##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 þ
    
    Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
 For the Quarterly Period Ended September 30, 2006
 Commission File Number 0-22280
 PHILADELPHIA CONSOLIDATED HOLDING CORP.
  PENNSYLVANIA
    
    23-2202671(State of Incorporation)
    
    (IRS Employer Identification No.)
 One Bala Plaza, Suite 100
Bala Cynwyd, Pennsylvania 19004
(610) 617-7900
 
   þ o
  þ o o
  o þ




---



##### 



INDEX
For the Quarterly Period Ended September 30, 2006
 Part I  Financial InformationItem 1. Financial Statements:Consolidated Balance Sheets September 30, 2006 and
December 31, 2005
    
    
    3Consolidated Statements of Operations and Comprehensive
Income  For the three and nine months ended September 30, 2006 and 2005
    
    
    4Consolidated Statements of Changes in Shareholders Equity  For
the nine months ended September 30, 2006 and the year ended
December 31, 2005
    
    
    5Consolidated Statements of Cash Flows  For the nine
months ended September 30, 2006 and 2005
    
    
    6Notes to Consolidated Financial Statements
    
    
    7-24Item 2.Managements Discussion and Analysis of Financial Condition
and Results of Operations
    
    
    25-42Item 3.Quantitative and Qualitative Disclosures About Market Risk
    
    
    43Item 4.Controls and Procedures
    
    
    44Part II  Other InformationItem 1.Legal Proceedings
    
    
    45Item 1A.Risk Factors
    
    
    45Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    45Item 3.Defaults Upon Senior Securities
    
    
    45Item 4.Submission of Matters to a Vote of Security Holders
    
    
    45Item 5.Other Information
    
    
    46Item 6.Exhibits
    
    
    46Signatures
    
    
    47Casualty (Clash) Excess of Loss Reinsurance AgreementAddendum No. 3 to the 3rd and 4th Property Excess of Loss Reinsurance AgreementCasualty Excess of Loss Reinsurance ContractEndorsement No. 4 to the Property Per RiskCommutation and Release Agreement$6,150,000 Excess $10,000,000 Catastrophe Reinsurance ContractFirst Excess Reinstatement Premium Protection Reinsurance ContractSecond and third Excess Reinstatement Premium Protection Reinsurance ContractFlorida Hurricane Catastrophe Fund Reimbursement ContractFlorida Hurricane Catastrophe Fund Reimbursement ContractCertification of the Company's chief executive officerCertification of the Company's chief financial officerCertification of the Company's chief executive officer pursuant to Section 906Certification of the Company's chief financial officer pursuant to Section 906
  2




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
 
 CONSOLIDATED BALANCE SHEETS
 As ofSeptember 30, 2006
    
    
    December 31,(Unaudited)
    
    
    2005ASSETSINVESTMENTS:FIXED MATURITIES AVAILABLE FOR SALE AT MARKET
(AMORTIZED COST $2,053,568 AND $1,778,215)
    
    $
    2,045,960
    
    
    $
    1,761,530EQUITY
SECURITIES AT MARKET (COST $245,989 AND $160,926)
    
    
    275,542
    
    
    
    173,455TOTAL INVESTMENTS
    
    
    2,321,502
    
    
    
    1,934,985CASH AND CASH EQUIVALENTS
    
    
    116,294
    
    
    
    74,385ACCRUED INVESTMENT INCOME
    
    
    18,505
    
    
    
    18,095PREMIUMS RECEIVABLE
    
    
    342,240
    
    
    
    286,778PREPAID REINSURANCE PREMIUMS AND REINSURANCE
RECEIVABLES
    
    
    272,838
    
    
    
    396,248DEFERRED INCOME TAXES
    
    
    32,251
    
    
    
    31,893DEFERRED ACQUISITION COSTS
    
    
    157,457
    
    
    
    129,486PROPERTY AND EQUIPMENT, NET
    
    
    26,441
    
    
    
    23,886OTHER ASSETS
    
    
    41,893
    
    
    
    32,070TOTAL ASSETS
    
    $
    3,329,421
    
    
    $
    2,927,826LIABILITIES AND SHAREHOLDERS EQUITYPOLICY LIABILITIES AND ACCRUALS:UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES
    
    $
    1,243,411
    
    
    $
    1,245,763UNEARNED PREMIUMS
    
    
    758,141
    
    
    
    631,468TOTAL POLICY LIABILITIES AND ACCRUALS
    
    
    2,001,552
    
    
    
    1,877,231FUNDS HELD PAYABLE TO REINSURER
    
    
    
    
    
    
    39,221PREMIUMS PAYABLE
    
    
    59,721
    
    
    
    58,839OTHER LIABILITIES
    
    
    194,486
    
    
    
    136,039TOTAL LIABILITIES
    
    
    2,255,759
    
    
    
    2,111,330COMMITMENTS AND CONTINGENCIESSHAREHOLDERS EQUITY:PREFERRED STOCK, $.01 PAR VALUE,
10,000,000 SHARES AUTHORIZED,
NONE ISSUED AND OUTSTANDING
    
    
    
    
    
    
    COMMON STOCK, NO PAR VALUE,
100,000,000 SHARES AUTHORIZED, 70,441,872 AND 69,266,016 SHARES ISSUED AND OUTSTANDING
    
    
    360,790
    
    
    
    332,757NOTES RECEIVABLE FROM SHAREHOLDERS
    
    
    (10,118
    )
    
    
    (7,217
    )ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
    
    
    14,264
    
    
    
    (2,702
    )RETAINED EARNINGS
    
    
    708,726
    
    
    
    493,658TOTAL SHAREHOLDERS EQUITY
    
    
    1,073,662
    
    
    
    816,496TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    3,329,421
    
    
    $
    2,927,826
   3




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME
 For the Three Months
    
    
    For the Nine MonthsEnded September 30,
    
    
    Ended September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005REVENUE:NET EARNED PREMIUMS
    
    $
    296,366
    
    
    $
    244,770
    
    
    $
    861,706
    
    
    $
    714,661NET INVESTMENT INCOME
    
    
    23,833
    
    
    
    16,979
    
    
    
    65,572
    
    
    
    45,843NET REALIZED INVESTMENT GAIN (LOSS)
    
    
    (6,976
    )
    
    
    1,097
    
    
    
    (9,782
    )
    
    
    12,191OTHER INCOME
    
    
    795
    
    
    
    600
    
    
    
    1,703
    
    
    
    1,380TOTAL REVENUE
    
    
    314,018
    
    
    
    263,446
    
    
    
    919,199
    
    
    
    774,075LOSSES AND EXPENSES:LOSS AND LOSS ADJUSTMENT EXPENSES
    
    
    95,662
    
    
    
    162,254
    
    
    
    353,289
    
    
    
    459,111NET REINSURANCE RECOVERIES
    
    
    (10,956
    )
    
    
    (20,395
    )
    
    
    (16,163
    )
    
    
    (74,979
    )NET LOSS AND LOSS ADJUSTMENT EXPENSES
    
    
    84,706
    
    
    
    141,859
    
    
    
    337,126
    
    
    
    384,132ACQUISITION COSTS AND OTHER
UNDERWRITING EXPENSES
    
    
    89,052
    
    
    
    67,542
    
    
    
    251,406
    
    
    
    189,316OTHER OPERATING EXPENSES
    
    
    3,364
    
    
    
    5,142
    
    
    
    8,644
    
    
    
    15,091TOTAL LOSSES AND EXPENSES
    
    
    177,122
    
    
    
    214,543
    
    
    
    597,176
    
    
    
    588,539INCOME BEFORE INCOME TAXES
    
    
    136,896
    
    
    
    48,903
    
    
    
    322,023
    
    
    
    185,536INCOME TAX EXPENSE (BENEFIT):CURRENT
    
    
    49,725
    
    
    
    13,544
    
    
    
    116,448
    
    
    
    67,404DEFERRED
    
    
    (2,719
    )
    
    
    269
    
    
    
    (9,493
    )
    
    
    (9,669
    )TOTAL INCOME TAX EXPENSE
    
    
    47,006
    
    
    
    13,813
    
    
    
    106,955
    
    
    
    57,735NET INCOME
    
    $
    89,890
    
    
    $
    35,090
    
    
    $
    215,068
    
    
    $
    127,801OTHER COMPREHENSIVE INCOME, NET OF TAX:HOLDING GAIN (LOSS) ARISING DURING
PERIOD
    
    $
    29,929
    
    
    $
    (8,619
    )
    
    $
    10,608
    
    
    $
    (11,895
    )RECLASSIFICATION ADJUSTMENT
    
    
    4,534
    
    
    
    (713
    )
    
    
    6,358
    
    
    
    (7,924
    )OTHER COMPREHENSIVE INCOME (LOSS)
    
    
    34,463
    
    
    
    (9,332
    )
    
    
    16,966
    
    
    
    (19,819
    )COMPREHENSIVE INCOME
    
    $
    124,353
    
    
    $
    25,758
    
    
    $
    232,034
    
    
    $
    107,982PER AVERAGE SHARE DATA:NET INCOME  BASIC
    
    $
    1.28
    
    
    $
    0.51
    
    
    $
    3.08
    
    
    $
    1.87NET INCOME  DILUTED
    
    $
    1.22
    
    
    $
    0.48
    
    
    $
    2.94
    
    
    $
    1.76WEIGHTED-AVERAGE COMMON SHARES
OUTSTANDING
    
    
    69,991,728
    
    
    
    69,008,412
    
    
    
    69,717,194
    
    
    
    68,386,476WEIGHTED-AVERAGE SHARE EQUIVALENTS
OUTSTANDING
    
    
    3,488,999
    
    
    
    4,368,114
    
    
    
    3,470,645
    
    
    
    4,381,077WEIGHTED-AVERAGE SHARES AND SHARE
EQUIVALENTS OUTSTANDING
    
    
    73,480,727
    
    
    
    73,376,526
    
    
    
    73,187,839
    
    
    
    72,767,553
   4




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CHANGES
IN SHAREHOLDERS EQUITY
 For the NineMonths EndedSeptember 30, 2006
    
    
    For the Year Ended(Unaudited)
    
    
    December 31, 2005COMMON SHARES:BALANCE AT BEGINNING OF YEAR
    
    
    69,266,016
    
    
    
    66,821,751ISSUANCE OF SHARES PURSUANT TO
STOCK PURCHASE PLANS, NET
    
    
    235,260
    
    
    
    1,589,406ISSUANCE OF SHARES PURSUANT TO STOCK
BASED COMPENSATION PLANS
    
    
    940,596
    
    
    
    854,859BALANCE AT END OF PERIOD
    
    
    70,441,872
    
    
    
    69,266,016COMMON STOCK:BALANCE AT BEGINNING OF YEAR
    
    $
    332,757
    
    
    $
    292,856ISSUANCE OF SHARES PURSUANT TO STOCK
PURCHASE PLANS
    
    
    6,626
    
    
    
    27,817EFFECTS OF ISSUANCE OF SHARES PURSUANT TO STOCK
BASED COMPENSATION PLANS
    
    
    21,123
    
    
    
    11,939OTHER
    
    
    284
    
    
    
    145BALANCE AT END OF PERIOD
    
    
    360,790
    
    
    
    332,757NOTES RECEIVABLE FROM SHAREHOLDERS:BALANCE AT BEGINNING OF YEAR
    
    
    (7,217
    )
    
    
    (5,465
    )NOTES RECEIVABLE ISSUED PURSUANT TO EMPLOYEE
STOCK PURCHASE PLANS
    
    
    (4,879
    )
    
    
    (4,095
    )COLLECTION OF NOTES RECEIVABLE
    
    
    1,978
    
    
    
    2,343BALANCE AT END OF PERIOD
    
    
    (10,118
    )
    
    
    (7,217
    )ACCUMULATED OTHER COMPREHENSIVE LOSS,
NET OF DEFERRED INCOME TAXES:BALANCE AT BEGINNING OF YEAR
    
    
    (2,702
    )
    
    
    19,796OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAXES
    
    
    16,966
    
    
    
    (22,498
    )BALANCE AT END OF PERIOD
    
    
    14,264
    
    
    
    (2,702
    )RETAINED EARNINGS:BALANCE AT BEGINNING OF YEAR
    
    
    493,658
    
    
    
    336,970NET INCOME
    
    
    215,068
    
    
    
    156,688BALANCE AT END OF PERIOD
    
    
    708,726
    
    
    
    493,658TOTAL SHAREHOLDERS EQUITY
    
    $
    1,073,662
    
    
    $
    816,496
   5




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
 
 CONSOLIDATED STATEMENTS OF CASH FLOWS
 For the Nine Months Ended September 30,2006
    
    
    2005CASH FLOWS FROM OPERATING ACTIVITIES:NET INCOME
    
    $
    215,068
    
    
    $
    127,801ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH
PROVIDED BY OPERATING ACTIVITIES:NET REALIZED INVESTMENT (GAIN) LOSS
    
    
    9,782
    
    
    
    (12,191
    )AMORTIZATION OF INVESTMENT PREMIUMS, NET OF DISCOUNT
    
    
    7,452
    
    
    
    8,794DEPRECIATION
    
    
    4,297
    
    
    
    3,436DEFERRED INCOME TAX BENEFIT
    
    
    (9,493
    )
    
    
    (9,669
    )CHANGE IN PREMIUMS RECEIVABLE
    
    
    (55,462
    )
    
    
    (49,865
    )CHANGE IN PREPAID REINSURANCE PREMIUMS AND REINSURANCE
RECEIVABLES, NET OF FUNDS HELD PAYABLE TO REINSURER
    
    
    84,189
    
    
    
