##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 Form 10-Q
 þ
    
    Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 For the quarterly period ended September 30, 2008
 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(State or other jurisdiction of 
incorporation or organization)
    
    34-1607394(I.R.S. Employer
Identification No.)
 
 3250 Interstate Drive
Richfield, Ohio 44286-9000
(330) 659-8900  (Address and telephone number of principal executive offices)
 
 þ o
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer   o
(Do not check if a smaller reporting company)
    
    Smaller Reporting Company o
 o þ




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##### 



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
    
    
    12Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    23Item 4. Controls and Procedures
    
    
    24Part II  Other Information
    
    
    25Item 1. Legal Proceedings
    
    
    25Item 1A. Risk Factors
    
    
    25Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    25Item 3. Defaults Upon Senior Securities
    
    
    25Item 4. Submission of Matters to a Vote of Security Holders
    
    
    25Item 5. Other Information
    
    
    25Item 6. Exhibits
    
    
    25EX-31.1EX-31.2EX-32.1EX-32.2
  1




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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)
 September 30,
    
    
    December 31,2008
    
    
    2007(Unaudited)ASSETSInvestments:Fixed maturities available-for-sale, at fair value (amortized cost  $442,204 and
$376,019, respectively)
    
    $
    432,937
    
    
    $
    376,300Equity securities available-for-sale, at fair value (cost  $57,079 and $57,800,
respectively)
    
    
    46,376
    
    
    
    52,640Short-term investments, at cost which approximates fair value
    
    
    85
    
    
    
    20,907Total investments
    
    
    479,398
    
    
    
    449,847Cash and cash equivalents
    
    
    64,750
    
    
    
    43,069Securities lending collateral (cost  $85,758 and $141,316, respectively)
    
    
    78,007
    
    
    
    139,305Accrued investment income
    
    
    4,954
    
    
    
    4,783Premiums receivable, net of allowance for doubtful accounts of $450 and $462,
respectively
    
    
    118,754
    
    
    
    84,708Reinsurance recoverables on paid and unpaid losses
    
    
    138,516
    
    
    
    98,091Prepaid reinsurance premiums
    
    
    39,585
    
    
    
    24,325Deferred policy acquisition costs
    
    
    22,066
    
    
    
    17,578Deferred federal income taxes
    
    
    19,257
    
    
    
    11,993Property and equipment, net
    
    
    19,876
    
    
    
    19,502Funds held by reinsurer
    
    
    2,949
    
    
    
    3,337Prepaid expenses and other assets
    
    
    2,363
    
    
    
    2,096Total assets
    
    $
    990,475
    
    
    $
    898,634LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Unpaid losses and loss adjustment expenses
    
    $
    388,715
    
    
    $
    302,088Unearned premiums and service fees
    
    
    185,577
    
    
    
    145,296Long-term debt
    
    
    15,000
    
    
    
    15,464Amounts withheld or retained for account of others
    
    
    48,413
    
    
    
    38,739Reinsurance balances payable
    
    
    17,441
    
    
    
    7,596Securities lending obligation
    
    
    86,900
    
    
    
    141,316Accounts payable and other liabilities
    
    
    27,572
    
    
    
    24,363Commissions payable
    
    
    10,810
    
    
    
    7,332Assessments and fees payable
    
    
    5,230
    
    
    
    3,634Total liabilities
    
    
    785,658
    
    
    
    685,828Shareholders equity:Preferred shares  no par valueAuthorized  10,000 sharesIssued  0 shares
    
    
    
    
    
    
    Common shares  $0.01 par valueAuthorized  50,000 sharesIssued  23,350 shares, including 4,055 and 4,145
shares, respectively, in treasury
    
    
    234
    
    
    
    234Additional paid-in capital
    
    
    47,680
    
    
    
    45,566Retained earnings
    
    
    184,406
    
    
    
    178,190Accumulated other comprehensive loss
    
    
    (21,765
    )
    
    
    (5,321
    )Treasury shares
    
    
    (5,738
    )
    
    
    (5,863
    )Total shareholders equity
    
    
    204,817
    
    
    
    212,806Total liabilities and shareholders equity
    
    $
    990,475
    
    
    $
    898,634
  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 September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Revenues:Premiums earned
    
    $
    75,058
    
    
    $
    66,187
    
    
    $
    214,521
    
    
    $
    189,742Net investment income
    
    
    5,417
    
    
    
    5,690
    
    
    
    16,849
    
    
    
    16,421Net realized gains (losses) on investments
    
    
    (8,376
    )
    
    
    (319
    )
    
    
    (10,824
    )
    
    
    (47
    )Other
    
    
    605
    
    
    
    1,564
    
    
    
    2,199
    
    
    
    3,384Total revenues
    
    
    72,704
    
    
    
    73,122
    
    
    
    222,745
    
    
    
