##### 



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
   FORM 10-Q T
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934For The Quarterly Period Ended March 31, 2005or£
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE ACT OF 1934For 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 Plaza
Chicago, Illinois
    
    60606(Address of principal executive office)
    
    (Zip Code)
 (888) 782-4672
(Registrants telephone number including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing requirement
for the past 90 days. Yes x      Noo Indicate by check mark whether the registrant is an accelerated filer (as defined in
the Exchange Act Rule 12b-2). Yes o     Nox As of May 13, 2005, there were 14,680,688 shares of common stock, $0.01 par value,
outstanding and 42,376 shares of Class B common stock, $0.01 par value, outstanding.




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##### 



SPECIALTY UNDERWRITERS ALLIANCE, INC. INDEX Page No.PART I  FINANCIAL INFORMATION
    
    
    4Item 1: Financial Statements
    
    
    4Item 2: Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    13Item 3: Quantitative and Qualitative Disclosures About Market Risk
    
    
    16Item 4: Controls and Procedures
    
    
    17PART II  OTHER INFORMATION
    
    
    18Item 1: Legal Proceedings
    
    
    18Item 2: Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    18Item 3: Defaults Upon Senior Securities
    
    
    18Item 4: Submission of Matters to a Vote of Security Holders
    
    
    18Item 5: Other Information
    
    
    18Item 6: Exhibits
    
    
    18Signatures
    
    
    19Certifications
  2




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##### 



Certain statements in this Quarterly Report on Form 10-Q are forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934. These statements are subject to the safe harbor provisions of this legislation. The
Company may, in some cases, use words such as project, believe, anticipate, plan, expect,
estimate, intend, should, would, could, will, or may, or other words that convey
uncertainty of future events or outcomes to identify these forward-looking statements. Even though
the Company believes that its expectations regarding future events are based on reasonable
assumptions, forward-looking statements are not guarantees of future performance. Important
factors could cause actual results to differ materially from the Companys expectations contained
in its forward-looking statements. There are a number of important factors that could cause actual results to differ materially
from the results anticipated by these forward-looking statements. These important factors include
those that we discuss in Item 3 under the caption Quantitative and Qualitative Disclosures About
Market Risk. You should read these factors and other cautionary statements as being applicable to
all related forward-looking statements wherever they appear. If one or more of these factors
materialize, or if any underlying assumptions prove incorrect, our actual results, performance or
achievements may vary materially from any future results, performance or achievements expressed or
implied by these forward-looking statements. The Company undertakes no obligation to publicly
update any forward-looking statements, whether as a result of new information, future events or
otherwise. 3




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##### 



PART I  FINANCIAL INFORMATION 
 Item 1: Financial Statements A. Financial Statements of Specialty Underwriters Alliance, Inc. Balance Sheets Specialty Underwriters' Alliance, Inc.UnauditedMarch 31,
    
    
    December 31,2005
    
    
    2004Assets
    
    (dollars in thousands)Fixed maturity investments, at fair value (cost: $85,300 and $50,455)
    
    $
    84,015
    
    
    $
    50,465Short-term investments, at amortized cost (which approximates fair value)
    
    
    13,241
    
    
    
    47,370Total investments
    
    
    97,256
    
    
    
    97,835Cash and cash equivalents
    
    
    1,463
    
    
    
    8,986Insurance receivables
    
    
    6,791
    
    
    
    Reinsurance recoverable on unpaid loss and loss adjustment expenses
    
    
    95,558
    
    
    
    95,959Prepaid reinsurance premiums
    
    
    871
    
    
    
    3Investment income accrued
    
    
    705
    
    
    
    677Equipment and capitalized software at cost (less accumulated depreciation of $447 and $0)
    
    
    3,192
    
    
    
    2,389Intangible assets
    
    
    10,745
    
    
    
    10,745Deferred acquisition costs
    
    
    1,707
    
    
    
    Other assets
    
    
    2,141
    
    
    
    637Total assets
    
    $
    220,429
    
    
    $
    217,231LiabilitiesLoss and loss adjustment expense reserves
    
    $
    95,832
    
    
    $
    95,959Unearned insurance premiums
    
    
    7,957
    
    
    
    3Payble for securities purchased
    
    
    
    
    
    
    1,000Accounts payable and other liabilities
    
    
    3,223
    
    
    