    44,087CHANGE IN OTHER RECEIVABLES
    
    
    (410
    )
    
    
    (3,773
    )CHANGE IN DEFERRED ACQUISITION COSTS
    
    
    (27,971
    )
    
    
    (35,953
    )CHANGE IN INCOME TAXES PAYABLE
    
    
    11,957
    
    
    
    (2,718
    )CHANGE IN OTHER ASSETS
    
    
    (8,126
    )
    
    
    5,551CHANGE IN UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES
    
    
    (2,352
    )
    
    
    124,710CHANGE IN UNEARNED PREMIUMS
    
    
    126,673
    
    
    
    97,800CHANGE IN OTHER LIABILITIES
    
    
    26,164
    
    
    
    14,202FAIR VALUE OF STOCK BASED COMPENSATION
    
    
    9,780
    
    
    
    297TAX BENEFIT FROM ISSUANCE OF SHARES PURSUANT TO
STOCK BASED COMPENSATION PLANS
    
    
    
    
    
    
    5,352EXCESS TAX BENEFIT FROM ISSUANCE OF SHARES PURSUANT
TO STOCK BASED COMPENSATION PLANS
    
    
    (8,411
    )
    
    
    NET CASH PROVIDED BY OPERATING ACTIVITIES
    
    
    383,137
    
    
    
    317,861CASH FLOWS FROM INVESTING ACTIVITIES:PROCEEDS FROM SALES OF INVESTMENTS IN FIXED MATURITIES
    
    
    133,439
    
    
    
    147,466PROCEEDS FROM MATURITY OF INVESTMENTS IN FIXED MATURITIES
    
    
    206,316
    
    
    
    147,169PROCEEDS FROM SALES OF INVESTMENTS IN EQUITY SECURITIES
    
    
    71,858
    
    
    
    135,646COST OF FIXED MATURITIES ACQUIRED
    
    
    (603,243
    )
    
    
    (694,353
    )COST OF EQUITY SECURITIES ACQUIRED
    
    
    (156,679
    )
    
    
    (165,170
    )SETTLEMENT OF CASH FLOW HEDGE
    
    
    
    
    
    
    (3,148
    )PURCHASE OF PROPERTY AND EQUIPMENT
    
    
    (6,852
    )
    
    
    (5,451
    )NET CASH USED BY INVESTING ACTIVITIES
    
    
    (355,161
    )
    
    
    (437,841
    )CASH FLOWS FROM FINANCING ACTIVITIES:REPAYMENTS ON LOANS PAYABLE
    
    
    
    
    
    
    (44,787
    )PROCEEDS FROM LOANS PAYABLE
    
    
    
    
    
    
    11,381PROCEEDS FROM EXERCISE OF EMPLOYEE STOCK OPTIONS
    
    
    6,474
    
    
    
    3,808PROCEEDS FROM COLLECTION OF NOTES RECEIVABLE
    
    
    1,978
    
    
    
    1,767PROCEEDS FROM SHARES ISSUED PURSUANT TO
STOCK PURCHASE PLANS
    
    
    1,746
    
    
    
    23,703EXCESS TAX BENEFIT FROM ISSUANCE OF SHARES PURSUANT TO
STOCK BASED COMPENSATION PLANS
    
    
    8,411
    
    
    
    COST OF SHARES WITHHELD TO SATISFY MINIMUM REQUIRED TAX
WITHHOLDING OBLIGATION ARISING UPON EXERCISE OF
OPTIONS
    
    
    (4,676
    )
    
    
    NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES
    
    
    13,933
    
    
    
    (4,128
    )NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    41,909
    
    
    
    (124,108
    )CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    74,385
    
    
    
    195,496CASH AND CASH EQUIVALENTS AT END OF PERIOD
    
    $
    116,294
    
    
    $
    71,388NON-CASH TRANSACTIONS:ISSUANCE OF SHARES PURSUANT TO EMPLOYEE STOCK
PURCHASE PLAN IN EXCHANGE FOR NOTES RECEIVABLE
    
    $
    4,879
    
    
    $
    4,555
  6




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
 
 Notes to Consolidated Financial Statements
  1.
    
    Basis of PresentationThe consolidated financial statements for the quarterly period ended September 30, 2006 are
unaudited, but in the opinion of management have been prepared on the same basis as the annual
audited consolidated financial statements and reflect all adjustments, consisting of normal
recurring adjustments and accruals, necessary for a fair statement of the information set forth
therein. The results of operations for the nine months ended September 30, 2006 are not
necessarily indicative of the operating results to be expected for the full year or any other
period. Certain prior years amounts have been reclassified for comparative purposes.These consolidated financial statements should be read in conjunction with the financial
statements and notes included in the Companys Annual Report on Form 10-K as of and for the year
ended December 31, 2005.2.
    
    InvestmentsThe carrying amount for the Companys investments approximates their estimated fair value. The
Company measures the fair value of investments based upon quoted market prices or by obtaining
quotes from third party broker-dealers. Material assumptions and factors utilized by such
broker-dealers in pricing these securities include: future cash flows, constant default rates,
recovery rates and any market clearing activity that may have occurred since the prior month-end
pricing period. For mortgage and asset-backed securities (structured securities) of high
credit quality, changes in expected cash flows are recognized using the retrospective method.
For structured securities where the possibility of credit loss is other than remote, changes in
expected cash flows are recognized on the prospective method over the remaining life of the
securities. Cash flow assumptions for structured securities are obtained from a primary market
provider of such information. These assumptions represent a market based best estimate of the
amount and timing of estimated principal and interest cash flows based on current information
and events.The Company regularly performs impairment reviews with respect to its investments. For
investments other than interests in securitized assets, these reviews include identifying any
security whose fair value is below its cost and an analysis of securities meeting predetermined
impairment thresholds to determine whether such decline is other than temporary. If the Company
determines that it does not intend to hold a security to maturity or determines a decline in
value to be other than temporary, the cost basis of the security is written down to its fair
value with the amount of the write down included in earnings as a realized investment loss in
the period the impairment arose. This evaluation resulted in non-cash realized investment
losses of $5.7 million and $0.1 million, respectively, for the three months ended September 30,
2006 and 2005, and $7.0 million and $0.3 million, respectively, for the nine months ended
September 30, 2006 and 2005. The Companys impairment review also includes an impairment
evaluation for interests in securitized assets conducted in accordance with the guidance
provided by the Emerging Issues Task Force of the Financial Accounting Standards Board. There
were no non-cash realized investment losses recorded for the three or nine months ended
September 30, 2006 or 2005 as a result of the Companys impairment evaluation for investments in
securitized assets.The following table identifies the period of time securities with an unrealized loss at
September 30, 2006 have continuously been in an unrealized loss position. Included in the
amounts displayed in the table are approximately $600 of unrealized losses due to non-investment
grade fixed maturity securities having a fair value of $2.4 million. No issuer of securities or
industry represents more than 3.8% and 26.1%, respectively, of the total estimated fair value,
or 5.3% and 28.0%, respectively, of the total gross unrealized loss included in the table below.
This industry concentration represents investments in AAA rated Mortgage Backed Securities
issued by Agencies of the U.S. Government which are collateralized by pools of residential
mortgage loans. The unrealized losses on these securities are attributable generally to
interest rate increases. The contractual repayment of these securities is guaranteed by
Agencies of the U.S. Government, and it is therefore expected that the securities would not be
settled at a price less than the amortized cost of the Companys investment. At the present
time, the Company has the ability and intent to hold these securities until a recovery of fair
value,
 7




---



##### Table of Contents



which may be at maturity; therefore the Company does not consider these investments to be other
than temporarily impaired at September 30, 2006.
 Less Than 12 Months
    
    12 Months or More
    
    TotalUnrealized
    
    
    
    
    
    Unrealized
    
    
    
    
    
    UnrealizedAs of September 30, 2006
    
    Fair Value
    
    Losses
    
    Fair Value
    
    Losses
    
    Fair Value
    
    Losses(In Thousands)Fixed Maturities Available for SaleU.S. Treasury Securities and
Obligations of U.S. Government
Agencies
    
    $
    1,407
    
    
    $
    14
    
    
    $
    12,695
    
    
    $
    257
    
    
    $
    14,102
    
    
    $
    271Obligations of States and
Political Subdivisions
    
    
    40,753
    
    
    
    213
    
    
    
    385,271
    
    
    
    4,834
    
    
    
    426,024
    
    
    
    5,047Corporate Debt Securities
    
    
    5,556
    
    
    
    20
    
    
    
    112,797
    
    
    
    2,803
    
    
    
    118,353
    
    
    
    2,823Asset Backed Securities
    
    
    36,300
    
    
    
    211
    
    
    
    34,311
    
    
    
    424
    
    
    
    70,611
    
    
    
    635Mortgage Pass-Through Securities
    
    
    121,890
    
    
    
    1,081
    
    
    
    175,383
    
    
    
    5,123
    
    
    
    297,273
    
    
    
    6,204Collateralized Mortgage Obligations
    
    
    84,253
    
    
    
    705
    
    
    
    80,347
    
    
    
    1,957
    
    
    
    164,600
    
    
    
    2,662Total Fixed Maturities
Available for Sale
    
    $
    290,159
    
    
    $
    2,244
    
    
    $
    800,804
    
    
    $
    15,398
    
    
    $
    1,090,963
    
    
    $
    17,642Equity Securities
    
    
    47,123
    
    
    
    4,512
    
    
    
    
    
    
    
    
    
    
    
    47,123
    
    
    
    4,512Total Investments
    
    $
    337,282
    
    
    $
    6,756
    
    
    $
    800,804
    
    
    $
    15,398
    
    
    $
    1,138,086
    
    
    $
    22,154
 The Companys impairment evaluation as of September 30, 2006 resulted in the following
conclusions:
 
 
 
 
 8




---



##### Table of Contents



The following table identifies the period of time securities with an unrealized loss at December
31, 2005 have continuously been in an unrealized loss position. None of the amounts displayed in
the table are due to non-investment grade fixed maturity securities. No issuer of securities or
industry represents more than 1.5% and 19.4%, respectively, of the total estimated fair value,
or 2.2% and 20.9%, respectively, of the total gross unrealized loss included in the table below.
 Less Than 12 Months
    
    12 Months or More
    
    TotalUnrealized
    
    
    
    
    
    Unrealized
    
    
    
    
    
    UnrealizedAs of December 31, 2005
    
    Fair Value
    
    Losses
    
    Fair Value
    
    Losses
    
    Fair Value
    
    Losses(In Thousands)Fixed Maturities Available for SaleU.S. Treasury Securities and
Obligations of U.S. Government
Agencies
    
    $
    10,968
    
    
    $
    141
    
    
    $
    47,030
    
    
    $
    505
    
    
    $
    57,998
    
    
    $
    646Obligations of States and
Political Subdivisions
    
    
    391,586
    
    
    
    4,732
    
    
    
    107,099
    
    
    
    2,135
    
    
    
    498,685
    
    
    
    6,867Corporate Debt Securities
    
    
    84,848
    
    
    
    2,367
    
    
    
    125,359
    
    
    
    3,896
    
    
    
    210,207
    
    
    
    6,263Asset Backed Securities
    
    
    75,151
    
    
    
    648
    
    
    
    20,029
    
    
    
    545
    
    
    
    95,180
    
    
    
    1,193Mortgage Pass-Through Securities
    
    
    202,901
    
    
    
    3,661
    
    
    
    61,399
    
    
    
    1,860
    
    
    
    264,300
    
    
    
    5,521Collateralized Mortgage Obligations
    
    
    175,397
    
    
    
    2,387
    
    
    
    20,865
    
    
    
    575
    
    
    
    196,262
    
    
    
    2,962Total Fixed Maturities
Available for Sale
    
    $
    940,851
    
    
    $
    13,936
    
    
    $
    381,781
    
    
    $
    9,516
    
    
    $
    1,322,632
    
    
    $
    23,452Equity Securities
    
    
    38,709
    
    
    
    3,012
    
    
    
    
    
    
    
    
    
    
    
    38,709
    
    
    
    3,012Total Investments
    
    $
    979,560
    
    
    $
    16,948
    
    
    $
    381,781
    
    
    $
    9,516
    
    
    $
    1,361,341
    
    
    $
    26,464
 Based upon the Companys impairment evaluation as of December 31, 2005, it was concluded that
the remaining unrealized losses in the table above were not other than temporary.
 9




---



##### Table of Contents



There are certain risks and uncertainties inherent in the Companys impairment methodology,
including, but not limited to, the financial condition of specific industry sectors and the
resultant effect on any such underlying security collateral values and changes in accounting,
tax, and/or regulatory requirements which may have an effect on either, or both, the investor
and/or the issuer. Should the Company subsequently determine that it does not intend to hold
the security until maturity or should it determine that a decline in the fair value below the
cost basis to be other than temporary, the security would be written down to its fair value and
the difference would be included in earnings as a realized investment loss for the period such
determination was made.3.
    
    Restricted AssetsThe Insurance Subsidiaries have investments, principally U.S. Treasury securities, Obligations
of U.S. Government Corporations and Agencies and Obligations of States and Political
Subdivisions, on deposit with the various states in which they are licensed insurers. At
September 30, 2006 and December 31, 2005, the carrying value of the securities on deposit
totaled $14.8 million and $15.1 million, respectively.4.
    