    209,500Expenses:Losses and loss adjustment expenses
    
    
    51,995
    
    
    
    39,844
    
    
    
    144,097
    
    
    
    112,564Commissions and other underwriting expenses
    
    
    18,529
    
    
    
    13,803
    
    
    
    46,685
    
    
    
    36,348Other operating and general expenses
    
    
    3,241
    
    
    
    2,795
    
    
    
    9,786
    
    
    
    8,990Expense on amounts withheld
    
    
    1,001
    
    
    
    997
    
    
    
    3,261
    
    
    
    2,641Interest expense
    
    
    133
    
    
    
    393
    
    
    
    704
    
    
    
    1,160Total expenses
    
    
    74,899
    
    
    
    57,832
    
    
    
    204,533
    
    
    
    161,703Income (loss) before federal income taxes
    
    
    (2,195
    )
    
    
    15,290
    
    
    
    18,212
    
    
    
    47,797Provision for federal income taxes
    
    
    2,033
    
    
    
    5,145
    
    
    
    8,499
    
    
    
    15,327Net income (loss)
    
    $
    (4,228
    )
    
    $
    10,145
    
    
    $
    9,713
    
    
    $
    32,470Net income (loss) per common share  basic
    
    $
    (0.22
    )
    
    $
    0.53
    
    
    $
    0.50
    
    
    $
    1.69Net income (loss) per common share  diluted
    
    $
    (0.22
    )
    
    $
    0.52
    
    
    $
    0.50
    
    
    $
    1.67Weighted average of common shares outstanding  basic
    
    
    19,293
    
    
    
    19,199
    
    
    
    19,281
    
    
    
    19,189Weighted average of common shares outstanding 
diluted
    
    
    19,293
    
    
    
    19,459
    
    
    
    19,375
    
    
    
    19,401Cash dividends per common share
    
    $
    0.06
    
    
    $
    0.05
    
    
    $
    0.18
    
    
    $
    0.15
 .
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##### Table of Contents



National Interstate Corporation and Subsidiaries
 
 Consolidated Statements of Shareholders Equity
 (Unaudited)
 (Dollars in thousands)
 Common
    
    
    Additional Paid-In
    
    
    Retained
    
    
    Accumulated Other
    
    
    TreasuryStock
    
    
    Capital
    
    
    Earnings
    
    
    Comprehensive Loss
    
    
    Stock
    
    
    TotalBalance at January 1, 2008
    
    $
    234
    
    
    $
    45,566
    
    
    $
    178,190
    
    
    $
    (5,321
    )
    
    $
    (5,863
    )
    
    $
    212,806Net income
    
    
    
    
    
    
    
    
    
    
    9,713
    
    
    
    
    
    
    
    
    
    
    
    9,713Unrealized depreciation of investment securities,
net of tax benefit of $4,387
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (16,444
    )
    
    
    
    
    
    
    (16,444
    )Comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,731
    )Dividends on common stock
    
    
    
    
    
    
    
    
    
    
    (3,497
    )
    
    
    
    
    
    
    
    
    
    
    (3,497
    )Issuance of 89,723 treasury shares upon exercise of options
and restricted stock issued, net of forfeitures
    
    
    
    
    
    
    706
    
    
    
    
    
    
    
    
    
    
    
    125
    
    
    
    831Tax benefit realized from exercise of stock options
    
    
    
    
    
    
    396
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    396Stock compensation expense
    
    
    
    
    
    
    1,012
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,012Balance at September 30, 2008
    
    $
    234
    
    
    $
    47,680
    
    
    $
    184,406
    
    
    $
    (21,765
    )
    
    $
    (5,738
    )
    
    $
    204,817Balance at January 1, 2007
    
    $
    234
    
    
    $
    43,921
    
    
    $
    138,450
    
    
    $
    (2,915
    )
    
    $
    (5,927
    )
    
    $
    173,763Net income
    
    
    
    
    
    
    
    
    
    
    32,470
    
    
    
    
    
    
    
    
    
    
    
    32,470Unrealized depreciation of investment securities,
net of tax benefit of $76
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (141
    )
    
    
    
    
    
    
    (141
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,329Dividends on common stock
    
    
    
    
    
    
    
    
    
    
    (2,892
    )
    
    
    
    
    
    
    
    
    
    
    (2,892
    )Issuance of 45,847 treasury shares upon exercise of options
and stock award grants
    
    
    
    
    
    
    388
    
    
    
    
    
    
    
    
    
    
    
    64
    
    
    
    452Tax benefit realized from exercise of stock options
    
    
    
    
    
    
    201
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    201Stock compensation expense
    
    
    
    
    
    
    776
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    776Balance at September 30, 2007
    
    $
    234
    
    
    $
    45,286
    
    
    $
    168,028
    
    
    $
    (3,056
    )
    