    1,339Total liabilities
    
    
    107,012
    
    
    
    98,301Commitments (Note 6)Stockholders equityCommon stock Class A at $.01 par value per share -
authorized 75,000,000 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 42,376 and 26,316 shares
    
    
    
    
    
    
    Paid-in capital  Class A
    
    
    127,256
    
    
    
    127,256Paid-in capital  Class B
    
    
    400
    
    
    
    250Accumulated deficit
    
    
    (13,225
    )
    
    
    (8,733
    )Accumulated other comprehensive income, net of tax
    
    
    (1,161
    )
    
    
    10Total stockholders equity
    
    
    113,417
    
    
    
    118,930Total liabilities and stockholders equity
    
    $
    220,429
    
    
    $
    217,231
 The accompanying notes are an integral part of these financial statements. 4




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##### 



Statements of Income and Comprehensive Income
(Unaudited) Specialty Underwriters'
    
    
    
    Potomac Insurance CompanyAlliance, Inc. (Successor)
    
    
    
    of Illinois (Predecessor)Three Months Ended
    
    
    
    Three Months EndedMarch 31,
    
    
    
    March 31,2005
    
    
    2004
    
    
    
    2004(dollars in thousands)Revenues:Earned insurance premiums
    
    $
    470
    
    
    $
    
    
    
    
    $
    2,752Net investment income
    
    
    793
    
    
    
    
    
    
    
    
    360Net realized (losses) gains
    
    
    2
    
    
    
    
    
    
    
    
    100Other revenue
    
    
    
    
    
    
    
    
    
    
    
    2Total revenue
    
    
    1,265
    
    
    
    
    
    
    
    
    3,214Expenses:Loss and loss adjustment expenses
    
    
    471
    
    
    
    
    
    
    
    
    1,721Amortization of deferred acquisition costs
    
    
    100
    
    
    
    
    
    
    
    
    124Service company fees
    
    
    2,205
    
    
    
    15
    
    
    
    
    Other operating expenses
    
    
    2,981
    
    
    
    441
    
    
    
    
    722Financing expenses
    
    
    
    
    
    
    1,352
    
    
    
    
    Accretion of loss and loss adjustment expenses to fair value
    
    
    
    
    
    
    
    
    
    
    
    50Total expenses
    
    
    5,757
    
    
    
    1,808
    
    
    
    
    2,617Pretax income (loss)
    
    
    (4,492
    )
    
    
    (1,808
    )
    
    
    
    597Federal income tax (expense) benefit
    
    
    
    
    
    
    
    
    
    
    
    (209
    )Net income (loss)
    
    
    (4,492
    )
    
    
    (1,808
    )
    
    
    
    388Net change in unrealized gains and losses for investments held, after tax
    
    
    (1,171
    )
    
    
    
    
    
    
    
    170Recognition of unrealized gains and losses for investments sold, after tax
    
    
    
    
    
    
    
    
    
    
    
    (65
    )Comprehensive net income (loss)
    
    $
    (5,663
    )
    
    $
    (1,808
    )
    
    
    $
    493Earnings (loss) per share available
to common stockholders     (in dollars)Basic
    
    $
    (0.31
    )
    
    $
    (180,800.00
    )
    
    
    NMDiluted
    
    $
    (0.31
    )
    
    $
    (180,800.00
    )
    
    
    NM
 The accompanying notes are an integral part of these financial statements. 5




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##### 



Statements of Stockholders Equity
(Unaudited) AccumulatedOtherCommon
    
    
    Paid-in
    
    
    Common
    
    
    Paid-in
    
    
    Retained
    
    
    Comprehensive
    
    
    TotalSpecialty Underwriters' Alliance, Inc.
    
