##### 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 June 30, 2006
 or
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the Transition Period from  to
 Commission file number 000-50891
 SPECIALTY UNDERWRITERS ALLIANCE, INC.
  Delaware
(State or other jurisdiction of incorporation or
organization)
    
    20-0432760
(I.R.S. Employer Identification
Number)222 South Riverside PlazaChicago, Illinois
(Address of principal executive office)
    
    60606
(Zip Code)
 (888) 782-4672
 þ o
  o þ o
 o þ




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##### 



SPECIALTY UNDERWRITERS ALLIANCE, INC.
 INDEX
  
 Page No.PART I  FINANCIAL INFORMATION
    
    
    3Item 1: Financial Statements
    
    
    3Item 2: Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    13Item 3: Quantitative and Qualitative Disclosures About Market Risk
    
    
    19Item 4: Controls and Procedures
    
    
    20PART II  OTHER INFORMATION
    
    
    22Item 1: Legal Proceedings
    
    
    22Item 1A: Risk Factors
    
    
    22Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    22Item 3: Defaults Upon Senior Securities
    
    
    22Item 4: Submission of Matters to a Vote of Security Holders
    
    
    22Item 5: Other Information
    
    
    22Item 6: Exhibits
    
    
    23Signatures
    
    
    24Certifications
    
    
    26CertificationCertificationCertificationCertificationAmendment to Partner Agent Program AgreementAmendment to Partner Agent Program AgreementAmendment to Partner Agent Program Agreement
  2




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 Item 1: Financial Statements
 Specialty Underwriters Alliance, Inc.
 Balance Sheets
 (dollars in thousands)
 June 30,
    
    
    December 31,2006
    
    
    2005Assets
    
    (unaudited)Fixed maturity investments, at fair value (amortized cost: $125,018 and $95,760)
    
    $
    121,751
    
    
    $
    94,129Short-term investments, at amortized cost (which approximates fair value)
    
    
    10,114
    
    
    
    8,862Total investments
    
    
    131,865
    
    
    
    102,991Cash and cash equivalents
    
    
    7,311
    
    
    
    5,329Insurance receivables
    
    
    55,758
    
    
    
    44,868Reinsurance recoverable on unpaid loss and loss adjustment expenses
    
    
    85,130
    
    
    
    88,997Prepaid reinsurance premiums
    
    
    1,059
    
    
    
    3,492Investment income accrued
    
    
    1,408
    
    
    
    1,102Equipment and capitalized software at cost (less accumulated depreciation of $2,539 and $1,488)
    
    
    6,925
    
    
    
    5,566Intangible assets
    
    
    10,745
    
    
    
    10,745Deferred acquisition costs
    
    
    15,256
    
    
    
    11,279Other assets
    
    
    1,902
    
    
    
    2,794Total assets
    
    $
    317,359
    
    
    $
    277,163LiabilitiesLoss and loss adjustment expense reserves
    
    $
    123,948
    
    
    $
    104,870Unearned insurance premiums
    
    
    72,391
    
    
    
    58,595Insured deposit funds
    
    
    11,934
    
    
    
    7,159Accounts payable and other liabilities
    
    
    5,214
    
    
    
    5,724Total liabilities
    
    
    213,487
    
    
    
    176,348Commitments (Note 4)Stockholders equityCommon stock
Class A at $.01 par value per share 
authorized 30,000,000 and 30,000,000 shares; issued and outstanding 14,680,688 shares
    
    
    147
    
    
    
    147Common stock
Class B at $.01 par value per share 
authorized 2,000,000 shares; issued and outstanding 562,632 and 223,694 shares
    
    
    6
    
    
    
    2Paid-in capital  Class A
    
    
    127,801
    
    
    
    127,256Paid-in capital  Class B
    
    
    3,947
    
    
    
    1,770Accumulated deficit
    
    
    (24,762
    )
    
    
    (26,729
    )Accumulated other comprehensive income (loss)
    
    
    (3,267
    )
    
    
    (1,631
    )Total stockholders equity
    
    
    103,872
    
    
    
    100,815Total liabilities and stockholders equity
    
    $
    317,359
    
    
    $
    277,163
  3




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##### Table of Contents



Specialty Underwriters Alliance, Inc.
Statements of Operations and Comprehensive Income (Loss)
(dollars in thousands)
(unaudited)
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005RevenuesEarned insurance premiums
    
    $
    25,230
    
    
    $
    3,032
    
    
    $
    48,486
    
    
    $
    3,502Net investment income
    
    
    1,432
    
    
    
