##### 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 March 31, 2007
 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
  o þ 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
    
    9Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    17Item 4. Controls and Procedures
    
    18Part II  Other Information
    
    18Item 1. Legal Proceedings
    
    18Item 1A. Risk Factors
    
    18Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    18Item 3. Defaults Upon Senior Securities
    
    18Item 4. Submission of Matters to a Vote of Security Holders
    
    18Item 5. Other Information
    
    18Item 6. Exhibits
    
    19EX-31.1EX-31.2EX-32.1EX-32.2




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##### Table of Contents



PART I  FINANCIAL INFORMATION
 
 ITEM 1. Financial Statements
 National Interstate Corporation and Subsidiaries
 
 Consolidated Balance Sheets
 (In thousands, except per share data)
 March 31,
    
    
    December 31,2007
    
    
    2006(Unaudited)ASSETSInvestments:Fixed maturities available-for-sale, at fair value (amortized cost  $350,054 and
$332,552, respectively)
    
    $
    346,211
    
    
    $
    327,449Equity securities available-for-sale, at fair value (cost  $43,718 and $33,476, respectively)
    
    
    44,375
    
    
    
    34,095Short-term investments, at cost which approximates fair value
    
    
    26,130
    
    
    
    22,744Total investments
    
    
    416,716
    
    
    
    384,288Cash and cash equivalents
    
    
    18,990
    
    
    
    22,166Securities lending collateral
    
    
    175,641
    
    
    
    158,928Accrued investment income
    
    
    4,437
    
    
    
    4,321Premiums receivable, net of allowance for doubtful accounts of $570 and $522, respectively
    
    
    119,063
    
    
    
    77,076Reinsurance recoverables on paid and unpaid losses
    
    
    98,247
    
    
    
    90,070Prepaid reinsurance premiums
    
    
    38,645
    
    
    
    21,272Deferred policy acquisition costs
    
    
    18,624
    
    
    
    15,035Deferred federal income taxes
    
    
    9,835
    
    
    
    10,731Property and equipment, net
    
    
    18,806
    
    
    
    18,586Funds held by reinsurer
    
    
    2,129
    
    
    
    2,340Other assets
    
    
    1,996
    
    
    
    1,435Total assets
    
    $
    923,129
    
    
    $
    806,248LIABILITIES AND SHAREHOLDERS EQUITYLiabilities:Unpaid losses and loss adjustment expenses
    
    $
    284,344
    
    
    $
    265,966Unearned premiums and service fees
    
    
    172,154
    
    
    
    127,723Long-term debt
    
    
    15,464
    
    
    
    15,464Amounts withheld or retained for account of others
    
    
    30,582
    
    
    
    27,885Reinsurance balances payable
    
    
    25,137
    
    
    
    7,156Securities lending obligation
    
    
    175,641
    
    
    
    158,928Accounts payable and other liabilities
    
    
    22,412
    
    
    
    19,676Commissions payable
    
    
    8,741
    
    
    
    6,347Assessments and fees payable
    
    
    3,902
    
    
    
    3,340Total liabilities
    
    
    738,377
    
    
    
    632,485Shareholders equity:Preferred shares  no par valueAuthorized  10,000 sharesIssued  0 shares
    
    
    
    
    
    
    Common shares  $0.01 par valueAuthorized  50,000 sharesIssued  23,350 shares including 4,163 and 4,191
shares, respectively, in treasury
    
    
    234
    
    
    
    234Additional paid-in capital
    
    
    44,528
    
    
    
    43,921Retained earnings
    
    
    147,949
    
    
    
    138,450Accumulated other comprehensive loss
    
    
    (2,071
    )
    
    
    (2,915
    )Treasury shares
    
    
    (5,888
    )
    
    
    (5,927
    )Total shareholders equity
    
    
    184,752
    
    
    
    173,763Total liabilities and shareholders equity
    
    $
    923,129
    
    
    $
    806,248
  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 31,2007
    
    
    2006Revenue:Premiums earned
    
    $
    60,290
    
    
    $
    50,315Net investment income
    
    
    5,145
    
    
    
