##### 



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, 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 000-51130
 
 National Interstate Corporation
 (Exact name of registrant as specified in its charter)
 Ohio
    
    34-1607394(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 
 3250 Interstate Drive
Richfield, Ohio 44286-9000
(330) 659-8900  (Address and telephone number of principal executive offices)
 
 þ o
  o o þ
 o þ




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##### 



National Interstate Corporation
Table of Contents
 PagePart I  Financial Information
    
    
    1Item 1. Financial Statements
    
    
    1Consolidated Balance Sheets
    
    
    1Consolidated Statements of Income
    
    
    2Consolidated Statements of Shareholders Equity
    
    
    3Consolidated Statements of Cash Flows
    
    
    4Notes to Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    11Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    22Item 4. Controls and Procedures
    
    
    22Part 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
    
    
    24




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##### 



PART I  FINANCIAL INFORMATION
 ITEM 1. Financial Statements
 National Interstate Corporation and Subsidiaries
Consolidated Balance Sheets
(In thousands, except per share data)
 September 30,
    
    
    December 31,2006
    
    
    2005(Unaudited)ASSETSInvestments:Fixed maturities available-for-sale, at fair value (amortized cost  $313,588 and $276,929, respectively)
    
    $
    308,260
    
    
    $
    272,578Equity securities available-for-sale, at fair value (cost  $33,042 and $32,017, respectively)
    
    
    33,639
    
    
    
    32,196Short-term investments, at cost which approximates fair value
    
    
    28,816
    
    
    
    7,985Total investments
    
    
    370,715
    
    
    
    312,759Cash and cash equivalents
    
    
    17,600
    
    
    
    7,461Securities lending collateral
    
    
    159,219
    
    
    
    Accrued investment income
    
    
    3,702
    
    
    
    3,172Premiums receivable, net of allowance for doubtful accounts of $478 and $580, respectively
    
    
    93,009
    
    
    
    53,589Reinsurance recoverables on paid and unpaid losses
    
    
    88,901
    
    
    
    77,834Prepaid reinsurance premiums
    
    
    26,471
    
    
    
    17,216Deferred policy acquisition costs
    
    
    15,801
    
    
    
    11,711Deferred federal income taxes
    
    
    10,487
    
    
    
    9,569Property and equipment, net
    
    
    11,448
    
    
    
    11,366Funds held by reinsurer
    
    
    2,201
    
    
    
    3,769Other assets
    
    
    2,436
    
    
    
    14,557Total assets
    
    $
    801,990
    
    
    $
    523,003LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Unpaid losses and loss adjustment expenses
    
    $
    263,033
    
    
    $
    223,207Unearned premiums and service fees
    
    
    138,531
    
    
    
    98,661Long-term debt
    
    
    15,464
    
    
    
    16,297Amounts withheld or retained for account of others
    
    
    26,391
    
    
    
    19,016Reinsurance balances payable
    
    
    10,268
    
    
    
    4,704Securities lending obligation
    
    
    159,219
    
    
    
    Accounts payable and other liabilities
    
    
    16,644
    
    
    
    14,379Commissions payable
    
    
    6,466
    
    
    
    4,730Assessments and fees payable
    
    
    3,289
    
    
    
    2,476Total liabilities
    
    
    639,305
    
    
    
    383,470Shareholders equity:Preferred shares  no par valueAuthorized  10,000 sharesIssued  0 shares
    
    
    
    
    
    
    Common shares  $0.01 par valueAuthorized  50,000 sharesIssued  23,350 shares, including 4,195 and 4,295 shares, respectively, in treasury
    
    
    234
    
    
    
    234Additional paid-in capital
    
    
    43,668
    
    
    
    42,257Retained earnings
    
    
    127,791
    
    
    
    105,826Accumulated other comprehensive loss
    
    
    (3,075
    )
    
    
    (2,712
    )Treasury shares
    
    
    (5,933
    )
    
    
    (6,072
    )Total shareholders equity
    
    
    162,685
    
    
    
    139,533Total liabilities and shareholders equity
    
    $
    801,990
    
    
    $
    523,003
  1




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##### 



National Interstate Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)
(In thousands, except per share data)
 Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenue:Premiums earned
    
    $
    56,619
    
    
    $
    52,866
    
    
    $
    159,363
    
    
    $
    142,466Net investment income
    
    
    4,528
    
    
    
    3,178
    
    
    
