##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
    Form 10-Q  þ
    Quarterly Annual Report Pursuant to Section 13 or15(d)of the Securities Exchange Act of
1934 For the quarterly period ended March 31, 2005
 OR o
    Transition Report Pursuant to Section 13 or15(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)    Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or
for such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days. þ Yes £ No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Act). £Yes þ No The number of shares outstanding of the registrants sole class of common shares as of May 1, 2005
was 18,965,200.




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National Interstate Corporation
Table of Contents PagePart I  Financial InformationItem 1. Financial StatementsConsolidated Balance Sheets
    
    
    1Consolidated Statements of Income
    
    
    2Consolidated Statement 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
    
    
    9Item 3. Quantitative and Qualitative Disclosures about Market Risk
    
    
    18Item 4. Controls and Procedures
    
    
    18Part II  Other InformationItem 1. Legal Proceedings
    
    
    19Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    19Item 3. Defaults Upon Senior Securities
    
    
    19Item 4. Submission of Matters to a Vote of Security Holders
    
    
    19Item 5. Other Information
    
    
    19Item 6. Exhibits
    
    
    19Signatures
    
    
    20Exhibit 31.1 302 CEO CertificationExhibit 31.2 302 CFO CertificationExhibit 32.1 906 CEO CertificationExhibit 32.2 906 CFO Certification




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##### Table of Contents



PART I  FINANCIAL INFORMATION 
 Item 1.Financial Statements National Interstate Corporation and Subsidiaries 
 Consolidated Balance Sheets
 (Dollars in thousands, except per share data)
 March 31,
    
    
    December 31,2005
    
    
    2004(Unaudited)ASSETSInvestments:Fixed maturities available-for-sale, at fair value (amortized cost  $236,911 and
$205,711, respectively)
    
    $
    234,096
    
    
    $
    206,221Equity securities available-for-sale, at fair value (cost  $20,197 and $16,522, respectively)
    
    
    20,114
    
    
    
    16,841Short-term investments, at cost which approximates fair value
    
    
    27,773
    
    
    
    5,280Total investments
    
    
    281,983
    
    
    
    228,342Cash and cash equivalents
    
    
    8,931
    
    
    
    10,609Accrued investment income
    
    
    2,490
    
    
    
    2,344Premiums receivable, net of allowance for doubtful accounts of $371 and $361, respectively
    
    
    87,262
    
    
    
    45,129Reinsurance recoverables on paid and unpaid losses
    
    
    68,911
    
    
    
    63,128Prepaid reinsurance premiums
    
    
    32,449
    
    
    
    16,190Deferred policy acquisition costs
    
    
    15,902
    
    
    
    11,606Deferred federal income taxes
    
    
    8,578
    
    
    
    6,400Property and equipment, net
    
    
    11,578
    
    
    
    11,738Funds held by reinsurer
    
    
    2,844
    
    
    
    3,599Other assets
    
    
    961
    
    
    
    2,151Total assets
    
    $
    521,889
    
    
    $
    401,236LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Unpaid losses and loss adjustment expenses
    
    $
    185,343
    
    
    $
    171,031Unearned premiums
    
    
    127,623
    
    
    
    80,928Long-term debt
    
    
    17,235
    
    
    
    17,547Note payable to affiliate
    
    
    
    
    
    
    15,000Amounts withheld or retained for account of others
    
    
    17,083
    
    
    
    14,911Reinsurance balances payable
    
    
    21,889
    
    
    
    3,429Other accounts payable
    
    
    19,685
    
    
    
    14,432Commissions payable
    
    
    7,017
    
    
    
    4,719Assessments and fees payable
    
    
    7,821
    
    
    
    6,450Total liabilities
    
    
    403,696
    
    
    
    328,447Shareholders equity:Preferred shares  no par valueAuthorized  10,000,000 sharesIssued  0 shares
    
    
    
    
    
    
    Common shares  $0.01 par valueAuthorized  50,000,000 sharesIssued  23,350,000 and 20,000,000 shares, including 4,384,800 and 4,470,400, respectively,
shares in treasury
    
    
    234
    
    
    
    200Additional paid-in capital
    
    
    41,800
    
    
    
    1,264Retained earnings
    
    
    84,241
    
    
    
    77,102Accumulated other comprehensive (loss) income
    
    
    (1,885
    )
    
    
    539Treasury shares
    
    
    (6,197
    )
    
    
    (6,316
    )Total shareholders equity
    
    
    118,193
    
    
    
    72,789Total liabilities and shareholders equity
    
    $
    521,889
    
    
    $
    401,236
 See notes to consolidated financial statements. 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 March 31,2005
    
    
    2004Revenue:Premiums earned
    
    $
    43,177
    
    
    $
    32,996Net investment income
    
    
    2,667
    
    
    
    1,757Realized gains on investments
    
    
    115
    
    
    
    692Other
    
    
    2,044
    
    
    
    1,781Total revenues
    
    
    48,003
    
    
    
    37,226Expenses:Losses and loss adjustment expenses
    
    
    26,067
    
    
    
    19,898Commissions and other underwriting expense
    
    
    8,788
    
    
    
    7,878Other operating and general expenses
    
    
    1,984
    
    
    
    1,619Interest expense
    
    
    401
    
    
    
    254Total expenses
    
    
    37,240
    
    
    
    29,649Income before federal income taxes
    
    
    10,763
    
    
    
    7,577Provision for federal income taxes
    
    
    3,608
    
    
    
    2,594Net income
    
    $
    7,155
    
    
    $
    4,983Net income per common share  basic
    
    $
    0.40
    
    
    $
    0.33Net income per common share  diluted
    
    $
    0.39
    
    
    $
    0.32Weighted average of common shares
outstanding, basic
    
    
    17,941
    
    
    
    15,024Weighted average of common shares
outstanding, diluted
    
    
    18,199
    
    
    
    15,379
 See notes to consolidated
financial statements. 2




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##### Table of Contents



National Interstate Corporation and Subsidiaries 
 Consolidated Statement of Shareholders Equity
 (Unaudited)
(Dollars in thousands)
 AccumulatedAdditional
    
    
    
    
    
    
    OtherCommon
    
    
    Paid-In
    
    
    Retained
    
    
    Comprehensive
    
    
    TreasuryShares
    
    
    Capital
    
    
    Earnings
    
    
    Income (Loss)
    
    
    Shares
    
    
    TotalBalance at January 1, 2005
    
    $
    200
    
    
    $
    1,264
    
    
    $
    77,102
    
    
    $
    539
    
    
    $
    (6,316
    )
    
    $
    72,789Net Income
    
    
    
    
    
    
    
    
    
    
    7,155
    
    
    
    
    
    
    
    
    
    
    