    Stock
    
    
    Capital
    
    
    Stock
    
    
    Capital
    
    
    Earnings
    
    
    Income (Loss),
    
    
    Stockholders'(Successor)
    
    Class A
    
    
    Class A
    
    
    Class B
    
    
    Class B
    
    
    (Deficit)
    
    
    Net of Tax
    
    
    Equity(dollars in thousands)Balance at December 31, 2003
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (578
    )
    
    $
    
    
    
    $
    (578
    )Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,808
    )
    
    
    
    
    
    
    (1,808
    )Balance at March 31, 2004
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,386
    )
    
    
    
    
    
    
    (2,386
    )Balance at December 31, 2004
    
    
    147
    
    
    
    127,256
    
    
    
    
    
    
    
    250
    
    
    
    (8,733
    )
    
    
    10
    
    
    
    118,930Net loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,492
    )
    
    
    
    
    
    
    (4,492
    )Net change in unrealized investment
losses, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,171
    )
    
    
    (1,171
    )Stock issuance
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    150
    
    
    
    
    
    
    
    
    
    
    
    150Balance at March 31, 2005
    
    $
    147
    
    
    $
    127,256
    
    
    $
    
    
    
    $
    400
    
    
    $
    (13,225
    )
    
    $
    (1,161
    )
    
    $
    113,417
 The accompanying notes are an integral part of these financial statements. 6




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##### 



Statement of Cash Flows
(Unaudited) Specialty Underwriters'
    
    
    
    Potomac Insurance CompanyAlliance, Inc. (Successor)
    
    
    
    of Illinois (Predecessor)Three Months Ended
    
    
    
    Three Months EndedMarch 31,
    
    
    
    March 31,2005
    
    
    2004
    
    
    
    2004Cash flows from operations:
    
    
    (dollars in thousands)Net income (loss)
    
    $
    (4,492
    )
    
    $
    (1,808
    )
    
    
    $
    388Charges (credits) to reconcile net income to cash
flows from operations:Amortization of deferred charges
    
    
    
    
    
    
    1,311
    
    
    
    
    Federal income tax expense (benefit)
    
    
    
    
    
    
    
    
    
    
    
    209Net realized losses (gains)
    
    
    (2
    )
    
    
    
    
    
    
    
    (100
    )Amortization of bond discount
    
    
    136
    
    
    
    
    
    
    
    
    Depreciation
    
    
    447
    
    
    
    
    
    
    
    
    Net change in:Deferred stock issuance costs
    
    
    
    
    
    
    (216
    )
    
    
    
    Reinsurance recoverable on unpaid loss and loss adjustment expense reserves
    
    
    401
    
    
    
    
    
    
    
    
    14,798Loss and loss adjustment expense reserves
    
    
    (127
    )
    
    
    
    
    
    
    
    (15,421
    )Insurance premiums receivable
    
    
    (6,791
    )
    
    
    
    
    
    
    
    (276
    )Unearned insurance premiums
    
    
    7,954
    
    
    
    
    
    
    
    
    314Deferred acquisition costs
    
    
    (1,707
    )
    
    
    
    
    
    
    
    (125
    )Prepaid reinsurance premiums
    
    
    (868
    )
    
    
    
    
    
    
    
    Other, net
    
    
    356
    
    
    
    435
    
    
    
    
    (401
    )Net cash flows (used for) provided by operations
    
    
    (4,693
    )
    
    
    (278
    )
    
    
    
    (614
    )Cash flows from investing activities:Acquisition deposit
    
    
    
    
    
    
    (250
    )
    
    
    
    Net (increase) decrease in short-term investments
    
    
    34,129
    
    
    
    
    
    
    
    
    12,020Sales of fixed maturity investments
    
    
    4,865
    
    
    
    
    
    
    
    
    1,943Redemptions, calls and maturities of fixed maturity investments
    
    
    
    
    
    
    
    
    
    
    
    340Purchases of fixed maturity investments
    
    
    (39,720
    )
    
    
    
    
    
    
    
    (3,252
    )Unsettled net investment purchases (sales)
    
    
    (1,004
    )
    
    
    
    
    
    
    
    (20,018
    )Purchase of equipment and capitalized software
    
    
    (1,250
    )
    
    
    
    
    
    
    
    Net cash flows (used for) provided by investing activities
    
    
    (2,980
    )
    
    
    (250
    )
    
    
    
    (8,967
    )Cash flows from financing activities:Proceeds from short-term borrowings
    
    
    
    
    
    
    575
    
    
    
    
    Issuance of common stock
    
    
    150
    
    
    
    
    
    
    
    
    Net cash provided by financing activities
    
    
    150
    
    
    
    575
    
    
    
    
    Net (decrease) increase in cash and cash equivalents
during the period
    
    
    (7,523
    )
    
    
    47
    
    
    
    
    (9,581
    )Cash and cash equivalents at beginning of the period
    
    
    8,986
    
    
    
    200
    
    
    