    1,043
    
    
    
    2,576
    
    
    
    1,836Net realized gain
(loss)
    
    
    (3
    )
    
    
    (3
    )
    
    
    (2
    )
    
    
    (1
    )Total revenues
    
    
    26,659
    
    
    
    4,072
    
    
    
    51,060
    
    
    
    5,337ExpensesLoss and loss adjustment
expenses
    
    
    14,475
    
    
    
    2,319
    
    
    
    28,472
    
    
    
    2,790Amortization of
deferred acquisition
costs
    
    
    5,188
    
    
    
    640
    
    
    
    10,731
    
    
    
    740Service company fees
    
    
    
    
    
    
    2,203
    
    
    
    
    
    
    
    4,408Other operating
expenses
    
    
    4,767
    
    
    
    2,920
    
    
    
    9,766
    
    
    
    5,901Total expenses
    
    
    24,430
    
    
    
    8,082
    
    
    
    48,969
    
    
    
    13,839Pretax income (loss)
    
    
    2,229
    
    
    
    (4,010
    )
    
    
    2,091
    
    
    
    (8,502
    )Federal income tax
expense
    
    
    (62
    )
    
    
    
    
    
    
    (124
    )
    
    
    Net income (loss)
    
    
    2,167
    
    
    
    (4,010
    )
    
    
    1,967
    
    
    
    (8,502
    )Net change in
unrealized gains and
losses for
investments held,
after tax
    
    
    (798
    )
    
    
    1,096
    
    
    
    (1,636
    )
    
    
    (75
    )Comprehensive income (loss)
    
    $
    1,369
    
    
    $
    (2,914
    )
    
    $
    331
    
    
    $
    (8,577
    )Earnings (loss) per share
available
to common stockholders
(in dollars)Basic
    
    $
    0.14
    
    
    $
    (0.27
    )
    
    $
    0.13
    
    
    $
    (0.58
    )Diluted
    
    $
    0.14
    
    
    $
    (0.27
    )
    
    $
    0.13
    
    
    $
    (0.58
    )Average Shares Outstanding
(in thousands)Basic
    
    
    15,176
    
    
    
    14,754
    
    
    
    15,096
    
    
    
    14,731Diluted
    
    
    15,176
    
    
    
    14,754
    
    
    
    15,096
    
    
    
    14,731
  4




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Specialty Underwriters Alliance, Inc.
Statement of Stockholders Equity
(dollars in thousands)
(unaudited)
 AccumulatedCommon
    
    
    Paid-in
    
    
    Common
    
    
    Paid-in
    
    
    Retained
    
    
    Other
    
    
    TotalStock
    
    
    Capital
    
    
    Stock
    
    
    Capital
    
    
    Earnings
    
    
    Comprehensive
    
    
    StockholdersClass A
    
    
    Class A
    
    
    Class B
    
    
    Class B
    
    
    (Deficit)
    
    
    Income (Loss)
    
    
    EquityBalance at December 31, 2005
    
    $
    147
    
    
    $
    127,256
    
    
    $
    2
    
    
    $
    1,770
    
    
    $
    (26,729
    )
    
    $
    (1,631
    )
    
    $
    100,815Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,967
    
    
    
    
    
    
    
    1,967Net change in unrealized investment losses, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,636
    )
    
    
    (1,636
    )Stock issuance
    
    
    
    
    
    
    
    
    
    
    4
    
    
    
    2,177
    
    
    
    
    
    
    
    
    
    
    
    2,181Stock based compensation
    
    
    
    
    
    
    545
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    545Balance at June 30, 2006
    
    $
    147
    
    
    $
    127,801
    
    
    $
    6
    
    
    $
    3,947
    
    
    $
    (24,762
    )
    
    $
    (3,267
    )
    
    $
    103,872
  5




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Specialty Underwriters Alliance, Inc.
Statements of Cash Flows
(dollars in thousands)
(unaudited)
 Six MonthsEndedJune 30,2006
    
    
    2005Cash flows from operationsNet income (loss)
    
    $
    1,967
    
    
    $
    (8,502
    )Charges (credits) to
reconcile net income to
cash flows from operations:Change in deferred income
tax
    
    
    124
    
    
    
    Net realized gains
    
    
    2
    
    
    
    1Amortization of bond
discount
    
    
    214
    
    
    
    109Depreciation
    
    
    1,051
    
    
    
    836Net change in:Reinsurance recoverable on unpaid loss and
loss adjustment expense reserves
    