    12,703
    
    
    
    8,985Realized gains on investments
    
    
    199
    
    
    
    178
    
    
    
    714
    
    
    
    484Other
    
    
    586
    
    
    
    559
    
    
    
    1,603
    
    
    
    1,474Total revenues
    
    
    61,932
    
    
    
    56,781
    
    
    
    174,383
    
    
    
    153,409Expenses:Losses and loss adjustment expenses
    
    
    38,092
    
    
    
    33,254
    
    
    
    98,426
    
    
    
    87,041Commissions and other underwriting expense
    
    
    11,283
    
    
    
    8,577
    
    
    
    29,982
    
    
    
    25,307Other operating and general expenses
    
    
    2,766
    
    
    
    2,322
    
    
    
    8,865
    
    
    
    6,558Interest expense
    
    
    389
    
    
    
    340
    
    
    
    1,132
    
    
    
    1,063Total expenses
    
    
    52,530
    
    
    
    44,493
    
    
    
    138,405
    
    
    
    119,969Income before federal income taxes
    
    
    9,402
    
    
    
    12,288
    
    
    
    35,978
    
    
    
    33,440Provision for federal income taxes
    
    
    2,859
    
    
    
    4,040
    
    
    
    11,706
    
    
    
    11,082Net income
    
    $
    6,543
    
    
    $
    8,248
    
    
    $
    24,272
    
    
    $
    22,358Net income per common share  basic
    
    $
    0.34
    
    
    $
    0.43
    
    
    $
    1.27
    
    
    $
    1.20Net income per common share  diluted
    
    $
    0.34
    
    
    $
    0.43
    
    
    $
    1.26
    
    
    $
    1.18Weighted average of common shares
outstanding, basic
    
    
    19,146
    
    
    
    18,985
    
    
    
    19,128
    
    
    
    18,634Weighted average of common shares
outstanding, diluted
    
    
    19,354
    
    
    
    19,229
    
    
    
    19,292
    
    
    
    18,885Cash dividends per common share
    
    $
    0.04
    
    
    $
    0.04
    
    
    $
    0.12
    
    
    $
    0.04
 .
 2




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##### 



National Interstate Corporation and Subsidiaries
Consolidated Statements of Shareholders Equity
(Unaudited)
(Dollars in thousands)
 AccumulatedAdditional
    
    
    
    
    
    
    OtherPaid-In
    
    
    Retained
    
    
    Comprehensive
    
    
    TreasuryCommon Stock
    
    
    Capital
    
    
    Earnings
    
    
    Income (Loss)
    
    
    Stock
    
    
    TotalBalance at January 1, 2006
    
    $
    234
    
    
    $
    42,257
    
    
    $
    105,826
    
    
    $
    (2,712
    )
    
    $
    (6,072
    )
    
    $
    139,533Net income
    
    
    
    
    
    
    
    
    
    
    24,272
    
    
    
    
    
    
    
    
    
    
    
    24,272Unrealized depreciation of
investment securities, net of tax
benefit of $196
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (363
    )
    
    
    
    
    
    
    (363
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,909Dividends on common stock
    
    
    
    
    
    
    
    
    
    
    (2,307
    )
    
    
    
    
    
    
    
    
    
    
    (2,307
    )Issuance of 100,000 treasury shares
upon exercise of stock options
    
    
    
    
    
    
    293
    
    
    
    
    
    
    
    
    
    
    
    139
    
    
    
    432Tax benefit realized from exercise
of stock options
    
    
    
    
    
    
    536
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    536Stock compensation expense
    
    
    
    
    
    
    582
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    582Balance at September 30, 2006
    
    $
    234
    
    
    $
    43,668
    
    
    $
    127,791
    
    
    $
    (3,075
    )
    
    $
    (5,933
    )
    
    $
    162,685Balance at January 1, 2005
    
    $
    200
    
    
    $
    1,264
    
    
    $
    77,102
    
    
    $
    539
    
    
    $
    (6,316
    )
    
    $
    72,789Net income
    
    
    
    
    
    
    
    
    
    
    22,358
    
    
    
    
    
    
    
    
    
    
    
    22,358Unrealized depreciation of
investment securities, net of tax
benefit of $1,168
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,169
    )
    
    
    
    
    
    
    (2,169
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,189Proceeds from initial public offering
    
    
    34
    
    
    
    40,357
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    40,391Dividends on common stock
    