    
    10,307Cash and cash equivalents at end of the period
    
    $
    1,463
    
    
    $
    247
    
    
    
    $
    726
 The accompanying notes are an integral part of these financial statements. 7




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (dollars in thousands) Note 1  Basis of Presentation The Condensed Consolidated Financial Statements (unaudited) include the accounts of Specialty
Underwriters Alliance, Inc. (SUA) and its consolidated subsidiary, SUA Insurance Company. SUA
completed an initial public offering (IPO) of its common stock on November 23, 2004. Concurrent
with the IPO, SUA completed the acquisition of Potomac Insurance Company of Illinois (Potomac). For
accounting purposes Potomac is considered an accounting predecessor. Potomac has subsequently been
renamed SUA Insurance Company. The accompanying financial statements have been prepared in conformity with accounting
principles generally accepted in the United States of America (GAAP). Certain financial
information that is normally included in annual financial statements, including certain financial
statements footnotes, prepared in accordance with GAAP, is not required for interim reporting
purposes and has been condensed or omitted. These statements should be read in conjunction with
the consolidated financial statements and notes thereto included in SUAs Form 10-K filed with the
Securities and Exchange Commission for the year ended December 31, 2004. The interim financial data as of March 31, 2005, and for the three months ended March 31, 2005
and for the three months ended March 31, 2004 is unaudited. However, in the opinion of management,
the interim data includes all adjustments, consisting of normal recurring accruals, necessary for a
fair statement of the company results for the interim periods. The results of operation for the
interim periods are not necessarily indicative of the results to be expected for the full year.
Certain reclassifications have been made to prior period financial statement line items to enhance
the comparability of the results presented. The predecessor financial statements of Potomac reflect Potomac as a participant in the One
Beacon Insurance Company (OneBeacon) Amended and Restated Reinsurance Agreement. Under that
agreement Potomac ceded all of its insurance assets and liabilities into a pool (Pool) and assumed
a 0.5% share of the Pools assets and liabilities. On April 1, 2004 Potomac ceased its
participation in the Pool and entered into reinsurance agreements whereby Potomac reinsured all of
its business written with One Beacon effective as of January 1, 2004. As a result, Potomac will
not share in any favorable or unfavorable development of prior losses recorded by it or the Pool
after January 1, 2004, unless One Beacon fails to perform on its reinsurance obligation. 8




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (dollars in thousands) Note 2. Net Loss Per Share Net Loss per share was determined by dividing the net loss by the applicable shares
outstanding (in thousands): Quarter Ended
    
    
    Quarter EndedMarch 31, 2005
    
    
    March 31, 2004Net loss, as reported (unaudited)
    
    $
    (4,492
    )
    
    $
    1,808Average common shares outstanding
(basic and diluted)
    
    
    14,707
    
    
    
    Net Loss Per Share (in dollars)
    
    $
    (0.31
    )
    
    $
    (180,800.00
    )
 Note 3. Income Taxes As of March 31, 2005 and December 31, 2004 the Company had net operating loss carryforwards of
$10,305 and $5,812, respectively. The Company also had, at March 31, 2005 and December 31, 2004,
accumulated start-up and organization expenditures of $2,920 that are deductible over a 60 month
period. These loss carry forwards and start up and organization expenditures generate a potential
asset of $4,497 and $2,969 at March 31, 2005 and December 31, 2004, respectively. The Company has
recorded a full valuation allowance against these tax assets until such time as its operating
results and future outlook produce sufficient taxable income to realize these tax assets. Note 4. Commitments The Company has entered into an arrangement with Syndicated Services Company, Inc. (SSC) for
administrative and operation support. The agreement with SSC, dated November 1, 2003, is for a
term of 26 months. For the 2005 calendar year the Company will pay SSC a fee of approximately
$8,733 in equal monthly installments, commencing January 1, 2005. Either the Company or SSC can
terminate the agreement at any time after October 1, 2005 upon 90 days written notice. On February 3, 2005, the Company entered into a lease agreement for its office space that
commences on May 1, 2005 and terminates on April 30, 2020. The Companys future net lease
obligations are $1,432 for years 1 through 5, $2,374 for years 6 through 10 and $2,686 for years 11
through 15. 9