    
    3,867
    
    
    
    11,655Loss and loss adjustment
expense reserves
    
    
    19,078
    
    
    
    (9,548
    )Insurance premiums
receivable
    
    
    (10,890
    )
    
    
    (25,360
    )Unearned insurance
premiums
    
    
    13,796
    
    
    
    29,572Deferred acquisition costs
    
    
    (3,977
    )
    
    
    (5,297
    )Prepaid reinsurance
premiums
    
    
    2,433
    
    
    
    (3,261
    )Insured deposit funds
    
    
    4,775
    
    
    
    Other, net
    
    
    497
    
    
    
    1,960Total adjustments
    
    
    30,970
    
    
    
    667Net cash flows from (used
for) operations
    
    
    32,937
    
    
    
    (7,835
    )Cash flows from investing
activitiesNet (increase) decrease
in short-term investments
    
    
    (1,252
    )
    
    
    42,715Sales of fixed maturity
investments
    
    
    3,876
    
    
    
    6,259Purchases of fixed
maturity investments
    
    
    (33,350
    )
    
    
    (46,480
    )Unsettled net investment
purchases
    
    
    
    
    
    
    (997
    )Purchase of equipment and
capitalized software
    
    
    (2,410
    )
    
    
    (2,128
    )Net cash flows (used for)
provided by investing
activities
    
    
    (33,136
    )
    
    
    (631
    )Cash flows from financing
activitiesIssuance of common stock
    
    
    2,181
    
    
    
    500Net cash provided by
financing activities
    
    
    2,181
    
    
    
    500Net (decrease) increase
in cash and cash
equivalents
during the period
    
    
    1,982
    
    
    
    (7,966
    )Cash and cash equivalents
at beginning of the
period
    
    
    5,329
    
    
    
    8,986Cash and cash equivalents
at end of the period
    
    $
    7,311
    
    
    $
    1,020
  6




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Note 1. Basis of Presentation
    7




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Note 2. Net Income (Loss) Per Share
  Three Months
    
    Three MonthsEnded
    
    EndedJune 30, 2006
    
    June 30, 2005Net income (loss), as reported
    
    $
    2,167
    
    
    $
    (4,010
    )Average common shares outstanding (basic
and diluted) (in thousands)
    
    
    15,176
    
    
    
    14,754Net income (loss) per share (in dollars)
(basic and diluted)
    
    $
    0.14
    
    
    $
    (0.27
    )
 Six Months
    
    Six MonthsEnded
    
    EndedJune 30, 2006
    
    June 30, 2005Net income (loss), as reported
    
    $
    1,967
    
    
    $
    (8,502
    )Average common shares outstanding (basic
and diluted) (in thousands)
    
    
    15,096
    
    
    
    14,731Net income (loss) per share (in dollars)
(basic and diluted)
    
    $
    0.13
    
    
    $
    (.58
    )
 Note 3. Income Taxes
   8




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Note 4. Commitments
   Note 5. Stock Options
   9




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Three Months Ended
    
    
    Six Months EndedJune 30, 2005
    
    
    June 30, 2005(dollars in thousands,
    
    
    (dollars in thousands,except per share
    
    
    except per shareamounts)
    
    
    amounts)Net income (loss) as reported
    
    $
    (4,010
    )
    
    $
    (8,502
    )Deduct: compensation expense
    
    
    (244
    )
    
    
    (482
    )Pro forma net income (loss)
    
    $
    (4,254
    )
    
    $
    (8,984
    )Basic loss per share:As reported
    
    $
    (0.27
    )
    
    $
    (0.58
    )Pro forma
    
    $
    (0.29
    )
    
    $
    (0.61
    )Diluted loss per share:As reported
    
    $
    (0.27
    )
    
    $
    (0.58
    )Pro forma
    
    $
    (0.29
    )
    
    $
    (0.61
    )
 weighted-average
  2006
    
    2005Risk free interest rate
    
    
    N/A
    
    
    
    3.67%  4.33
    %Expected life
    
    
    N/A
    
    
    3.7  6.9 yearsExpected volatility
    
    
    N/A
    
    
    
    45
    %Expected dividend yield
    
    
    N/A
    
    
    2% beginning after 5 years
 10




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WeightedAverage
    
    
    
    
    
    WeightedExercise
    
    
    
    
    
    AveragePrice Per
    
    Aggregate
    
    ContractualNumber of
    
    Share (in
    
    Intrinsic
    
    RemainingOption Plan Activity
    
    Shares
    
    dollars)
    