    3,899Realized gains on investments
    
    
    65
    
    
    
    370Other
    
    
    865
    
    
    
    477Total revenues
    
    
    66,365
    
    
    
    55,061Expenses:Losses and loss adjustment expenses
    
    
    35,533
    
    
    
    29,896Commissions and other underwriting expense
    
    
    11,401
    
    
    
    8,765Other operating and general expenses
    
    
    3,791
    
    
    
    2,793Interest expense
    
    
    382
    
    
    
    364Total expenses
    
    
    51,107
    
    
    
    41,818Income before federal income taxes
    
    
    15,258
    
    
    
    13,243Provision for federal income taxes
    
    
    4,791
    
    
    
    4,517Net income
    
    $
    10,467
    
    
    $
    8,726Net income per common share  basic
    
    $
    0.55
    
    
    $
    0.46Net income per common share  diluted
    
    $
    0.54
    
    
    $
    0.45Weighted average of common shares outstanding  basic
    
    
    19,174
    
    
    
    19,101Weighted average of common shares outstanding  diluted
    
    
    19,341
    
    
    
    19,253Cash dividends per common share
    
    $
    0.05
    
    
    $
    0.04
  2




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##### Table of Contents



National Interstate Corporation and Subsidiaries
 
 Consolidated Statements of Shareholders Equity
 (Unaudited)
 (Dollars in thousands)
 AccumulatedAdditional
    
    
    
    
    
    
    OtherCommon
    
    
    Paid-In
    
    
    Retained
    
    
    Comprehensive
    
    
    TreasuryStock
    
    
    Capital
    
    
    Earnings
    
    
    Income (Loss)
    
    
    Stock
    
    
    TotalBalance at January 1, 2007
    
    $
    234
    
    
    $
    43,921
    
    
    $
    138,450
    
    
    $
    (2,915
    )
    
    $
    (5,927
    )
    
    $
    173,763Net income
    
    
    
    
    
    
    
    
    
    
    10,467
    
    
    
    
    
    
    
    
    
    
    
    10,467Unrealized appreciation of investment securities,
net of tax expense of $454
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    844
    
    
    
    
    
    
    
    844Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,311Dividends on common stock
    
    
    
    
    
    
    
    
    
    
    (968
    )
    
    
    
    
    
    
    
    
    
    
    (968
    )Issuance of 28,212 treasury shares upon exercise
of stock
options and stock award grants
    
    
    
    
    
    
    171
    
    
    
    
    
    
    
    
    
    
    
    39
    
    
    
    210Tax benefit realized from exercise of stock options
    
    
    
    
    
    
    166
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    166Stock compensation expense
    
    
    
    
    
    
    270
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    270Balance at March 31, 2007
    
    $
    234
    
    
    $
    44,528
    
    
    $
    147,949
    
    
    $
    (2,071
    )
    
    $
    (5,888
    )
    
    $
    184,752Balance at January 1, 2006
    
    $
    234
    
    
    $
    42,257
    
    
    $
    105,826
    
    
    $
    (2,712
    )
    
    $
    (6,072
    )
    
    $
    139,533Net income
    
    
    
    
    
    
    
    
    
    
    8,726
    
    
    
    
    
    
    
    
    
    
    
    8,726Unrealized depreciation of investment securities,
net of tax benefit of $1,084
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,013
    )
    
    
    
    
    
    
    (2,013
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,713Dividends on common stock
    
    
    
    
    
    
    
    
    
    
    (770
    )
    
    
    
    
    
    
    
    
    
    
    (770
    )Issuance of 59,000 treasury shares upon exercise
of stock
options
    
    
    
    
    
    
    100
    
    
    
    
    
    
    
    
    
    
    
    82
    
    
    
    182Tax benefit realized from exercise of stock options
    
    
    
    
    
    
    346
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    346Stock compensation expense
    
    
    
    
    
    
    213
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    213Balance at March 31, 2006
    
    $
    234
    
    
    $
    42,916
    
    
    $
    113,782
    
    
    $
    (4,725
    )
    