    
    
    
    
    
    
    
    
    
    (771
    )
    
    
    
    
    
    
    
    
    
    
    (771
    )Issuance of 143,900 treasury shares
upon exercise of stock options
    
    
    
    
    
    
    26
    
    
    
    (16
    )
    
    
    
    
    
    
    200
    
    
    
    210Tax benefit realized from exercise
of stock options
    
    
    
    
    
    
    418
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    418Balance at September 30, 2005
    
    $
    234
    
    
    $
    42,065
    
    
    $
    98,673
    
    
    $
    (1,630
    )
    
    $
    (6,116
    )
    
    $
    133,226
  3




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##### 



National Interstate Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
 Nine Months endedSeptember 30,2006
    
    
    2005Operating activitiesNet income
    
    $
    24,272
    
    
    $
    22,358Adjustments to reconcile net income to net cash provided by operating activities:Net amortization of bond premiums and discounts
    
    
    185
    
    
    
    706Provision for depreciation and amortization
    
    
    827
    
    
    
    898Net realized gains on investment securities
    
    
    (714
    )
    
    
    (484
    )Deferred federal income taxes
    
    
    (689
    )
    
    
    (1,513
    )Tax benefit realized from exercise of stock options
    
    
    
    
    
    
    418Stock compensation expense
    
    
    582
    
    
    
    Increase in deferred policy acquisition costs, net
    
    
    (4,115
    )
    
    
    (2,723
    )Increase in reserves for losses and loss adjustment expenses
    
    
    37,647
    
    
    
    42,652Increase in premiums receivable
    
    
    (38,404
    )
    
    
    (38,018
    )Increase in unearned premiums and service fees
    
    
    39,870
    
    
    
    46,832Decrease (increase) in interest receivable and other assets
    
    
    1,819
    
    
    
    (1,883
    )Increase in prepaid reinsurance premiums
    
    
    (9,255
    )
    
    
    (11,332
    )Increase (decrease) in accounts payable, commissions and other liabilities
and assessments and fees payable
    
    
    4,022
    
    
    
    (2,484
    )Increase in amounts withheld or reatined for account of others
    
    
    7,072
    
    
    
    4,128Increase in reinsurance recoverable
    
    
    (11,009
    )
    
    
    (10,884
    )Increase in reinsurance balances payable
    
    
    5,564
    
    
    
    6,447Other
    
    
    2
    
    
    
    (4
    )Net cash provided by operating activities
    
    
    57,676
    
    
    
    55,114Investing activitiesPurchases of fixed maturities
    
    
    (57,095
    )
    
    
    (104,072
    )Purchases of equity securities
    
    
    (44,864
    )
    
    
    (36,645
    )Proceeds from sale of fixed maturities
    
    
    1,917
    
    
    
    17,101Proceeds from sale of equity securities
    
    
    23,213
    
    
    
    11,810Proceeds from maturity of investments
    
    
    27,983
    
    
    
    35,920Additional cash paid for purchase of subsidiary
    
    
    (1,246
    )
    
    
    Cash and cash equivalents of business acquired
    
    
    5,585
    
    
    
    Capital expenditures
    
    
    (858
    )
    
    
    (447
    )Net cash used in investing activities
    
    
    (45,365
    )
    
    
    (76,333
    )Financing activitiesProceeds from issuance of common shares
    
    
    
    
    
    
    40,391Repayment of note payable to affiliate
    
    
    
    
    
    
    (15,000
    )Repayment of long-term debt
    
    
    (833
    )
    
    
    (937
    )Increase in securities lending collateral
    
    
    (159,219
    )
    
    
    Increase in securities lending obligation
    
    
    159,219
    
    
    
    Tax benefit realized from exercise of stock options
    
    
    536
    
    
    
    Issuance of common shares from treasury upon exercise of stock options
    
    
    432
    
    
    
    210Cash dividends paid on common shares
    
    
    (2,307
    )
    
    
    (771
    )Net cash (used in) provided by financing activities
    
    
    (2,172
    )
    
    
    23,893Net increase in cash and cash equivalents
    
    
    10,139
    
    
    
    2,674Cash and cash equivalents at beginning of period
    
    
    7,461
    
    
    