    Derivative InstrumentsStatement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and
Hedging Activities (SFAS 133), as amended, requires that derivatives be recorded on the
balance sheet as either assets or liabilities measured at fair value. Changes in the fair value
of derivatives are recorded either through current earnings or as other comprehensive income,
depending on the type of hedge transaction. Gains and losses on the derivative instrument
reported in other comprehensive income are reclassified into earnings in the periods in which
earnings are impacted by the variability of the cash flow of the hedged item. The ineffective
portion of all hedge transactions is recognized in current period earnings.During the first quarter of 2005, a cash flow hedge derivative instrument was purchased to
manage interest rate risk for a potential debt offering. Subsequent to the purchase of the cash
flow hedge, the Company decided against the issuance of a debt offering, and as a result, the
cash flow hedge became an ineffective hedge. For the three months ended March 31, 2005, the
Company recorded the change in fair value of $0.3 million as a reduction to net realized
investment gain. Subsequently, upon settlement, the loss in fair value increased to $3.2
million. The $2.9 million change in fair value since March 31, 2005 was recorded as a net
realized investment loss during the three months ended June 30, 2005. The Company does not
hold any other derivative instruments.5.
    
    Liability for Unpaid Loss and Loss Adjustment ExpensesThe liability for unpaid loss and loss adjustment expenses reflects the Companys best estimate
for future amounts needed to pay losses and related settlement expenses with respect to insured
events. The process of establishing the ultimate claims liability is necessarily a complex and
imprecise process, requiring the use of informed estimates and judgments using data currently
available. The liability includes an amount determined on the basis of claim adjusters
evaluations with respect to insured events that have occurred and been reported to the Company
and an amount for losses incurred that have not yet been reported to the Company. In some cases
significant periods of time, up to several years or more, may elapse between the occurrence of
an insured loss and the reporting of such to the Company. Estimates for unpaid loss and loss
adjustment expenses are based upon managements assessment of known facts and circumstances,
review of past loss experience and settlement patterns and consideration of other internal and
external factors. These factors include, but are not limited to, the Companys growth, changes
in the Companys operations, and legal, social, and economic developments. These estimates are
reviewed regularly and any resulting adjustments are made in the accounting period in which the
adjustment arose. If the Companys ultimate losses, net of reinsurance, prove to differ
substantially from the amounts recorded at September 30, 2006, the related adjustments could
have a material adverse impact on the Companys financial condition and results of operations.
 10




---



##### Table of Contents



During the three months ended September 30, 2006, the Company decreased the estimated net unpaid
loss and loss adjustment expenses for accident years 2005 and prior by the following amounts:
 Net Basis Decrease(In millions)Accident Year 2005
    
    $
    32.2Accident Year 2004
    
    
    8.0Accident Year 2003
    
    
    2.5Accident Years 2002 and prior
    
    
    Total Decrease
    
    $
    42.7
 For accident year 2005, the decrease in estimated net unpaid loss and loss adjustment expenses
was principally due to lower loss estimates for all coverages on commercial package policies due
to better than expected case incurred loss development.For accident year 2004, the decrease in estimated net unpaid loss and loss adjustment expenses
was principally due to lower loss estimates for general liability and automobile coverages on
commercial package polices due to better than expected case incurred loss development.For accident year 2003, the decrease in estimated net unpaid loss and loss adjustment expenses
was principally due to lower loss estimates for commercial automobile policies and automobile
coverages on commercial package policies due to better than expected case incurred loss
development.In addition, during the three months ended September 30, 2006, the Company lowered its estimated
net unpaid loss and loss adjustment expenses for the 2006 accident year as a result of the
implications of the favorable development observed on the prior accident years noted previously.
The impact of this lower loss estimate related to the net earned premiums for the six months
ended June 30, 2006 was a reduction of approximately $14.8 million to net unpaid loss and loss
adjustment expenses during the three months ended September 30, 2006.6.
    
    Funds Held Payable To ReinsurerEffective April 1, 2003, the Company entered into a quota share reinsurance agreement. Under
this agreement, the Company ceded 22% of its net written premiums and loss and loss adjustment
expenses for substantially all of the Companys lines of business on policies effective April 1,
2003 through December 31, 2003, and 10% of its commercial and specialty lines net written
premiums and loss and loss adjustment expenses for policies effective January 1, 2004 through
December 31, 2004. The Company received a provisional commission of 33% adjusted pro-rata based
upon the ratio of losses incurred to premiums earned. Pursuant to this reinsurance agreement
the Company withheld the reinsurance premium due the reinsurers reduced by the reinsurers
expense allowance, and the Companys ceding commission allowance in a Funds Held Payable to
Reinsurer account. This Funds Held Payable to Reinsurer account was also reduced by ceded paid
losses and loss adjustment expenses under this agreement, and increased by an interest credit.
In addition, the agreement allowed for a profit commission to be paid to the Company upon
commutation. Effective January 1, 2006 and January 1, 2005, the Company entered into
Reinsurance Commutation and Release Agreements with respect to the 2004 Whole Account Net Quota
Share Reinsurance Contract and the 2003 Whole Account Net Quota Share Reinsurance Contract,
respectively. As a result of the commutation effective January 1, 2006, the Funds Held Payable
to Reinsurer liability was reduced by approximately $39.2 million, offset by an increase to net
Unpaid Loss and Loss Adjustment Expenses of $31.9 million, an increase to net Unearned Premiums
of $0.3 million, and a reduction to the profit commission receivable of approximately $7.0
million. No gain or loss was realized as a result of this commutation.
 11




---



##### Table of Contents



Activity for the Funds Held Payable to Reinsurer is summarized as follows (in thousands):
 As of and for the
    
    
    As of and for theNine Months Ended
    
    
    Year EndedSeptember 30, 2006
    
    
    December 31, 2005Funds Held Payable to Reinsurer
Balance at Beginning of Period
    
    $
    39,221
    
    
    $
    131,119Net Written Premiums Ceded
    
    
    
    
    
    
    (316
    )Reinsurer Expense Allowance
    
    
    
    
    
    
    11Provisional Commission
    
    
    
    
    
    
    (6,722
    )Paid Loss and Loss Adjustment Expenses
    
    
    
    
    
    
    (8,451
    )Interest Credit
    
    
    
    
    
    
    1,486Commutation
    
    
    (39,221
    )
    
    
    (77,906
    )Other
    
    
    
    
    
    
    Subtotal Activity
    
    
    (39,221
    )
    
    
    (91,898
    )Funds Held Payable to Reinsurer
Balance at End of Period
    
    $
    
    
    
    $
    39,221
 7.
    
    Shareholders EquityThe Philadelphia Consolidated Holding Corp Amended and Restated Employees Stock Incentive and
Performance Based Compensation Plan (the Plan) (formerly known as Philadelphia Consolidated
Holding Corp. Stock Option Plan) provides incentives and awards to those employees and members
of the Board of Directors (participants) largely responsible for the long term success of the
Company.The maximum number of shares of the Companys common stock which may be subject to awards
granted under the Plan are 18,750,000 (restated to reflect a three-for-one split of the
Companys common stock distributed on March 1, 2006), and the Plan permits (but does not
require) the grant of restricted stock awards under conditions meeting the performance based
compensation requirements of Section 162(m) of the Internal Revenue Code. The maximum number of
            shares includes all shares previously available for grants under the stock option plan prior to
the adoption of this Plan. As of September 30, 2006, 5,006,466 shares of common stock remain
reserved for future issuance pursuant to awards granted under the Plan. Under the Plan, the
Company may grant stock options, stock settled appreciation rights (SARS), restricted stock
awards and restricted stock units to participants. Stock options, restricted stock awards and
SARS have been granted to employees, and restricted stock awards have been granted to the
Companys non-employee directors pursuant to the Plan as of September 30, 2006.During 2006, the Company granted SARS and restricted stock awards to certain employees and
granted restricted stock awards to its non-employee directors. All stock options that have been
granted have provided for the purchase of common stock at a price not less than the fair market
value on the grant date. A SAR grant consists of a right that is the economic equivalent of a
stock option that could have been granted under the Plan, except that on the exercise of a SAR,
the employee receives shares of the Companys common stock having a fair market value that is
equal to the fair market value of the shares of common stock that would be subject to such
hypothetical option, reduced by the amount that would be required to be paid by the employee as
the purchase price on exercise of such hypothetical option. All grants of SARS have provided
for a hypothetical option purchase price of not less than the fair market value on the grant
date. Stock options and SARS are generally exercisable after the expiration of five years
following the grant date and expire ten years following the grant date. Compensation expense
for stock options and SARS is recognized ratably over the vesting period. Stock options and
SARS are generally forfeited by participants who terminate employment prior to vesting.Compensation expense for restricted stock awards is recognized ratably over the vesting period
(Restriction Period). Stock subject to restricted stock awards granted to employees during
2006 become free of the risk of forfeiture (i.e., become vested) generally after the expiration
of five years following the grant date (the applicable Restriction Period). Stock subject to
restricted stock awards granted to the Companys non-
 12




---



##### Table of Contents



employee directors during 2006 become free of the risk of forfeiture after the expiration of
three years following the grant date. Generally, if a participant terminates employment prior
to the expiration of the Restriction Period, the award will lapse and all shares of common stock
still subject to the restriction are forfeited.The following table presents certain information regarding stock option transactions.
 As of and for the Nine Months
    
    As of and for the Year EndedEnded September 30, 2006 (1)
    
    December 31, 2005 (1)Exercise Price
    
    
    
    
    
    Exercise PriceOptions
    
    Per Option(2)
    
    Options
    
    Per Option(2)Outstanding at beginning of period
    
    
    8,483,991
    
    
    $
    13.54
    
    
    
    7,931,100
    
    
    $
    10.86Granted
    
    
    
    
    
    $
    
    
    
    
    1,485,000
    
    
    $
    23.34Exercised
    
    
    (1,050,843
    )
    
    $
    6.16
    
    
    
    (854,859
    )
    
    $
    5.36Canceled
    
    
    (358,500
    )
    
    $
    17.62
    
    
    
    (77,250
    )
    
    $
    17.58Outstanding at end of period
    
    
    7,074,648
    
    
    $
    14.43
    
    
    
    8,483,991
    
    
    $
    13.54Exercisable at end of period
    
    
    1,719,648
    
    
    $
    8.22
    
    
    
    1,474,491
    
    
    $
    6.18Weighted-average fair value of
options granted during the
period(3)
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    9.40
 The total intrinsic value of options exercised during the nine months ended September 30, 2006
and the year ended December 31, 2005 was $28.4 million and $18.6 million, respectively.
 
 (1)
    
    Restated to reflect a three-for-one split of the Companys common stock
distributed on March 1, 2006.(2)
    
    Weighted Average.(3)
    
    The Company uses the Black-Scholes pricing model to calculate the fair value of
the options awarded as of the date of grant. The aggregate intrinsic value of outstanding and exercisable options as of September 30, 2006
was $179.0 million and $54.2 million, respectively. The total fair value of exercisable options
as of September 30, 2006 was $5.8 million. The weighted average remaining contractual life of
options outstanding as of September 30, 2006 was 6.4 years.
 The following table presents information regarding SARS transactions.
 As of and for the Nine Months
    
    
    As of and for the Year EndedEnded September 30, 2006
    
    
    December 31, 2005 (1)SARS
    
    
    SARSOutstanding at beginning of period
    
    
    
    
    
    
    Granted
    
    
    949,000
    
    
    
    Exercised
    
    
    
    
    
    
    Canceled
    
    
    
    
    
    
    Outstanding at end of period
    
    
    949,000
    
    
    
    Exercisable at end of period
    
    
    
    
    
    
    Weighted-average fair value of
SARS granted during the period
(2)
    
    $
    16.54
    
    
    $
    
 
 (1)
    
    Restated to reflect a three-for-one split of the Companys common stock
distributed on March 1, 2006. 13




---



##### Table of Contents



(2)
    
    The Company uses the Black-Scholes pricing model to calculate the fair
value of the options awarded as of the date of grant. The aggregate intrinsic value of outstanding SARS as of September 30, 2006 was $6.0 million.
The weighted average remaining contractual life of SARS outstanding as of September 30, 2006 was
9.4 years.
 The following table presents information regarding restricted stock award transactions.
 As of and for the Nine Months
    
    
    As of and for the Year EndedEnded September 30, 2006(1)
    
    
    December 31, 2005(1)Weighted
    
    
    
    
    
    
    WeightedAverage Grant
    
    
    
    
    
    
    Average GrantRestricted Stock
    
    
    Date Fair
    
    
    Restricted Stock
    
    
    Date FairShares
    
    
    Value(2)
    
    
    Shares
    
    
    Value(2)Unvested at beginning of period
    
    
    141,465
    
    
    $
    27.75
    
    
    
    
    
    
    $
    Granted
    
    
    42,680
    
    
    $
    33.67
    
    
    
    145,140
    
    
    $
    27.74Vested
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    Forfeited
    
    
    (8,436
    )
    
    $
    25.28
    
    
    
    (3,675
    )
    
    $
    27.52Unvested at end of period
    
    
    175,709
    
    
    $
    29.31
    
    
    
    141,465
    
    
    $
    27.75
 
 (1)
    
    Restated to reflect a three-for-one split of the Companys common stock
distributed on March 1, 2006.(2)
    
    The Company uses the Black-Scholes pricing model to calculate the fair value of
the options awarded as of the date of grant. As of September 30, 2006, there was $31.4 million of pre-tax unrecognized compensation costs
related to stock options, SARS and restricted stock granted under the Companys Plan. This
unrecognized compensation cost is expected to be recognized over a weighted-average period of
3.4 years.
 The fair value of each stock option and SAR award is estimated on the date of grant using the
Black-Scholes option valuation model that uses the assumptions noted in the following table.
Expected volatilities are based on the historical volatility of the Companys common stock. The
Company uses historical data to estimate stock option and SAR terms, and employee terminations
that are utilized within the valuation model; separate groups of employees that have similar
historical exercise behavior are considered separately for valuation purposes. The expected
term of stock options and SARS granted represents the period of time that granted stock option
and SAR awards are expected to be outstanding. The risk-free interest rate is based on the U.S.
Treasury yield curve in effect at the time of grant appropriate for the expected life of the
Companys stock options and SARS. The dividend yield assumption is based on history and
expectation of dividend payouts. The ranges given below result from certain groups of employees
exhibiting different behavior and from the differing market conditions which existed on the
various grant dates.
 For the Nine MonthsEnded September 30,
    