    $
    (5,863
    )
    
    $
    204,629
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##### Table of Contents



National Interstate Corporation and Subsidiaries
 
 Consolidated Statements of Cash Flows
 (Unaudited)
 (Dollars in thousands)
 Nine Months Ended September 30,2008
    
    
    2007Operating activitiesNet income
    
    $
    9,713
    
    
    $
    32,470Adjustments to reconcile net income to net cash provided by
operating activities:Net amortization of bond premiums and discounts
    
    
    1,251
    
    
    
    253Provision for depreciation and amortization
    
    
    1,017
    
    
    
    948Net realized losses on investment securities
    
    
    10,824
    
    
    
    47Deferred federal income taxes
    
    
    (2,877
    )
    
    
    (268
    )Stock compensation expense
    
    
    1,012
    
    
    
    776Increase in deferred policy acquisition costs, net
    
    
    (4,488
    )
    
    
    (4,621
    )Increase in reserves for losses and loss adjustment expenses
    
    
    86,627
    
    
    
    43,903Increase in premiums receivable
    
    
    (34,046
    )
    
    
    (26,229
    )Increase in unearned premiums and service fees
    
    
    40,281
    
    
    
    34,206Increase in interest receivable and other assets
    
    
    (80
    )
    
    
    (2,089
    )Increase in prepaid reinsurance premiums
    
    
    (15,260
    )
    
    
    (10,914
    )Increase in accounts payable, commissions and other liabilities
and assessments and fees payable
    
    
    8,283
    
    
    
    9,380Increase in amounts withheld or retained for account of others
    
    
    9,674
    
    
    
    7,505Increase in reinsurance recoverable
    
    
    (40,425
    )
    
    
    (18,877
    )Increase in reinsurance balances payable
    
    
    9,845
    
    
    
    3,386Other
    
    
    (3
    )
    
    
    Net cash provided by operating activities
    
    
    81,348
    
    
    
    69,876Investing activitiesPurchases of fixed maturities
    
    
    (342,290
    )
    
    
    (127,238
    )Purchases of equity securities
    
    
    (3,443
    )
    
    
    (57,143
    )Proceeds from sale of fixed maturities
    
    
    1,148
    
    
    
    Proceeds from sale of equity securities
    
    
    10,115
    
    
    
    14,593Proceeds from maturity of investments
    
    
    278,896
    
    
    
    111,672Capital expenditures
    
    
    (1,359
    )
    
    
    (1,578
    )Net cash used in investing activities
    
    
    (56,933
    )
    
    
    (59,694
    )Financing activitiesDecrease in securities lending collateral
    
    
    54,416
    
    
    
    11,187Decrease in securities lending obligation
    
    
    (54,416
    )
    
    
    (11,187
    )Additional long-term borrowings
    
    
    15,000
    
    
    
    Reductions of long-term debt
    
    
    (15,464
    )
    
    
    Tax benefit realized from exercise of stock options
    
    
    396
    
    
    
    201Issuance of common shares from treasury upon exercise of stock
options or stock award grants
    
    
    831
    
    
    
    452Cash dividends paid on common shares
    
    
    (3,497
    )
    
    
    (2,892
    )Net cash used in financing activities
    
    
    (2,734
    )
    
    
    (2,239
    )Net increase in cash and cash equivalents
    
    
    21,681
    
    
    
    7,943Cash and cash equivalents at beginning of period
    
    
    43,069
    
    
    
    22,166Cash and cash equivalents at end of period
    
    $
    64,750
    
    
    $
    30,109
  4




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##### Table of Contents



NATIONAL INTERSTATE CORPORATION AND SUBSIDIARIES
 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 1. Basis of Presentation
     2. Recent Accounting Pronouncements
 The Fair Value Option for Financial Assets and Financial Liabilities  Including an amendment of
FASB Statement No. 115
 The Fair Value Option for Financial Assets and Financial
Liabilities
 3. Fair Value Measurements
 Fair Value Measurements,
  5




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##### Table of Contents



September 30, 2008Level 1
    
    
    Level 2
    
    
    Level 3
    
    
    Fair Value(Dollars in thousands)Fixed maturities:U.S. Government and government agency obligations
    
    $
    
    
    
    $
    208,695
    
    
    $
    
    
    
    $
    208,695State and local government obligations
    
    
    
    
    
    
    108,207
    
    
    
    7,069
    
    
    
    115,276Mortgage-backed securities
    
    
    
    
    
    
    66,189
    
    
    
    
    
    
    
    66,189Corporate obligations
    
    
    
    
    
    
    38,459
    
    
    
    4,318
    
    
    
    42,777Total fixed maturities
    
    
    
    
    
    
    421,550
    
    
    
    11,387
    
    
    
    432,937Equity securities:Preferred stock
    
    
    10,407
    
    
    