    Value
    
    LifeBalance at March 31, 2006
    
    
    752,466
    
    
    $
    9.30
    
    
    $
    14,500
    
    
    8.76 yearsOptions granted
    
    
    0
    
    
    
    N/A
    
    
    
    N/A
    
    
    N/AOptions exercised
    
    
    0
    
    
    
    N/A
    
    
    
    N/A
    
    
    N/AOptions forfeited
    
    
    0
    
    
    
    N/A
    
    
    
    N/A
    
    
    N/ABalance at June 30, 2006
    
    
    752,466
    
    
    $
    9.30
    
    
    $
    11,500
    
    
    8.51 yearsTotal options vested at
June 30, 2006
    
    
    232,501
    
    
    $
    9.38
    
    
    $
    0
    
    
    8.44 years
  Weighted AverageExercise PriceShares
    
    Per Share (in dollars)Nonvested at March 31, 2006
    
    
    543,303
    
    
    $
    9.22Options granted
    
    
    0
    
    
    
    N/AOptions vested
    
    
    (23,338
    )
    
    $
    8.21Options forfeited
    
    
    0
    
    
    
    N/ANonvested at June 30, 2006
    
    
    519,965
    
    
    $
    9.26
  Note 6. Unpaid Loss and Loss Adjustment Expense Reserves
   11




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##### Table of Contents



As of June 30, 2006
    
    
    As of December 31, 2005Company direct reserves
    
    $
    45,128
    
    
    $
    18,134Potomac direct reserves
    
    
    78,820
    
    
    
    86,736Gross reserves
    
    
    123,948
    
    
    
    104,870Ceded reserves
    
    
    85,130
    
    
    
    88,997Net reserves
    
    $
    38,818
    
    
    $
    15,873
  Note 7. Recent Accounting Pronouncements
  12




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Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations
  Overview
     13




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Results of Operations
 Three Months Ended June 30, 2006 as compared to the Three Months Ended June 30, 2005
       14




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15




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Six Months Ended June 30, 2006 as compared to the Six Months Ended June 30, 2005
           16




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For the Three

    
    For the Six

    
    For theMonths Ended

    
    Months Ended

    
    Year EndedJune 30, 2006

    
    June 30, 2006

    
    December 31, 2005California
    
    
    31.0
    %
    
    
    32.3
    %
    
    
    39.4
    %Florida
    
    
    49.2
    %
    
    
    41.3
    %
    
    
    42.6
    %Other States
    
    
    19.8
    %
    
    
    26.4
    %
    
    
    18.0
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
  For the Three

    
    For the Six

    
    For theMonths Ended

    
    Months Ended

    
    Year EndedJune 30, 2006

    
    June 30, 2006

    
    December 31, 2005Workers compensation
    
    
    62.9
    %
    
    
    65.2
    %
    
    
    68.8
    %Commercial automobile
    
    
    15.3
    %
    
    
    13.2
    %
    
    
    10.4
    %General liability
    
    
    20.2
    %
    
    
    20.1
    %
    
    
    11.8
    %All other
    
    
    1.6
    %
    
    
    1.5
    %
    
    
    9.0
    %Total
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
 17




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For The
    
    For The
    
    For The
    
    For TheThree Months
    
    Three Months
    
    Six Months
    
    Six MonthsEnded
    
    Ended
    
    Ended
    
    EndedJune 30, 2006
    
    June 30, 2005
    
    June 30, 2006
    
    June 30,2005Gross premiums written
    
    $
    37.4
    
    
    $
    25.0
    
    
    $
    68.2
    
    
    $
    33.5Net premiums earned
    
    $
    25.2
    
    
    $
    3.0
    
    
    $
    48.5
    
    
    $
    3.5Net loss and loss
adjustment expense ratio
    
    
    57.4
    %
    
    
    76.5
    %
    
    
    58.7
    %
    
    
    79.7
    %Ratio of amortization of
deferred acquisition
expense to earned premium
    
    
    20.6
    %
    
    
    21.1
    %
    
    
    22.1
    %
    
    
    21.1
    %Ratio of all other
expenses to gross written
premium
    
    
    12.7
    %
    
    
    20.2
    %
    
    
    14.3
    %
    
    
    30.6
    %
 Liquidity and Capital Resources
     18




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Item 3: Quantitative and Qualitative Disclosures About Market Risk
  Interest Rate Risk
   EstimatedAssumed Change
    