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NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (dollars in thousands) Note 5. Stock Options The Board of Directors approved the Stock Option Plan during 2004. The Stock Option Plan
authorizes the grant of options to certain personnel for up to 850,000 shares of the Companys
common stock. All options granted have ten-year terms and vest ratably over the three-year period
following the date of grant. The number of shares available for the granting of options under the
Stock Option Plan as of March 31, 2005, was 198,534. The following table presents activity under the Stock Option Plan as of March 31, 2005. WeightedAverageExerciseNumber
    
    
    Price PerOption Plan Activity
    
    of Shares
    
    
    ShareBalance at January 1, 2005
    
    
    624,800
    
    
    $
    9.50Options granted
    
    
    36,666
    
    
    
    9.64Options exercised
    
    
    
    
    
    
    Options forfeited
    
    
    (10,000
    )
    
    
    9.50Balance at March 31, 2005
    
    
    651,466
    
    
    
    9.51Options exercisable at March 31, 2005
    
    
    
    
    
    
    
 The weighted average fair value per share of options granted in the first quarter of 2005 was
$4.23. Pro forma information regarding net income and earnings per share is required by FAS No. 123,
Accounting for Stock-Based Compensation (FAS 123) to reflect net income and earnings per share
under the fair value method. In December 2002, the FASB issued FAS No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure (FAS 148). FAS 148 amends the disclosure
requirements of FAS 123 to require prominent disclosure in both annual and interim financial
statements regarding the method of accounting for stock-based compensation and the effect of the
method used on reported results. In December 2004, the FASB issued FAS No. 123 (revised 2004), Share-Based Payment (FAS
123R). FAS 123R replaces FAS No. 123, Accounting for Stock-Based Compensation (FAS 123) and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). In April
2005, the SEC amended compliance dates for FASB Statement No. 123R on Employee Stock Options to
allow implementation at the beginning of the next fiscal year, instead of the next reporting
period, that begins after June 15, 2005. 10




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##### 



NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (dollars in thousands) March 31, 2005(In thousands ofU.S. dollars,except per shareamounts)Net income (loss) as reported
    
    $
    (4,492
    )Deduct: Compensation expense
    
    
    (238
    )Pro forma net income (loss)
    
    $
    (4,730
    )Basic earnings (loss) per share:As reported
    
    $
    (0.31
    )Pro forma
    
    $
    (0.32
    )Diluted earnings (loss) per share:As reported
    
    $
    (0.31
    )Pro forma
    
    $
    (0.32
    )
 The fair value of options issued is estimated on the date of grant using the binomial lattice
option-pricing model, with the following weighted-average assumptions used for grants as of March
31, 2005: dividend yield of 0% expected for five years beginning 2005 and no more than 2% expected
for five years beginning 2010, expected volatility of 45%, risk free interest rate of 2.71% to
4.30% and an expected life of 5.63 years. Note 6. Intangible Assets Intangible assets consist of the cost of insurance licenses of Potomac, allocated as part of
the purchase, of $10,745. The cost of insurance licenses is an indefinite life intangible asset
because they will remain in effect indefinitely as long as the Company complies with relevant state
insurance regulations. This intangible asset will not be amortized, but will be evaluated for
impairment at least annually. 11




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##### 



NOTES TO FINANCIAL STATEMENTS  SPECIALTY UNDERWRITERS
ALLIANCE, INC. (dollars in thousands) Note 7. Unpaid Loss and Loss Adjustment Expenses Loss and LAE reserves are estimates of amounts needed to pay claims and related expenses in
the future for insured events that have already occurred. The Company establishes estimates of
amounts recoverable from its reinsurers in a manner consistent with the claims liability covered by
the reinsurance contracts, net of an allowance for uncollectible amounts. The Companys loss and
LAE reserves represent managements best estimate of reserves based on a composite of the results
of the various actuarial methods, as well as consideration of known facts and trends. At March 31, 2005 the Company reported gross loss and loss adjustment expense reserves of
$95,832 of which $95,537 represented the gross direct loss and loss adjustment expenses reserves of
Potomac, which was fully reinsured by OneBeacon. At December 31, 2004 the Company reported gross
loss and loss adjustment expense reserves of $95,959, all of which represented the gross direct
loss and loss adjustment expense reserves of Potomac, which was fully reinsured by OneBeacon. 12