    15,869Cash and cash equivalents at end of period
    
    $
    17,600
    
    
    $
    18,543
  4




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##### 



NATIONAL INTERSTATE CORPORATION AND SUBSIDIARIES
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 1. Basis of Presentation
     2. Recent Accounting Pronouncements
 Accounting for Certain Hybrid Instruments
 Accounting for Certain Hybrid Financial Instruments
 Accounting for Uncertainty in Income Taxes
 Accounting for Uncertainty in
Income Taxes
 Fair Value Measurements
 Fair Value Measurements
 5




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##### 



3. Securities Lending
  4. Stock-Based Compensation
 Accounting for
Stock Issued to Employees Accounting for Stock-Based
Compensation
    6




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##### 



For the Three Months Ended
    
    
    For the Nine Months EndedSeptember 30, 2005
    
    
    September 30, 2005Pro forma
    
    
    
    
    
    
    
    
    
    
    Pro formaAs
    
    
    Stock Based
    
    
    
    
    
    
    As
    
    
    Stock BasedReported
    
    
    Compensation Expense
    
    
    Pro forma
    
    
    Reported
    
    
    Compensation Expense
    
    
    Pro forma(In thousands, except per share)
    
    
    (In thousands, except per share)Income before income taxes
    
    $
    12,288
    
    
    $
    (385
    )
    
    $
    11,903
    
    
    $
    33,440
    
    
    $
    (890
    )
    
    $
    32,550Income taxes
    
    
    4,040
    
    
    
    (44
    )
    
    
    3,996
    
    
    
    11,082
    
    
    
    (97
    )
    
    
    10,985Net Income
    
    $
    8,248
    
    
    $
    (341
    )
    
    $
    7,907
    
    
    $
    22,358
    
    
    $
    (793
    )
    
    $
    21,565Basic earnings per share
    
    $
    0.43
    
    
    $
    (0.01
    )
    
    $
    0.42
    
    
    $
    1.20
    
    
    $
    (0.04
    )
    
    $
    1.16Diluted earnings per share
    
    
    0.43
    
    
    
    (0.02
    )
    
    
    0.41
    
    
    
    1.18
    
    
    
    (0.04
    )
    
    
    1.14
   Nine months ended September 30, 2006Total options outstandingWeighted
    
    
    Weighted
    
    
    WeightedAverage
    
    
    Average
    
    
    AverageExercise
    
    
    Fair
    
    
    RemainingShares
    
    
    Price
    
    
    Value
    
    
    Contractual TermOptions outstanding, beginning of period
    
    
    785,000
    
    
    $
    12.43
    
    
    $
    5.58Forfeited
    
    
    (116,000
    )
    
    
    12.85
    
    
    
    5.98Exercised
    
    
    (100,000
    )
    
    
    4.32
    
    
    
    1.98Granted
    
    
    100,000
    
    
    
    22.13
    
    
    
    8.71Options outstanding, end of period
    
    
    669,000
    
    
    $
    15.02
    
    
    $
    6.51
    
    
    7.3 yearsOptions exercisable, end of period
    
    
    69,200
    
    
    $
    10.28
    
    
    $
    4.95
    
    
    4.6 years
  Three months ended September 30,
    
    Nine months ended September 30,2006
    
    2005
    
    2006
    
    2005Risk-free interest rate
    
    
    N/A
    
    
    
    4.2
    %
    
    
    4.7
    %
    
    
    4.2
    %Expected option life
    
    
    N/A
    
    
    7.4 years
    
    6.7 years
    
    9.1 yearsExpected stock price volatility
    
    
    N/A
    
    
    
    31.0
    %
    
    
    29.6
    %
    
    
    31.0
    %Dividend yield
    
    
    N/A
    
    
    
    0.3
    %
    
    
    0.3
    %
    
    
    0.3
    %Weighted average fair value of
options granted during period
    
    
    N/A
    
    
    $
    8.26
    
    
    $
    8.71
    
    
    $
    7.20
 
 N/A  There were no options granted in the third quarter of 2006. 7




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##### 



2007
    
    $
    7842008
    
    
    7842009
    
    
    7842010
    
    
    4282011
    
    
    61
 5. Premiums, Reinsurance and Transactions with Related Parties
   Three months ended September 30,
    
    Nine months ended September 30,2006
    
    2005
    
    2006
    
    2005(Dollars in thousands)
    
    (Dollars in thousands)Written premiums assumed
    
    $
    1,418
    
    
    $
    2,139
    
    
    $
    7,094
    
    
    $
    7,290Assumed premiums earned
    
    
    2,371
    
    
    