    $
    (5,990
    )
    
    $
    146,217
  3




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National Interstate Corporation and Subsidiaries
 
 Consolidated Statements of Cash Flows
 (Unaudited)
 (Dollars in thousands)
 Three Months Ended March 31,2007
    
    
    2006Operating activitiesNet income
    
    $
    10,467
    
    
    $
    8,726Adjustments to reconcile net income to net cash provided by operating activities:Net amortization of bond premiums and discounts
    
    
    65
    
    
    
    38Provision for depreciation and amortization
    
    
    305
    
    
    
    292Net realized gains on investment securities
    
    
    (65
    )
    
    
    (370
    )Deferred federal income taxes
    
    
    442
    
    
    
    Stock compensation expense
    
    
    270
    
    
    
    213Increase in deferred policy acquisition costs, net
    
    
    (3,589
    )
    
    
    (2,689
    )Increase in reserves for losses and loss adjustment expenses
    
    
    18,378
    
    
    
    11,548Increase in premiums receivable
    
    
    (41,987
    )
    
    
    (40,923
    )Increase in unearned premiums and service fees
    
    
    44,431
    
    
    
    44,303(Increase) decrease in interest receivable and other assets
    
    
    (488
    )
    
    
    1,104Increase in prepaid reinsurance premiums
    
    
    (17,373
    )
    
    
    (15,224
    )Increase in accounts payable, commissions and other liabilities
and assessments and fees payable
    
    
    5,692
    
    
    
    3,119Increase in amounts withheld or retained for account of others
    
    
    2,697
    
    
    
    1,742Increase in reinsurance recoverable
    
    
    (8,177
    )
    
    
    (4,932
    )Increase in reinsurance balances payable
    
    
    17,981
    
    
    
    18,186Other
    
    
    50
    
    
    
    (1
    )Net cash provided by operating activities
    
    
    29,099
    
    
    
    25,132Investing activitiesPurchases of fixed maturities
    
    
    (54,280
    )
    
    
    (39,662
    )Purchases of equity securities
    
    
    (14,808
    )
    
    
    (17,785
    )Proceeds from sale of fixed maturities
    
    
    
    
    
    
    997Proceeds from sale of equity securities
    
    
    1,210
    
    
    
    11,985Proceeds from maturity of investments
    
    
    36,748
    
    
    
    16,088Additional cash paid for purchase of subsidiary
    
    
    
    
    
    
    (1,246
    )Cash and cash equivalents of business acquired
    
    
    
    
    
    
    5,585Capital expenditures
    
    
    (553
    )
    
    
    (364
    )Net cash used in investing activities
    
    
    (31,683
    )
    
    
    (24,402
    )Financing activitiesRepayment of long-term debt
    
    
    
    
    
    
    (312
    )Increase in securities lending collateral
    
    
    (16,713
    )
    
    
    Increase in securities lending obligation
    
    
    16,713
    
    
    
    Tax benefit realized from exercise of stock options
    
    
    166
    
    
    
    346Issuance of common shares from treasury upon exercise of stock options
    
    
    210
    
    
    
    182Cash dividends paid on common shares
    
    
    (968
    )
    
    
    (770
    )Net cash used in financing activities
    
    
    (592
    )
    
    
    (554
    )Net (decrease) increase in cash and cash equivalents
    
    
    (3,176
    )
    
    
    176Cash and cash equivalents at beginning of period
    
    
    22,166
    
    
    
    7,461Cash and cash equivalents at end of period
    
    $
    18,990
    
    
    $
    7,637
  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
 Fair Value Measurements
 Fair Value Measurements
 Accounting for Uncertainty in Income Taxes
 Accounting for Uncertainty in
Income Taxes
 5




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##### Table of Contents



3. Shareholders Equity
  Accounting for Stock-Based Compensation,
   4. Transactions with Related Parties
   Three Months Ended March 31,2007
    
    2006(Dollars in thousands)Written premiums assumed
    
    $
    1,672
    
    
    $
    1,111Assumed premiums earned
    
    
    1,203
    
    
    