    
    Fair Value After
    
    
    IncreaseFair Value
    
    
    in Relevant
    
    
    Change in
    
    
    (Decrease)$ in thousands
    
    at 6/30/06
    
    
    Interest Rate
    
    
    Interest Rate
    
    
    in Carrying ValueTotal Investments
    
    $
    131,865
    
    
    100 bp decrease
    
    $
    135,050
    
    
    $
    3,18550 bp decrease
    
    $
    133,485
    
    
    $
    1,62050 bp increase
    
    $
    130,223
    
    
    $
    (1,642
    )100 bp increase
    
    $
    128,571
    
    
    $
    (3,294
    )
 Credit Risk
  19




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6/30/2006
    
    
    12/31/2005Market Value
    
    
    Percent of
    
    
    Market Value
    
    
    Percent of(000) omitted
    
    
    Portfolio
    
    
    (000) omitted
    
    
    PortfolioUS Govt & Other Bonds
    
    $
    66,325
    
    
    
    54.5
    %
    
    $
    41,279
    
    
    
    43.9
    %AA Rated
    
    $
    17,171
    
    
    
    14.1
    %
    
    $
    15,940
    
    
    
    16.9
    %A Rated
    
    $
    38,255
    
    
    
    31.4
    %
    
    $
    36,910
    
    
    
    39.2
    %$
    121,751
    
    
    
    100.0
    %
    
    $
    94,129
    
    
    
    100.0
    %
  
 Item 4: Controls and Procedures
 Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures.
  Changes in Internal Control Over Financial Reporting.
 Inherent Limitations on Effectiveness of Controls.
 20




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21




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PART II  OTHER INFORMATION
 
 Item 1: Legal Proceedings
  
 Item 1A: Risk Factors
  
 Item 2: Recent Sales of Unregistered Securities
  
 Item 3: Defaults Upon Senior Securities
  
 Item 4: Submission of Matters to a Vote of Security Holders
  For
    
    WithheldCourtney C. Smith
    
    
    12,296,420
    
    
    
    18,985Peter E. Jokiel
    
    
    12,202,957
    
    
    
    112,448Robert E. Dean
    
    
    12,296,420
    
    
    
    18,985Raymond A. Groth
    
    
    12,296,420
    
    
    
    18,985Paul A. Philp
    
    
    12,296,420
    
    
    
    18,985Robert H. Whitehead
    
    
    12,295,920
    
    
    
    19,485Russell E. Zimmermann
    
    
    12,295,920
    
    
    
    19,485
  For
    
    Against
    
    Abstention12,311,177
    
    
    4,020
    
    
    
    208
  
 Item 5: Other Information
  22




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##### Table of Contents



Item 6: Exhibits
  ExhibitNumber
    
    Description31.1
    
    Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 200232.1
    
    Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 200299.1
    
    Amendment No. 2 to the Specialty Underwriters Alliance, Inc.
Partner Agent Program Agreement  American Patriot Insurance
Agency, Inc.99.2
    
    Amendment No. 1 to the Specialty Underwriters Alliance, Inc.
Partner Agent Program Agreement  AEON Insurance Group, Inc.99.3
    
    Amendment No. 2 to the Specialty Underwriters Alliance, Inc.
Partner Agent Program Agreement  Risk Transfer Holdings, Inc.
 23




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##### Table of Contents



SPECIALTY UNDERWRITERS ALLIANCE, INC.(Registrant)Dated: August 4, 2006
    
    By:
    
    /s/ Courtney C. SmithName: Courtney C. SmithTitle: President and Chief Executive Officer (PrincipalExecutive Officer)Dated: August 4, 2006
    
    By:
    
    /s/ Peter E. JokielName: Peter E. JokielTitle: Executive Vice President, Chief FinancialOfficer and Treasurer (Principal Financial Officer)
 24




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##### Table of Contents



ExhibitNumber
    
    Description31.1
    
    Certification of Chief Executive Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer pursuant to Section 302
of the Sarbanes-Oxley Act of 200232.1
    
    Certification of Chief Executive Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to Section 906
of the Sarbanes-Oxley Act of 200299.1
    
    Amendment No. 2 to the Specialty Underwriters Alliance, Inc.
Partner Agent Program Agreement  American Patriot Insurance
Agency99.2
    
    Amendment No. 1 to the Specialty Underwriters Alliance, Inc.
Partner Agent Program Agreement  AEON Insurance Group, Inc99.3
    
    Amendment No. 2 to the Specialty Underwriters Alliance, Inc.
Partner Agent Program Agreement  Risk Transfer Holdings, Inc.
 25