    2,353
    
    
    
    7,051
    
    
    
    6,876Assumed losses and loss adjustment
expense incurred
    
    
    1,768
    
    
    
    1,596
    
    
    
    5,371
    
    
    
    5,146Payable to Great American as of period end
    
    
    947
    
    
    
    1,099
    
    
    
    947
    
    
    
    1,099
   Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Written
    
    
    Earned
    
    
    Written
    
    
    Earned
    
    
    Written
    
    
    Earned
    
    
    Written
    
    
    Earned(Dollars in thousands)
    
    
    (Dollars in thousands)Direct
    
    $
    59,924
    
    
    $
    68,697
    
    
    $
    50,342
    
    
    $
    62,758
    
    
    $
    234,631
    
    
    $
    193,652
    
    
    $
    220,050
    
    
    $
    174,507Assumed
    
    
    1,803
    
    
    
    2,971
    
    
    
    6,643
    
    
    
    5,662
    
    
    
    9,362
    
    
    
    9,611
    
    
    
    12,648
    
    
    
    11,362Ceded
    
    
    (10,705
    )
    
    
    (15,049
    )
    
    
    (9,936
    )
    
    
    (15,554
    )
    
    
    (54,042
    )
    
    
    (43,900
    )
    
    
    (54,746
    )
    
    
    (43,403
    )Net Premium
    
    $
    51,022
    
    
    $
    56,619
    
    
    $
    47,049
    
    
    $
    52,866
    
    
    $
    189,951
    
    
    $
    159,363
    
    
    $
    177,952
    
    
    $
    142,466
 8




---



##### 



6. Commitments and Contingencies
    7. Earnings Per Common Share
  Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands, except per share)
    
    
    (In thousands, except per share)Net income
    
    $
    6,543
    
    
    $
    8,248
    
    
    $
    24,272
    
    
    $
    22,358Weighted average shares outstanding
during period
    
    
    19,146
    
    
    
    18,985
    
    
    
    19,128
    
    
    
    18,634Additional shares issuable under
employee common stock
option plans using treasury stock method
    
    
    208
    
    
    
    244
    
    
    
    164
    
    
    
    251Weighted average shares outstanding
assuming exercise of
stock option
    
    
    19,354
    
    
    
    19,229
    
    
    
    19,292
    
    
    
    18,885Net income per share:Basic
    
    $
    0.34
    
    
    $
    0.43
    
    
    $
    1.27
    
    
    $
    1.20Diluted
    
    
    0.34
    
    
    
    0.43
    
    
    
    1.26
    
    
    
    1.18
  8. Segment Information
  9




---



##### 



Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(Dollars in thousands)
    
    
    (Dollars in thousands)Revenue:Premiums earned:Alternative Risk
Transfer
    
    $
    21,111
    
    
    $
    16,603
    
    
    $
    54,393
    
    
    $
    43,620Transportation
    
    
    17,800
    
    
    
    18,430
    
    
    
    53,460
    
    
    
    52,013Specialty Personal Lines
    
    
    11,981
    
    
    
    10,195
    
    
    
    34,245
    
    
    
    28,280Hawaii and Alaska
    
    
    3,964
    
    
    
    3,711
    
    
    
    11,201
    
    
    
    11,599Other
    
    
    1,763
    
    
    
    3,927
    
    
    
    6,064
    
    
    
    6,954Total premiums earned
    
    
    56,619
    
    
    
    52,866
    
    
    
    159,363
    
    
    
    142,466Net investment income
    
    
    4,528
    
    
    
    3,178
    
    
    
    12,703
    
    
    
    8,985Realized gains on
investments
    
    
    199
    
    
    
    178
    
    
    
    714
    
    
    
    484Other
    
    
    586
    
    
    
    559
    
    
    
    1,603
    
    
    
    1,474Total revenues
    
    $
    61,932
    
    
    $
    56,781
    
    
    $
    174,383
    
    
    $
    153,409
 9. Comprehensive Income
  10. Acquisition of Company
    11. Fixed Assets
  12. Subsequent Event
  10