    7,155Unrealized depreciation of investment securities,
net of tax benefit of $1,305
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,424
    )
    
    
    
    
    
    
    (2,424
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,731Proceeds from initial public offering
    
    
    34
    
    
    
    40,410
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    40,444Issuance of 85,600 treasury shares upon exercise of stock
options
    
    
    
    
    
    
    33
    
    
    
    (16
    )
    
    
    
    
    
    
    119
    
    
    
    136Tax benefit realized from exercise of stock options
    
    
    
    
    
    
    93
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    93Balance at March 31, 2005
    
    $
    234
    
    
    $
    41,800
    
    
    $
    84,241
    
    
    $
    (1,885
    )
    
    $
    (6,197
    )
    
    $
    118,193
 See notes to consolidated financial statements. 3




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National Interstate Corporation and Subsidiaries 
 Consolidated Statements of Cash Flows
 (Unaudited)
(In thousands)
 Three months endedMarch 31,2005
    
    
    2004Operating activitiesNet income
    

    $
    7,155
    
    
    $
    4,983Adjustments to reconcile net income to net cash provided by operating activities:Net amortization of bond premiums and discounts
    
    
    196
    
    
    
    136Provision for depreciation and amortization
    
    
    293
    
    
    
    293Net realized gain on investment securities
    
    
    (115
    )
    
    
    (692
    )Tax benefit realized from exercise of stock options
    
    
    93
    
    
    
    Deferred federal income taxes
    
    
    (874
    )
    
    
    (1,337
    )Increase in deferred policy acquisition costs, net
    
    
    (4,296
    )
    
    
    (2,558
    )Increase in reserves for losses and loss adjustment expenses
    
    
    14,312
    
    
    
    8,844Increase in premiums receivable
    
    
    (42,133
    )
    
    
    (33,826
    )Increase in unearned premiums and service fees
    
    
    46,695
    
    
    
    56,600Increase in interest receivable, prepaid reinsurance premiums and other assets
    
    
    (14,481
    )
    
    
    (32,562
    )Increase in accounts payable, commissions and other liabilities, premiums
and other funds collected from others and assessments and fees payable
    
    
    11,094
    
    
    
    7,301Increase in reinsurance recoverable
    
    
    (5,783
    )
    
    
    (3,848
    )Increase in reinsurance balances payable
    
    
    18,460
    
    
    
    17,243Other
    
    
    (2
    )
    
    
    Net cash provided by operating activities
    
    
    30,614
    
    
    
    20,577Investing activitiesPurchases of investments
    
    
    (77,380
    )
    
    
    (53,964
    )Proceeds from sale or maturity of investments
    
    
    19,929
    
    
    
    40,646Purchases of property and equipment
    
    
    (109
    )
    
    
    (215
    )Net cash used in investing activities
    
    
    (57,560
    )
    
    
    (13,533
    )Financing activitiesProceeds from IPO of common shares
    
    
    40,444
    
    
    
    Repayment of note payable to affiliate
    
    
    (15,000
    )
    
    
    Repayment of mortgage loan and notes payable
    
    
    (312
    )
    
    
    (416
    )Issuance of common shares from treasury upon exercise of stock options
    
    
    136
    
    
    
    Net cash provided by (used in) financing activities
    
    
    25,268
    
    
    
    (416
    )Net (decrease) increase in cash and cash equivalents
    
    
    (1,678
    )
    
    
    6,628Cash and cash equivalents at beginning of period
    
    
    10,609
    
    
    
    21,610Cash and cash equivalents at end of period
    
    $
    8,931
    
    
    $
    28,238
 See notes to consolidated financial statements. 4




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##### Table of Contents



NATIONAL INTERSTATE CORPORATION AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
(Dollars in thousands, except share data)
 1. Basis of Presentation The accompanying unaudited consolidated financial statements of National Interstate Corporation and
its subsidiaries (the Company) have been prepared in accordance with Form 10-Q and Article 10 of
Regulation S-X instructions. Accordingly, the financials do not include all of the information and
footnotes required by accounting principles generally accepted in the United States for complete
financial statements. These interim consolidated financial statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Companys Annual Report on Form 10-K for the
year ended December 31, 2004. The interim financial statements reflect all adjustments which are,
in the opinion of management, necessary for the fair presentation of the results for the periods
presented. Such adjustments are of a normal recurring nature. Operating results for the
three-month period ended March 31, 2005 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2005. Historical financial statements have been adjusted to reflect the 200-for-1 common share split
effective December 6, 2004 and the reclassification of all Class A common shares as common shares
effective immediately prior to the Companys February 2005 initial public offering (IPO). The
Company has neither paid nor declared dividends for the three months ended March 31, 2005 and 2004. The preparation of the financial statements requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying notes. Changes in
circumstances could cause actual results to differ materially from those estimates. 2. Quarterly Operating Results  As Corrected (Unaudited) The Quarterly Operating Results that were stated in Note 18 in the 2004 Form 10-K Notes to
Consolidated Financial Statements contained a clerical error. The net earnings, net income per
share  basic and net income per share  diluted amounts for the first three quarters of 2004 were
incorrectly stated due to this clerical error. The same error occurred in Note 17 in the Form S-1
Notes to Consolidated Financial Statements. The Consolidated Statements of Income for both the year
ended December 31, 2004 and the nine months ended September 30, 2004 were correctly stated in the
Form 10-K and Form S-1, respectively. The 2004 quarterly results will be correctly presented on a
prospective basis. The original amounts from the Form 10-K Notes to Consolidated Financial
Statements (Note 18) and the quarterly operating results as corrected are shown in the following
table: 1st
    
    
    2nd
    
    
    3rd
    
    
    4th
    
    
    Total2004 (As stated in Form 10-K)
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    YearRevenues
    
    $
    37,226
    
    
    $
    44,992
    
    
    $
    43,309
    
    
    $
    46,181
    
    
    $
    171,708Net earnings
    
    
    4,138
    
    
    
    6,046
    
    
    
    5,931
    
    
    
    6,653
    
    
    
    22,768Net income per share  basic
    
    
    0.28
    
    
    
    0.40
    
    
    
    0.39
    
    
    
    0.43
    
    
    
    1.50Net income per share  diluted
    
    
    0.27
    
    
    
    0.39
    
    
    
    0.38
    
    
    
    0.42
    
    
    
    1.47
 1st
    
    
    2nd
    
    
    3rd
    
    
    4th
    
    
    Total2004 (As corrected)
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    Quarter
    
    
    YearRevenues
    
    $
    37,226
    
    
    $
    44,992
    
    
    $
    43,309
    
    
    $
    46,181
    
    
    $
    171,708Net earnings
    
    
    4,983
    
    
    
    6,411
    
    
    
    4,721
    
    
    
