable conditions, it may jeopardize or postpone the
completion of the merger, result in additional expenditures of money and resources and/or reduce
the anticipated benefits of the merger.
  The market price of Tower common stock and Towers earnings per share may decline as a result of
the merger.
  There may be unexpected delays in the consummation of the merger, which would impact Towers
ability to timely achieve cost savings associated with the merger.
  35




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##### Table of Contents



As a result of the merger, Tower stockholders ownership will be diluted and voting power will
decline.
  Potential payments made to dissenting CastlePoint shareholders in respect of their shares could
exceed the amount of consideration otherwise due to them under the terms of the merger agreement.
  If the total number of CastlePoint common shares for which appraisal rights have been exercised
exceeds 15% of the CastlePoint common shares, Tower will have the right to terminate the merger
agreement.
  The respective financial advisors to the Tower special committee and the CastlePoint special
committee reviewed and relied on, among other things, certain projected financial forecasts
provided by the managements of Tower and CastlePoint and a failure of the combined company to
achieve those results could have a material adverse effect on Towers business, financial condition
and operating results, as well as the market price of its common stock, following the merger.
  Results predicted in financial forecasts and projections considered by Tower and CastlePoint may
not be realized, which may adversely affect the market price of Tower common stock following the
merger.
  36




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##### Table of Contents



If the merger or the Hermitage acquisition is completed after December 31, 2008, Tower and
CastlePoint will be required to expense the full amount of their transaction expenses in 2009.
  Risk Factors Relating to Tower Following the Merger
 If CastlePoints business does not perform well or Tower does not integrate CastlePoints business
successfully, Tower may incur significant charges to write down the goodwill and other intangible
assets established in the merger.
  If the merger is completed, Tower will be exposed to greater risk of loss and thus may wish to
utilize more third party reinsurers, but such reinsurers may not offer reinsurance on terms
acceptable to Tower.
  It may be difficult for a third party to acquire Tower, even if doing so may be beneficial to Tower
stockholders.
  
    
    authorizing the issuance of preferred stock, the terms of which may be determined at the sole
discretion of Towers board of directors;
 
    
    classifying its board of directors with staggered three-year terms, which may lengthen the
time required to gain control of Towers board of directors;
 
    
    prohibiting stockholder action by written consent, thereby requiring all stockholder actions
to be taken at a meeting of the stockholders;
 37




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##### Table of Contents




    
    limiting who may call special meetings of stockholders;
 
    
    establishing advance notice requirements for nominations of candidates for election to its
board of directors or for proposing matters that can be acted upon by stockholders at
stockholder meetings; and
 
    
    the existence of authorized and unissued Tower common stock which would allow Towers board
of directors to issue shares to persons friendly to current management.
  There can be no assurance that the merger will not result in a ratings downgrade of Tower or its
insurance companies (including the newly-acquired CastlePoint insurance and reinsurance operating
companies) by A.M. Best Company, which may result in a material adverse effect on Towers business,
financial condition and operating results, as well as the market price of its common stock.
   Risk Factors Related to the Hermitage Acquisition
 The Hermitage acquisition may not be completed.
  
    
    consents, authorizations and approvals by regulatory authorities;
 
    
    the absence of orders and regulatory actions by governmental authorities that impose any
condition, restriction, undertaking or limitation which would, individually or in the
aggregate, reasonably be expected to have a material adverse effect (as defined in the stock
purchase agreement related to the Hermitage acquisition) upon Hermitage and its subsidiaries
taken as a whole, or a material adverse effect on CastlePoint Re and its affiliates taken as a
whole; and
 
    
    other customary closing conditions.
  Integrating Hermitage may be costly and difficult and may cause disruption to its business or the
businesses of Tower and CastlePoint.
  38




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##### Table of Contents



The anticipation of the Hermitage acquisition and the integration of Hermitage with CastlePoint and
Tower may cause disruptions in Hermitages, Towers and CastlePoints respective businesses, which
could have an adverse effect on their financial condition and operating results, as well as the
market price of Towers common stock.
  
    
    current employees and producers of Hermitage, Tower and CastlePoint may experience
uncertainty about their future roles with the combined company, which might adversely affect
the parties ability to retain key executives, managers and other employees and producers; and
 
    
    the attention of Hermitages, CastlePoints and Towers management may be directed toward the
completion of the Hermitage acquisition or the integration of operations and not the ongoing
business of Hermitage, CastlePoint or Tower, as the case may be.
 The parties must obtain governmental and other consents to complete the Hermitage acquisition. If
these consents are delayed, not granted or granted with unacceptable conditions, it may jeopardize
or postpone the completion of the Hermitage acquisition, result in additional expenditures of money
and resources and/or reduce the anticipated benefits of the Hermitage acquisition.
  If Hermitages business does not perform well or CastlePoint and Tower do not integrate Hermitages
business successfully, CastlePoint or Tower may incur significant charges to write down the
goodwill and other intangibles established in the Hermitage acquisition.
  39




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##### Table of Contents



Hermitage has been a private company and has not put in place the internal controls over financial
reporting meeting the standard that is required of a publicly traded company.
  Hermitages business is subject to many of the same risks as Towers and CastlePoints businesses.
  
