##### 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 000-51130
 
 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
    
    
    10Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    21Item 4. Controls and Procedures
    
    
    21Part II  Other Information
    
    
    21Item 1. Legal Proceedings
    
    
    21Item 1A . Risk Factors
    
    
    21Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    21Item 3. Defaults Upon Senior Securities
    
    
    21Item 4. Submission of Matters to a Vote of Security Holders
    
    
    22Item 5. Other Information
    
    
    22Item 6. Exhibits
    
    
    22Signatures
    
    
    23EX-31.1EX-31.2EX-32.1EX-32.2




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 ITEM 1. Financial Statements
 National Interstate Corporation and Subsidiaries
 
 Consolidated Balance Sheets
 (In thousands, except per share data)
 June 30,
    
    
    December 31,2006
    
    
    2005(Unaudited)ASSETSInvestments:Fixed maturities available-for-sale, at fair value (amortized cost  $312,861 and
$276,929, respectively)
    
    $
    302,381
    
    
    $
    272,578Equity securities available-for-sale, at fair value (cost  $29,819 and $32,017, respectively)
    
    
    29,236
    
    
    
    32,196Short-term investments, at cost which approximates fair value
    
    
    23,365
    
    
    
    7,985Total investments
    
    
    354,982
    
    
    
    312,759Cash and cash equivalents
    
    
    11,017
    
    
    
    7,461Accrued investment income
    
    
    3,754
    
    
    
    3,172Premiums receivable, net of allowance for doubtful accounts of $455 and $580, respectively
    
    
    98,731
    
    
    
    53,589Reinsurance recoverables on paid and unpaid losses
    
    
    87,599
    
    
    
    77,834Prepaid reinsurance premiums
    
    
    30,760
    
    
    
    17,216Deferred policy acquisition costs
    
    
    15,888
    
    
    
    11,711Deferred federal income taxes
    
    
    12,556
    
    
    
    9,569Property and equipment, net
    
    
    11,411
    
    
    
    11,366Funds held by reinsurer
    
    
    1,978
    
    
    
    3,769Other assets
    
    
    1,216
    
    
    
    14,557Total assets
    
    $
    629,892
    
    
    $
    523,003LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Unpaid losses and loss adjustment expenses
    
    $
    249,529
    
    
    $
    223,207Unearned premiums and service fees
    
    
    148,380
    
    
    
    98,661Long-term debt
    
    
    15,672
    
    
    
    16,297Amounts withheld or retained for account of others
    
    
    22,520
    
    
    
    19,016Reinsurance balances payable
    
    
    15,312
    
    
    
    4,704Accounts payable and other liabilities
    
    
    15,841
    
    
    
    14,379Commissions payable
    
    
    7,144
    
    
    
    4,730Assessments and fees payable
    
    
    3,032
    
    
    
    2,476Total liabilities
    
    
    477,430
    
    
    
    383,470Shareholders equity:Preferred shares  no par valueAuthorized  10,000 sharesIssued  0 sharesCommon stock  $0.01 par valueAuthorized  50,000 sharesIssued  23,350 shares, including 4,205 and 4,295
shares, respectively, in treasury
    
    
    234
    
    
    
    234Additional paid-in capital
    
    
    43,350
    
    
    
    42,257Retained earnings
    
    
    122,016
    
    
    
    105,826Accumulated other comprehensive loss
    
    
    (7,191
    )
    
    
    (2,712
    )Treasury stock
    
    
    (5,947
    )
    
    
    (6,072
    )Total shareholders equity
    
    
    152,462
    
    
    
    139,533Total liabilities and shareholders equity
    
    $
    629,892
    
    
    $
    523,003
  1




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##### Table of Contents



National Interstate Corporation and Subsidiaries
 
 Consolidated Statements of Income
 (Unaudited)
 (In thousands, except per share data)
 Three months ended June 30,
    
    
    Six months ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Revenue:Premiums earned
    
    $
    52,429
    
    
    $
    46,423
    
    
    $
    102,744
    
    
    $
    89,600Net investment income
    
    
    4,276
    
    
    
    3,140
    
    
    
    8,175
    
    
    
    5,807Realized gains on investments
    
    
    145
    
    
    
    191
    
    
    
    515
    
    
    
    306Other
    
    
    540
    
    
    