    6,653
    
    
    
    22,768Net income per share  basic
    
    
    0.33
    
    
    
    0.43
    
    
    
    0.31
    
    
    
    0.43
    
    
    
    1.50Net income per share  diluted
    
    
    0.32
    
    
    
    0.42
    
    
    
    0.31
    
    
    
    0.42
    
    
    
    1.47
 3. Initial Public Offering In February 2005, National Interstate Corporation (NIC) completed an IPO in which it issued
3,350,000 shares and selling shareholders sold 1,074,000 shares at an initial offering price of
$13.50 per share. Proceeds from the offering totaled approximately $40.4 million after a deduction
for the underwriting discount and offering expenses. Net proceeds were used to repay a loan from NICs majority shareholder, 5




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Great American Insurance Company (Great American), with the remainder
to be used for other general corporate purposes. 4. Stock-Based Compensation The Company applies the intrinsic value method in accordance with Accounting Principles Board
Opinion No. 25 (APB No. 25), Accounting for Stock Issued to Employees, and its related
interpretations for its accounting of stock compensation plans for employees. In accordance with
the intrinsic value method prescribed by APB No. 25, compensation cost is measured as the excess,
if any, of the fair value of the equity instrument awarded at the measurement date over the amount
an employee must pay to acquire the equity instrument. Since options are granted at exercise prices
equal to the fair value of the shares at the date of grant, no compensation expense is currently
recognized. Statement of Financial Accounting Standard (SFAS) No. 148 , Accounting for Stock-Based
Compensation  Transition and Disclosure, permits entities to continue to apply the provisions of
APB No. 25 and provide pro forma net income and pro forma earnings per share disclosures for
employee stock option grants as if the fair-value-based method, as defined in SFAS No. 123,
Accounting for Stock-Based Compensation, had been applied. SFAS No. 148 provides alternative
methods of transitioning to SFAS No. 123s fair value method of accounting for stock-based employee
compensation, but does not require companies to account for employee stock options using the fair
value method. The Company has elected to continue to apply provisions of APB No. 25 and provide the
pro forma disclosures required by SFAS No. 148. The following table illustrates the effect on net income and earnings per share if the fair value
based method described by SFAS No. 148 had been applied to all outstanding and unvested awards in
each period. The fair value was calculated using the Black-Scholes option pricing method for
options granted during 2005 and the minimum value option pricing method for all prior grants. Both
the Black-Scholes method and the minimum value method reflect the value of the right to defer
payment of the exercise price until the end of the options term but the Black-Scholes method also
factors in the right to benefit from increases in the price of the underlying share without being
exposed to losses beyond the premium paid (volatility value). Therefore, the Black-Scholes method
is deemed more appropriate for a publicly traded company than the minimum value method. Due to the
change in valuation methods, the computations of the effect on net income and earnings per share
for the three months ended March 31, 2005 and 2004 are not comparable. Three months endedMarch 31,2005
    
    
    2004Net income, as reported
    
    $
    7,155
    
    
    $
    4,983Less: Proforma stock option expense, net of tax
    
    
    200
    
    
    
    14Proforma net income
    
    $
    6,955
    
    
    $
    4,969Earnings per share:Basic  as reported
    
    $
    0.40
    
    
    $
    0.33Basic  proforma
    
    
    0.39
    
    
    
    0.33Diluted  as reported
    
    
    0.39
    
    
    
    0.32Diluted  proforma
    
    
    0.38
    
    
    
    0.33
 The following assumptions were used for grants in the three months ended March 31, 2005 and March
31, 2004. Three Months EndedMarch 31,2005
    
    
    2004Dividend yield
    
    
    0.3
    %
    
    
    Volatility
    
    
    31.0
    %
    
    
    Risk-free interest rate
    
    
    4.18% - 4.50
    %
    
    
    4.37
    %Expected Life of grant
    
    10 years
    
    10 years
 The estimated weighted-average date of grant fair value of options granted were $6.77 and $1.20 for
the three months ended March 31, 2005 and 2004, respectively. 6




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##### Table of Contents



On December 16, 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123R ,
Share-Based Payment, which replaces SFAS No. 123, Accounting for Stock-Based Compensation, and
supercedes APB Opinion No. 25, Accounting for Stock Issued to Employees. SFAS No. 123R requires
compensation costs related to share-based payment transactions to be recognized in the financial
statements over the period that an employee provides service in exchange for the award. Public
companies are required to adopt the new standard using a modified prospective method and may elect
to restate prior periods using the modified retrospective method. Under the modified prospective
method, companies are required to record compensation cost for new and modified awards over the
related vesting period of such awards prospectively and record compensation cost prospectively for
the unvested options, at the date of adoption, of previously issued and outstanding awards over the
remaining vesting period of such awards. No change to prior periods presented is permitted under
the modified prospective method. Under the modified retrospective method, companies record
compensation costs for prior periods retroactively through restatement of such periods using the
exact pro forma amounts disclosed in the companies footnotes. Also, in the period of adoption and
after, companies record compensation cost based on the modified prospective method. On April 14,
2005, the Securities and Exchange Commission modified the implementation of SFAS No. 123R to be
effective for the annual period beginning after June 15, 2005 effectively delaying implementation
for the Company until January 1, 2006. Early application of SFAS 123R is encouraged, but not
required. The Company intends to use the modified prospective method to adopt SFAS No. 123R. If the Company
were to adopt SFAS No. 123R on January 1, 2006, using the modified prospective method, the Company
estimates that total stock-based compensation expense, net of related tax effects, will increase by
$668 for the year ending December 31, 2006. 5. Comprehensive Income Comprehensive income includes the Companys net income plus the changes in the unrealized gains or
losses (net of income taxes) on the Companys available-for-sale securities. The details of
comprehensive income are reported in the Consolidated Statement of Shareholders Equity. Total
comprehensive income was $4,731 and $5,843 for the three months ended March 31, 2005 and 2004,
respectively. 6. Note Payable and Long-term Debt Long-term debt consisted of the following: March 31,
    
    
    December 31,2005
    
    
    2004Junior subordinated debentures
    
    $
    15,464
    
    
    $
    15,464Term note payable to bank
    
    
    1,771
    
    
    
    2,083Note payable to affiliate
    
    
    
    
    
    
    15,000Total notes payable and long-term debt
    
    $
    17,235
    
    
    $
    32,547
 A portion of the net proceeds from the IPO was used to repay the note payable to affiliate during
the first quarter of 2005. 7. Premiums, Reinsurance and Transactions with Related Parties The Companys principal insurance subsidiary, National Interstate Insurance Company (NIIC) is
involved in both the cession and assumption of reinsurance. NIIC is a party to a reinsurance
agreement, and National Interstate Insurance Agency (NIIA), a wholly-owned subsidiary, is a party
to an underwriting management agreement with Great American. The reinsurance agreement calls for
the assumption by NIIC of all of the risk on Great Americans net premiums written for public
transportation and recreational vehicle risks. NIIA provides administrative services to Great
American in connection with Great Americans underwriting of public transportation risks. The table below summarizes the reinsurance balance and activity with Great American: Three Months EndedMarch 31,2005
    
