UNITED
STATES SECURITIES AND


EXCHANGE
COMMISSION


Washington,
D.C. 20549


___________________________________





FORM
10-Q





(Mark
One)


T  
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934


For the quarterly period ended
September 30, 2009


or





£   Transition
Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of
1934


For the transition period from ________
to ________





Commission
File Number 001-34204





SeaBright
Insurance Holdings, Inc.


(Exact
name of registrant as specified in its charter)





Delaware
            
            56-2393241(State
      or other jurisdiction of incorporation or organization)
            
            (IRS
      Employer Identification No.)





1501
4th Avenue, Suite 2600


Seattle,
WA 98101


(Address
of principal executive offices, including zip code)





(206)
269-8500


(Registrant’s
telephone number, including area code)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports) and (2) has been subject to such filing requirements for
the past 90 days.


Yes T    No
£





Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).   Yes
£    No
£





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large
      accelerated filer £
            Accelerated
      filer T
            Non-accelerated
      filer £
            Smaller
      reporting company £





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act):   Yes £   No
T





Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date:




Class
            
            Shares
      outstanding as of November 6, 2009Common
      Stock, $0.01 Par Value
            
            21,673,286










SeaBright Insurance Holdings, Inc.





Index
to Form 10-Q





PagePart
      I.
            
            Financial
      InformationItem
      1.
            
            Financial Statements (unaudited)
            
            2Condensed Consolidated Balance Sheets as of
      September 30, 2009 and December 31, 2008
            
            2Condensed Consolidated Statements of
      Operations for the Three Months and Nine Months Ended September 30,
      2009 and 2008
            
            3Condensed Consolidated Statements of Cash Flows for the
      Nine Months Ended September 30, 2009 and 2008
            
            4Notes to Unaudited Condensed Consolidated Financial
      Statements
            
            5Item
      2.
            
            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
            
            18Item
      3.
            
            Quantitative and Qualitative Disclosures About Market
      Risk
            
            39Item
      4.
            
            Controls and Procedures
            
            40Part
      II.
            
            Other
      InformationItem
      1A.
            
            Risk Factors
            
            41Item
      6.
            
            Exhibits
            
            41Signatures
            
            42


- 1
-
 Index


PART
I – FINANCIAL INFORMATION




Item 1.    Financial Statements





SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES




CONDENSED
CONSOLIDATED BALANCE SHEETS





September 30,
      2009
            
            
            December 31,
      2008(Unaudited)(in
      thousands, except share and per share amounts)ASSETSFixed
      income securities available for sale, at fair value (amortized cost
      $579,347 in 2009 and $523,892 in 2008)
            
            $
            605,408
            
            
            $
            522,289Equity
      securities available for sale, at fair value (cost $11,333 in 2009 and
      2008)
            
            
            10,444
            
            
            
            8,856Preferred
      stock available for sale, at fair value (cost $851 in
2008)
            
            
            −
            
            
            
            360Cash
      and cash equivalents
            
            
            24,073
            
            
            
            22,872Accrued
      investment income
            
            
            6,308
            
            
            
            6,054Premiums
      receivable, net of allowance
            
            
            12,898
            
            
            
            16,374Deferred
      premiums
            
            
            167,013
            
            
            
            163,322Service
      income receivable
            
            
            301
            
            
            
            322Reinsurance
      recoverables
            
            
            30,892
            
            
            
            18,544Due
      from reinsurer
            
            
            11,802
            
            
            
            9,125Receivable
      under adverse development cover
            
            
            3,603
            
            
            
            4,179Prepaid
      reinsurance
            
            
            6,088
            
            
            
            1,619Property
      and equipment, net
            
            
            5,750
            
            
            
            5,190Federal
      income tax recoverable
            
            
            2,438
            
            
            
            1,671Deferred
      income taxes, net
            
            
            18,801
            
            
            
            25,144Deferred
      policy acquisition costs, net
            
            
            24,328
            
            
            