    407
    
    
    
    1,017
    
    
    
    915Total revenues
    
    
    57,390
    
    
    
    50,161
    
    
    
    112,451
    
    
    
    96,628Expenses:Losses and loss adjustment expenses
    
    
    30,438
    
    
    
    27,720
    
    
    
    60,334
    
    
    
    53,787Commissions and other underwriting expense
    
    
    9,934
    
    
    
    9,478
    
    
    
    18,699
    
    
    
    16,730Other operating and general expenses
    
    
    3,306
    
    
    
    2,252
    
    
    
    6,099
    
    
    
    4,236Interest expense
    
    
    379
    
    
    
    322
    
    
    
    743
    
    
    
    723Total expenses
    
    
    44,057
    
    
    
    39,772
    
    
    
    85,875
    
    
    
    75,476Income before federal income taxes
    
    
    13,333
    
    
    
    10,389
    
    
    
    26,576
    
    
    
    21,152Provision for federal income taxes
    
    
    4,330
    
    
    
    3,434
    
    
    
    8,847
    
    
    
    7,042Net income
    
    $
    9,003
    
    
    $
    6,955
    
    
    $
    17,729
    
    
    $
    14,110Net income per common share  basic
    
    $
    0.47
    
    
    $
    0.37
    
    
    $
    0.93
    
    
    $
    0.76Net income per common share  diluted
    
    $
    0.47
    
    
    $
    0.36
    
    
    $
    0.92
    
    
    $
    0.75Weighted average of common shares outstanding, basic
    
    
    19,136
    
    
    
    18,965
    
    
    
    19,119
    
    
    
    18,456Weighted average of common shares outstanding, diluted
    
    
    19,279
    
    
    
    19,223
    
    
    
    19,271
    
    
    
    18,710Cash dividends per common share
    
    $
    0.04
    
    
    $
    
    
    
    $
    0.08
    
    
    $
    
 .
 2




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##### Table of Contents



National Interstate Corporation and Subsidiaries
 
 Consolidated Statements of Shareholders Equity
 (Unaudited)
 (Dollars in thousands)
 AccumulatedAdditional
    
    
    
    
    
    
    OtherCommon
    
    
    Paid-In
    
    
    Retained
    
    
    Comprehensive
    
    
    TreasuryStock
    
    
    Capital
    
    
    Earnings
    
    
    Income (Loss)
    
    
    Stock
    
    
    TotalBalance at January 1, 2006
    
    $
    234
    
    
    $
    42,257
    
    
    $
    105,826
    
    
    $
    (2,712
    )
    
    $
    (6,072
    )
    
    $
    139,533Net income
    
    
    
    
    
    
    
    
    
    
    17,729
    
    
    
    
    
    
    
    
    
    
    
    17,729Unrealized depreciation of investment securities,
net of tax benefit of $2,412
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4,479
    )
    
    
    
    
    
    
    (4,479
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,250Dividends on common stock
    
    
    
    
    
    
    
    
    
    
    (1,539
    )
    
    
    
    
    
    
    
    
    
    
    (1,539
    )Issuance of 90,000 treasury shares upon exercise of
stock options
    
    
    
    
    
    
    171
    
    
    
    
    
    
    
    
    
    
    
    125
    
    
    
    296Tax benefit realized from exercise of stock options
    
    
    
    
    
    
    523
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    523Stock compensation expense
    
    
    
    
    
    
    399
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    399Balance at June 30, 2006
    
    $
    234
    
    
    $
    43,350
    
    
    $
    122,016
    
    
    $
    (7,191
    )
    
    $
    (5,947
    )
    
    $
    152,462Balance at January 1, 2005
    
    $
    200
    
    
    $
    1,264
    
    
    $
    77,102
    
    
    $
    539
    
    
    $
    (6,316
    )
    
    $
    72,789Net income
    
    
    
    
    
    
    
    
    
    
    14,110
    
    
    
    
    
    
    
    
    
    
    
    14,110Unrealized depreciation of investment securities,
net of tax benefit of $325
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (604
    )
    
    
    
    
    
    
    (604
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,506Proceeds from initial public offering
    
    
    34
    
    
    
    40,357
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    40,391Issuance of 85,600 treasury shares upon exercise
of stock
options
    
    
    
    
    