---



##### 



ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
 Forward-Looking Statements
  
    
    general economic conditions and other factors, including prevailing interest
rate levels and stock and credit market performance which may affect (among other things)
our ability to sell our products, our ability to access capital resources and the costs
associated with such access to capital and the market value of our investments;
    
    customer response to new products and marketing initiatives;
    
    tax law changes;
    
    increasing competition in the sale of our insurance products and services and the retention of existing customers;
    
    changes in legal environment;
    
    regulatory changes or actions, including those relating to regulation of the
sale, underwriting and pricing of insurance products and services and capital requirements;
    
    levels of natural catastrophes, terrorist events, incidents of war and other major losses;
    
    adequacy of insurance reserves; and
    
    availability of reinsurance and ability of reinsurers to pay their obligations.
  General
    11




---



##### 



Results of Operations
 Overview
   Underwriting and Loss Ratio Analysis
 Gross Written Premium
  Three months ended September 30,2006
    
    
    2005Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Alternative Risk
Transfer
    
    $
    17,561
    
    
    
    28.4
    %
    
    $
    9,851
    
    
    
    17.3
    %Transportation
    
    
    24,159
    
    
    
    39.2
    %
    
    
    26,623
    
    
    
    46.7
    %Specialty Personal
Lines
    
    
    12,230
    
    
    
    19.8
    %
    
    
    10,951
    
    
    
    19.2
    %Hawaii and Alaska
    
    
    6,872
    
    
    
    11.1
    %
    
    
    5,686
    
    
    
    10.0
    %Other
    
    
    905
    
    
    
    1.5
    %
    
    
    3,874
    
    
    
    6.8
    %Gross premiums written
    
    $
    61,727
    
    
    
    100.0
    %
    
    $
    56,985
    
    
    
    100.0
    %
 Nine months ended September 30,2006
    
    
    2005Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Alternative Risk Transfer
    
    $
    112,853
    
    
    
    46.3
    %
    
    $
    100,712
    
    
    
    43.3
    %Transportation
    
    
    67,419
    
    
    
    27.6
    %
    
    
    72,202
    
    
    
    31.0
    %Specialty Personal
Lines
    
    
    41,059
    
    
    
    16.8
    %
    
    
    35,989
    
    
    
    15.5
    %Hawaii and Alaska
    
    
    18,536
    
    
    
    7.6
    %
    
    
    17,845
    
    
    
    7.7
    %Other
    
    
    4,126
    
    
    
    1.7
    %
    
    
    5,950
    
    
    
    2.5
    %Gross premiums written
    
    $
    243,993
    
    
    
    100.0
    %
    
    $
    232,698
    
    
    
    100.0
    %
  12




---



##### 



Net Earned Premium
 Three months ended September 30, 2006 compared to September 30, 2005.
 Three months ended September 30,
    
    
    Change2006
    
    
    2005
    
    
    Amount
    
    
    Percent(Dollars in thousands)Revenue:Premiums earned:Alternative Risk
Transfer
    
    $
    21,111
    
    
    $
    16,603
    
    
    $
    4,508
    
    
    
    27.2
    %Transportation
    
    
    17,800
    
    
    
    18,430
    
    
    
    (630
    )
    
    
    (3.4
    %)Specialty Personal Lines
    
    
    11,981
    
    
    
    10,195
    
    
    
    1,786
    
    
    
    17.5
    %Hawaii and Alaska
    
    
    3,964
    
    
    
    3,711
    
    
    
    253
    
    
    
    6.8
    %Other
    
    
    1,763
    
    
    
    3,927
    
    
    
    (2,164
    )
    
    
    (55.1
    %)Total premiums earned
    
    $
    56,619
    
    
    $
    52,866
    
    
    $
    3,753
    
    
    
    7.1
    %
 13




---



##### 



Nine months ended September 30, 2006 compared to September 30, 2005.
 Nine months ended September 30,
    
    
    Change2006
    
    
    2005
    
    
    Amount
    
    
    Percent(Dollars in thousands)Revenue:Premiums earned:Alternative Risk Transfer
    
    $
    54,393
    
    
    $
    43,620
    
    
    $
    10,773
    
    
    
    24.7
    %Transportation
    
    
    53,460
    
    
    
    52,013
    
    
    
    1,447
    
    
    
    2.8
    %Specialty Personal Lines
    
    
    34,245
    
    
    
    28,280
    
    
    
    5,965
    
    
    
    21.1
    %Hawaii and Alaska
    
    
    11,201
    
    
    
    11,599
    
    
    
    (398
    )
    
    
    (3.4
    %)Other
    
    
    6,064
    
    
    
    6,954
    
    
    
    (890
    )
    