    For the Year Ended2006
    
    December 31, 2005Expected Stock Volatility
    
    33.4% - 35.5%
    
    33.9%Weighted Average Expected Stock Volatility
    
    33.9%
    
    33.9%Risk-Free Interest Rate
    
    4.4% - 4.8%
    
    3.8% - 4.2%Weighted Average Risk-Free Interest Rate
    
    4.6%
    
    3.8%Expected Life (Years)
    
    6.0  9.0
    
    6.0Weighted Average Expected Life (Years)
    
    6.5
    
    6.0Expected Dividends
    
    0.0%
    
    0.0%
 The Company has established the following stock purchase plans (all 2005 share and purchase
rights granted amounts have been restated to reflect a three-for-one split of the Companys
common stock which was distributed on March 1, 2006):
 14




---



##### Table of Contents



Employee Stock Purchase Plan (the Stock Purchase
Plan): The aggregate maximum number of shares that may be issued pursuant to the Stock Purchase Plan, as amended, is 3,000,000.
Shares may be purchased under the Stock Purchase Plan by eligible employees during
designated one-month offering periods established by the Compensation Committee of the Board
of Directors at a purchase price of the lesser of 85% of the fair market value of the shares
on the first business day of the offering period or the date the shares are purchased.
Shares purchased are restricted for a period of two years from the first day of the offering
period. The purchase price of shares may be paid by the employee over six years pursuant to
the execution of a promissory note. The promissory note(s) are collateralized by such shares
purchased under the Stock Purchase Plan and are interest free. Under the Stock Purchase
Plan, the Company issued 180,322 shares during the nine months ended September 30, 2006 and
issued 217,806 shares during the year ended December 31, 2005. The weighted-average fair
value per share of those purchase rights granted in 2006 and 2005 was $5.94 and $4.13,
respectively.The Nonqualified Employee Stock Purchase Plan (the Nonqualified Stock Plan): The aggregate
maximum number of shares that may be issued pursuant to the Nonqualified Stock Plan is
3,000,000. Shares may be purchased under the Nonqualified Stock Plan by eligible employees
during designated one-month offering periods established by the Compensation Committee of
the Board of Directors at a purchase price of the lesser of 85% of the fair market value of
the shares on the first business day of the offering period or the date the shares are
purchased. Shares purchased are restricted for a period of five years from the first day of
the offering period. The purchase price of shares may be paid by the employee over nine
years pursuant to the execution of a promissory note. The promissory note(s) are
collateralized by such shares purchased under the Nonqualified Stock Plan and are interest
free. Under the Nonqualified Stock Plan, the Company issued 4,733 shares during the nine
months ended September 30, 2006 and issued 1,263,600 shares during the year ended December
31, 2005. The weighted-average fair value per share of those purchase rights granted in 2006
and 2005 was $5.94 and $4.03, respectively.Directors Stock Purchase Plan (Directors Plan): The Directors Plan has been established
for the benefit of non-employee Directors. The aggregate maximum number of shares that may
be issued pursuant to the Directors Plan is 150,000. Non-employee Directors, during monthly
offering periods, may designate a portion of his or her fees to be
used for the purchase of shares under the terms of the Directors Plan at a purchase price of the lesser of 85% of the
fair market value of the shares on the first business day of the offering period or the date
the shares are purchased. Under the Directors Plan, the Company issued 6,348 shares during
the nine months ended September 30, 2006 and 8,883 shares during the year ended December 31,
2005. The weighted-average fair value per share of those purchase rights granted in 2006 and
2005 was $5.82 and $3.90, respectively.Preferred Agents Stock Purchase Plan (Preferred Agents Plan): The Preferred Agents Plan
has been established for the benefit of eligible Preferred Agents. The aggregate maximum
number of shares that may be issued pursuant to the Preferred Agents Plan is 600,000.
During designated offering periods, eligible Preferred Agents may either remit cash or have
the Company withhold from commissions or other compensation amounts to be used for the
purchase of shares under the terms of the Preferred Agents Plan at a purchase price of the
lesser of 85% of the fair market value of the shares on the first business day of the
offering period or the date the shares are purchased. Shares purchased are restricted for a
period of two years from the first day of the offering period. Under the Preferred Agent
Plan, the Company issued 60,492 shares during the nine months ended September 30, 2006.
There were no shares issued during the year ended December 31, 2005. The weighted-average
fair value of those purchase rights granted in 2006 was $5.80.8.
    
    Earnings Per ShareEarnings per common share have been calculated by dividing net income for the period by the
weighted average number of common shares and common share equivalents outstanding during the
period. Following is the computation of earnings per share for the three and nine months ended
September 30, 2006 and 2005, respectively (in thousands, except per share data):
 15




---



##### Table of Contents



As of and For the Three
    
    
    As of and For the NineMonths Ended
    
    
    Months EndedSeptember 30,
    
    
    September 30,2006
    
    
    2005(1)
    
    
    2006
    
    
    2005(1)Weighted-Average Common Shares Outstanding
    
    
    69,992
    
    
    
    69,009
    
    
    
    69,717
    
    
    
    68,387Weighted-Average Potential Shares Issuable
    
    
    3,489
    
    
    
    4,368
    
    
    
    3,471
    
    
    
    4,381Weighted-Average Shares and Potential
Shares Issuable
    
    
    73,481
    
    
    
    73,377
    
    
    
    73,188
    
    
    
    72,768Net Income
    
    $
    89,890
    
    
    $
    35,090
    
    
    $
    215,068
    
    
    $
    127,801Basic Earnings per Share
    
    $
    1.28
    
    
    $
    0.51
    
    
    $
    3.08
    
    
    $
    1.87Diluted Earnings per Share
    
    $
    1.22
    
    
    $
    0.48
    
    
    $
    2.94
    
    
    $
    1.76
 
 (1)
    
    Share information restated to reflect a three-for-one split of the Companys
common stock and distributed on March 1, 2006. 9.
    
    Stock Based CompensationEffective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No.
123 (revised 2004), Share Based Payment (SFAS 123(R)) using the modified prospective
transition method, which requires the measurement and recognition of compensation expense for
all share-based payment awards made to the Companys employees and directors including stock
options, stock settled appreciation rights (SARS), restricted stock and employee and director
stock purchases related to the Employee Stock Purchase Plan, Nonqualified Employee Stock
Purchase Plan, and Directors Stock Purchase Plan based on fair values. The Companys financial
statements as of and for the three and nine months ended September 30, 2006 reflect the impact
of SFAS 123(R). In accordance with the modified prospective transition method, the Companys
financial statements for prior periods have not been restated to reflect, and do not include,
the impact of SFAS 123(R). Share-based compensation expense recognized is based on the value of
the portion of share-based payment awards that is ultimately expected to vest. Share-based
compensation expense recognized in the Companys Consolidated Statement of Operations and
Comprehensive Income for the three and nine months ended September 30, 2006 included
compensation expense for share-based payment awards granted prior to, but not yet vested as of
December 31, 2005 based on the grant date fair value estimated in accordance with the pro forma
provisions of SFAS 123 and compensation expense for the share-based payment awards granted
subsequent to December 31, 2005 based on the grant date fair value estimated in accordance with
the provisions of SFAS 123(R). In conjunction with the adoption of SFAS 123(R), the Company
elected to attribute the value of share-based compensation to expense using the straight-line
method, which was previously used for its pro forma information required under SFAS 123.
Share-based compensation expense related to stock options and SARS was $2.0 million and $5.0
million, respectively, before income taxes for the three and nine months ended September 30,
2006. During the three and nine months ended September 30, 2005, no share-based compensation
expense related to stock options was recognized under the intrinsic value method in accordance
with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, (APB
25). During the three and nine months ended September 30, 2006, share-based compensation
expense related to restricted stock grants and employee and director stock purchase plans was
$0.9 million and $2.5 million, respectively. During the three and nine months ended September
30, 2005, share-based compensation expense related to restricted stock grants was $0.2 million
and $0.2 million, respectively, under APB 25.Upon adoption of SFAS 123(R), the Company elected to value share-based payment awards granted
beginning in 2006 using the Black-Scholes option-pricing model, (the Black-Scholes model),
which was also previously used for the pro forma information required under SFAS 123. The
Black-Scholes model requires the input of certain assumptions. The Companys stock options and
the option component of the Employee Stock Purchase Plan shares have characteristics
significantly different from those of traded options, and changes in the assumptions can
materially affect the fair value estimates.
 16




---



##### Table of Contents



The expected term of stock options and SARS represent the weighted-average period the stock
options and SARS are expected to remain outstanding. The expected term is based on the observed
and expected time to post-vesting exercise and forfeitures of options by the Companys
employees. The Company uses historical volatility in deriving the expected volatility
assumption. The risk-free interest rate is based on the U.S. Treasury yield curve in effect at
the time of grant appropriate for the expected life of the Companys stock options and SARS. The
dividend yield assumption is based on history and expectation of dividend payouts.As the share-based compensation expense recognized in the Consolidated Statement of Operations
and Comprehensive Income for the three and nine months ended September 30, 2006 is based on
awards ultimately expected to vest, it has been reduced for estimated forfeitures. SFAS 123(R)
requires forfeitures to be estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated
based on historical experience. In the Companys pro forma information required under SFAS 123
for the periods prior to January 1, 2006, forfeitures were estimated based on historical
experience.SFAS 123(R) requires that share-based compensation cost is recorded in the financial statements
in the same classifications as the related employees cash compensation. Accordingly, upon
adoption of SFAS 123(R), a portion of the share-based compensation cost related to unvested
awards and new awards has been capitalized as part of the Companys Deferred Acquisition Costs.
As of September 30, 2006, approximately $2.2 million of share-based compensation cost is
included in Deferred Acquisition Costs on the Consolidated Balance Sheet. In the Companys pro
forma information required under SFAS 123 for the periods prior to January 1, 2006, share-based
compensation costs were not capitalized.The effect of recording share-based compensation expense for the three and nine months ended
September 30, 2006 is as follows:
 Three Months Ended
    
    
    Nine Months Ended(In thousands, except per share amounts)
    
    September 30, 2006
    
    
    September 30, 2006Stock-based compensation expense
    
    $
    2,872
    
    
    $
    7,540Tax benefit
    
    
    (1,005
    )
    
    
    (2,639
    )Net decrease in net income
    
    $
    1,867
    
    
    $
    4,901Stock-based compensation cost capitalized (gross
of amortization) as deferred acquisition costs
    
    $
    1,181
    
    
    $
    3,440Effect on:Cash flows from operating activities
    
    $
    172
    
    
    $
    1,419Cash flows from financing activities
    
    $
    323
    
    
    $
    8,411Effect on:Net earnings per share  Basic
    
    $
    0.03
    
    
    $
    0.07Net earnings per share  Diluted
    
    $
    0.00
    
    
    $
    0.01
 SFAS 123(R) requires the Company to present pro forma information for the comparative period
prior to the adoption as if it had accounted for all of its share-based compensation under the
fair value method of SFAS 123. The following table illustrates the pro forma information
regarding the effect on net earnings and net earnings per share if the Company had accounted for
the share-based employee compensation under the fair value method of accounting:
 17




---



##### Table of Contents



Three Months Ended
    
    
    Nine Months Ended(In thousands, except per share amounts)
    
    September 30, 2005(1)
    
    
    September 30, 2005(1)Net income, as reported
    
    $
    35,090
    
    
    $
    127,801Add: Stock-based employee compensation
expense included in reported net income
under APB No. 25, net of related tax
effects
    
    
    
    
    
    
    Deduct: Total stock-based employee
compensation determined under the fair
value method for all awards, net of
related tax effects
    
    
    (1,550
    )
    
    
    (4,577
    )Pro forma net income
    
    $
    33,540
    
    
    $
    123,224Net earnings per share  Basic:As reported
    
    $
    0.51
    
    
    $
    1.87Pro forma
    
    $
    0.49
    
    
    $
    1.80Net earnings per share  Diluted:As reported
    
    $
    0.48
    
    
    $
    1.76Pro forma
    
    $
    0.46
    
    
    $
    1.69
 
 (1)
    
    Share information restated to reflect a three-for-one split of the Companys common
stock distributed on March 1, 2006. 10.
    
    Income TaxesThe effective tax rate differs from the 35% marginal tax rate principally as a result of
tax-exempt interest income, the dividend received deduction and other differences in the
recognition of revenues and expenses for tax and financial reporting purposes.11.
    