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##### 



Item 2: Managements Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of financial condition and results of operations should be
read in conjunction with the companys unaudited financial statement and notes thereto included
elsewhere in this Quarterly Report on Form 10-Q and the annual audited financial statements and
notes thereto included in the Companys Annual Report on Form 10-K for the year ended December 31,
2004 filed with the Securities and Exchange Commission. Certain of the information in this
discussion and analysis includes forward-looking statements that involve risks and uncertainties.
Many factors will cause our actual results to differ materially from those anticipated or implied
by these forward-looking statements. The Company Overview We were formed on April 3, 2003 for the purpose of achieving attractive returns in the
specialty program commercial property and casualty insurance business by using an innovative
business model. Specialty programs typically serve niche groups of insureds that require highly
specialized knowledge of a business class to achieve underwriting profits. This segment has
traditionally been underserved by most standard commercial property and casualty insurers, due to
the complex business knowledge and the investment required to achieve attractive underwriting
profits. Competition in this segment is based primarily on customer service, availability of
insurance capacity, specialized policy forms, efficient claim handling and other value-based
considerations, rather than price. On November 23, 2004 we completed our initial public offering (IPO) and concurrent private
placements and completed the acquisition of Potomac Insurance Company of Illinois (Potomac). Prior to our IPO, all activities consisted of start-up activities related to our IPO and costs
to establish the infrastructure required to commence insurance operations. The historic results of Potomac, our accounting predecessor, reflects Potomacs operations as
a member of the OneBeacon Insurance Company (OneBeacon) inter-company pooling arrangement (Pool),
under which Potomac ceded all of its insurance business into the Pool and assumed 0.5% of the
Pools insurance business. On April 1, 2004, effective January 1, 2004, Potomac ceased its
participation in the Pool and entered into reinsurance agreements whereby it ceded all of its
business to OneBeacon. As a result, Potomac will not share in any favorable or unfavorable
development of prior losses recorded by it or the Pool after January 1, 2004, unless OneBeacon
fails to perform on its reinsurance obligations. 13




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Results of Operations Three Months Ended March 31, 2005 and Three Months Ended March 31, 2004 On January 1, 2005 we commenced our insurance operations. However, due to the lead times
necessary to quote and place business, we did not effectively begin writing policies until March
2005. Gross written premiums for the first quarter were $8,466. Total revenues consisted of
earned premium of $470, investment income of $793 and realized gains of $2. Total expenses were
$5,757 consisting of loss and loss adjustment expense of $471, amortization of deferred acquisition
cost of $100, service company fees of $2,205 and other operating expenses of $2,981. Other
operating expenses include $1,280 of salaries and benefit costs, $600 of professional and
consulting fees, $500 of depreciation and amortization and $601 of other expenses. For the three
months ended March 31, 2005 we reported a net loss of $4,492. For the three months ended March 31, 2004 we reported a net loss of $1,808 as a result of
start up costs while not recording any revenues. Total expenses consisted of financing expenses of
$1,352 and other operating expenses of $456. For the three months ended March 31, 2004, Potomac was still a member of the Pool and reported
net income of $388. Total revenues were $3,214 consisting primarily of earned premiums of $2,752
and investment income and realized gains of $460. Total expenses were $2,617 representing loss and
loss adjustment expenses of $1,721, acquisition and other operating expenses of $846, and $50 of
accretion of loss and loss adjustment expenses to fair value. Net income tax expense was $209. Liquidity and Capital Resources We are organized as a Delaware holding company and, as such, have no direct operations of our
own. Our assets consist primarily of investments in our subsidiary, through which we will conduct
substantially all of our insurance operations. As a holding company, we will have continuing funding needs for general corporate expenses,
the payment of principal and interest on future borrowings, if any, taxes and the payment of other
obligations. Funds to meet these obligations are expected to come primarily from dividends,
interest and other statutorily permissible payments from our operating subsidiary. The ability of
our operating subsidiary to make these payments will be limited by the applicable laws and
regulations of Illinois. There will be restrictions on the payment of dividends by our insurance
subsidiary to us. For the three months ended March 31, 2005 net cash used for operating activities was $4,693
reflecting the initiation of our insurance operations where premiums, investment income and
realized gains were insufficient to cover loss, loss adjustment expenses, acquisition and other
operating expenses. For the three month ended March 31, 2004 our net cash used by operating activities was $278
representing start-up activities. Cash used for investment activities was $250 for an acquisition
deposit paid to OneBeacon for the purchase of Potomac. We also received funds from additional
borrowings of $575. 14