    
    2004Written premiums assumed
    
    $
    2,579
    
    
    $
    2,757Assumed premiums earned
    
    
    2,230
    
    
    
    1,805Assumed losses and loss adjustment expense incurred
    
    
    1,458
    
    
    
    1,621Payable to Great American as of period end
    
    
    1,009
    
    
    
    2,523
 7




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##### Table of Contents



The Company also cedes premiums through reinsurance agreements with non-affiliated reinsurers to
reduce exposure in certain of its property-casualty insurance programs. Ceded losses and loss
adjustment expense recoveries recorded for the three months ended March 31, 2005 and 2004 were
$7,642 and $3,310 , respectively. The Company remains primarily liable as the direct insurer on all
risks reinsured and a contingent liability exists to the extent that the reinsurance companies are
unable to meet their obligations for losses assumed. To minimize its exposure to significant losses
from reinsurer insolvencies, the Company regularly evaluates the financial condition of its
reinsurers. Premiums and reinsurance activity consisted of the following: Three Months Ended March 31,2005
    
    
    2004Written
    
    
    Earned
    
    
    Written
    
    
    EarnedDirect
    
    $
    100,678
    
    
    $
    54,037
    
    
    $
    84,771
    
    
    $
    43,131Assumed
    
    
    2,899
    
    
    
    2,829
    
    
    
    4,169
    
    
    
    3,281Ceded
    
    
    (29,948
    )
    
    
    (13,689
    )
    
    
    (32,449
    )
    
    
    (13,416
    )Net Premium
    
    $
    73,629
    
    
    $
    43,177
    
    
    $
    56,491
    
    
    $
    32,996
 Great American, or its parent American Financial Group, Inc., performs certain services for the
Company without charge including, without limitation, actuarial and internal audit services.
Management believes, based on discussions with Great American, that these services will continue to
be provided by the affiliated entity in future periods and the relative impact on operating results
is not material. 8. Commitments and Contingencies From time to time, the Company is subject to other legal proceedings and claims in the ordinary
course of business. In the opinion of management, the effects, if any, of such litigation are not
expected to be material to the Companys consolidated financial condition or results of operations.
In addition, regulatory bodies, such as state insurance departments, the Securities and Exchange
Commission, the Department of Labor and other regulatory bodies may make inquiries and conduct
examinations or investigations concerning our compliance with insurance laws, securities laws,
labor laws and the Employee Retirement Income Security Act of 1974, as amended, among other things. Our insurance companies have lawsuits pending where by the plaintiff seeks extra-contractual
damages from the Company in addition to damages claimed under an insurance policy. These lawsuits
generally mirror similar lawsuits filed against other carriers in the industry. Although we are
vigorously defending these lawsuits, the lawsuits are in the early stages of litigation and their
outcomes cannot be determined at this time. However, management does not believe these lawsuits
will have a material adverse effect on the Companys business, financial condition or results of
operations based on managements belief that any adverse outcomes have either been provided for in
the loss reserves or such unfavorable result would be immaterial. The number of insurance companies that are under regulatory supervision has increased, which is
expected to result in an increase in assessments by state guaranty funds to cover losses to
policyholders of insolvent or rehabilitated companies. These mandatory assessments may be partially
recovered through a reduction in future premium taxes in some states. At March 31, 2005 and
December 31, 2004, the liability for such assessments was $7,821 and $6,450, respectively, and will
be paid over several years as assessed by the guaranty funds. 8




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##### Table of Contents



9. Earnings Per Common Share The following table sets forth the computation of basic and diluted income per share: Three Months Ended March 31,2005
    
    
    2004Net income
    
    $
    7,155
    
    
    $
    4,983Weighted average shares outstanding during period
    
    
    17,941
    
    
    
    15,024Additional shares issuable under employee common stock
option plans using treasury stock method
    
    
    258
    
    
    
    355Weighted average shares outstanding assuming exercise of
stock options
    
    
    18,199
    
    
    
    15,379Net income per share:Basic
    
    $
    0.40
    
    
    $
    0.33Diluted
    
    
    0.39
    
    
    
    0.32
 10. Segment Information The Company operates its business as one segment, property and casualty insurance. The Company
manages this segment through a product management structure. The following table shows revenues
summarized by the broader business component description. These business components were determined based primarily on
similar economic characteristics, products and services: Three Months Ended March 31,2005
    
    
    2004Revenue:Premiums earned:Transportation
    
    $
    16,306
    
    
    $
    15,168Alternate Risk Transfer
    
    
    12,753
    
    
    
    7,451Specialty Personal Lines
    
    
    8,665
    
    
    
    5,547Hawaii
    
    
    3,766
    
    
    
    3,717Other
    
    
    1,687
    
    
    
    1,113Total
    
    
    43,177
    
    
    
    32,996Net investment income
    
    
    2,667
    
    
    
    1,757Realized gains on investments
    
    
    115
    
    
    
    692Other
    
    
    2,044
    
    
    
    1,781Total revenues
    
    $
    48,003
    
    
    $
    37,226
 11. Shareholders Equity On August 5, 2004, the Board of Directors of the Company authorized a 200-for-1 common share split
effective December 6, 2004. On October 18, 2004, the Board of Directors recommended and the
shareholders approved an amendment and restatement of the Companys Articles of Incorporation
effective immediately prior to the Companys IPO. Pursuant to this action, all Class A common
shares were reclassified as common shares and 10 million shares of preferred stock were authorized.
Historical financial information presented herein has been adjusted to give effect for these
actions. The Company has a Long Term Incentive Plan (LTIP), which provides for the granting of stock options
to officers of the Company. The Company granted 386,000 stock options during the first quarter of
2005 under the LTIP. At March 31, 2005, there were 1,252,400 of the Companys common shares
reserved for issuance upon exercise of stock options and options for 718,000 shares were
outstanding. Treasury shares are used to fulfill the options exercised. Options vest ratably over
an initial five-year period and must be exercised no later than the tenth anniversary of the date
of grant. As set forth in the LTIP, the Company may accelerate vesting and exercisability of
options. The Compensation Committee of the Board of Directors must approve all grants. 
 ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations Forward-Looking Statements This document, including information incorporated by reference, contains forward-looking
statements (within the meaning of Private Securities Litigation Reform Act of 1995). All
statements, trend analyses and other information contained in this Form 10-Q relative to markets
for our products and trends in our operations or financial results, as well as other statements
including words such as may, target, anticipate, believe, plan, estimate, expect,
intend, project, and other similar expressions, constitute forward-looking statements. 9