    1,834
    
    
    
    7,813
    
    
    
    20,054Common stock
    
    
    15,855
    
    
    
    10,467
    
    
    
    
    
    
    
    26,322Total equity securities
    
    
    26,262
    
    
    
    12,301
    
    
    
    7,813
    
    
    
    46,376Short-term investments
    
    
    
    
    
    
    85
    
    
    
    
    
    
    
    85Total investments
    
    $
    26,262
    
    
    $
    433,936
    
    
    $
    19,200
    
    
    $
    479,398
  September 30, 2008Level 1
    
    
    Level 2
    
    
    Level 3
    
    
    Fair Value(Dollars in thousands)Fixed maturities:Cash and cash equivalents
    
    $
    22,852
    
    
    $
    2,000
    
    
    $
    
    
    
    $
    24,852Mortgage-backed securities
    
    
    
    
    
    
    19,062
    
    
    
    3,416
    
    
    
    22,478Corporate obligations
    
    
    
    
    
    
    28,102
    
    
    
    2,575
    
    
    
    30,677Total fixed maturities:
    
    $
    22,852
    
    
    $
    49,164
    
    
    $
    5,991
    
    
    $
    78,007
 6




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##### Table of Contents



Three Months Ended September 30, 2008State and localCorporate
    
    
    government
    
    
    Preferred
    
    
    Securities lendingobligations
    
    
    obligations
    
    
    stock
    
    
    collateral(Dollars inthousands)Beginning balance at June 30, 2008
    
    $
    1,403
    
    
    $
    7,279
    
    
    $
    8,348
    
    
    $
    3,489Total gains or (losses):Included in realized investment gains and (losses)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (495
    )Included in other comprehensive income
    
    
    (10
    )
    
    
    (210
    )
    
    
    (535
    )
    
    
    (35
    )Purchases, issuances and settlements (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (384
    )Transfers in and/or (out) of Level 3(2)
    
    
    2,925
    
    
    
    
    
    
    
    
    
    
    
    3,416Ending balance at September 30, 2008
    
    $
    4,318
    
    
    $
    7,069
    
    
    $
    7,813
    
    
    $
    5,991The amount of total gains or losses for the period
included in earnings attributable to the change in unrealized
gains or losses relating to assets still held at the reporting
date
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (495
    )
 State and localCorporate
    
    
    government
    
    
    Preferred
    
    
    Securities lendingobligations
    
    
    obligations
    
    
    stock
    
    
    collateral(Dollars inthousands)Beginning balance at January 1, 2008
    
    $
    1,388
    
    
    $
    
    
    
    $
    3,812
    
    
    $
    4,675Total gains or (losses):Included in realized investment gains and (losses)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,141
    )Included in other comprehensive income
    
    
    5
    
    
    
    (210
    )
    
    
    (549
    )
    
    
    321Purchases, issuances and settlements (1)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,280
    )Transfers in and/or (out) of Level 3(2)
    
    
    2,925
    
    
    
    7,279
    
    
    
    4,550
    
    
    
    3,416Ending balance at September 30, 2008
    
    $
    4,318
    
    
    $
    7,069
    
    
    $
    7,813
    
    
    $
    5,991The amount of total gains or losses for the period included
in earnings attributable to the change in unrealized gains
or losses relating to assets still held at the
reporting date
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    (1,142
    )
 
 (1)
    
    The settlement is attributable to a security which experienced a principal pay down
during the three and nine months ended September 30, 2008.(2)
    
    Transfers in and/or (out) of Level 3 during the three and nine months ended
September 30, 2008 are attributable to a change in the availability of market observable
information for securities within the respective category. 4. Securities Lending
  7




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##### Table of Contents



September 30,
    
    
    December 31,2008
    
    
    2007(Dollars in thousands)Collateral obligation
    
    $
    86,900
    
    
    $
    141,316Pretax unrealized loss on fair value of collateral held
    
    
    (7,751
    )
    
    
    (2,011
    )Other than temporary impairment charge
    
    
    (1,142
    )
    
    
    Fair value of collateral held
    
    
    78,007
    
    
    
    139,305Fair value of securities lent plus accrued interest
    
    
    85,280
    
    
    
    138,581
 5. Shareholders Equity and Stock-Based Compensation
    6. Transactions with Related Parties
   Three Months Ended September 30,
    
    Nine Months Ended September 30,2008
    
    2007
    
    2008
    
    2007(Dollars in thousands)
    
    (Dollars in thousands)Assumed premiums written
    
    $
    821
    
    
    $
    1,288
    
    
    $
    4,779
    
    
    $
    4,901Assumed premiums earned
    
    
    1,617
    
    
    
    1,467
    
    
    
    4,818
    
    
    
    4,060Assumed losses and loss adjustment expense incurred
    
    
    1,347
    
    
    