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For the three months ended March 31, 2004 Potomacs net decrease in cash was $9,581. As of March 31, 2005, we had no long-term debt obligations or short-term borrowings. The investment portfolio consists of marketable fixed maturity and short-term investments.
All fixed maturity investments are classified as available for sale and are reported at their
estimated fair value based on quoted market prices. Realized gains and losses are credited or
charged to income in the period in which they are realized. Changes in unrealized gains or losses
are reported as a separate component of comprehensive net income, and accumulated unrealized gains
or losses are reported as a separate component of accumulated other comprehensive net income in
stockholders equity. The aggregate fair market value of our fixed maturity investments at March 31, 2005 was
$84,015 compared to cost of $85,300. The aggregate fair market value of our fixed maturity
investments at December 31, 2004 was $50,465 compared to cost of $50,455. Recent Accounting Pronouncements In December 2004, the FASB issued FAS No. 123 (revised 2004), Share-Based Payment (FAS
123R). FAS 123R replaces FAS No. 123, Accounting for Stock-Based Compensation (FAS 123) and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees (APB 25). In April
2005, the SEC amended compliance dates for FASB Statement No. 123R on Employee Stock Options to
allow implementation at the beginning of the next fiscal year, instead of the next reporting
period, that begins after June 15, 2005. As permitted by FAS 123, we currently account for
share-based payments to employees using APB 25s intrinsic value method and, as such, generally
recognize no compensation expense for employee stock options. Accordingly, the adoption of FAS
123Rs fair value method will have a significant impact on our result of operations, although it
will have no impact on our overall financial position. The impact of adoption of FAS 123R cannot
be predicted at this time because it will depend on levels of share-based payments granted in the
future. However, had we adopted FAS 123R in prior periods, the impact of that standard would have
approximated the impact of FAS 123 as described in the disclosure of pro forma net income and
earnings per share in Note 7 to our consolidated financial statements. FAS 123R also requires the
benefits of tax deductions in excess of recognized compensation expense to be reported as a
financing cash flow, rather than as an operating cash flow as required under current literature.
This requirement will reduce net operating cash flows and increase net financing cash flows in
periods after adoption. While we cannot estimate what those amounts will be in the future (because
they depend on, among other things, when employees exercise stock options), the amount of operating
cash flows recognized in prior periods for such excess tax deductions were zero in 2004, as we had
a net operating loss carry forward in 2004 and have never paid any tax. Commitments On February 3, 2005, we entered into a lease agreement for our office space that commences on
May 1, 2005 and terminates on April 30, 2020. Our future net lease obligations are $1,432 for
years 1 through 5, $2,374 for years 6 through 10 and $2,686 for years 11 through 15. 15




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Item 3: Quantitative and Qualitative Disclosures About Market Risk Market risk can be described as the risk of change in fair value of a financial instrument due
to changes in interest rates, creditworthiness, foreign exchange rates or other factors. We will
seek to mitigate that risk by a number of actions, as described below. Interest Rate Risk Our exposure to market risk for changes in interest rates is concentrated in our investment
portfolio. We expect that changes in investment values attributable to interest rate changes will
be mitigated, however, by corresponding and partially offsetting changes in the economic value of
our insurance reserves to the extent we have established such loss reserves. We will monitor this
exposure through periodic reviews of our consolidated asset and liability positions. We will model
and periodically review estimates of cash flows, as well as the impact of interest rate
fluctuations relating to the investment portfolio and insurance reserves. The table below summarizes the estimated effects of hypothetical increases and decreases in
market interest rates on the Companys fixed maturity portfolio: Estimated
    