    
    (12.8
    %)Total premiums earned
    
    $
    159,363
    
    
    $
    142,466
    
    
    $
    16,897
    
    
    
    11.9
    %
  Underwriting and Loss Ratio Analysis
  14




---



##### 



Three months ended September 30,
    
    
    Nine months ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(Dollars in thousands)
    
    
    (Dollars in thousands)Gross premiums written
    
    $
    61,727
    
    
    $
    56,985
    
    
    $
    243,993
    
    
    $
    232,698Ceded reinsurance
    
    
    (10,705
    )
    
    
    (9,936
    )
    
    
    (54,042
    )
    
    
    (54,746
    )Net premiums written
    
    
    51,022
    
    
    
    47,049
    
    
    
    189,951
    
    
    
    177,952Change in unearned premiums, net of ceded
    
    
    5,597
    
    
    
    5,817
    
    
    
    (30,588
    )
    
    
    (35,486
    )Net earned premiums
    
    $
    56,619
    
    
    $
    52,866
    
    
    $
    159,363
    
    
    $
    142,466Combined Ratios:Loss and LAE ratio (1)
    
    
    67.3
    %
    
    
    62.9
    %
    
    
    61.8
    %
    
    
    61.1
    %Underwriting expense ratio (2)
    
    
    23.8
    %
    
    
    19.6
    %
    
    
    23.4
    %
    
    
    21.3
    %Combined ratio
    
    
    91.1
    %
    
    
    82.5
    %
    
    
    85.2
    %
    
    
    82.4
    %
 
 (1)
    
    The ratio of losses and loss adjustment expenses to premiums earned.(2)
    
    The ratio of the sum of commissions and other underwriting expenses and other operating
expenses less other income to premiums earned. Three months ended September 30, 2006 compared to September 30, 2005.
  Nine months ended September 30, 2006 compared to September 30, 2005.
  15




---



##### 



Investment Income
 2006 compared to 2005.
 Realized Gains (Losses) on Investments
 2006 compared to 2005.
 Other Operating and General Expenses
 2006 compared to 2005.
 Income Taxes
  Financial Condition
 Investments
   16




---



##### 



Securities with
    
    Securities withUnrealized
    
    UnrealizedGains
    
    Losses(Dollars in thousands)Fixed Maturities:Fair value of securities
    
    $
    73,580
    
    
    $
    234,680Amortized cost of securities
    
    $
    72,905
    
    
    $
    240,683Gross unrealized gain or (loss)
    
    $
    675
    
    
    $
    (6,003
    )Fair value as a percent of amortized cost
    
    
    100.9
    %
    
    
    97.5
    %Number of security positions held
    
    
    142
    
    
    
    238Number individually exceeding $50,000 gain or (loss)
    
    
    1
    
    
    
    19Concentration of gains or losses by type or industry:US Government and government agencies
    
    $
    300
    
    
    $
    (3,925
    )State, municipalities, and political subdivisions
    
    
    201
    
    
    
    (266
    )Banks, insurance, and brokers
    
    
    107
    
    
    
    (1,603
    )Electric services
    
    
    
    
    
    
    (14
    )Industrial and other
    
    
    67
    
    
    
    (195
    )Percentage rated investment grade (1)
    
    
    97.9
    %
    
    
    100.0
    %Equity Securities:Fair value of securities
    
    $
    24,420
    
    
    $
    9,219Cost of securities
    
    $
    23,638
    
    
    $
    9,404Gross unrealized gain or (loss)
    
    $
    782
    
    
    $
    (185
    )Fair value as percent of cost
    
    
    103.3
    %
    
    
    98.0
    %Number individually exceeding $50,000 gain or (loss)
    
    
    5
    
    
    
    
 
 (1)
    
    Investment grade of AAA to BBB by Standard & Poors Corporation.  Securities with
    
    Securities withUnrealized
    
    UnrealizedGains
    
    LossesMaturity:One year or less
    
    
    6.0
    %
    
    
    6.3
    %After one year through five years
    
    
    51.1
    %
    
    
    43.5
    %After five years through ten years
    
    
    32.8
    %
    
    
    41.6
    %After ten years
    
    
    10.1
    %
    
    
    8.6
    %100.0
    %
    
    
    100.0
    %
 17




---



##### 



September 30, 2006Aggregate
    
    
    Fair Value asAggregate
    
    
    Unrealized
    
    
    % of CostFair Value
    
    
    Gain/Loss
    
    
    Basis(Dollars in thousands)Fixed Maturities:Securities with unrealized gains:Exceeding $50,000 and for:Less than one year (1 issue)
    