    2,123
    
    
    
    3,763
    
    
    
    4,581Ceded premiums written
    
    
    576
    
    
    
    658
    
    
    
    3,026
    
    
    
    3,410Ceded premiums earned
    
    
    880
    
    
    
    1,013
    
    
    
    2,707
    
    
    
    2,966Ceded losses
and loss adjustment expense recoveries
    
    
    452
    
    
    
    146
    
    
    
    849
    
    
    
    1,186Payable to Great American as of period end
    
    
    526
    
    
    
    725
    
    
    
    526
    
    
    
    725
  8




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##### Table of Contents



7. Reinsurance
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007Written
    
    
    Earned
    
    
    Written
    
    
    Earned
    
    
    Written
    
    
    Earned
    
    
    Written
    
    
    Earned(Dollars in thousands)
    
    
    
    
    
    
    
    
    
    
    (Dollars in thousands)Direct
    
    $
    75,487
    
    
    $
    93,386
    
    
    $
    67,867
    
    
    $
    79,700
    
    
    $
    304,508
    
    
    $
    264,561
    
    
    $
    265,626
    
    
    $
    231,713Assumed
    
    
    1,964
    
    
    
    2,748
    
    
    
    4,190
    
    
    
    3,878
    
    
    
    7,739
    
    
    
    7,934
    
    
    
    9,244
    
    
    
    8,952Ceded
    
    
    (15,035
    )
    
    
    (21,076
    )
    
    
    (12,786
    )
    
    
    (17,391
    )
    
    
    (72,674
    )
    
    
    (57,974
    )
    
    
    (61,837
    )
    
    
    (50,923
    )Net Premium
    
    $
    62,416
    
    
    $
    75,058
    
    
    $
    59,271
    
    
    $
    66,187
    
    
    $
    239,573
    
    
    $
    214,521
    
    
    $
    213,033
    
    
    $
    189,742
  8. Commitments and Contingencies
    9




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##### Table of Contents



9. Earnings Per Common Share
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(In thousands, except per share)
    
    
    (In thousands, except per share)Net (loss) income
    
    $
    (4,228
    )
    
    $
    10,145
    
    
    $
    9,713
    
    
    $
    32,470Weighted average shares outstanding during period
    
    
    19,293
    
    
    
    19,199
    
    
    
    19,281
    
    
    
    19,189Additional shares issuable under employee common stock
option plans using treasury stock method
    
    
    
    
    
    
    260
    
    
    
    94
    
    
    
    212Weighted average shares outstanding assuming exercise of
stock options 1
    
    
    19,293
    
    
    
    19,459
    
    
    
    19,375
    
    
    
    19,401Net (loss) income per share:Basic
    
    $
    (0.22
    )
    
    $
    0.53
    
    
    $
    0.50
    
    
    $
    1.69Diluted
    
    $
    (0.22
    )
    
    $
    0.52
    
    
    $
    0.50
    
    
    $
    1.67
 
 1
    
    Since the Company reported a net loss for third quarter 2008, the calculated diluted
earnings per share was antidilutive; therefore, basic earnings per share is used.  10. Segment Information
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands)
    
    
    (Dollars in thousands)Revenue:Premiums earned:Alternative Risk Transfer
    
    $
    35,814
    
    
    $
    27,033
    
    
    $
    99,212
    
    
    $
    77,495Transportation
    
    
    19,162
    
    
    
    18,596
    
    
    
    56,882
    
    
    
    55,436Specialty
Personal Lines and Commercial Vehicle
    
    
    14,046
    
    
    
    13,252
    
    
    
    40,797
    
    
    
    38,564Hawaii and Alaska
    
    
    4,467
    
    
    
    4,562
    
    
    
    13,393
    
    
    
    13,075Other
    
    
    1,569
    
    
    
    2,744
    
    
    
    4,237
    
    
    
    5,172Total premiums earned
    
    
    75,058
    
    
    
    66,187
    
    
    
    214,521
    
    
    
    189,742Net investment income
    
    
    5,417
    
    
    
    5,690
    
    
    
    16,849
    
    
    
    16,421Net realized
gains (losses) on investments
    
    
    (8,376
    )
    
    
    (319
    )
    
    
    (10,824
    )
    
    
    (47
    )Other
    
    
    605
    
    
    
    1,564
    
    
    
    2,199
    
    
    
    3,384Total revenues
    
    $
    72,704
    
    
    $
    73,122
    
    
    $
    222,745
    
    
    $
    209,500
 10




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##### Table of Contents



11. Income Taxes
  Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands)Expected federal income tax expense (benefit) at statutory rate
    
    $
    (768
    )
    
    $
    5,351
    
    
    $
    6,374
    
    
    $
    16,729Tax effect of tax-exempt investment income
    
    
    (339
    )
    