    ReinsuranceIn the normal course of business, the Company has entered into various reinsurance contracts
with unrelated reinsurers. The Company participates in such agreements for the purpose of
limiting loss exposure, managing capacity constraints and diversifying business. Reinsurance
contracts do not relieve the Company from its obligations to policyholders. The effect of
reinsurance on premiums written and earned is as follows:
  For the Three Months Ended
    
    
    For the Nine Months EndedSeptember 30, 2006
    
    
    September 30, 2006Written
    
    
    Earned
    
    
    Written
    
    
    EarnedDirect Business
    
    $
    455,446
    
    
    $
    348,926
    
    
    $
    1,122,553
    
    
    $
    996,011Reinsurance Assumed
    
    
    1,145
    
    
    
    1,048
    
    
    
    3,444
    
    
    
    3,312Reinsurance Ceded
    
    
    (64,525
    )
    
    
    (53,608
    )
    
    
    (149,723
    )
    
    
    (137,617
    )Net Premiums
    
    $
    392,066
    
    
    $
    296,366
    
    
    $
    976,274
    
    
    $
    861,706
 For the Three Months Ended
    
    
    For the Nine Months EndedSeptember 30, 2005
    
    
    September 30, 2005Written
    
    
    Earned
    
    
    Written
    
    
    EarnedDirect Business
    
    $
    387,392
    
    
    $
    291,049
    
    
    $
    954,837
    
    
    $
    857,215Reinsurance Assumed
    
    
    1,129
    
    
    
    907
    
    
    
    3,135
    
    
    
    2,956Reinsurance Ceded
    
    
    (48,152
    )
    
    
    (47,186
    )
    
    
    (113,467
    )
    
    
    (145,510
    )Net Premiums
    
    $
    340,369
    
    
    $
    244,770
    
    
    $
    844,505
    
    
    $
    714,661
 18




---



##### Table of Contents



Certain of the Companys reinsurance contracts have provisions whereby the Company is entitled
to a return profit commission based on the ultimate experience of the underlying business ceded
to the contracts. Under the terms of these contracts, the Company accrued profit commissions of
$0.8 million and $3.3 million for the three and nine months ended September 30, 2005,
respectively. There were no profit commissions recognized during 2006. The profit commissions
reduce ceded written and earned premiums and increase net written and earned premiums.Approximately $16.9 million of the Companys reinsurance receivable balances at September 30,
2006 are with Converium Reinsurance North American Inc. (CRNA). During 2004, Converium AG
(Switzerland), CRNAs parent company, placed CRNA into an orderly runoff. On October 17, 2006,
Converium AG (Switzerland) announced that it had signed a definitive agreement to sell CRNA to
National Indemnity Company, a subsidiary of Berkshire Hathaway, that is rated A++ (Superior) by
A.M. Best Company. Of the $16.9 million reinsurance receivable balances with CRNA, $0.6 million
are receivables on paid losses and $16.3 million are receivables on unpaid loss and loss
adjustment expense. The Company continues to monitor CRNAs ability to pay claims, and at this
time, believes that the amounts with CRNA will be collectible.12.
    
    Commitments and ContingenciesThe Company is subject to routine legal proceedings in connection with its property and casualty
insurance business. The Company is not involved in any other pending or threatened legal or
administrative proceedings which management believes can reasonably be expected to have a
material adverse effect on the Companys financial condition or results of operations.Credit Agreement:
On June 30, 2006, the Company entered into an unsecured Credit Agreement (the Credit
Agreement) which establishes a revolving credit facility providing for loans to the Company of
up to $50.0 million in principal amount outstanding at any one time, with a maturity date of
June 29, 2007. The Credit Agreement contains an annual commitment fee of 8.0 basis points per
annum on the unused commitments under the Credit Agreement. As of September 30, 2006, no
borrowings have been made by the Company under this Credit Agreement.Each loan under the Facility will bear interest at a per annum rate equal to, at the Companys
option, (i) Libor plus 0.40% or the higher of the Administrative Agent and Lenders prime rate
and/or the Federal Funds rate plus 0.50%. The Credit Agreement contains various
representations, covenants and events of default typical for credit facilities of this type. As
of September 30, 2006, the Company was in compliance with all covenants contained in the Credit
Agreement.State Insurance Guaranty Funds:
As of September 30, 2006 and December 31, 2005, included in Other Liabilities in the
Consolidated Balance Sheets were $22.1 million and $12.8 million, respectively, of liabilities
for state guaranty funds. As of September 30, 2006 and December 31, 2005, included in Other
Assets in the Consolidated Balance Sheets were $0.1 million and $0.1 million , respectively, of
related assets for premium tax offsets or policy surcharges, The related asset is limited to
the amount that is determined based upon future premium collections or policy surcharges from
policies in force.State Insurance Facility Assessments:
The Company continually monitors developments with respect to state insurance facilities. The
Company is required to participate in various state insurance facilities that provide insurance
coverage to individuals or entities that otherwise are unable to purchase such coverage from
private insurers. Because of the Companys participation, it may be exposed to losses that
surpass the capitalization of these facilities and/or to assessments from these facilities.Among other state insurance facilities, the Company is subject to assessments from Florida
Citizens Property Insurance Corporation (Florida Citizens), which was created by the state of
Florida to provide insurance to property owners unable to obtain coverage in the private
insurance market. Florida Citizens, at the discretion and direction of its Board of Governors
(Florida Citizens Board), can levy a regular assessment on
 19




---



##### Table of Contents



participating companies for a deficit in any calendar year up to a maximum of the greater of 10%
of the deficit or 10% of Florida property premiums industry-wide for the prior year. The portion
of the total assessment attributable to the Company is based on its market share. An insurer
may recoup a regular assessment through a surcharge to policyholders. If a deficit remains after
the regular assessment, Florida Citizens can also fund any remaining deficit through emergency
assessments in the current and subsequent years. Companies are required to collect the emergency
assessments directly from residential property policyholders and remit to Florida Citizens as
collected. In addition, Florida Citizens may issue bonds to further fund a deficit.
Participating companies are obligated to purchase any unsold bonds issued by Florida Citizens.Florida Citizens reported a deficit for the 2004 plan year. During 2005, the Company recognized
a pre-tax $3.9 million net (of reinsurance recoveries) assessment expense for Florida Citizens
amounts assessed and paid during 2005. Any recoupments of the Florida Citizens assessment
through future policy surcharges will be allocated between the Company and its reinsurers.
Recoupments are recorded by the Company as the related premiums are written. During the three
and nine months ended September 30, 2006, the Company recognized a pre-tax reduction to its net
(of reinsurance recoveries) expense related to the Florida Citizens 2004 plan year of $0.4
million and $1.4 million, respectively, primarily attributable to policy surcharge recoupments.During 2005, Florida Citizens also reported losses from Hurricane Wilma, which followed the
deficit for the 2004 plan year, and announced that a future assessment as a result of Florida
Citizens current financial deficit was both probable and could be reasonably estimated. As of
December 31, 2005, the Company accrued its estimated gross (of reinsurance recoveries)
assessment of $12.4 million, which represented its portion of the maximum regular assessment
available to Florida Citizens, and resulted in a $2.0 million net (of reinsurance recoveries)
assessment expense during 2005. During the second quarter of 2006, the Florida legislature
approved a $715 million budget appropriation to be used to reduce the Florida Citizens deficit.
During the third quarter of 2006, Florida Citizens submitted a request to the Florida Office of
Insurance Regulation (FLOIR) seeking approval of an assessment for the 2005 Plan Year. As a
result, during the third quarter of 2006, the Company reduced its accrual of its estimated gross
(of reinsurance recoveries) assessment to $2.8 million, which represents its portion of the
regular assessment for the Florida Citizens 2005 plan year, which is pending approval by FLOIR.
During the three and nine months ended September 30, 2006, the Company recognized a reduction to
its net (of reinsurance recoveries) expense related to this assessment of $0.1 million and $1.8
million, respectively, due primarily to changes in related reinsurance recoveries resulting from
updated estimates of 2005 hurricane losses reported by Florida citizens during 2006 as well as
the impact of the budget appropriation noted above.The Company continues to monitor developments with respect to various other state facilities
such as the Mississippi Windstorm Underwriting Association, the Alabama Insurance Underwriting
Association, and the Texas Windstorm Insurance Association. The ultimate impact of the 2005
hurricane season on these facilities is currently uncertain, but could result in the facilities
recognizing a financial deficit or a financial deficit greater than the level currently
estimated by the facility. They may, in turn, have the ability to assess participating insurers
when financial deficits occur, adversely affecting the Companys results of operations.Florida Hurricane Catastrophe Fund:
The Company and other insurance companies writing residential property policies in Florida must
participate in the Florida Hurricane Catastrophe Fund (FHCF). If the FHCF does not have
sufficient funds to pay its ultimate reimbursement obligations to participating insurance
companies, it has the authority to issue bonds, which are funded by assessments on generally all
property and casualty premiums in Florida. By law, these assessments are the obligation of
insurance policyholders, which insurance companies must collect. The FHCF assessments are
limited to 6% of premiums per year beginning the first year in which reimbursements require
bonding, and up to a total of 10% of premiums per year for assessments in the second and
subsequent years, if required to fund additional bonding. Upon the order of the Florida Office
of Insurance Regulation (FLOIR), companies are required to collect the FHCF assessments
directly from its policyholders and remit them to the FHCF as they are collected.During June 2006, the FLOIR approved a 1% emergency assessment effective January 1, 2007 which
the Company must collect from its policyholders and remit to the FHCF beginning January 1, 2007.
 20




---



##### Table of Contents



13.
    
    Comprehensive IncomeComponents of comprehensive income, as detailed in the Consolidated Statements of Operations and
Comprehensive Income, are net of tax. The related tax effect of Holding Gains (Losses) arising
during the three and nine months ended September 30, 2006 and 2005 was $16.1 million and $(4.6)
million, respectively, and $5.7 million and $(6.4) million, respectively. The related tax
effect of Reclassification Adjustments for the three and nine months ended September 30, 2006
and 2005 was $2.4 million and $(0.4) million, respectively, and $3.4 million and $(4.3) million,
respectively.14.
    
    New Accounting PronouncementsIn February 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 155,
Accounting for Certain Hybrid Financial Instruments (SFAS No. 155). Under current generally
accepted accounting principles, an entity that holds a financial instrument with an embedded
derivative must bifurcate the financial instrument, resulting in the host and the embedded
derivative being accounted for separately. SFAS No. 155 permits, but does not require, entities
to account for financial instruments with an embedded derivative at fair value thus negating the
need to bifurcate the instrument between its host and the embedded derivative. SFAS No. 155 is
effective as of the beginning of the first annual reporting period that begins after September
15, 2006. Subsequently, SFAS No. 155 was modified.At the FASB meeting on October 25, 2006, the FASB approved a narrow scope exception for certain
beneficial interests that require an embedded derivative analysis. The issue is not whether the
beneficial interests contain an embedded derivative, but when the embedded derivative is
required to be separately accounted for in accordance with Statement No. 133, Accounting for
Derivative Instruments and Hedging Activities (SFAS No. 133). The Board directed the FASB
Staff to prepare an exposure draft for a 30 day comment period with the expectation that final
guidance in the form of an SFAS No. 133 Implementation Issue will be issued in the first quarter
of 2007.The narrow scope exception approved by the FASB appears to exempt securities backed by financial
assets where the only embedded derivative is prepayment based. This appears to exempt fixed rate
asset backed, mortgage pass-through, and collateralized mortgage obligation securities
previously thought to be subject to SFAS No. 155. Should the final determination be that these
securities are exempt from SFAS No. 155, the Company believes that the financial impact of
application will not be significant.In July 2006, the FASB released Interpretation No. 48, Accounting for Uncertainty in Income
Taxes, an interpretation of FASB Statement No. 109 (FIN 48). FIN 48 clarifies the accounting
for uncertainty in income taxes recognized in accordance with SFAS No. 109, Accounting for
Income Taxes. FIN 48 prescribes a recognition threshold and measurement attribute for the
financial statement recognition and measurement of a tax position taken or expected to be taken
in a tax return. FIN 48, which is effective for fiscal years beginning after December 15, 2006,
also provides guidance on derecognition, classification, interest and penalties, accounting for
interim periods, disclosure and transition. The Company is currently in the process of
evaluating the impact of FIN 48.In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (SFAS No.
157), which clarifies that the term fair value is intended to mean a market-based measure, not
an entity-specific measure and gives the highest priority to quoted prices in active markets in
determining fair value. SFAS No. 157 requires disclosures about (1) the extent to which
companies measure assets and liabilities at fair value, (2) the methods and assumptions used to
measure fair value, and (3) the effect of fair value measures on earnings. SFAS No. 157 is
effective for fiscal years beginning after November 15, 2007. The Company is currently in the
process of evaluating the impact of SFAS No. 157.15.
    