    
    33
    
    
    
    (16
    )
    
    
    
    
    
    
    119
    
    
    
    136Tax benefit realized from exercise of stock options
    
    
    
    
    
    
    93
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93Balance at June 30, 2005
    
    $
    234
    
    
    $
    41,747
    
    
    $
    91,196
    
    
    $
    (65
    )
    
    $
    (6,197
    )
    
    $
    126,915
  3




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##### Table of Contents



National Interstate Corporation and Subsidiaries
 
 Consolidated Statements of Cash Flows
 (Unaudited)
 (Dollars in thousands)
 Six months endedJune 30,2006
    
    
    2005Operating activitiesNet income
    
    $
    17,729
    
    
    $
    14,110Adjustments to reconcile net income to net cash provided by operating activities:Net amortization of bond premiums and discounts
    
    
    107
    
    
    
    423Provision for depreciation and amortization
    
    
    579
    
    
    
    593Net realized gains on investment securities
    
    
    (515
    )
    
    
    (306
    )Tax benefit realized from exercise of stock options
    
    
    523
    
    
    
    93Deferred federal income taxes
    
    
    (542
    )
    
    
    (2,197
    )Stock compensation expense
    
    
    399
    
    
    
    Increase in deferred policy acquisition costs, net
    
    
    (4,202
    )
    
    
    (2,853
    )Increase in reserves for losses and loss adjustment expenses
    
    
    24,143
    
    
    
    26,265Increase in premiums receivable
    
    
    (44,126
    )
    
    
    (48,789
    )Increase in unearned premiums and service fees
    
    
    49,719
    
    
    
    58,287Increase in interest receivable, prepaid reinsurance premiums and other assets
    
    
    (10,326
    )
    
    
    (16,111
    )Increase (decrease) in accounts payable, commissions and other liabilities, premiums
and other funds collected from others and assessments and fees payable
    
    
    6,841
    
    
    
    (190
    )Increase in reinsurance recoverable
    
    
    (9,707
    )
    
    
    (6,978
    )Increase in reinsurance balances payable
    
    
    10,608
    
    
    
    16,438Other
    
    
    
    
    
    
    (5
    )Net cash provided by operating activities
    
    
    41,230
    
    
    
    38,780Investing activitiesPurchases of fixed maturities
    
    
    (48,337
    )
    
    
    (75,009
    )Purchases of equity securities
    
    
    (30,635
    )
    
    
    (28,656
    )Proceeds from sale of fixed maturities
    
    
    997
    
    
    
    15,809Proceeds from sale of equity securities
    
    
    17,739
    
    
    
    5,359Proceeds from maturity of investments
    
    
    20,670
    
    
    
    25,995Additional cash paid for purchase of subsidiary
    
    
    (1,246
    )
    
    
    Cash and cash equivalents of business acquired
    
    
    5,585
    
    
    
    Capital expenditures
    
    
    (579
    )
    
    
    (283
    )Net cash used in investing activities
    
    
    (35,806
    )
    
    
    (56,785
    )Financing activitiesProceeds from issuance of common shares
    
    
    
    
    
    
    40,391Repayment of note payable to affiliate
    
    
    
    
    
    
    (15,000
    )Repayment of long-term debt
    
    
    (625
    )
    
    
    (625
    )Issuance of common shares from treasury upon exercise of stock options
    
    
    296
    
    
    
    136Cash dividends paid on common shares
    
    
    (1,539
    )
    
    
    Net cash (used in) provided by financing activities
    
    
    (1,868
    )
    
    
    24,902Net increase in cash and cash equivalents
    
    
    3,556
    
    
    
    6,897Cash and cash equivalents at beginning of period
    
    
    7,461
    
    
    
    15,869Cash and cash equivalents at end of period
    
    $
    11,017
    
    
    $
    22,766
  4




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##### Table of Contents



NATIONAL INTERSTATE CORPORATION AND SUBSIDIARIES
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 1. Basis of Presentation
     Recent Accounting Pronouncements
 Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection with Modifications
or Exchanges of Insurance Contracts
 Accounting
by Insurance Enterprises for Deferred Acquisition Costs in Connection With Modifications or
Exchanges of Insurance Contracts,
 Accounting for Certain Hybrid Instruments
 Accounting for Certain Hybrid Financial Instruments
 5