    
    (241
    )
    
    
    (1,006
    )
    
    
    (665
    )Change of valuation allowance on capital losses
    
    
    3,191
    
    
    
    
    
    
    
    3,191
    
    
    
    Other items, net
    
    
    (51
    )
    
    
    35
    
    
    
    (60
    )
    
    
    (737
    )$
    2,033
    
    
    $
    5,145
    
    
    $
    8,499
    
    
    $
    15,327
  September 30, 2008
    
    
    December 31, 2007(Dollars in thousands)Deferred Tax Assets:Unearned premiums
    
    $
    10,280
    
    
    $
    8,528Unpaid losses and LAE expenses
    
    
    8,024
    
    
    
    6,599Assignments and assessments
    
    
    1,516
    
    
    
    992Unrealized losses on investments
    
    
    9,702
    
    
    
    2,412Realized losses on investments
    
    
    3,867
    
    
    
    Other, net
    
    
    1,949
    
    
    
    1,22035,338
    
    
    
    19,751Valuation allowance
    
    
    (6,976
    )
    
    
    (842
    )28,362
    
    
    
    18,909Deferred Tax Liabilities:Deferred policy acquisition costs
    
    
    (7,723
    )
    
    
    (6,152
    )Other, net
    
    
    (1,382
    )
    
    
    (764
    )Total deferred tax liabilities
    
    
    (9,105
    )
    
    
    (6,916
    )Net deferred income tax assets
    
    $
    19,257
    
    
    $
    11,993
  12. Comprehensive Income
  11




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##### Table of Contents



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
   Results of Operations
 Overview
  12




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##### Table of Contents



Gross Premiums Written
  Three Months Ended September 30,2008
    
    
    2007Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Alternative Risk Transfer
    
    $
    33,808
    
    
    
    43.7
    %
    
    $
    22,435
    
    
    
    31.1
    %Transportation
    
    
    20,972
    
    
    
    27.1
    %
    
    
    25,717
    
    
    
    35.7
    %Specialty
Personal Lines and Commercial Vehicle
    
    
    14,120
    
    
    
    18.2
    %
    
    
    12,773
    
    
    
    17.7
    %Hawaii and Alaska
    
    
    6,996
    
    
    
    9.0
    %
    
    
    7,747
    
    
    
    10.8
    %Other
    
    
    1,555
    
    
    
    2.0
    %
    
    
    3,385
    
    
    
    4.7
    %Gross premiums written
    
    $
    77,451
    
    
    
    100.0
    %
    
    $
    72,057
    
    
    
    100.0
    %
 Nine Months Ended September 30,2008
    
    
    2007Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Alternative Risk Transfer
    
    $
    172,024
    
    
    
    55.1
    %
    
    $
    132,866
    
    
    
    48.4
    %Transportation
    
    
    71,735
    
    
    
    23.0
    %
    
    
    72,830
    
    
    
    26.5
    %Specialty Personal Lines
and Commercial Vehicle
    
    
    46,800
    
    
    
    15.0
    %
    
    
    43,746
    
    
    
    15.9
    %Hawaii and Alaska
    
    
    17,727
    
    
    
    5.7
    %
    
    
    19,834
    
    
    
    7.2
    %Other
    
    
    3,961
    
    
    
    1.2
    %
    
    
    5,594
    
    
    
    2.0
    %Gross premiums written
    
    $
    312,247
    
    
    
    100.0
    %
    
    $
    274,870
    
    
    
    100.0
    %
  13




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##### Table of Contents



Premiums Earned
 Three months ended September 30, 2008 compared to September 30, 2007.
 Three Months Ended September 30,
    
    
    Change2008
    
    
    2007
    
    
    Amount
    
    
    Percent(Dollars in thousands)Premiums earned:Alternative Risk Transfer
    
    $
    35,814
    
    
    $
    27,033
    
    
    $
    8,781
    
    
    
    32.5
    %Transportation
    
    
    19,162
    
    
    
    18,596
    
    
    
    566
    
    
    
    3.0
    %Specialty Personal Lines and CV
    
    
    14,046
    
    
    
    13,252
    
    
    
    794
    
    
    
    6.0
    %Hawaii and Alaska
    
    
    4,467
    
    
    
    4,562
    
    
    
    (95
    )
    
    
    (2.1
    %)Other
    
    
    1,569
    
    
    
    2,744
    
    
    
    (1,175
    )
    
    
    (42.8
    %)Total premiums earned
    
    $
    75,058
    
    
    $
    66,187
    
    
    $
    8,871
    
    
    
    13.4
    %
  14




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##### Table of Contents



Nine months ended September 30, 2008 compared to September 30, 2007.
 Nine Months Ended September 30,
    