    Segment InformationThe Companys operations are classified into three reportable business segments which are
organized around its three underwriting divisions: The Commercial Lines Underwriting Group,
which has underwriting responsibility for the commercial multi-peril package, commercial
automobile and commercial property
 21




---



##### Table of Contents



insurance products; The Specialty Lines Underwriting Group, which has underwriting
responsibility for the professional liability insurance products; and The Personal Lines Group,
which designs, markets and underwrites personal property and casualty insurance products for the
homeowners and manufactured housing markets. Each business segments responsibilities include:
pricing, managing the risk selection process and monitoring the loss ratios by product and
insured. The reportable segments operate solely within the United States and have not been
aggregated.The segments follow the same accounting policies used for the Companys consolidated financial
statements, as described in the summary of significant accounting policies. Management
evaluates a segments performance based upon premium production and the associated loss
experience, which includes paid losses, an amount determined on the basis of claim adjusters
evaluation with respect to insured events that have occurred and been reported to the Company,
and an amount for losses incurred that have not been reported. Investments and investment
performance, including investment income and net realized investment gain (loss), acquisition
costs and other underwriting expenses, including commissions, premium taxes and other
acquisition costs, and other operating expenses are managed at a corporate level by the
corporate accounting function in conjunction with other corporate departments, and are included
in Corporate.Following is a tabulation of business segment information for the three and nine months ended
September 30, 2006 and 2005. Corporate information is included to reconcile segment data to the
consolidated financial statements (in thousands):
 22




---



##### Table of Contents



Three Months Ended September 30,Commercial
    
    Specialty
    
    PersonalLines
    
    Lines
    
    Lines
    
    Corporate
    
    Total2006:Gross Written Premiums
    
    $
    367,785
    
    
    $
    62,602
    
    
    $
    26,204
    
    
    
    
    
    
    $
    456,591Net Written Premiums
    
    $
    339,409
    
    
    $
    50,217
    
    
    $
    2,440
    
    
    
    
    
    
    $
    392,066Revenue:Net Earned Premiums
    
    $
    246,905
    
    
    $
    45,415
    
    
    $
    4,046
    
    
    
    
    
    
    $
    296,366Net Investment Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,833
    
    
    
    23,833Net Realized Investment Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (6,976
    )
    
    
    (6,976
    )Other Income
    
    
    
    
    
    
    
    
    
    
    677
    
    
    
    118
    
    
    
    795Total Revenue
    
    
    246,905
    
    
    
    45,415
    
    
    
    4,723
    
    
    
    16,975
    
    
    
    314,018Losses and Expenses:Net Loss and Loss Adjustment Expenses
    
    
    54,841
    
    
    
    26,385
    
    
    
    3,480
    
    
    
    
    
    
    
    84,706Acquisition Costs and Other Underwriting
Expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    89,052
    
    
    
    89,052Other Operating Expenses
    
    
    
    
    
    
    
    
    
    
    508
    
    
    
    2,856
    
    
    
    3,364Total Losses and Expenses
    
    
    54,841
    
    
    
    26,385
    
    
    
    3,988
    
    
    
    91,908
    
    
    
    177,122Income Before Income Taxes
    
    
    192,064
    
    
    
    19,030
    
    
    
    735
    
    
    
    (74,933
    )
    
    
    136,896Total Income Tax Expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    47,006
    
    
    
    47,006Net Income
    
    $
    192,064
    
    
    $
    19,030
    
    
    $
    735
    
    
    $
    (121,939
    )
    
    $
    89,890Total Assets
    
    
    
    
    
    
    
    
    
    $
    143,860
    
    
    $
    3,185,561
    
    
    $
    3,329,4212005:Gross Written Premiums
    
    $
    305,482
    
    
    $
    55,463
    
    
    $
    27,577
    
    
    $
    
    
    
    $
    388,522Net Written Premiums
    
    $
    284,315
    
    
    $
    44,751
    
    
    $
    11,303
    
    
    $
    
    
    
    $
    340,369Revenue:Net Earned Premiums
    
    $
    197,400
    
    
    $
    39,006
    
    
    $
    8,364
    
    
    $
    
    
    
    $
    244,770Net Investment Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,979
    
    
    
    16,979Net Realized Investment Gain
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,097
    
    
    
    1,097Other Income
    
    
    
    
    
    
    
    
    
    
    259
    
    
    
    341
    
    
    
    600Total Revenue
    
    
    197,400
    
    
    
    39,006
    
    
    
    8,623
    
    
    
    18,417
    
    
    
    263,446Losses and Expenses:Net Loss and Loss Adjustment Expenses
    
    
    107,237
    
    
    
    25,535
    
    
    
    9,087
    
    
    
    
    
    
    
    141,859Acquisition Costs and Other Underwriting
Expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    67,542
    
    
    
    67,542Other Operating Expenses
    
    
    
    
    
    
    
    
    
    
    242
    
    
    
    4,900
    
    
    
    5,142Total Losses and Expenses
    
    
    107,237
    
    
    
    25,535
    
    
    
    9,329
    
    
    
    72,442
    
    
    
    214,543Income (Loss) Before Income Taxes
    
    
    90,163
    
    
    
    13,471
    
    
    
    (706
    )
    
    
    (54,025
    )
    
    
    48,903Total Income Tax Expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    13,813
    
    
    
    13,813Net Income (Loss)
    
    $
    90,163
    
    
    $
    13,471
    
    
    $
    (706
    )
    
    $
    (67,838
    )
    
    $
    35,090Total Assets
    
    $
    
    
    
    $
    
    
    
    $
    184,277
    
    
    $
    2,560,271
    
    
    $
    2,744,548
 23




---



##### Table of Contents



Nine Months Ended September 30,Commercial
    
    Specialty
    
    PersonalLines
    
    Lines
    
    Lines
    
    Corporate
    
    Total2006:Gross Written Premiums
    
    $
    875,386
    
    
    $
    175,097
    
    
    $
    75,514
    
    
    
    
    
    
    $
    1,125,997Net Written Premiums
    
    $
    814,543
    
    
    $
    140,081
    
    
    $
    21,650
    
    
    
    
    
    
    $
    976,274Revenue:Net Earned Premiums
    
    $
    706,445
    
    
    $
    129,278
    
    
    $
    25,983
    
    
    
    
    
    
    $
    861,706Net Investment Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    65,572
    
    
    
    65,572Net Realized Investment Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (9,782
    )
    
    
    (9,782
    )Other Income
    
    
    
    
    
    
    
    
    
    
    1,459
    
    
    
    244
    
    
    
    1,703Total Revenue
    
    
    706,445
    
    
    
    129,278
    
    
    
    27,442
    
    
    
    56,034
    
    
    
    919,199Losses and Expenses:Net Loss and Loss Adjustment Expenses
    
    
    250,013
    
    
    
    74,580
    
    
    
    12,533
    
    
    
    
    
    
    
    337,126Acquisition Costs and Other Underwriting
Expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    251,406
    
    
    
    251,406Other Operating Expenses
    
    
    
    
    
    
    
    
    
    
    1,022
    
    
    
    7,622
    
    
    
    8,644Total Losses and Expenses
    
    
    250,013
    
    
    
    74,580
    
    
    
    13,555
    
    
    
    259,028
    
    
    
    597,176Income Before Income Taxes
    
    
    456,432
    
    
    
    54,698
    
    
    
    13,887
    
    
    
    (202,994
    )
    
    
    322,023Total Income Tax Expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    106,955
    
    
    
    106,955Net Income
    
    $
    456,432
    
    
    $
    54,698
    
    
    $
    13,887
    
    
    $
    (309,949
    )
    
    $
    215,068Total Assets
    
    
    
    
    
    
    
    
    
    $
    143,860
    
    
    $
    3,185,561
    
    
    $
    3,329,4212005:Gross Written Premiums
    
    $
    727,292
    
    
    $
    157,286
    
    
    $
    73,394
    
    
    $
    
    
    
    $
    957,972Net Written Premiums
    
    $
    686,689
    
    
    $
    120,660
    
    
    $
    37,156
    
    
    $
    
    
    
    $
    844,505Revenue:Net Earned Premiums
    
    $
    564,575
    
    
    $
    111,227
    
    
    $
    38,859
    
    
    $
    
    
    
    $
    714,661Net Investment Income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    45,843
    
    
    
    45,843Net Realized Investment Gain
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,191
    
    
    
    12,191Other Income
    
    
    
    
    
    
    
    
    
    
    709
    
    
    
    671
    
    
    
    1,380Total Revenue
    
    
    564,575
    
    
    
    111,227
    
    
    
    39,568
    
    
    
    58,705
    
    
    
    774,075Losses and Expenses:Net Loss and Loss Adjustment Expenses
    
    $
    280,161
    
    
    $
    75,276
    
    
    $
    28,695
    
    
    $
    
    
    
    $
    384,132Acquisition Costs and Other Underwriting
Expenses
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    189,316
    
    
    
    189,316Other Operating Expenses
    
    
    
    
    
    
    
    
    
    
    285
    
    
    
    14,806
    
    
    
    15,091Total Losses and Expenses
    
    
    280,161
    
    
    
    75,276
    
    
    
    28,980
    
    
    
    204,122
    
    
    
    588,539Income (Loss) Before Income Taxes
    
    
    284,414
    
    
    
    35,951
    
    
    
    10,588
    
    
    
    (145,417
    )
    
    
    185,536Total Income Tax Expense
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    57,735
    
    
    
    57,735Net Income (Loss)
    
    $
    284,414
    
    
    $
    35,951
    
    
    $
    10,588
    
    
    $
    (203,152
    )
    
    $
    127,801Total Assets
    
    $
    
    
    
    $
    
    
    
    $
    184,277
    
    
    $
    2,560,271
    
    
    $
    2,744,548
 24




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
 
 Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 General
   Critical Accounting Estimates
  Share-based Compensation Expense
 
 25




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
     Results of Operations (Nine Months ended September 30, 2006 vs. September 30, 2005)
 Premiums
 Commercial Lines
    
    Specialty Lines
    
    Personal Lines
    
    Total2006 Gross Written Premiums
    
    $
    875.4
    
    
    $
    175.1
    
    
    $
    75.5
    
    
    $
    1,126.02005 Gross Written Premiums
    
    $
    727.3
    
    
    $
    157.3
    
    
    $
    73.4
    
    
    $
    958.0Percentage Increase
    
    
    20.4
    %
    
    
    11.3
    %
    
    
    2.9
    %
    
    
    17.5
    %2006 Gross Earned Premiums
    
    $
    761.8
    
    
    $
    161.0
    
    
    $
    76.5
    
    
    $
    999.32005 Gross Earned Premiums
    
    $
    643.2
    
    
    $
    143.6
    
    
    $
    73.4
    
    
    $
    860.2Percentage Increase
    
    
    18.4
    %
    
    
    12.1
    %
    
    
    4.2
    %
    
    
    16.2
    %
  26




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 
    
    Prospecting efforts by marketing personnel in conjunction with long term relationships
formed by the Companys marketing Regional Vice Presidents continue to result in additional
prospects and increased premium writings, most notably for the Companys various commercial
package and non profit management liability product lines.
    
    Continued expansion of marketing efforts relating to commercial lines and specialty
lines products through the Companys field organization and preferred agents.
    
    The introduction of several new niche product offerings, including religious
organization commercial package and sports and fitness products.
    
    An increase to in-force policy counts as of September 30, 2006 versus September 30, 2005
of 39.2% and 17.3% for the commercial lines and specialty lines segments, respectively,
primarily as a result of the factors discussed above.
    
    Realized average rate increases on renewal business approximating 0.9%, and 20.4% for
the commercial and personal lines segments, respectively.
    
    An increase of $9.1 million in homeowners gross written premium as a result of Liberty
American Insurance Group, Inc.s continued planned shift in product mix of increasing
homeowners product policies and reducing mobile homeowners product policies.
  
    
    The decision by an automobile leasing customer to self-insure business previously
written by the Company. As a result, gross written premiums for the commercial lines
segment were reduced by $12.7 million.
    
    A decrease in mobile homeowners gross written premium of $12.2 million resulting from
the continued planned shift in product mix noted above.
    
    A decrease in in-force policy counts for the personal lines segment of 24.2%, resulting
from a decrease to the in-force counts for the mobile homeowners product of 79.1% and an
increase to the in-force policy counts for the homeowners product of 14.7%, as a result of
the continued planned shift in product mix noted above.
    
    Realized average rate decreases on renewal business approximating 0.8% for the specialty
lines segment.
  Commercial Lines
    
    Specialty Lines
    
    Personal Lines
    
    Total2006 Net Written Premiums
    
    $
    814.5
    
    
    $
    140.1
    
    
    $
    21.7
    
    
    $
    976.32005 Net Written Premiums
    
    $
    686.7
    
    
    $
    120.6
    
    
    $
    37.2
    
    
    $
    844.5Percentage Increase (Decrease)
    
    
    18.6
    %
    
    
    16.2
    %
    
    
    (41.7
    )%
    
    
    15.6
    %2006 Net Earned Premiums
    
    $
    706.4
    
    
    $
    129.3
    
    
    $
    26.0
    
    
    $
    861.72005 Net Earned Premiums
    
    $
    564.6
    
    
    $
    111.2
    
    
    $
    38.9
    
    
    $
    714.7Percentage Increase (Decrease)
    
    
    25.1
    %
    
    
    16.3
    %
    
    
    (33.2
    )%
    
    
    20.6
    %
  27




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 
    
    A change in the Companys net liability cession percentage under
its quota share reinsurance agreement whereby the Company ceded
10% of its commercial and specialty lines net written and earned
premiums and loss and loss adjustment expenses for policies
incepting during 2004, due to its decision to terminate this
agreement on a run-off basis effective December 31, 2004. Pursuant
to the agreement, during the nine months ended September 30, 2006
and 2005, the Company ceded $(0.3) million (commercial lines
segment) and $(0.5) million ($0.2 million for the commercial lines
segment, $(0.7) million for the specialty lines segment) of net
written premiums, respectively, and $0 million and $41.0 million
($34.2 million for the commercial lines segment, $6.7 million for
the specialty lines segment, and $0.1 million for the personal
lines segment) of net earned premiums, respectively.
    
    Certain of the Companys reinsurance contracts have reinstatement
or additional premium provisions under which the Company must pay
reinstatement or additional reinsurance premiums to reinstate
coverage provisions upon utilization of initial reinsurance
coverage. During the nine months ended September 30, 2006 and
2005, the Company accrued $3.4 million ($1.4 million for the
commercial lines segment and $2.0 million for the specialty lines
segment) and $2.4 million ($1.0 million for the commercial lines
segment and $1.4 million for the specialty lines segment)
respectively, of reinstatement or additional reinsurance premium
under its casualty excess of loss reinsurance treaty, as a result
of changes in ultimate loss estimates. The reinstatement premium
increased ceded written and earned premiums and reduced net
written and earned premiums.
    