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##### Table of Contents



Accounting for Uncertainty in Income Taxes
 Accounting for Uncertainty in
Income Taxes
 2. Stock-Based Compensation
 Accounting for
Stock Issued to Employees Accounting for Stock-Based
Compensation
     For the Three Months Ended
    
    
    For the Six Months EndedJune 30, 2005
    
    
    June 30, 2005SFAS
    
    
    If
    
    
    
    
    
    
    SFAS
    
    
    IfAs
    
    
    123(R)
    
    
    Under
    
    
    As
    
    
    123(R)
    
    
    UnderReported
    
    
    Adjustment
    
    
    SFAS 123(R)
    
    
    Reported
    
    
    Adjustment
    
    
    SFAS 123(R)(Dollars in thousands)
    
    
    (Dollars in thousands)Income before income taxes
    
    $
    10,389
    
    
    $
    (316
    )
    
    $
    10,073
    
    
    $
    21,152
    
    
    $
    (545
    )
    
    $
    20,607Income taxes
    
    
    3,434
    
    
    
    (25
    )
    
    
    3,409
    
    
    
    7,042
    
    
    
    (54
    )
    
    
    6,988Net Income
    
    $
    6,955
    
    
    $
    (291
    )
    
    $
    6,664
    
    
    $
    14,110
    
    
    $
    (491
    )
    
    $
    13,619Basic earnings per share
    
    $
    0.37
    
    
    $
    (0.02
    )
    
    $
    0.35
    
    
    $
    0.76
    
    
    $
    (0.02
    )
    
    $
    0.74Diluted earnings per share
    
    
    0.36
    
    
    
    (0.01
    )
    
    
    0.35
    
    
    
    0.75
    
    
    
    (0.02
    )
    
    
    0.73
 6




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##### Table of Contents



Six months ended June 30, 2006Total options outstandingWeighted
    
    
    Weighted
    
    
    WeightedAverage
    
    
    Average
    
    
    AverageExercise
    
    
    Fair
    
    
    RemainingShares
    
    
    Price
    
    
    Value
    
    
    Contractual TermOptions outstanding, beginning of period
    
    
    785,000
    
    
    $
    12.43
    
    
    $
    5.58Forfeited
    
    
    (70,000
    )
    
    
    9.73
    
    
    
    4.72Exercised
    
    
    (90,000
    )
    
    
    3.30
    
    
    
    1.47Granted
    
    
    100,000
    
    
    
    22.13
    
    
    
    8.71Options outstanding, end of period
    
    
    725,000
    
    
    $
    15.17
    
    
    $
    6.60
    
    
    8.2 yearsOptions exercisable, end of period
    
    
    79,200
    
    
    $
    10.69
    
    
    $
    5.15
    
    
    6.2 years
  Three months ended June 30,
    
    Six months ended June 30,2006
    
    2005
    
    2006
    
    2005Risk-free interest rate
    
    
    5.1
    %
    
    
    4.0
    %
    
    
    4.7
    %
    
    
    4.2
    %Expected option life
    
    6.5 years
    
    7.5 years
    
    6.7 years
    
    9.8 yearsExpected stock price volatility
    
    
    29.4
    %
    
    
    31.0
    %
    
    
    29.6
    %
    
    
    31.0
    %Dividend yield
    
    
    0.7
    %
    
    
    0.3
    %
    
    
    0.3
    %
    
    
    0.3
    %Weighted average fair value of
options granted during year
    
    $
    8.86
    
    
    $
    6.23
    
    
    $
    8.71
    
    
    $
    6.72
   2007
    
    $
    8472008
    
    
    8472009
    
    
    8472010
    
    
    4652011
    
    
    98
 7




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##### Table of Contents



3. Premiums, Reinsurance and Transactions with Related Parties
   Three Months Ended June 30,
    
    Six Months Ended June 30,2006
    
    2005
    
    2006
    
    2005(Dollars in thousands)
    
    (Dollars in thousands)Written premiums assumed
    
    $
    2,919
    
    
    $
    2,572
    
    
    $
    5,676
    
    
    $
    5,151Assumed premiums earned
    
    
    2,380
    
    
    
    2,293
    
    
    
    4,680
    
    
    
    4,523Assumed losses and loss adjustment expense incurred
    
    
    1,672
    
    
    