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We made
these statements based on our plans and current analyses of our business and the insurance industry
as a whole. We caution that these statements may and often do vary from actual results and the
differences between these statements and actual results can be material. Accordingly, we cannot
assure you that actual results will not differ from those expressed or implied by the
forward-looking statements. Factors that could contribute to these differences include, among other
things:  
    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. The forward-looking statements herein are made only as of the date of this report. The Company
assumes no obligation to publicly update any forward-looking statements. General National Interstate Corporation and its subsidiaries operate as an insurance holding company group
that underwrites and sells traditional and alternative property and casualty insurance products to
the passenger transportation industry and the trucking industry, general commercial insurance to
small businesses in Hawaii, and personal insurance to owners of recreational vehicles and boats
throughout the United States. As of March 31, 2005, Great American owned 53.8% of the Company. Great American is a wholly owned
subsidiary of American Financial Group, Inc. On February 2, 2005, the Company completed an IPO in
which it issued 3,350,000 shares of its common stock at $13.50 a share and began trading its
common shares on the Nasdaq National Market under the symbol NATL. Prior to its IPO, no public
market existed for the Companys common shares. The Company has three property and casualty insurance subsidiaries, National Interstate Insurance
Company (NIIC), Hudson Indemnity, Ltd. (HIL) and National Interstate Insurance Company of Hawaii,
Inc. (NIIC-HI) and four other agency and service subsidiaries. NIIC is licensed in all 50 states
and the District of Columbia. HIL is domiciled in the Cayman Islands and conducts insurance
business outside the United States. The Company writes its insurance policies on a direct basis
through NIIC and in the state of Hawaii through NIIC-HI. The Company also assumes a portion of
premiums written by other affiliate companies whose passenger transportation insurance business it
manages. Insurance products are marketed through affiliates and independent agents and brokers. In
addition, the Company has agency and service subsidiaries. Critical Accounting Policies The preparation of financial statements in conformity with accounting principals generally accepted
in the United States (GAAP) requires management to make estimates and assumptions that affect
amounts reported in the financial statements. As more information becomes known, these estimates
and assumptions could change and thus impact amounts reported in the future. Management believes
that the establishment of losses and loss adjustment reserves and the determination of other than
temporary impairment on investments are the two areas where the degree of judgment required to
determine amounts recorded in the financial statements make the accounting policies critical. 10




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##### Table of Contents



For a
more detailed discussion of these policies, see Managements Discussion and Analysis  Critical
Accounting Policies in NICs 2004 Form 10-K. Losses and Loss Adjustment Expense (LAE) Reserves Significant periods of time can elapse between the occurrence of an insured loss, the reporting of
that loss to us and our final payment of that loss, and its related LAE. To recognize liabilities
for unpaid losses, we establish reserves as balance sheet liabilities. At March
31, 2005 and December 31, 2004, we had $185.3 million and $171.0 million, respectively, of gross
losses and LAE reserves, representing managements best estimate of the ultimate loss. Management
records on a monthly and quarterly basis its best estimate of loss reserves. For purposes of
computing the recorded reserves, management utilizes various data inputs, including analysis that
is derived from a review of prior quarter results performed by actuaries employed by Great
American, an affiliated company. In addition, on an annual basis, actuaries from Great American
review the recorded reserves utilizing current period data and provide a Statement of Actuarial
Opinion, required annually in accordance with state insurance regulations, on the reserves recorded
by our subsidiaries, NIIC and NIIC-HI. Since 1990, our first full year of operations, the actuaries
have opined each year that the reserves recorded at December 31 are reasonable. The actuarial
analysis of NIICs and NIIC-HIs net reserves as of the end of fiscal year ending December 31, 2004
reflected point estimates that were within one-half of 1% of managements recorded net reserves as
of such date. Using this actuarial data along with its other data inputs, management concluded that
the recorded reserves appropriately reflect managements best estimates of the liability as of
March 31, 2005 and December 31, 2004. The quarterly reviews of unpaid losses and LAE reserves by Great American Insurance Company actuaries
are prepared using standard actuarial techniques. These may include (but may not be limited to):  
    the Case Incurred Development Method;
    the Paid Development Method;
    the Bornhuetter-Ferguson Method; and
    the Incremental Paid LAE to Paid Loss Methods. Supplementary statistical information is reviewed to determine which methods are most
appropriate and whether adjustments are needed to particular methods. This information includes:  
    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 Our principal investments are in fixed maturities, all of which are exposed to at least one of
three primary sources of investment risk: credit, interest rate and market valuation risks. The
financial statement risks are those associated with the recognition of impairments and income, as
well as the determination of fair values. Recognition of income ceases when a bond goes into
default. We evaluate whether impairments have occurred on a case-by-case basis. Management
considers a wide range of factors about the security issuer and uses its best judgment in
evaluating the cause and amount of decline in the estimated fair value of the security and in
assessing the prospects for near-term recovery. Inherent in managements evaluation of the security
are assumptions and estimates about the operations of the issuer and its future earnings potential. 11




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Considerations we use in the impairment evaluation process include, but are not limited to:  
    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. When an investment is determined to have other-than-temporary impairment, in most cases we will
dispose of the investment. This approach allows us to realize the loss for tax purposes and to
reinvest the proceeds in what we view as more productive investments. For those investments we
choose to retain, we record an adjustment for impairment. We recorded no impairment adjustments for
the three months ended March 31, 2005 or the year ended December 31, 2004. Because total unrealized
losses are a component of shareholders equity, any recognition of other-than-temporary impairment
losses has no effect on our comprehensive income or consolidated financial position. See
Managements Discussions and Analysis of Financial Condition and Results of Operations 
Investments. Results of Operations Overview Through the operations of its subsidiaries, NIC is engaged in property and casualty insurance
operations. We generate underwriting profits by providing what we view as specialized insurance
products, services and programs not generally available in the marketplace. We focus on niche
insurance markets where we offer insurance products designed to meet the unique needs of targeted
insurance buyers that we believe are underserved by the insurance industry. We derive our revenues primarily from premiums from our insurance policies and income from our
investment portfolio. Our expenses consist primarily of losses and loss adjustment expenses, or
LAE; commissions and other underwriting expenses; and other operating and general expenses. The Companys net earnings for the first three months of 2005 were $7.2 million or $0.39 per share
(diluted), compared to $5.0 million or $0.32 per share recorded in the first quarter of
2004. The increase in net earnings of 43.6% from the first quarter of 2005 compared to the same
period in 2004 is primarily due to a 30.9% increase in net premiums earned with a lower increase in
underwriting expenses of 11.6% and a 51.8% increase in net investment income. Underwriting Underwriting profitability, as opposed to overall profitability or net earnings, is measured by the
combined ratio. The combined ratio is the sum of the losses and loss adjustment expense ratio and
the underwriting expense ratio. A combined ratio under 100% is indicative of an underwriting
profit. The Companys combined ratio was 80.6% for the first quarter of 2005, and 83.7% for the same period
in 2004. Our underwriting approach is to price our products to achieve an underwriting profit even if we forgo volume as a result. Since 2000, our insurance subsidiaries have been increasing their
premium rates to offset rising losses and reinsurance costs. Rate increases have continued during
2005, but at a slower pace compared to 2004. 12