    During the nine months ended September 30, 2005, the Company
experienced catastrophe losses attributable to Hurricanes Dennis,
Katrina and Rita. These multiple hurricane events resulted in the
recognition of reinstatement and accelerated catastrophe
reinsurance premium expense of $1.4 million ($1.0 million for the
Commercial Lines Segment and $0.4 million for the Personal Lines
Segment) during the nine months ended September 30, 2005 due to
the utilization of certain of the catastrophe reinsurance
coverages. This recognition of reinstatement and accelerated
reinsurance premium expense increased reinsurance ceded written
and earned premiums and reduced net written and earned premiums.
    
    The Company also experienced higher property catastrophe
reinsurance costs, increased catastrophe loss retentions, and
decreased catastrophe coverage limits for its June 1, 2006
reinsurance renewal compared to the June 1, 2005 renewal as a
result of the hardening property catastrophe reinsurance market.
This hardening of the property catastrophe reinsurance market is
generally due to the extent of catastrophe losses incurred by
reinsurers during 2004 and 2005, along with the revision of
reinsurers predictive models of potential future catastrophe
risk. The Companys property catastrophe reinsurance coverage
effective June 1, 2006 through May 31, 2007 is summarized as
follows:
 -
    
    For its personal lines catastrophe losses, the Companys reinsurance coverage
is approximately $200.2 million in excess of the Companys $7.5 million per occurrence
retention. Of this total amount, the Florida Hurricane Catastrophe Fund (the FHCF)
provides on an aggregate basis for Liberty American Select Insurance Company (LASIC)
and Liberty American Insurance Company (LAIC) 90% coverage for approximately $108.6
million in excess of $34.4 million. In addition, LASIC purchased additional
reimbursement coverage of $10.0 million in excess of approximately $7.5 million, which
includes one prepaid reinstatement premium at no additional charge. The FHCF coverage
inures to the benefit of the Companys open-market catastrophe program. The coverage
provided by the open-market catastrophe program (large reinsurers that are rated at
least A- (Excellent) by A.M. Best Company) includes one mandatory reinstatement, but
the FHCF coverage does not reinstate, except for the $10.0 million provided for in
LASICs additional reimbursement coverage. Since the FHCF reimbursement coverage cannot
be reinstated, the Companys open-market program is structured such that catastrophe
reinsurance coverage in excess of the FHCF coverage will drop down and fill in any
portion of the FHCF coverage which has been utilized.-
    
    In addition, the Company has purchased reinstatement premium protection
reinsurance contracts for its personal lines open-market catastrophe reinsurance
contracts, effective September 1, 2006, which pay 100% of the reinstatement premium for
the one mandatory reinstatement which the Company becomes liable to pay as a result of loss occurrences exceeding $17.5 million for its personal
lines open-market catastrophe reinsurance program.
 28




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 -
    
    For its commercial lines catastrophe losses, the Companys open-market
catastrophe reinsurance coverage is $90.0 million in excess of the Companys $10.0
million per occurrence retention. In addition, the FHCF provides on an aggregate basis
for Philadelphia Indemnity Insurance Company 90% coverage for approximately $1.1
million in excess of $0.4 million, resulting in total commercial lines reinsurance
coverage of approximately $91.1 million in excess of the Companys $10.0 per occurrence
retention.
 Net Investment Income:
  Net Realized Investment Gain (Loss):
  Other Income
 29




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Net Loss and Loss Adjustment Expenses:
  
    
    Net reserve actions taken during the nine months ended September 30, 2006, wherein the
net estimated unpaid loss and loss adjustment expenses for accident years 2005 and prior
were decreased by $78.3 million, as compared to net reserve actions taken during the nine
months ended September 30, 2005 wherein the estimated net unpaid loss and loss adjustment
expenses for accident years 2004 and prior were decreased by $14.7 million. Decreases in
the estimated net unpaid loss and loss adjustment expenses for prior accident years during
the nine months ended September 30, 2006 were as follows:
 Net Basis Decrease(In millions)Accident Year 2005
    
    $
    58.6Accident Year 2004
    
    
    11.6Accident Year 2003
    
    
    3.1Accident Years 2002 and prior
    
    
    5.0Total Decrease
    
    $
    78.3
 
    
    For accident year 2005, the decrease in estimated net unpaid loss and loss
adjustment expenses was principally due to lower loss estimates for all coverages on
commercial package policies and for professional liability policies due to better than
expected case incurred loss development.
    
    For accident year 2004, the decrease in estimated net unpaid loss and loss
adjustment expenses was principally due to lower loss estimates for all coverages on
commercial package polices due to better than expected case incurred loss development.
    
    For accident year 2003, the decrease in estimated net unpaid loss and loss
adjustment expenses was principally due to lower loss estimates for commercial
automobile policies and automobile coverages on commercial package policies due to
better than expected case incurred development.
    
    For accident years 2002 and prior, the decrease in net unpaid loss and loss
adjustment expenses was principally due to lower loss estimates for commercial
automobile policies due to lower than expected case incurred development.
 Establishing loss reserve estimates is a necessarily complex and imprecise process. The Companys methodology is to employ several generally
accepted actuarial methods to determine net unpaid loss and loss
adjustment expenses. Over time, more reliance is placed on actuarial
methods based on actual loss development, and accordingly, over time,
less reliance is placed on actuarial methods based on expected loss
development.The principal factor contributing to the decreases in the estimated net unpaid loss and loss
adjustment expenses for prior accident years is the reconsideration of an assumption underlying previous estimates
that loss ratio deterioration would result from the high growth rates experienced by the
Company in the most recent accident years. As actual losses experienced on these accident
years have continued to be lower than anticipated, it has become more likely that the
ultimate loss ratio will prove to be better than originally estimated. Over time, greater
credibility has been given to this favorable trend by applying greater weight to actuarial methods based on actual loss
development. The result is a reduction to these years net
unpaid loss and loss adjustment expenses, which, in turn, leads to
lower ultimate loss ratio expectations for the more recent accident
years. As significant weight is given to actuarial methods based on
expected losses for the more recent accident years, the result of
lower expectations is a reduction to these years net unpaid loss and loss
adjustment expenses.
    
    A reduction in the current accident year net ultimate loss and loss adjustment expense
ratio, excluding catastrophe losses for the nine months ended September 30, 2006 compared
to the same period in 2005. During the nine months ended September 30, 2006, a net
ultimate loss and loss adjustment expense ratio, excluding catastrophe losses, of 48.2% was
estimated for the 2006 accident year. During the nine months
 30




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 ended September 30, 2005, a net ultimate loss and loss adjustment expense ratio, excluding
catastrophe losses, of 53.3% was estimated for the 2005 accident year.Since expectations for the current accident year ultimate loss ratio are derived from the
Companys expectations with respect to the preceding accident years, the improvement with
respect to the 2003 to 2005 accident years due to better than expected case incurred
development has favorable implications for the Companys outlook of accident year 2006 as
well. Therefore, ultimate loss ratio expectations for 2006 have been reassessed to reflect
that business in the most recent accident years now appears to have better ultimate loss
ratios than previously expected. However, while recognizing that better than originally
expected ultimate loss ratios now appear to be emerging in 2005 and possibly 2006,
sustainability remains in some doubt for the remainder of accident year 2006 and beyond due
primarily to plans for continued high rates of growth as well as increasing competition.
Though not yet strong enough to have material adverse effects on pricing or coverage terms,
competitive pressures have been increasing since 2004. Premium rates have fallen slightly
in some of the Companys business segments. The impact of a softening insurance market on
the Companys underwriting results cannot be fully quantified in advance.
    
    A $17.0 million reduction in hurricane catastrophe losses incurred. During the nine
months ended September 30, 2005, the Company incurred $17.0 million of net loss and loss
adjustment expenses related to Hurricanes Dennis, Katrina and Rita. There were no such
catastrophe losses during the nine months ended September 30, 2006.
    
    During the nine months ended September 30, 2005, the Company incurred $3.0 million of
net loss and loss adjustment expenses attributable to estimated personal lines catastrophe
losses from hailstorms which struck Florida in March 2005. There were no such catastrophe
losses during the nine months ended September 30, 2006.
  
    
    The growth in net earned premiums.
    
    An $18.6 million reduction in ceded loss and loss adjustment expenses pursuant to a 10%
quota share agreement (See Premiums). Ceded loss and loss adjustment expenses pursuant to
this quota share agreement for the nine months ended September 30, 2005 were $18.6 million;
however, due to the Companys decision to terminate this agreement on a run-off basis
effective December 31, 2004, there were no losses ceded to this agreement during 2006.
 Acquisition Costs and Other Underwriting Expenses:
 
    
    The growth in net earned premiums.
    
    An increase in insurance guaranty fund assessment expenses.
    
    Share-based compensation expense recognized under SFAS 123(R), which was adopted by the
Company on January 1, 2006.
    
    An $18.9 million decrease in ceding commission earned pursuant to the Companys quota
share agreements (See Premiums). During the nine months ended September 30, 2006, the
Company earned no ceding commissions related to quota share agreements as compared to $18.9
million during the same period of 2005. There were no ceded earned premiums pursuant to
these quota share agreements for the nine months
 31




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 ended September 30, 2006 as compared to $41.0 million for the same period of 2005 due to the
Companys decision to terminate its 10% quota share agreement on a run-off basis effective
December 31, 2004.
 Other Operating Expenses
 Income Tax Expense:
 Results of Operations (Three Months ended September 30, 2006 vs. September 30, 2005)
 Premiums
 Commercial Lines
    
    Specialty Lines
    
    Personal Lines
    
    Total2006 Gross Written Premiums
    
    $
    367.8
    
    
    $
    62.6
    
    
    $
    26.2
    
    
    $
    456.62005 Gross Written Premiums
    
    $
    305.4
    
    
    $
    55.5
    
    
    $
    27.6
    
    
    $
    388.5Percentage Increase (Decrease)
    
    
    20.4
    %
    
    
    12.8
    %
    
    
    (5.1
    )%
    
    
    17.5
    %2006 Gross Earned Premiums
    
    $
    268.7
    
    
    $
    56.0
    
    
    $
    25.3
    
    
    $
    350.02005 Gross Earned Premiums
    
    $
    220.2
    
    
    $
    49.1
    
    
    $
    22.7
    
    
    $
    292.0Percentage Increase
    
    
    22.0
    %
    
    
    14.1
    %
    
    
    11.5
    %
    
    
    19.9
    %
  
    
    Prospecting efforts by marketing personnel in conjunction with long term relationships
formed by the Companys marketing Regional Vice Presidents continue to result in additional
prospects and increased premium writings, most notably for the Companys various commercial
package and non-profit management liability product lines.
    
    Continued expansion of marketing efforts relating to commercial lines and specialty
lines products through the Companys field organization and preferred agents.
    
    The introduction of several new niche product offerings, including religious
organization commercial package and sports and fitness products.
    
    An increase to in-force policy counts as of September 30, 2006 versus September 30, 2005
of 39.2% and 17.3% for the commercial lines and specialty lines segments, respectively,
primarily as a result of the factors discussed above.
    
    Realized average rate increases on renewal business approximating 0.8%, and 39.1% for
the commercial and personal lines segments, respectively.
  
    
    A decrease in mobile homeowners gross written premium of $2.7 million, resulting from
the continued planned shift in product mix to homeowners product policies.
 32




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 
    
    A decrease in in-force policy counts for the personal lines segment of 24.2%, resulting
from a decrease to the in-force counts for the mobile homeowners product of 79.1% and an
increase to the in-force policy counts for the homeowners product of 14.7%, as a result of
the continued planned shift in product mix noted above.
    
    Realized average rate decreases on renewal business approximating 1.1% for the specialty
lines segment.
  Commercial Lines
    
    Specialty Lines
    
    Personal Lines
    
    Total2006 Net Written Premiums
    
    $
    339.4
    
    
    $
    50.2
    
    
    $
    2.5
    
    
    $
    392.12005 Net Written Premiums
    
    $
    284.3
    
    
    $
    44.8
    
    
    $
    11.3
    
    
    $
    340.4Percentage Increase (Decrease)
    
    
    19.4
    %
    
    
    12.1
    %
    
    
    (77.9
    )%
    
    
    15.2
    %2006 Net Earned Premiums
    
    $
    246.9
    
    
    $
    45.4
    
    
    $
    4.1
    
    
    $
    296.42005 Net Earned Premiums
    
    $
    197.4
    
    
    $
    39.0
    
    
    $
    8.4
    
    
    $
    244.8Percentage Increase (Decrease)
    
    
    25.1
    %
    
    
    16.4
    %
    
    
    (51.2
    )%
    
    
    21.1
    %
  
    
    A change in the Companys net liability cession percentage under its quota share
reinsurance agreement, whereby the Company ceded 10% of its commercial and specialty lines
net written and earned premiums and loss and loss adjustment expenses for policies
incepting during 2004, due to its decision to terminate this agreement on a run-off basis
effective December 31, 2004. Pursuant to the agreement, during the three months ended
September 30, 2006 and 2005, the Company ceded $0 million and $(0.1) million for the
commercial lines segment of net written premiums, respectively, and $0 million and $7.8
million ($6.5 million for the commercial lines segment, $1.3 million for the specialty
lines segment, and $0 million for the personal lines segment) of net earned premiums,
respectively.
    