    
    Change2008
    
    
    2007
    
    
    Amount
    
    
    Percent(Dollars in thousands)Premiums earned:Alternative Risk Transfer
    
    $
    99,212
    
    
    $
    77,495
    
    
    $
    21,717
    
    
    
    28.0
    %Transportation
    
    
    56,882
    
    
    
    55,436
    
    
    
    1,446
    
    
    
    2.6
    %Specialty Personal Lines and CV
    
    
    40,797
    
    
    
    38,564
    
    
    
    2,233
    
    
    
    5.8
    %Hawaii and Alaska
    
    
    13,393
    
    
    
    13,075
    
    
    
    318
    
    
    
    2.4
    %Other
    
    
    4,237
    
    
    
    5,172
    
    
    
    (935
    )
    
    
    (18.1
    %)Total premiums earned
    
    $
    214,521
    
    
    $
    189,742
    
    
    $
    24,779
    
    
    
    13.1
    %
  Underwriting and Loss Ratio Analysis
   Three Months Ended September 30,
    
    
    Nine Months Ended September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands)
    
    
    (Dollars in thousands)Gross premiums written
    
    $
    77,451
    
    
    $
    72,057
    
    
    $
    312,247
    
    
    $
    274,870Ceded reinsurance
    
    
    (15,036
    )
    
    
    (12,786
    )
    
    
    (72,674
    )
    
    
    (61,837
    )Net premiums written
    
    
    62,415
    
    
    
    59,271
    
    
    
    239,573
    
    
    
    213,033Change in unearned premiums, net of ceded
    
    
    12,643
    
    
    
    6,916
    
    
    
    (25,052
    )
    
    
    (23,291
    )Net premiums earned
    
    $
    75,058
    
    
    $
    66,187
    
    
    $
    214,521
    
    
    $
    189,742Combined Ratios:Loss and LAE ratio(1)
    
    
    69.3
    %
    
    
    60.2
    %
    
    
    67.2
    %
    
    
    59.3
    %Underwriting expense ratio (2)
    
    
    28.2
    %
    
    
    22.7
    %
    
    
    25.3
    %
    
    
    22.1
    %Combined ratio
    
    
    97.5
    %
    
    
    82.9
    %
    
    
    92.5
    %
    
    
    81.4
    %
 
 (1)
    
    The ratio of losses and LAE to premiums earned.(2)
    
    The ratio of the sum of commissions and other underwriting expenses, other operating
expenses less other income to premiums earned. 15




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##### Table of Contents



Three months ended September 30, 2008 compared to September 30, 2007.
  Nine months ended September 30, 2008 compared to September 30, 2007.
  Net Investment Income
 2008 compared to 2007.
 Net Realized Gains (Losses) on Investments
 2008 compared to 2007.
  16




---



##### Table of Contents



Commissions and Other Underwriting Expenses
 2008 compared to 2007.
 Other Operating and General Expenses
 2008 compared to 2007.
 Expense on Amounts Withheld
 2008 compared to 2007.
 Income Taxes
 2008 compared to 2007.
 Financial Condition
 Investments and Securities Lending Collateral
    17




---



##### Table of Contents



Securities with
    
    Securities withUnrealized
    
    UnrealizedGains
    
    Losses(Dollars in thousands)Fixed Maturities:Fair value of securities
    
    $
    187,839
    
    
    $
    243,278Amortized cost of securities
    
    $
    186,010
    
    
    $
    254,374Gross unrealized gain or (loss)
    
    $
    1,829
    
    
    $
    (11,096
    )Fair value as a % of amortized cost
    
    
    101.0
    %
    
    
    95.6
    %Number of security positions held
    
    
    171
    
    
    
    201Number individually exceeding $50,000 gain or loss
    
    
    4
    
    
    
    46Concentration of gains or (losses) by type or industry:US Government and government agencies
    
    $
    1,060
    
    
    $
    (928
    )State, municipalities and political subdivisions
    
    
    235
    
    
    
    (3,544
    )Mortgage-backed securities
    
    
    391
    
    
    
    (427
    )Banks, insurance and brokers
    
    
    121
    
    
    
    (5,679
    )Industrial and other
    
    
    22
    
    
    
    (518
    )Percentage rated investment grade (1)
    
    
    99.6
    %
    
    
    99.6
    %Equity Securities:Fair value of securities
    
    $
    3,244
    
    
    $
    29,679Cost of securities
    
    $
    3,054
    
    
    $
    40,572Gross unrealized gain or (loss)
    
    $
    190
    
    
    $
    (10,893
    )Fair value as a % of cost
    
    
    106.2
    %
    
    
    73.2
    %Number individually exceeding $50,000 gain or (loss)
    
    
    1
    
    
    
    40
 
 (1)
    
    Investment grade of AAA to BBB- by Standard & Poors Corporation.  UnrealizedLossesFixed Maturities:Fair value of securities
    