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##### Table of Contents



The table below presents our net earned premiums and combined ratios for the periods indicated: Three Months EndedMarch 31,2005
    
    
    2004(Dollars in thousands)Gross premiums written
    
    $
    103,577
    
    
    $
    88,940Ceded reinsurance
    
    
    (29,948
    )
    
    
    (32,448
    )Net premiums written
    
    
    73,629
    
    
    
    56,492Change in unearned premiums
    
    
    (30,452
    )
    
    
    (23,496
    )Net earned premiums
    
    $
    43,177
    
    
    $
    32,996Combined Ratios:Losses and LAE ratio (1)
    
    
    60.4
    %
    
    
    60.3
    %Underwriting expense ratio (2)
    
    
    20.2
    %
    
    
    23.4
    %Combined ratio
    
    
    80.6
    %
    
    
    83.7
    %
   
  There are distinct differences in the timing of written premiums in our traditional transportation
component and our alternative risk transfer component that is primarily composed of group captive
programs. We write traditional transportation insurance policies throughout all 12 months of the
year and commence new annual policies at the expiration of the old policy. Under the group captive
programs, all members of a group share a common expiration date that occurs during the first half
of the calendar year. Any policy for a new captive program participant written during the last half
of the calendar year will be written for less than a full annual term so its next renewal date
coincides with the common expiration date of the group captive program it has joined. Gross
written premium includes both direct premium and assumed premium. The alternative risk transfer
component of our business was the largest portion of total gross premiums written at 62.8% for the
first quarter 2005. This represented a 5.3 basis point increase compared to the same period in 2004. The Company operates its business as one segment  property and casualty insurance. The Company
manages this segment through a product management structure. The following table sets forth an
analysis of gross premiums written by business component during the periods indicated: Three Months Ended March 31,2005
    
    
    2004Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Transportation
    
    $
    19,427
    
    
    
    18.8
    %
    
    $
    20,870
    
    
    
    23.5
    %Alternative Risk Transfer
    
    
    65,027
    
    
    
    62.8
    %
    
    
    51,129
    
    
    
    57.5
    %Specialty Personal Lines
    
    
    11,886
    
    
    
    11.5
    %
    
    
    9,891
    
    
    
    11.1
    %Hawaii
    
    
    6,048
    
    
    
    5.8
    %
    
    
    6,289
    
    
    
    7.1
    %Other
    
    
    1,189
    
    
    
    1.1
    %
    
    
    761
    
    
    
    0.8
    %Gross Premiums Written
    
    $
    103,577
    
    
    
    100.0
    %
    
    $
    88,940
    
    
    
    100.0
    %
 13




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##### Table of Contents



The following table shows revenues summarized by the broader business component description, which
were determined based primarily on similar economic characteristics, products and services: Three Months Ended March 31,
    
    
    Change2005
    
    
    2004
    
    
    Amount
    
    
    Percent(Dollars in thousands)
    
    
    (Dollars in thousands)Revenue:Premiums earned:Transportation
    
    $
    16,306
    
    
    $
    15,168
    
    
    $
    1,138
    
    
    
    7.5
    %Alternate Risk Transfer
    
    
    12,753
    
    
    
    7,451
    
    
    
    5,302
    
    
    
    71.2
    %Specialty Personal Lines
    
    
    8,665
    
    
    
    5,547
    
    
    
    3,118
    
    
    
    56.2
    %Hawaii
    
    
    3,766
    
    
    
    3,717
    
    
    
    49
    
    
    
    1.3
    %Other
    
    
    1,687
    
    
    
    1,113
    
    
    
    574
    
    
    
    51.6
    %Net Premiums Earned
    
    
    43,177
    
    
    
    32,996
    
    
    
    10,181
    
    
    
    30.9
    %Net investment income
    
    
    2,667
    
    
    
    1,757
    
    
    
    910
    
    
    
    51.8
    %Realized gains on investments
    
    
    115
    
    
    
    692
    
    
    
    (577
    )
    
    
    (83.4
    %)Other
    
    
    2,044
    
    
    
    1,781
    
    
    
    263
    
    
    
    14.8
    %Total revenues
    
    $
    48,003
    
    
    $
    37,226
    
    
    $
    10,777
    
    
    
    28.9
    %
 Our net premiums earned increased $10.2 million, or 30.9%, to $43.2 million during the three
months ended March 31, 2005 compared to $33.0 million for the same period in 2004. Our alternative
risk transfer component increased 71.2% during the first quarter of 2005 compared to the same
period in 2004, primarily due to new insureds. During this period and prior periods, our
alternative risk transfer business was one of the fastest growing components of our business. A
portion of the new customers in the alternative risk transfer component were larger premium
customers that were previously in our transportation component that joined group captive programs.
Due to an increase in the number of policies in force primarily from expanded distribution, our
specialty personal lines component increased 56.2% in the first quarter of 2005 compared to the
same period in 2004. The transportation component also increased 7.5% in the first quarter of 2005
due to increased rates on renewed policies. Additionally, a portion of the increase in the
transportation component is related to our community service and paratransit product that has added
new customers. The increase in the transportation component is partially offset by (i) a decline in
assumed premium from a reinsurance arrangement involving primarily physical damage coverage on
trucks because the company with whom we had the agreement elected to exit the business and (ii)
larger premium customers moving from the transportation component to our captive programs in the
alternative risk transfer component. Losses and loss adjustment expenses are a function of the amount and type of insurance contracts we
write and of the loss experience of the underlying risks. We record losses and loss adjustment
expenses based on an actuarial analysis of the estimated losses we expect to be reported on
contracts written. We seek to establish case reserves at the maximum probable exposure based on our
historical claims experience. Our ability to accurately estimate losses and loss adjustment
expenses at the time of pricing our contracts is a critical factor in determining our
profitability. The amount reported under losses and loss adjustment expenses in any period includes
payments in the period net of the change in the value of the reserves for unpaid losses and loss
adjustment expenses between the beginning and the end of the period. The loss and LAE ratio for the
first quarter of 2005 was 60.4% compared to 60.3% for the same period in 2004. The underwriting expense ratio for the first quarter of 2005 improved 3.2 basis points to
20.2% compared to 23.4% for the same period in 2004. The improvement resulted from our fixed
expenses increasing at a slower rate than the net earned premium growth. Specifically, our
employee-related expenses grew at a slower rate than our revenue growth because the new positions
created during this period were primarily entry-level and we better leveraged existing management
as our business grew. Investment Income Net investment income increased $0.9 million or 51.8 % to $2.7 million for the three months
ended March 31, 2005 compared to the first quarter of 2004, due primarily to a 48.4% increase in
average cash and invested assets over the same period. The growth in cash and invested assets
reflected the growth in premiums written and the proceeds, net of debt repayment, of $25.4 million
from the IPO in February of 2005. 14