    973Assumed losses and loss adjustment expense incurred
    
    
    1,006
    
    
    
    1,137Ceded losses and loss adjustment expense recoveries
    
    
    930
    
    
    
    963Payable to Great American as of quarter end
    
    
    294
    
    
    
    551
 6




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##### Table of Contents



5. Reinsurance
  Three Months Ended March 31,2007
    
    
    2006Written
    
    
    Earned
    
    
    Written
    
    
    Earned(Dollars in thousands)Direct
    
    $
    118,212
    
    
    $
    73,871
    
    
    $
    106,131
    
    
    $
    61,504Assumed
    
    
    2,718
    
    
    
    2,749
    
    
    
    3,407
    
    
    
    3,171Ceded
    
    
    (33,702
    )
    
    
    (16,330
    )
    
    
    (30,131
    )
    
    
    (14,360
    )Net Premium
    
    $
    87,228
    
    
    $
    60,290
    
    
    $
    79,407
    
    
    $
    50,315
  6. Commitments and Contingencies
    7




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##### Table of Contents



7. Earnings Per Common Share
  Three Months Ended March 31,2007
    
    
    2006(Dollars in thousands, except per share)Net income
    
    $
    10,467
    
    
    $
    8,726Weighted average shares outstanding during period
    
    
    19,174
    
    
    
    19,101Additional shares issuable under employee common
stock
option plans using treasury stock method
    
    
    167
    
    
    
    152Weighted average shares outstanding assuming
exercise of
stock options
    
    
    19,341
    
    
    
    19,253Net income per share:Basic
    
    $
    0.55
    
    
    $
    0.46Diluted
    
    $
    0.54
    
    
    $
    0.45
  8. Segment Information
  Three Months Ended March 31,2007
    
    
    2006(Dollars in thousands)Revenue:Premiums earned:Alternate Risk Transfer
    
    $
    23,845
    
    
    $
    15,928Transportation
    
    
    18,064
    
    
    
    17,860Specialty Personal Lines
    
    
    12,103
    
    
    
    10,828Hawaii and Alaska
    
    
    4,048
    
    
    
    3,220Other
    
    
    2,230
    
    
    
    2,479Total Premiums Earned
    
    
    60,290
    
    
    
    50,315Net investment income
    
    
    5,145
    
    
    
    3,899Realized gains on investments
    
    
    65
    
    
    
    370Other
    
    
    865
    
    
    
    477Total revenues
    
    $
    66,365
    
    
    $
    55,061
 8




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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
   9




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##### Table of Contents



Results of Operations
 Overview
   Underwriting and Loss Ratio Analysis
 Gross Premiums Written
  Three Months Ended March 31,2007
    
    
    2006Amount
    
    
    Percent
    
    
    Amount
    
    
    Percent(Dollars in thousands)Alternative Risk
Transfer
    
    $
    76,710
    
    
    
    63.4
    %
    
    $
    70,064
    
    
    
    64.0
    %Transportation
    
    
    21,875
    
    
    
    18.1
    %
    
    
    18,519
    
    
    
    16.9
    %Specialty Personal Lines
    
    
    14,936
    
    
    
    12.4
    %
    
    
    13,773
    
    
    
    12.6
    %Hawaii and Alaska
    
    
    6,154
    
    
    
    5.1
    %
    
    
    5,743
    
    
    
    5.2
    %Other
    
    
    1,255
    
    
    
    1.0
    %
    
    
    1,439
    
    
    
    1.3
    %Gross premiums written
    
    $
    120,930
    
    
    
    100.0
    %
    
    $
    109,538
    
    
    
    100.0
    %
     10




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##### Table of Contents



Premiums Earned
 2007 compared to 2006.
 Three Months Ended March 31,
    
    
    Change2007
    
    
    2006
    
    
    Amount
    
    
    Percent(Dollars in thousands)Premiums earned:Alternative Risk Transfer
    
    $
    23,845
    
    
    $
    15,928
    
    
    $
    7,917
    
    
    
    49.7
    %Transportation
    
    
    18,064
    
    
    
    17,860
    
    
    