    During the three months ended September 30, 2005, the Company experienced catastrophe
losses attributable to Hurricanes Dennis, Katrina and Rita. These events resulted in the
recognition of reinstatement and accelerated catastrophe reinsurance premium expense of
$1.4 million ($1.0 million for the Commercial Lines Segment, and $0.4 million for the
Personal Lines Segment) during the three months ended September 30, 2005 due to the
utilization of certain of the catastrophe reinsurance coverage. This recognition of
reinstatement and accelerated reinsurance premium expense increased reinsurance ceded
written and earned premiums and reduced net written and earned premiums.
  Net Investment Income:
 33




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Net Realized Investment Gain (Loss):
  Other Income
 Net Loss and Loss Adjustment Expenses:
  
    
    Net reserve actions taken during the three months ended September 30, 2006, wherein the
net estimated unpaid loss and loss adjustment expenses for accident years 2005 and prior
were decreased by $42.7 million as compared to reserve actions taken during the three
months ended September 30, 2005 wherein the estimated net unpaid loss and loss adjustment
expenses for accident years 2004 and prior were decreased by $7.3 million. Decreases in
the estimated net unpaid loss and loss adjustment expenses for prior accident years during
the three months ended September 30, 2006 were as follows:
 34




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 
 Net Basis Decrease(In millions)Accident Year 2005
    
    $
    32.2Accident Year 2004
    
    
    8.0Accident Year 2003
    
    
    2.5Accident Years 2002 and prior
    
    
    Total Decrease
    
    $
    42.7
 
    
    For accident year 2005, the decrease in estimated net unpaid loss and loss
adjustment expenses was principally due to lower loss estimates for all coverages on
commercial package policies due to better than expected case incurred loss development.
    
    For accident year 2004, the decrease in estimated net unpaid loss and loss
adjustment expenses was principally due to lower loss estimates for general liability
and automobile coverages on commercial package polices due to better than expected case
incurred loss development.
    
    For accident year 2003, the decrease in estimated net unpaid loss and loss
adjustment expenses was principally due to lower loss estimates for commercial
automobile policies and automobile coverages on commercial package policies due to
better than expected case incurred development.
 Establishing loss reserve estimates is a necessarily complex
and imprecise process. The Companys methodology is to employ several generally
accepted actuarial methods to determine net unpaid loss and loss
adjustment expenses. Over time, more reliance is placed on actuarial
methods based on actual loss development, and accordingly, over time,
less reliance is placed on actuarial methods based on expected loss
development.The principal factor contributing to the decreases in the estimated net unpaid loss and loss
adjustment expenses for prior accident years is the reconsideration of an assumption underlying previous estimates
that loss ratio deterioration would result from the high growth rates experienced by the
Company in the most recent accident years. As actual losses experienced on these accident
years have continued to be lower than anticipated, it has become more likely that the
ultimate loss ratio will prove to be better than originally estimated. Over time, greater
credibility has been given to this favorable trend by applying greater weight to actuarial methods based on actual loss
development. The result is a reduction to these years net
unpaid loss and loss adjustment expenses, which, in turn, leads to
lower ultimate loss ratio expectations for the more recent accident
years. As significant weight is given to actuarial methods based on
expected losses for the more recent accident years, the result of
lower expectations is a reduction to these years net unpaid loss and loss
adjustment expenses.
    
    A reduction in the current accident year net ultimate loss and loss adjustment expense
ratio, excluding catastrophe losses for the three months ended September 30, 2006, compared
to the same period in 2005. During the three months ended September 30, 2006, a net
ultimate loss and loss adjustment expense ratio, excluding catastrophe losses, of 43.0% was
estimated for the 2006 accident year. During the three months ended September 30, 2005, a
net ultimate loss and loss adjustment expense ratio, excluding catastrophe losses, of 54.0%
was estimated for the 2005 accident year..Since expectations for the current accident year ultimate loss and loss adjustment expense
ratio are derived from the Companys expectations with respect to the preceding accident
years, the improvement with respect to the 2003 to 2005 accident years due to better than
expected case incurred development has favorable implications for the Companys outlook of
accident year 2006 as well. Therefore, ultimate loss ratio expectations for 2006 have been
reassessed to reflect that business in the most recent accident years now appears to have
better ultimate loss ratios than previously expected. However, while recognizing that
better than originally expected ultimate loss ratios now appear to be emerging in 2005 and
possibly 2006, sustainability remains in some doubt for the remainder of accident year 2006
and beyond due primarily to plans for continued high rates of growth as well as increasing
competition. Though not yet strong enough to have material adverse effects on pricing or
coverage terms, competitive pressures have been increasing since 2004. Premium rates have
fallen slightly in some of the Companys business segments. The impact of a softening
insurance market on the Companys underwriting results cannot be fully quantified in
advance.
 35




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 
    
    A $17.0 million reduction in hurricane catastrophe losses incurred. During the three
months ended September 30, 2005, the Company incurred $17.0 million of net loss and loss
adjustment expenses related to Hurricanes Dennis, Katrina and Rita. There were no such
catastrophe losses during the three months ended September 30, 2006.
  Acquisition Costs and Other Underwriting Expenses:
 
    
    The growth in net earned premiums.
    
    An increase in insurance guaranty fund assessment expenses.
    
    Share-based compensation expense recognized under SFAS 123(R), which was adopted by the
Company on January 1, 2006.
    
    A $3.9 million decrease in ceding commission earned pursuant to quota share agreements
(See Premiums). During the three months ended September 30, 2006, the Company earned no
ceding commissions related to quota share agreements as compared to $3.9 million of earned
ceding commissions related to quota share agreements during the same period of 2005. There
were no ceded earned premiums pursuant to these quota share agreements for the three months
ended September 30, 2006 as compared to $7.8 million for the same period of 2005, due to
the Companys decision to terminate its 10% quota share agreement on a run-off basis
effective December 31, 2004.
  Other Operating Expenses
 Income Tax Expense:
 Investments
  36




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
     37




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Gross Unrealized Losses as of September 30, 2006(in millions)Fixed MaturitiesContinuous
    
    Available for Sale
    
    
    
    
    
    
    Totaltime in unrealized
    
    Excluding Interests
    
    
    Interests in
    
    
    Fixed Maturitiesloss position
    
    in Securitized Assets
    
    
    Securitized Assets
    
    
    Available for Sale
    
    
    Equity Securities
    
    
    Total Investments0  3 months
    
    $
    
    
    
    $
    0.1
    
    
    $
    0.1
    
    
    $
    1.1
    
    
    $
    1.24  6 months
    
    
    0.1
    
    
    
    
    
    
    
    0.1
    
    
    
    1.6
    
    
    
    1.77  9 months
    
    
    0.1
    
    
    
    1.2
    
    
    
    1.3
    
    
    
    1.8
    
    
    
    3.110  12 months
    
    
    0.1
    
    
    
    0.7
    
    
    
    0.8
    
    
    
    
    
    
    
    0.813  18 months
    
    
    2.4
    
    
    
    4.2
    
    
    
    6.6
    
    
    
    
    
    
    
    6.619  24 months
    
    
    4.2
    
    
    
    2.5
    
    
    
    6.7
    
    
    
    
    
    
    
    6.7> 24 months
    
    
    1.3
    
    
    
    0.8
    
    
    
    2.1
    
    
    
    
    
    
    
    2.1Total Gross
Unrealized Losses
    
    $
    8.2
    
    
    $
    9.5
    
    
    $
    17.7
    
    
    $
    4.5
    
    
    $
    22.2Estimated fair
value of securities
with a gross
unrealized loss
    
    $
    558
    
    
    $
    533
    
    
    $
    1,091
    
    
    $
    47
    
    
    $
    1,138
 The Companys impairment evaluation as of September 30, 2006 for fixed maturities available for
sale excluding interests in securitized assets resulted in the following conclusions:
       The Companys impairment evaluation as of September 30, 2006 for interests in securitized assets
resulted in the following conclusions:
   38




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
            39




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Liquidity and Capital Resources
       40




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   New Accounting Pronouncements
      41




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
 Forward-Looking Information
  42




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
   Estimated
    
    Hypothetical PercentageHypothetical Change
    
    Fair Value after
    
    Increase (Decrease) inEstimated
    
    in Interest Rates
    
    Hypothetical Changes
    
    
    
    
    
    ShareholdersFair Value
    
    (bp=basis points)
    
    in Interest Rates
    
    Fair Value
    
    Equity(Dollars in Thousands)September 30, 2006:InvestmentsTotal Fixed Maturities Available For Sale
    
    $
    2,045,960
    
    
    200 bp decrease
    
    $
    2,203,927
    
    
    
    7.7
    %
    
    
    9.6
    %100 bp decrease
    
    $
    2,125,622
    
    
    
    3.9
    %
    
    
    4.8
    %50 bp decrease
    
    $
    2,086,185
    
    
    
    2.0
    %
    
    
    2.4
    %50 bp increase
    
    $
    2,005,102
    
    
    
    (2.0
    )%
    
    
    (2.5
    )%100 bp increase
    
    $
    1,963,708
    
    
    
    (4.0
    )%
    
    
    (5.0
    )%200 bp increase
    
    $
    1,880,367
    
    
    
    (8.1
    )%
    
    
    (10.0
    )%September 30, 2005:InvestmentsTotal Fixed Maturities Available For Sale
    
    $
    1,670,815
    
    
    200 bp decrease
    
    $
    1,796,534
    
    
    
    7.5
    %
    
    
    10.4
    %100 bp decrease
    
    $
    1,737,497
    
    
    
    4.0
    %
    
    
    5.5
    %50 bp decrease
    
    $
    1,705,111
    
    
    
    2.0
    %
    
    
    2.8
    %50 bp increase
    
    $
    1,635,843
    
    
    
    (2.1
    )%
    
    
    (2.9
    )%100 bp increase
    
    $
    1,600,881
    
    
    
    (4.2
    )%
    
    
    (5.8
    )%200 bp increase
    
    $
    1,532,688
    
    
    
    (8.3
    )%
    
    
    (11.4
    )%
 43




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
 
 Item 4. Controls and Procedures
    44




---



##### Table of Contents



PHILADELPHIA CONSOLIDATED HOLDING CORP. AND SUBSIDIARIES
 
  
  Not Applicable.
 
  There were no material changes to the risk factors disclosed in Item 1A of the Companys
Annual Report on Form 10-K for the fiscal year ended December 31, 2005.
 
  The Companys purchases of its common stock during the third quarter of 2006 are shown in
the following table:
 (c) Total
    
    (d)Number of
    
    ApproximateShares
    
    Dollar Value ofPurchased as
    
    Shares ThatPart of
    
    May Yet BePublicly
    
    Purchased(a) Total Number
    
    (b) Average
    
    Announced
    
    Under theof Shares
    
    Price Paid per
    
    Plans or
    
    Plans orPeriod
    
    Purchased
    
    Share
    
    Programs
    
    ProgramsJuly 1  July 31
    
    
    875
    (1)
    
    $
    27.83
    
    
    
    
    
    
    
    $
    45,000,000
    (2)August 1  August 31
    
    
    483
    (1)
    
    $
    27.85
    
    
    
    
    
    
    
    $
    45,000,000
    (2)September 1  September 30
    
    
    150
    (1)
    
    $
    27.79
    
    
    
    
    
    
    
    $
    45,000,000
    (2)
 
 (1)
    
    Such shares were issued under the Companys Employee Stock Purchase Plan and
Amended and Restated Employees Stock Incentive and Performance Based Compensation Plan
and were repurchased by the Company upon the employees termination.(2)
    
    The Companys total stock purchase authorization, which was publicly announced
in August 1998 and subsequently increased, amounted to $75.3 million, of which $30.3
million has been utilized. 
  Not applicable.
 
  Not applicable.
 45




---



##### Table of Contents



Not Applicable.
 
  Exhibits:
 Exhibit No.
    
    Description10.1
    
    Casualty (Clash) Excess of Loss Reinsurance Agreement with
Swiss Reinsurance America Corporation effective January 1,
200610.2
    
    Addendum No. 3 to the 3rd and 4th Property Excess of Loss
Reinsurance Agreement with Swiss Reinsurance America
Corporation  50% Placement  effective January 1, 200610.3
    
    Casualty Excess of Loss Reinsurance Contract effective January
1, 2006  20% Placement with Employers Reinsurance Corporation10.4
    
    Endorsement No. 4 to the Property Per Risk 1st and 2nd Excess
of Loss and Terrorism Reinsurance Contract with General
Reinsurance Corporation effective January 1, 200610.5
    
    Commutation and Release Agreement with Trenwick America
Reinsurance Corporation10.6
    
    $6,150,000 Excess $10,000,000 Catastrophe Reinsurance Contract
with Aspen Insurance Limited effective June 1, 200610.7
    
    First Excess Reinstatement Premium Protection Reinsurance
Contract with Subscribing Reinsurers effective June 1, 2006
(Liberty American and Liberty American Select Insurance
Companies)10.8
    
    Second and Third Excess Reinstatement Premium Protection
Reinsurance Contract with Subscribing Reinsurers effective
June 1, 2006 (Liberty American and Liberty American Select
Insurance Companies)10.9
    
    Florida Hurricane Catastrophe Fund Reimbursement Contract and
Addendum No. 1 effective June 1, 2006 (Liberty American
Insurance Company)10.10
    
    Florida Hurricane Catastrophe Fund Reimbursement Contract and
Addendums No. 1 and No. 2 effective June 1, 2006 (Liberty
American Select Insurance Company)31.1
    
    Certification of the Companys chief executive officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of the Companys chief financial officer
pursuant to Section 302 of the Sarbanes-Oxley Act of 200232.1
    
    Certification of the Companys 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 the Companys chief financial officer
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
 46




---



##### Table of Contents



SIGNATURES
  PHILADELPHIA CONSOLIDATED HOLDING CORP.Registrant
 Date November 9, 2006
    
    James J. Maguire, Jr.James J. Maguire, Jr.President and Chief Executive Officer(Principal Executive Officer)Date November 9, 2006
    
    Craig P. KellerCraig P. KellerExecutive Vice President, Secretary, Treasurerand Chief Financial Officer (PrincipalFinancial and Accounting Officer)
 47