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##### Table of Contents



Realized Gains (Losses) on Investments Net realized gains were $0.1 million for first quarter of 2005 compared to net realized gains of
$0.7 million for the first quarter of 2004. An increase in interest rates in the first quarter led
to decreased opportunities to realize gains in our portfolio. Other Operating and General Expenses Other operating and general expenses increased approximately 22.5% to $2.0 million during the
three-month period ended March 31, 2005 compared to $1.6 million for the same period in 2004,
reflecting the continuing growth in our business and additional costs incurred related to being a
publicly traded company. Income Taxes Our effective tax rate was 33.5% for the three-month period ended March 31, 2005 and 34.2% for the
same period in 2004. Differences in the effective tax rates are primarily due to the effect of tax
exempt investment income and adjustments to the reserve for income taxes related to exposure items. Investments At March 31, 2005, our investment portfolio contained $234.1 million in fixed maturity securities
and $20.1 million in equity securities, all carried at fair value with unrealized gains and losses
reported as a separate component of shareholders equity on an after-tax basis. At March 31, 2005,
we had pretax net unrealized losses of $2.8 million on fixed maturities and pretax unrealized
losses of $0.1 million on equity securities. At March 31, 2005, 99.4% of the fixed maturities in our portfolio were rated investment grade
(credit rating of AAA to BBB) by Standard & Poors Corporation. Investment grade securities
generally bear lower yields and lower degrees of risk than those that are unrated or non-investment
grade. Summary information for securities with unrealized gains or losses at March 31, 2005 follows: Securities with
    
    
    Securities withUnrealized
    
    
    UnrealizedGains
    
    
    Losses(Dollars in thousands)Fixed Maturities:Fair value of securities
    
    $
    42,950
    
    
    $
    191,146Amortized cost of securities
    
    
    42,355
    
    
    
    194,556Gross unrealized gain or loss
    
    
    595
    
    
    
    (3,410
    )Fair value as a % of amortized cost
    
    
    101.4
    %
    
    
    98.2
    %Number of security positions held
    
    
    63
    
    
    
    158Number individually exceeding $50,000 gain or loss
    
    
    
    
    
    
    15Concentration of gains or losses by type or industry:US Government and government agencies
    
    $
    181
    
    
    $
    (1,859
    )State, municipalities and political subdivisions
    
    
    287
    
    
    
    (719
    )Banks, insurance and brokers
    
    
    83
    
    
    
    (570
    )Electric services
    
    
    13
    
    
    
    (11
    )Industrial and other
    
    
    31
    
    
    
    (251
    )Percentage rated investment grade (1)
    
    
    97.9
    %
    
    
    99.7
    %
 15




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##### Table of Contents



Securities with
    
    
    Securities withUnrealized
    
    
    UnrealizedGains
    
    
    Losses(Dollars in thousands)Equity Securities:Fair value of securities
    
    $
    7,787
    
    
    $
    12,327Cost of securities
    
    
    7,359
    
    
    
    12,838Gross unrealized gain or loss
    
    
    428
    
    
    
    (511
    )Fair value as a % of cost
    
    
    105.8
    %
    
    
    96.0
    %Number individually exceeding $50,000 gain or loss
    
    
    1
    
    
    
    3
 
  The table below sets forth the scheduled maturities of fixed maturity securities at March 31, 2005
based on their fair values: Securities with
    
    
    Securities withUnrealized
    
    
    UnrealizedGains
    
    
    LossesMaturity:One year or less
    
    
    4.1
    %
    
    
    0.0
    %After one year through five years
    
    
    44.1
    %
    
    
    21.2
    %After five years through ten years
    
    
    36.2
    %
    
    
    49.3
    %After ten years
    
    
    15.6
    %
    
    
    29.5
    %100.0
    %
    
    
    100.0
    %
 The table below summarizes the unrealized gains and losses on fixed maturities and equity
securities by dollar amount: March 31, 2005Aggregate
    
    
    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 (0 issues)
    
    $
    
    
    
    $
    More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (63 issues)
    
    
    42,950
    
    
    
    595
    
    
    
    101.4
    %$
    42,950
    
    
    $
    595Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (15 issues)
    
    $
    27,199
    
    
    $
    (1,059
    )
    
    
    96.3
    %More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (143 issues)
    
    
    163,947
    
    
    
    (2,351
    )
    
    
    98.6
    %$
    191,146
    
    
    $
    (3,410
    )Equity Securities:Securities with unrealized gains:Exceeding $50,000 and for:Less than one year (1 issue)
    
    $
    710
    
    
    $
    110
    
    
    
    118.4
    %More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (32 issues)
    
    
    7,077
    
    
    
    318
    
    
    
    104.7
    %$
    7,787
    
    
    $
    428Equity Securities:Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (3 issues)
    
    $
    2,805
    
    
    $
    (277
    )
    
    
    91.0
    %More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (17 issues)
    
    
    9,522
    
    
    
    (234
    )
    