    
    Hermitages actual losses and loss adjustment expenses may exceed its reserves;
 
    
    much of Hermitages business is conducted in concentrated geographic areas, which could
expose it to catastrophes or other exposures affecting losses or business conditions in those
areas;
 
    
    Hermitages reinsurers may not pay losses in a timely fashion, or at all;
 
    
    a decline in the ratings assigned by A. M. Best or other rating agencies to Hermitages
insurance subsidiaries could affect its standing among brokers, agents and insureds and cause
its sales and earnings to decrease;
 
    
    loss limitation methods employed by Hermitage may not be as effective as planned;
 
    
    Hermitage faces exposure to terrorism;
 
    
    the effects of emerging claims and coverage issues on Hermitages business are uncertain;
 
    
    Hermitage may lose the business provided by one or more of its core of selected producers;
 
    
    Hermitage is exposed to the credit risk of its producers;
 
    
    Hermitage could be adversely affected by the loss of one or more principal employees or the
inability to attract and retain staff;
 
    
    Hermitages investment portfolio could be adversely affected by interest rate changes, market
volatility and other factors that affect the value of securities;
 
    
    the regulatory system in which Hermitage operates, and changes thereto, could have a material
adverse effect on its business;
 
    
    Hermitages competitive position may be adversely affected by new, proposed or potential
legislative or industry developments or other developments that affect the markets it serves;
 
    
    Hermitages results of operations and financial condition would be adversely affected if
assessments that Hermitage is required to pay increase dramatically;
 
    
    CastlePoints ability to receive dividends from Hermitages insurance subsidiaries is limited
by Hermitages holding company structure and regulatory constraints;
 
    
    Hermitage relies on information technology and telecommunications services to conducts its
businesses, and is vulnerable to disruptions or failure of its equipment, software or
telecommunications services;
 40




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##### Table of Contents




    
    the threat of terrorism and military and other actions may adversely affect Hermitages
investment portfolio and may result in decreases in its net income, revenue and assets under
management; and
 
    
    Hermitages results of operations and revenues may fluctuate as a result of many factors,
including cyclical changes in the insurance industry.
 Risk Factors Relating to Disruptions in the Financial Markets and a Possible Recession
 Adverse capital and credit market conditions may significantly affect our ability to meet liquidity
needs, access to capital and cost of capital.
     Difficult conditions in the global capital markets and the economy generally may materially
adversely affect our business and results of operations and we do not expect these conditions to
improve in the near future.
   41




---



##### Table of Contents



There can be no assurance that actions of the U.S. government, Federal Reserve and other
governmental and regulatory bodies for the purpose of stabilizing the financial markets will
achieve the intended effect.
  The impairment of other financial institutions could adversely affect us.
  We are exposed to significant financial and capital markets risk which may adversely affect our
results of operations, financial condition and liquidity, and our net investment income can vary
from period to period .
   42




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##### Table of Contents



Our valuation of fixed maturity and equity securities may include methodologies, estimations and
assumptions which are subject to differing interpretations and could result in changes to
investment valuations that may materially adversely affect our results of operations or financial
condition
  Level 1
 Level 2
 Level 3
   Some of our investments are relatively illiquid and are in asset classes that have been
experiencing significant market valuation fluctuations.
   The determination of the amount of allowances and impairments taken on our investments is highly
subjective and could materially impact our results of operations or financial position.
 43




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##### Table of Contents



Gross unrealized losses may be realized or result in future impairments.
  An economic slowdown or recession could adversely affect our business.
  If our business does not perform well, we may be required to recognize an impairment of our
goodwill, intangible or other long-lived assets or to establish a valuation allowance against the
deferred income tax asset, which could adversely affect our results of operations or financial
condition.
    44




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##### Table of Contents



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
   Maximum Number (orTotal Number of
    
    Approximate DollarTotal
    
    
    
    
    
    Shares Purchased as
    
    Value) of Shares thatNumber of
    
    Average
    
    Part of Publicly
    
    May Yet Be PurchasedShares
    
    Price Paid
    
    Announced Plans or
    
    Under the Plans orPeriod
    
    Purchased
    
    per Share
    
    Programs
    
    ProgramsJuly 1 - 31, 2008
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    August 1 - 31, 2008
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    September 1 - 30, 2008
    
    
    1,071
    
    
    
    25.19
    
    
    
    
    
    
    
    Total
    
    
    1,071
    
    
    $
    25.19
    
    
    
    
    
    
    $
    
 
 Item 6. Exhibits
 31.1
    
    Chief Executive Officer  Certification pursuant to Sarbanes-Oxley Act of 2002 Section 30231.2
    
    Chief Financial Officer  Certification pursuant to Sarbanes-Oxley Act of 2002 Section 30232
    
    Chief Executive Officer and Chief Financial Officer  Certification pursuant to Sarbanes-Oxley Act
of 2002 Section 906
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##### Table of Contents



Signatures
  Tower Group, Inc.RegistrantDate:
November 10, 2008
    
    /s/ Michael H. LeeMichael H. LeeChairman of the Board,President and Chief Executive OfficerDate
:November 10, 2008
    
    /s/ Francis M. ColalucciFrancis M. ColalucciSenior Vice President,Chief Financial Officer and Treasurer
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