    $
    791
    
    
    $
    56
    
    
    
    107.6
    %More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (141 issues)
    
    
    72,789
    
    
    
    619
    
    
    
    100.9
    %$
    73,580
    
    
    $
    675Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (13 issues)
    
    $
    18,476
    
    
    $
    (2,670
    )
    
    
    87.4
    %More than one year (6 issue)
    
    
    14,296
    
    
    
    (678
    )
    
    
    95.5
    %Less than $50,000 (219 issues)
    
    
    201,908
    
    
    
    (2,655
    )
    
    
    98.7
    %$
    234,680
    
    
    $
    (6,003
    )Equity Securities:Securities with unrealized gains:Exceeding $50,000 and for:Less than one year (4 issues)
    
    $
    4,331
    
    
    $
    268
    
    
    
    106.6
    %More than one year (1 issue)
    
    
    79
    
    
    
    53
    
    
    
    303.8
    %Less than $50,000 (46 issues)
    
    
    20,010
    
    
    
    461
    
    
    
    102.4
    %$
    24,420
    
    
    $
    782Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (0 issues)
    
    $
    
    
    
    $
    More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (21 issues)
    
    
    9,219
    
    
    
    (185
    )
    
    
    98.0
    %$
    9,219
    
    
    $
    (185
    )
  Premiums and Reinsurance
    18




---



##### 



Liquidity and Capital Resources
            19




---



##### 



st
  Critical Accounting Policies
  Losses and Loss Adjustment Expense (LAE) Reserves
   
    
    the Case Incurred Development Method;
    
    the Paid Development Method;
    
    the Bornhuetter-Ferguson Method; and
    
    the Incremental Paid LAE to Paid Loss Methods.
  
    
    open and closed claim counts;
 20




---



##### 




    
    average case reserves and average incurred on open claims;
    
    closure rates and statistics related to closed and open claim percentages;
    
    average closed claim severity;
    
    ultimate claim severity;
    
    reported loss ratios;
    
    projected ultimate loss ratios; and
    
    loss payment patterns.
 Other-Than-Temporary Impairment
  
    
    the length of time and the extent to which the market value has been below amortized cost;
    
    whether the issuer is experiencing significant financial difficulties;
    
    economic stability of an entire industry sector or subsection;
    
    whether the issuer, series of issuers or industry has a catastrophic type of loss;
    
    the extent to which the unrealized loss is credit-driven or a result of changes in market interest rates;
    
    historical operating, balance sheet and cash flow data;
    
    internally generated financial models and forecasts;
    
    our ability and intent to hold the investment for a period of time sufficient to
allow for any anticipated recovery in market value; and
    
    other subjective factors, including concentrations and information obtained from
regulators and rating agencies.
  Contractual Obligations/ Off-Balance Sheet Arrangements
  21




---



##### 



ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
  ITEM 4. Controls and Procedures
   PART
II  OTHER INFORMATION
 ITEM 1. Legal Proceedings
  ITEM 1A. Risk Factors.
  ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
  ITEM 3. Defaults Upon Senior Securities
  ITEM 4. Submission of Matters to a Vote of Security Holders
  ITEM 5. Other Information
   22




---



##### 



ITEM 6. Exhibits
 Exhibit No.
    
    Exhibit Description3.1
    
    Amended and Restated Articles of Incorporation (1)3.2
    
    Amended and Restated Code of Regulations (1)10.1
    
    National Interstate Corporation Management Bonus Plan31.1
    
    Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934, as amended, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 200231.2
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of
1934, as amended, as adopted pursuant to Section 302 of
the Sarbanes-Oxley Act of 200232.1
    
    Certification of Chief Executive Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002
 
 (1)
    
    These exhibits are incorporated by reference to our Registration Statement
on Form S-1, as amended (Registration No. 333-119270) filed on November 12,
2004. 23




---



##### 



SIGNATURES
  NATIONAL INTERSTATE CORPORATIONDate: November 7, 2006
    
    /s/ Alan R. SpachmanAlan R. SpachmanChairman of the Board and President
(Duly Authorized Officer and Principal Executive Officer)Date: November 7, 2006
    
    /s/ Julie A. McGrawJulie A. McGrawVice President and Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer) 24