    
    97.6
    %$
    12,327
    
    
    $
    (511
    )
 16




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##### Table of Contents



Liquidity and Capital Resources Sources of Funds.The liquidity requirements of our insurance subsidiaries relate primarily to the
liabilities associated with their products as well as operating costs and payments of dividends and
taxes to us. Historically, cash flows from premiums and investment income have provided more than
sufficient funds to meet these requirements without requiring the sale of investments. If our cash
flows change dramatically from historical patterns, for example as a result of a decrease in
premiums or an increase in claims paid or operating expenses, we may be required to sell securities
before their maturity and possibly at a loss. Our insurance subsidiaries generally hold a
significant amount of highly liquid, short-term investments to meet their liquidity needs. Funds
received in excess of cash requirements are generally invested in additional marketable securities.
Ordinarily, we collect premiums and earn investment income on the policies we issue in advance of
the payment of losses. Our historic pattern of using premium receipts for the payment of
liabilities has enabled us to extend slightly the maturities of our investment portfolio beyond the
estimated settlement date of our loss reserves. In an IPO completed in February 2005, the Company sold 3,350,000 shares of common stock, generating
approximately $40.4 million of net proceeds. We used the net proceeds for the repayment in full of
a $15.0 million loan plus the accrued interest from Great American, our majority shareholder, and
the remainder will be used for other general purposes including surplus contributions to our
insurance company subsidiaries, as needed. Our insurance subsidiaries generate liquidity primarily by collecting and investing premiums in
advance of paying claims. We believe that our insurance subsidiaries maintain sufficient liquidity
to pay claims and operating expenses, as well as meet commitments in the event of unforeseen events
such as reserve deficiencies, inadequate premium rates or reinsurer insolvencies. We will have continuing cash needs for administrative expenses, the payment of principal and
interest on borrowings, shareholder dividends and taxes. Funds to meet these obligations will come
primarily from dividend and tax payments from our insurance company subsidiaries and from our line
of credit. In May 2003, we purchased the outstanding common equity of a business trust that issued mandatorily
redeemable preferred capital securities. The trust used the proceeds from the issuance of its
capital securities and common equity to buy $15.5 million of debentures issued by us. These
debentures are the trusts only assets and mature in 2033. The interest rate is equal to the
three-month LIBOR (2.91% at March 31, 2005 and 2.40% at December 31, 2004) plus 420 basis points
with interest payments due quarterly. Payments from the debentures finance the distributions paid
on the capital securities. We have the right to redeem the debentures, in whole or in part, on or
after May 23, 2008. We used the net proceeds from the debentures to fund our obligations to our
subsidiaries and to increase the capitalization of our insurance company subsidiaries. We also have a $2.0 million line of credit (unused at March 31, 2005) that bears interest at the
lending institutions prime rate (5.75% at March 31, 2005 and 5.25% at December 31, 2004) less 50
basis points and requires an annual commitment fee of $1,000. In accordance with the terms of the
line of credit agreement, interest payments are due monthly and the principal balance is due upon
demand. The line of credit is available currently, and has been used in the past, for general
corporate purposes, including the capitalization of our insurance company subsidiaries in order to
support the growth of their written premiums. We may request an increase in this line of credit in
the future based on liquidity and capital needs, although we have no current plans to do so. We have an unsecured term loan that is governed by a four-year loan agreement that was executed in
August 2002. The bears interest at the lenders prime rate (5.75% at March 31, 2005 and 5.25% at
December 31, 2004) less 50 basis points. The outstanding principal amount at March 31, 2005 was
$1.8 million. Payments on the note are due in monthly principal installments of $104,000 plus
interest. At March 31, 2005, we were in compliance with all of our loan covenants. We believe that the remaining net proceeds from our IPO, funds generated from operations, including
dividends from insurance subsidiaries, and funds available under our line of credit will provide
sufficient resources to meet our liquidity requirements for at least the next 12 months. However,
if these funds are insufficient to meet fixed charges in any period, we would be required to
generate cash through additional borrowings, sale of assets, sale of portfolio securities or
similar transactions. Historically, and during the first quarter of 2005, we have not had the need
to sell our investments to generate liquidity. If we were required to sell portfolio securities
early for liquidity purposes rather than holding them to maturity, we would recognize gains or
losses on those securities earlier than anticipated. If we were forced to borrow additional funds
in order to meet liquidity needs, we would incur additional interest expense, which would have a
negative impact on our earnings. Since our ability to meet our obligations in the long term (beyond
a 12-month period) is dependent upon factors such as market changes, 17




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##### Table of Contents



insurance regulatory changes
and economic conditions, no assurance can be given that the available net cash flow will be
sufficient to meet our operating needs. Off-Balance Sheet Arrangements We do not have any off-balance sheet arrangements (as such term is defined in applicable Securities
and Exchange Commission rules) that are reasonably likely to have a current or future material
effect on our financial condition, results of operations, liquidity, capital expenditures or
capital resources. Contractual Obligations During the first quarter 2005, the Companys contractual obligations have not changed materially
from those discussed in the Companys Annual Report of Form 10-K for the year ended December 31,
2004. 
 ITEM 3.Quantitative and Qualitative Disclosures About Market Risk As of March 31, 2005,
there were no other material changes to the information provided in
NICs Form 10-K for 2004 under Item 7A
Quantitative and Qualitative Disclosures About Market
Risk. 
 ITEM 4.Controls and Procedures During the preparation of our Form S-1, our Independent Registered Public Accounting Firm, Ernst &
Young LLP, concluded that a significant deficiency over our disclosure controls and procedures
existed that did not constitute a material weakness. We have implemented corrective actions that
we believe address the deficiency through the engagement of additional personnel with the
appropriate experience and qualifications to perform quality review procedures and to satisfy our
future financial reporting obligations as a public company. During the preparation of our Form 10-Q
for the quarter ended March 31, 2005, a clerical error was identified that occurred during the
preparation of our Registration Statement on Form S-1, which was also reflected in our December 31,
2004 Form 10-K. See Note 2 to Consolidated Financial Statements for further information. NICs management is responsible for establishing and maintaining effective disclosure controls and
procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934.
NICs management, with participation of its Chief Executive Officer and Chief Financial Officer,
has evaluated the effectiveness of NICs disclosure controls and procedures (as defined in Exchange
Act Rule 13a-15) as of March 31, 2005. Based on that evaluation, NICs CEO and CFO concluded that
the disclosure controls and procedures were effective as of March 31, 2005 in alerting them on a
timely basis to material information relating to the Company (including its consolidated
subsidiaries) required to be included in the Companys periodic filings under the Exchange Act. 18




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##### Table of Contents



PART II  OTHER INFORMATION 
 ITEM 1.Legal Proceedings There have been no material change in legal proceedings during the first quarter of 2005 from our
Annual Report on Form 10-K for the year ended December 31, 2004. 
 ITEM 2.Unregistered Sales of Equity Securities and Use of Proceeds None. 
 ITEM 3.Defaults Upon Senior Securities None. 
 ITEM 4.Submission of Matters to a Vote of Security Holders None. 
 ITEM 5.Other Information None. 
 ITEM 6.Exhibits Exhibit No.
    
    Exhibit Description31.1
    
    
    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
 19




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized. NATIONAL INTERSTATE CORPORATIONDate: May 12, 2005
    
    /s/ Alan R. SpachmanAlan R. SpachmanChairman of the Board and President(Duly Authorized Officer and Principal Executive Officer)Date: May 12, 2005
    
    /s/ Gary N. MondaGary N. MondaVice President and Chief Financial Officer(Duly Authorized Officer and Principal Financial and
Accounting Officer)
 20