    2,092
    
    
    
    3,603
    
    
    
    3,550Payable to Great American as of period end
    
    
    841
    
    
    
    754
    
    
    
    841
    
    
    
    754
   Three Months Ended June 30,
    
    
    Six Months Ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Written
    
    
    Earned
    
    
    Written
    
    
    Earned
    
    
    Written
    
    
    Earned
    
    
    Written
    
    
    Earned(Dollars in thousands)
    
    
    (Dollars in thousands)Direct
    
    $
    68,576
    
    
    $
    63,451
    
    
    $
    69,030
    
    
    $
    57,712
    
    
    $
    174,707
    
    
    $
    124,955
    
    
    $
    169,708
    
    
    $
    111,749Assumed
    
    
    4,152
    
    
    
    3,469
    
    
    
    3,106
    
    
    
    2,871
    
    
    
    7,559
    
    
    
    6,640
    
    
    
    6,005
    
    
    
    5,700Ceded
    
    
    (13,206
    )
    
    
    (14,491
    )
    
    
    (14,862
    )
    
    
    (14,160
    )
    
    
    (43,337
    )
    
    
    (28,851
    )
    
    
    (44,810
    )
    
    
    (27,849
    )Net Premium
    
    $
    59,522
    
    
    $
    52,429
    
    
    $
    57,274
    
    
    $
    46,423
    
    
    $
    138,929
    
    
    $
    102,744
    
    
    $
    130,903
    
    
    $
    89,600
  4. Commitments and Contingencies
   8




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##### Table of Contents



5. Earnings Per Common Share
  Three months ended June 30,
    
    
    Six months ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(In thousands)
    
    
    (In thousands)Net income
    
    $
    9,003
    
    
    $
    6,955
    
    
    $
    17,729
    
    
    $
    14,110Weighted average shares outstanding during period
    
    
    19,136
    
    
    
    18,965
    
    
    
    19,119
    
    
    
    18,456Additional shares issuable under employee common stock
option plans using treasury stock method
    
    
    143
    
    
    
    258
    
    
    
    152
    
    
    
    254Weighted average shares outstanding assuming exercise of
stock options
    
    
    19,279
    
    
    
    19,223
    
    
    
    19,271
    
    
    
    18,710Net income per share:Basic
    
    $
    0.47
    
    
    $
    0.37
    
    
    $
    0.93
    
    
    $
    0.76Diluted
    
    
    0.47
    
    
    
    0.36
    
    
    
    0.92
    
    
    
    0.75
  6. Segment Information
  Three months ended June 30,
    
    
    Six months ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(Dollars in thousands)
    
    
    (Dollars in thousands)Revenue:Premiums earned:Alternative Risk Transfer
    
    $
    17,354
    
    
    $
    14,264
    
    
    $
    33,282
    
    
    $
    27,017Transportation
    
    
    17,800
    
    
    
    17,277
    
    
    
    35,660
    
    
    
    33,583Specialty Personal Lines
    
    
    11,436
    
    
    
    9,420
    
    
    
    22,264
    
    
    
    18,085Hawaii and Alaska
    
    
    4,017
    
    
    
    4,122
    
    
    
    7,237
    
    
    
    7,888Other
    
    
    1,822
    
    
    
    1,340
    
    
    
    4,301
    
    
    
    3,027Total Premiums Earned
    
    
    52,429
    
    
    
    46,423
    
    
    
    102,744
    
    
    
    89,600Net investment income
    
    
    4,276
    
    
    
    3,140
    
    
    
    8,175
    
    
    
    5,807Realized gains on investments
    
    
    145
    
    
    
    191
    
    
    
    515
    
    
    
    306Other
    
    
    540
    
    
    
    407
    
    
    
    1,017
    
    
    
    915Total revenues
    
    $
    57,390
    
    
    $
    50,161
    
    
    $
    112,451
    
    
    $
    96,628
 9




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##### Table of Contents



7. Comprehensive Income
  8. Acquisition of Company
    
 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.
  10




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##### Table of Contents



General
    Results of Operations
 Overview
    11




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##### Table of Contents



Gross Written Premium
  Three months ended June 30,2006
    
    
    2005Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Alternative Risk Transfer
    
    $
    25,228
    
    
    