    $
    50,580Amortized cost of securities
    
    $
    58,331Gross unrealized gain or (loss)
    
    $
    (7,751
    )Fair value as a % of amortized cost
    
    
    86.7
    %Number of security positions held
    
    
    16Number individually exceeding $50,000 gain or loss
    
    
    11Concentration of gains or (losses) by type:Repurchase agreements  overnight
    
    
    Mortgage-backed securities
    
    
    (6,854
    )Banks, insurance and brokers
    
    
    (897
    )Percentage rated investment grade (1)
    
    
    96.0
    %
 
 (1)
    
    Investment grade of AAA to BBB- by Standard & Poors Corporation. 18




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##### Table of Contents



Securities with
    
    Securities withUnrealized
    
    UnrealizedGains
    
    LossesMaturity:One year or less
    
    
    3.9
    %
    
    
    4.9
    %After one year through five years
    
    
    69.9
    %
    
    
    31.8
    %After five years through ten years
    
    
    6.8
    %
    
    
    45.0
    %After ten years
    
    
    1.1
    %
    
    
    5.2
    %81.7
    %
    
    
    86.9
    %Mortgage-backed securities
    
    
    18.3
    %
    
    
    13.1
    %100.0
    %
    
    
    100.0
    %
  Securities withUnrealizedLossesMaturity:One year or less
    
    
    48.7
    %After one year through five years
    
    
    6.9
    %55.6
    %Mortgage-backed securities
    
    
    44.4
    %100.0
    %
  September 30, 2008Aggregate
    
    
    Fair Value asAggregate Fair
    
    
    Unrealized
    
    
    % of CostValue
    
    
    Gain (Loss)
    
    
    Basis(Dollars in thousands)Fixed Maturities:Securities with unrealized gains:Exceeding $50,000 and for:Less than one year (4 issues)
    
    $
    7,037
    
    
    $
    281
    
    
    
    104.2
    %More than one year (0 issues)
    
    
    
    
    
    
    
    
    
    
    Less than $50,000 (167 issues)
    
    
    180,802
    
    
    
    1,548
    
    
    
    100.9
    %$
    187,839
    
    
    $
    1,829Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (39 issues)
    
    $
    55,478
    
    
    $
    (4,409
    )
    
    
    92.6
    %More than one year (7 issues)
    
    
    8,834
    
    
    
    (4,157
    )
    
    
    68.0
    %Less than $50,000 (155 issues)
    
    
    178,966
    
    
    
    (2,530
    )
    
    
    98.6
    %$
    243,278
    
    
    $
    (11,096
    )Equity Securities:Securities with unrealized gains:Exceeding $50,000 and for:Less than one year (0 issue)
    
    $
    
    
    
    $
    
    
    
    
    More than one year (1 issues)
    
    
    2,150
    
    
    
    150
    
    
    
    107.5
    %Less than $50,000 (2 issues)
    
    
    1,094
    
    
    
    40
    
    
    
    103.8
    %$
    3,244
    
    
    $
    190Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (36 issues)
    
    $
    23,138
    
    
    $
    (8,465
    )
    
    
    73.2
    %More than one year (4 issues)
    
    
    3,517
    
    
    
    (1,942
    )
    
    
    64.4
    %Less than $50,000 (19 issues)
    
    
    3,024
    
    
    
    (486
    )
    
    
    86.2
    %$
    29,679
    
    
    $
    (10,893
    )
 19




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##### Table of Contents



September 30, 2008Aggregate
    
    
    Fair Value asAggregate Fair
    
    
    Unrealized
    
    
    % of CostValue
    
    
    Gain (Loss)
    
    
    Basis(Dollars in thousands)Fixed Maturities:Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (9 issues)
    
    $
    18,335
    
    
    $
    (6,396
    )
    
    
    74.1
    %More than one year (2 issues)
    
    
    5,046
    
    
    
    (1,269
    )
    
    
    Less than $50,000 (5 issues)
    
    
    27,199
    
    
    
    (86
    )
    
    
    99.7
    %$
    50,580
    
    
    $
    (7,751
    )
  Premiums and Reinsurance
    Liquidity and Capital Resources
  
 20




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##### Table of Contents



Critical Accounting Policies
  Losses and Loss Adjustment Expense Reserves
  21




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##### 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
  22




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##### Table of Contents




    
    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
   
 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
  23




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ITEM 4. Controls and Procedures
   24




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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
  
 ITEM 6. Exhibits
 3.1
    
    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. 25




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SIGNATURES
  NATIONAL INTERSTATE CORPORATIONDate: November 4, 2008
    /s/ David W. MichelsonDavid W. MichelsonPresident and Chief Executive Officer
(Duly Authorized Officer and Principal Executive Officer)  /s/ Julie A. McGrawJulie A. McGrawVice President and Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer) 26