    204
    
    
    
    1.1
    %Specialty Personal Lines
    
    
    12,103
    
    
    
    10,828
    
    
    
    1,275
    
    
    
    11.8
    %Hawaii and Alaska
    
    
    4,048
    
    
    
    3,220
    
    
    
    828
    
    
    
    25.7
    %Other
    
    
    2,230
    
    
    
    2,479
    
    
    
    (249
    )
    
    
    (10.0
    %)Total premiums earned
    
    $
    60,290
    
    
    $
    50,315
    
    
    $
    9,975
    
    
    
    19.8
    %
  Underwriting and Loss Ratio Analysis
   Three Months Ended March 31,2007
    
    
    2006(Dollars in thousands)Gross premiums written
    
    $
    120,930
    
    
    $
    109,538Ceded reinsurance
    
    
    (33,702
    )
    
    
    (30,131
    )Net premiums written
    
    
    87,228
    
    
    
    79,407Change in unearned premiums, net of ceded
    
    
    (26,938
    )
    
    
    (29,092
    )Net premiums earned
    
    $
    60,290
    
    
    $
    50,315Combined Ratios:Loss and LAE ratio(1)
    
    
    58.9
    %
    
    
    59.4
    %Underwriting expense ratio (2)
    
    
    23.8
    %
    
    
    22.0
    %Combined ratio
    
    
    82.7
    %
    
    
    81.4
    %
 
 (1)
    
    The ratio of losses and LAE to premiums earned.(2)
    
    The ratio of the sum of commissions and other underwriting expenses and other
operating expenses less other income to premiums earned. 11




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##### Table of Contents



2007 compared to 2006.
  Investment Income
 2007 compared to 2006.
 Realized Gains on Investments
 2007 compared to 2006.
 Income Taxes
 2007 compared to 2006.
 Financial Condition
 Investments
   12




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##### Table of Contents



Securities with
    
    Securities withUnrealized
    
    UnrealizedGains
    
    Losses(Dollars in thousands)Fixed Maturities:Fair value of securities
    
    $
    97,002
    
    
    $
    249,209Amortized cost of securities
    
    $
    96,142
    
    
    $
    253,912Gross unrealized gain or loss
    
    $
    860
    
    
    $
    (4,703
    )Fair value as a percent of amortized cost
    
    
    100.9
    %
    
    
    98.1
    %Number of security positions held
    
    
    158
    
    
    
    230Number individually exceeding $50,000 gain or loss
    
    
    2
    
    
    
    20Concentration of gains or losses by type or industry:US Government and government agencies
    
    $
    363
    
    
    $
    (2,784
    )State, municipalities, and political subdivisions
    
    
    162
    
    
    
    (274
    )Banks, insurance, and brokers
    
    
    280
    
    
    
    (1,454
    )Industrial and other
    
    
    55
    
    
    
    (191
    )Percentage rated investment grade (1)
    
    
    98.9
    %
    
    
    98.9
    %Equity Securities:Fair value of securities
    
    $
    30,300
    
    
    $
    14,075Cost of securities
    
    $
    29,430
    
    
    $
    14,288Gross unrealized gain or loss
    
    $
    870
    
    
    $
    (213
    )Fair value as percent of cost
    
    
    103.0
    %
    
    
    98.5
    %Number individually exceeding $50,000 gain or loss
    
    
    3
    
    
    
    
 
 (1)
    
    Investment grade of AAA to BBB by Standard & Poors Corporation.  Securities with
    
    Securities withUnrealized
    
    UnrealizedGains
    
    LossesMaturity:One year or less
    
    
    5.6
    %
    
    
    8.0
    %After one year
through five years
    
    
    51.3
    %
    
    
    46.5
    %After five years
through ten years
    
    
    34.6
    %
    
    
    40.0
    %After ten years
    
    
    8.5
    %
    
    
    5.5
    %100.0
    %
    
    
    100.0
    %
 13




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##### Table of Contents



March 31, 2007Aggregate
    
    
    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 (2 issues)
    
    $
    1,521
    
    
    $
    202
    
    
    