    34.7
    %
    
    $
    25,834
    
    
    
    35.8
    %Transportation
    
    
    24,741
    
    
    
    34.0
    %
    
    
    26,152
    
    
    
    36.3
    %Specialty Personal Lines
    
    
    15,056
    
    
    
    20.7
    %
    
    
    13,152
    
    
    
    18.2
    %Hawaii and Alaska
    
    
    5,921
    
    
    
    8.1
    %
    
    
    6,111
    
    
    
    8.5
    %Other
    
    
    1,782
    
    
    
    2.5
    %
    
    
    887
    
    
    
    1.2
    %Gross Premiums Written
    
    $
    72,728
    
    
    
    100.0
    %
    
    $
    72,136
    
    
    
    100.0
    %
 Six months ended June 30,2006
    
    
    2005Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Alternative Risk Transfer
    
    $
    95,292
    
    
    
    52.3
    %
    
    $
    90,861
    
    
    
    51.7
    %Transportation
    
    
    43,260
    
    
    
    23.7
    %
    
    
    45,579
    
    
    
    25.9
    %Specialty Personal Lines
    
    
    28,829
    
    
    
    15.8
    %
    
    
    25,038
    
    
    
    14.3
    %Hawaii and Alaska
    
    
    11,664
    
    
    
    6.4
    %
    
    
    12,159
    
    
    
    6.9
    %Other
    
    
    3,221
    
    
    
    1.8
    %
    
    
    2,076
    
    
    
    1.2
    %Gross Premiums Written
    
    $
    182,266
    
    
    
    100.0
    %
    
    $
    175,713
    
    
    
    100.0
    %
    12




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##### Table of Contents



Net Earned Premium
 Three months ended June 30, 2006 compared to June 30, 2005.
 Three months ended June 30,
    
    
    Change2006
    
    
    2005
    
    
    Amount
    
    
    Percent(Dollars in thousands)Revenue:Premiums earned:Alternative Risk Transfer
    
    $
    17,354
    
    
    $
    14,264
    
    
    $
    3,090
    
    
    
    21.7
    %Transportation
    
    
    17,800
    
    
    
    17,277
    
    
    
    523
    
    
    
    3.0
    %Specialty Personal Lines
    
    
    11,436
    
    
    
    9,420
    
    
    
    2,016
    
    
    
    21.4
    %Hawaii and Alaska
    
    
    4,017
    
    
    
    4,122
    
    
    
    (105
    )
    
    
    (2.5
    %)Other
    
    
    1,822
    
    
    
    1,340
    
    
    
    482
    
    
    
    36.0
    %Total Premiums Earned
    
    
    52,429
    
    
    
    46,423
    
    
    
    6,006
    
    
    
    12.9
    %Net investment income
    
    
    4,276
    
    
    
    3,140
    
    
    
    1,136
    
    
    
    36.2
    %Realized gains on investments
    
    
    145
    
    
    
    191
    
    
    
    (46
    )
    
    
    (24.1
    %)Other
    
    
    540
    
    
    
    407
    
    
    
    133
    
    
    
    32.7
    %Total revenues
    
    $
    57,390
    
    
    $
    50,161
    
    
    $
    7,229
    
    
    
    14.4
    %
  Six months ended June 30, 2006 compared to June 30, 2005.
 13




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##### Table of Contents



Six months ended June 30,
    
    
    Change2006
    
    
    2005
    
    
    Amount
    
    
    Percent(Dollars in thousands)Revenue:Premiums earned:Alternative Risk Transfer
    
    $
    33,282
    
    
    $
    27,017
    
    
    $
    6,265
    
    
    
    23.2
    %Transportation
    
    
    35,660
    
    
    
    33,583
    
    
    
    2,077
    
    
    
    6.2
    %Specialty Personal Lines
    
    
    22,264
    
    
    
    18,085
    
    
    
    4,179
    
    
    
    23.1
    %Hawaii and Alaska
    
    
    7,237
    
    
    
    7,888
    
    
    
    (651
    )
    
    
    (8.3
    %)Other
    
    
    4,301
    
    
    
    3,027
    
    
    
    1,274
    
    
    
    42.1
    %Total Premiums Earned
    
    
    102,744
    
    
    
    89,600
    
    
    
    13,144
    
    
    