    
    After TaxAssumed Change
    
    
    Fair Value After
    
    
    IncreaseFair Value
    
    
    in Relevant
    
    
    Change in
    
    
    (Decrease)dollars in thousands
    
    at 3/31/05
    
    
    Interest Rate
    
    
    Interest Rate
    
    
    in Carrying ValueFixed Maturity
Investments
    
    $
    97,256
    
    
    100 bp decrease
    
    $
    99,168
    
    
    $
    1,91250 bp decrease
    
    $
    97,742
    
    
    $
    48650 bp increase
    
    $
    94,789
    
    
    $
    (2,467
    )100 bp increase
    
    $
    93,292
    
    
    $
    (3,964
    )
 Credit Risk Our portfolio includes primarily fixed income securities and short-term investments, which are
subject to credit risk. This risk is defined as default or the potential loss in market value
resulting from adverse changes in the borrowers ability to repay the debt. In our risk management
strategy and investment policy, we plan to earn competitive relative returns while investing in a
diversified portfolio of securities of high credit quality issuers and to limit the amount of
credit exposure to any one issuer. The portfolio of fixed maturities consists solely of high quality bonds at March 31, 2005 and
December 31, 2004. The following table summarizes bond ratings at Market or Fair value. 16




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##### 



3/31/2005
    
    
    12/31/2004(dollars in thousands)Percent of
    
    
    
    
    
    
    Percent ofMarket Value
    
    
    Portfolio
    
    
    Market Value
    
    
    PortfolioUS Govt & Other Bonds
    
    $
    27,834
    
    
    
    33.1
    %
    
    $
    15,624
    
    
    
    31.0
    %AA Rated
    
    $
    15,938
    
    
    
    19.0
    %
    
    $
    3,917
    
    
    
    8.0
    %A Rated
    
    $
    40,243
    
    
    
    47.9
    %
    
    $
    30,924
    
    
    
    61.0
    %$
    84,015
    
    
    
    100.0
    %
    
    $
    50,465
    
    
    
    100.0
    %
 We also have other receivable amounts subject to credit risk, including reinsurance
recoverables from OneBeacon. To mitigate the risk of counterparties nonpayment of amounts due
under these arrangements, we will establish business and financial standards for reinsurer
approval, incorporating ratings by major rating agencies and considering then-current market
information. 
 Item 4: Controls and Procedures As required by SEC rules 13a-15(b) and 15d-15(b), the Company has evaluated the effectiveness
of the design and operation of its disclosure controls and procedures as of the end of the period
covered by this quarterly report. This evaluation was carried out under the supervision and with
the participation of its management, including its principal executive officer and principal
financial officer. Based on this evaluation, these officers have concluded that the design and
operation of the Companys disclosure controls and procedures are effective. There were no
significant changes to the Companys internal controls or in other factors that occurred during the
three months ended March 31, 2005 that have materially affected, or are reasonably likely to
materially effect, our internal controls over financial reporting. Disclosure controls and procedures are the Companys controls and procedures that are designed
to ensure that information required to be disclosed by it in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported, within the time periods
specified in the SECs rules and forms. Disclosure controls and procedures include, without
limitation, controls and procedures designed to ensure that information required to be disclosed by
it in the reports that it files under the Exchange Act is accumulated and communicated to its
management, including its principal executive officer and principal financial officer, as
appropriate, to allow timely decisions regarding required disclosure. 17




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##### 



PART II  OTHER INFORMATION 
 Item 1: Legal Proceedings None. 
 Item 2: Unregistered
Sales of Equity Securities and Use of Proceeds None. 
 Item 3: Defaults Upon Senior Securities None. 
 Item 4: Submission of Matters to a Vote of Security Holders None. 
 Item 5: Other Information None. 
 Item 6: Exhibits Exhibits: ExhibitNumber
    
    Description31.1
    
    Certification of Courtney C. Smith pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2
    
    Certification of Peter E. Jokiel pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1
    
    Certification of Courtney C. Smith pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 200232.2
    
    Certification of Peter E. Jokiel pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
 18




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##### 



SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the
Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly
authorized. SPECIALTY UNDERWRITERS ALLIANCE, INC.
(Registrant)Dated:  May 16, 2005
    By:
    /s/ Courtney C. SmithName:
    Courtney C. SmithTitle:
    President and Chief Executive Officer Dated:  May 16, 2005
    By:
    /s/ Peter E. JokielName:
    Peter E. JokielTitle:
    Executive Vice President, Chief Financial
Officer and Treasurer 19




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##### 



Exhibits Index ExhibitNumber
    
    Description31.1
    
    Certification of Courtney C. Smith pursuant to Section 302 of the
Sarbanes-Oxley Act of 200231.2
    
    Certification of Peter E. Jokiel pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1
    
    Certification of Courtney C. Smith pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 200232.2
    
    Certification of Peter E. Jokiel pursuant to 18 U.S.C. Section
1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002
 20