    115.3
    %More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (156 issues)
    
    
    95,481
    
    
    
    658
    
    
    
    100.7
    %$
    97,002
    
    
    $
    860Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (2 issues)
    
    $
    1,873
    
    
    $
    (128
    )
    
    
    93.6
    %More than one year (18 issues)
    
    
    32,621
    
    
    
    (2,619
    )
    
    
    92.6
    %Less than $50,000 (210 issues)
    
    
    214,715
    
    
    
    (1,956
    )
    
    
    99.1
    %$
    249,209
    
    
    $
    (4,703
    )Equity Securities:Securities with unrealized gains:Exceeding $50,000 and for:Less than one year (3 issues)
    
    $
    2,551
    
    
    $
    177
    
    
    
    107.5
    %More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (69 issues)
    
    
    27,749
    
    
    
    693
    
    
    
    102.6
    %$
    30,300
    
    
    $
    870Securities with unrealized losses:Exceeding $50,000 and for:Less than one year (0 issues)
    
    $
    
    
    
    $
    More than one year (0 issues)
    
    
    
    
    
    
    Less than $50,000 (29 issues)
    
    
    14,075
    
    
    
    (213
    )
    
    
    98.5
    %$
    14,075
    
    
    $
    (213
    )
  Premiums and Reinsurance
   14




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##### Table of Contents



Liquidity and Capital Resources
         st
  15




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##### Table of Contents



Critical Accounting Policies
  Losses and Loss Adjustment Expense Reserves
   
    
    the Case Incurred Development Method;
    
    the Paid Development Method;
    
    the Bornhuetter-Ferguson Method; and
    
    the Incremental Paid LAE to Paid Loss Methods.
  
    
    open and closed claim counts;
    
    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;
 16




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##### Table of Contents




    
    reported loss ratios;
    
    projected ultimate loss ratios; and
    
    loss payment patterns.
 Other-Than-Temporary Impairment
  
    
    the length of time and the extent to which the market value has been below amortized cost;
    
    whether the issuer is experiencing significant financial difficulties;
    
    economic stability of an entire industry sector or subsection;
    
    whether the issuer, series of issuers or industry has a catastrophic type of loss;
    
    the extent to which the unrealized loss is credit-driven or a result of changes in market interest rates;
    
    historical operating, balance sheet and cash flow data;
    
    internally generated financial models and forecasts;
    
    our ability and intent to hold the investment for a period of time sufficient to
allow for any anticipated recovery in market value; and
    
    other subjective factors, including concentrations and information obtained from
regulators and rating agencies.
  Contractual Obligations/Off-Balance Sheet Arrangements
   
 ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
  17




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##### Table of Contents



ITEM 4. Controls and Procedures
   
 PART II  OTHER INFORMATION
 
 ITEM 1. Legal Proceedings
  
 ITEM 1A. Risk Factors.
  
 ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
  
 ITEM 3. Defaults Upon Senior Securities
  
 ITEM 4. Submission of Matters to a Vote of Security Holders
  
 ITEM 5. Other Information
  18




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##### Table of Contents



ITEM 6. Exhibits
 Exhibit No.
    
    Exhibit Description3.1
    
    Amended and Restated Articles of Incorporation (1)3.2
    
    Amended and Restated Code of Regulations (1)31.1
    
    Certification of Chief Executive Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as
amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 200231.2
    
    Certification of Chief Financial Officer pursuant to Rule
13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as
amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 200232.1
    
    Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 200232.2
    
    Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
 
 (1)
    
    These exhibits are incorporated by reference to our Registration Statement on Form S-1, as
amended (Registration No. 333-119270) filed on November 12, 2004.
 19




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##### Table of Contents



SIGNATURES
   Date: May 8, 2007
    /s/ Alan R. SpachmanAlan R. SpachmanChairman of the Board and Chief Executive Officer
(Duly Authorized Officer and Principal Executive Officer) Date: May 8, 2007
    /s/ Julie A. McGrawJulie A. McGrawVice President and Chief Financial Officer
(Duly Authorized Officer and Principal Financial Officer)