    14.7
    %Net investment income
    
    
    8,175
    
    
    
    5,807
    
    
    
    2,368
    
    
    
    40.8
    %Realized gains on investments
    
    
    515
    
    
    
    306
    
    
    
    209
    
    
    
    68.3
    %Other
    
    
    1,017
    
    
    
    915
    
    
    
    102
    
    
    
    11.1
    %Total revenues
    
    $
    112,451
    
    
    $
    96,628
    
    
    $
    15,823
    
    
    
    16.4
    %
  Underwriting and Loss Ratio Analysis
   Three months ended June 30,
    
    
    Six months ended June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005(Dollars in thousands)
    
    
    (Dollars in thousands)Gross premiums written
    
    $
    72,728
    
    
    $
    72,136
    
    
    $
    182,266
    
    
    $
    175,713Ceded reinsurance
    
    
    (13,206
    )
    
    
    (14,862
    )
    
    
    (43,337
    )
    
    
    (44,810
    )Net premiums written
    
    
    59,522
    
    
    
    57,274
    
    
    
    138,929
    
    
    
    130,903Change in unearned premiums, net of ceded
    
    
    (7,093
    )
    
    
    (10,851
    )
    
    
    (36,185
    )
    
    
    (41,303
    )Net earned premiums
    
    $
    52,429
    
    
    $
    46,423
    
    
    $
    102,744
    
    
    $
    89,600Combined Ratios:Loss and LAE ratio (1)
    
    
    58.1
    %
    
    
    59.7
    %
    
    
    58.7
    %
    
    
    60.0
    %Underwriting expense ratio (2)
    
    
    24.2
    %
    
    
    24.4
    %
    
    
    23.1
    %
    
    
    22.4
    %Combined ratio
    
    
    82.3
    %
    
    
    84.1
    %
    
    
    81.8
    %
    
    
    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 June 30, 2006 compared to June 30, 2005.
 14




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##### Table of Contents



Six months ended June 30, 2006 compared to June 30, 2005.
  Investment Income
 2006 compared to 2005.
 Realized Gains (Losses) on Investments
 2006 compared to 2005.
 Other Operating and General Expenses
 2006 compared to 2005.
 15




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##### Table of Contents



Income Taxes
 2006 compared to 2005.
 Financial Condition
 Investments
    Securities with
    
    Securities withUnrealized
    
    UnrealizedGains
    
    Losses(Dollars in thousands)Fixed Maturities:Fair value of securities
    
    $
    13,888
    
    
    $
    288,493Amortized cost of securities
    
    $
    13,679
    
    
    $
    299,182Gross unrealized gain or (loss)
    
    $
    209
    
    
    $
    (10,689
    )Fair value as a percent of amortized cost
    
    
    101.5
    %
    
    
    96.4
    %Number of security positions held
    
    
    36
    
    
    
    327Number individually exceeding $50,000 gain or (loss)
    
    
    
    
    
    
    58Concentration of gains or losses by type or industry:US Government and government agencies
    
    $
    54
    
    
    $
    (6,937
    )State, municipalities, and political subdivisions
    
    
    93
    
    
    
    (1,111
    )Banks, insurance, and brokers
    
    
    8
    
    
    
    (2,242
    )Electric services
    
    
    
    
    
    
    (22
    )Industrial and other
    
    
    54
    
    
    
    (377
    )Percentage rated investment grade (1)
    
    
    87.2
    %
    
    
    99.8
    %Equity Securities:Fair value of securities
    
    $
    10,372
    
    
    $
    18,864Cost of securities
    
    $
    10,033
    
    
    $
    19,786Gross unrealized gain or (loss)
    
    $
    339
    
    
    $
    (922
    )Fair value as percent of cost
    
    
    103.4
    %
    
    
    95.3
    %Number individually exceeding $50,000 gain or (loss)
    
    
    1
    
    
    
    7
 
 (1)
    
    Investment grade of AAA to BBB by Standard & Poors Corporation. 16




---



##### Table of Contents



Securities with
    
    
    Securities withUnrealized
    
    
    UnrealizedGains
    
    
    LossesMaturity:One year or less
    
    
    19.4
    %
    
    
    4.4
    %After one year through five years
    
    
    42.3
    %
    
    
    44.0
    %After five years through ten years
    
    
    29.2
    %
    
    
    42.2
    %After ten years
    
    
    9.1
    %
    
    
    9.4
    %100.0
    %
    
    
    100.0
    %
  June 30, 2006Aggregate
    
    
    Fair ValueAggregate
    
    
    Unrealized
    
    
    as % of CostFair Value
    
    
    Gain/Loss
    
    
    Basis(Dollars in thousands)Fixed Maturities:Securities with unrealized gains:Exceeding $50,000 and for:Less than one year (0 issues)
    
    $
    
    
    
    $
    More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (36 issues)
    
    
    13,888
    
    
    
    209
    
    
    
    101.5
    %$
    13,888
    
    
    $
    209Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (57 issues)
    
    $
    97,178
    
    
    $
    (6,516
    )
    
    
    93.7
    %More than one year (1 issue)
    
    
    660
    
    
    
    (332
    )
    
    
    66.5
    %Less than $50,000 (269 issues)
    
    
    190,655
    
    
    
    (3,841
    )
    
    
    98.0
    %$
    288,493
    
    
    $
    (10,689
    )Equity Securities:Securities with unrealized gains:Exceeding $50,000 and for:Less than one year (1 issue)
    
    $
    82
    
    
    $
    57
    
    
    
    328.0
    %More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (29 issues)
    
    
    10,290
    
    
    
    282
    
    
    
    102.8
    %$
    10,372
    
    
    $
    339Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (7 issues)
    
    $
    6,189
    
    
    $
    (532
    )
    
    
    92.1
    %More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (34 issues)
    
    
    12,675
    
    
    
    (390
    )
    
    
    97.0
    %$
    18,864
    
    
    $
    (922
    )
  17




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##### Table of Contents



Premiums and Reinsurance
    Liquidity and Capital Resources
         18




---



##### Table of Contents



st
  Critical Accounting Policies
  Losses and Loss Adjustment Expense (LAE) Reserves
  19




---



##### Table of Contents




    
    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;
    
    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
 20




---



##### Table of Contents




    
    other subjective factors, including concentrations and information obtained from
regulators and rating agencies.
  Contractual Obligations/ Off-Balance Sheet Arrangements
   
 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
  21




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##### Table of Contents



ITEM 4. Submission of Matters to a Vote of Security Holders
   Name
    
    Term Expires
    
    For
    
    Against
    
    Withheld
    
    Abstain
    
    Broker Non-VotesProposal 1:Keith A. Jensen
    
    
    2008
    
    
    
    16,791,389
    
    
    
    N/A
    
    
    
    1,887,356
    
    
    
    N/A
    
    
    
    N/AJames C. Kennedy
    
    
    2008
    
    
    
    16,787,714
    
    
    
    N/A
    
    
    
    1,891,031
    
    
    
    N/A
    
    
    
    N/AJoel Schiavone
    
    
    2008
    
    
    
    18,007,562
    
    
    
    N/A
    
    
    
    671,183
    
    
    
    N/A
    
    
    
    N/AAlan R. Spachman
    
    
    2008
    
    
    
    17,211,868
    
    
    
    N/A
    
    
    
    1,466,877
    
    
    
    N/A
    
    
    
    N/AProposal 2
    
    
    
    
    
    
    18,464,023
    
    
    
    214,609
    
    
    
    N/A
    
    
    
    113
    
    
    
    N/A
 
 N/A
    
    -
    
    Not applicable
  Name
    
    Term ExpiresTheodore H. Elliott, Jr.
    
    
    2007Gary J. Gruber
    
    
    2007Donald D. Larson
    
    
    2007K. Brent Somers
    
    
    2007
  
 ITEM 5. Other Information
  
 ITEM 6. Exhibits
 Exhibit No.
    
    Exhibit Description3.1
    
    Amended and Restated Articles of Incorporation (1)3.2
    
    Amended and Restated Code of Regulations (1)31.1
    
    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. 22




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##### Table of Contents



SIGNATURES
  NATIONAL INTERSTATE CORPORATIONDate: August 8, 2006
    /s/ Alan R. SpachmanAlan R. SpachmanChairman of the Board and President
(Duly Authorized Officer and Principal Executive Officer)Date: August 8, 2006
    /s/ Julie A. McGrawJulie A. McGrawVice President and Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer) 23