            23,175Intangible
      assets, net
            
            
            1,225
            
            
            
            1,225Goodwill
            
            
            4,324
            
            
            
            4,212Other
      assets
            
            
            6,240
            
            
            
            8,154Total
      assets
            
            $
            941,936
            
            
            $
            842,687LIABILITIES
      AND STOCKHOLDERS’ EQUITYLiabilities:Unpaid
      loss and loss adjustment expense
            
            $
            334,644
            
            
            $
            292,027Unearned
      premiums
            
            
            164,072
            
            
            
            155,931Reinsurance
      funds withheld and balances payable
            
            
            5,640
            
            
            
            1,615Premiums
      payable
            
            
            6,215
            
            
            
            6,783Accrued
      expenses and other liabilities
            
            
            55,098
            
            
            
            49,518Surplus
      notes
            
            
            12,000
            
            
            
            12,000Total
      liabilities
            
            
            577,669
            
            
            
            517,874Commitments
      and contingenciesStockholders’
      equity:Series
      A preferred stock, $0.01 par value; 750,000 shares authorized; no shares
      issued and outstanding
            
            
            −
            
            
            
            −Undesignated
      preferred stock, $0.01 par value; 10,000,000 shares authorized; no shares
      issued and outstanding
            
            
            –
            
            
            
            –Common
      stock, $0.01 par value; 75,000,000 shares authorized; issued and
      outstanding – 21,673,286 shares at September 30, 2009 and 21,392,854
      shares at December 31, 2008
            
            
            217
            
            
            
            214Paid-in
      capital
            
            
            204,036
            
            
            
            200,893Accumulated
      other comprehensive income (loss)
            
            
            17,344
            
            
            
            (4,009
            )Retained
      earnings
            
            
            142,670
            
            
            
            127,715Total
      stockholders’ equity
            
            
            364,267
            
            
            
            324,813Total
      liabilities and stockholders’ equity
            
            $
            941,936
            
            
            $
            842,687





See
accompanying notes to unaudited condensed consolidated financial
statements.


- 2
-
 Index


SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES




CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)





Three Months Ended
      September 30,
            
            
            Nine Months Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008(in
      thousands, except share and earnings per share
information)Revenue:Premiums
      earned
            
            $
            64,427
            
            
            $
            68,687
            
            
            $
            182,460
            
            
            $
            181,094Claims
      service income (loss)
            
            
            293
            
            
            
            (79
            )
            
            
            782
            
            
            
            751Other
      service income
            
            
            36
            
            
            
            80
            
            
            
            147
            
            
            
            179Net
      investment income
            
            
            5,888
            
            
            
            5,571
            
            
            
            17,186
            
            
            
            16,852Other-than-temporary
      impairment losses:Total
      other-than-temporary impairment losses
            
            
            –
            
            
            
            (11,456
            )
            
            
            (258
            )
            
            
            (13,405
            )Less
      portion of losses recognized in accumulated other comprehensive income
      (loss)
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Net
      impairment losses recognized in earnings
            
            
            –
            
            
            
            (11,456
            )
            
            
            (258
            )
            
            
            (13,405
            )Other
      net realized gains (losses) recognized in earnings
            
            
            292
            
            
            
            (221
            )
            
            
            217
            
            
            
            (401
            )Other
      income
            
            
            1,986
            
            
            
            2,820
            
            
            
            6,308
            
            
            
            6,27172,922
            
            
            
            65,402
            
            
            
            206,842
            
            
            
            191,341Losses
      and expenses:Loss
      and loss adjustment expenses
            
            
            42,216
            
            
            
            39,154
            
            
            
            121,992
            
            
            
            101,719Underwriting,
      acquisition and insurance expenses
            
            
            18,155
            
            
            
            17,350
            
            
            
            54,039
            
            
            
            50,674Interest
      expense
            
            
            140
            
            
            
            205
            
            
            
            466
            
            
            
            666Other
      expenses
            
            
            3,529
            
            
            
            2,793
            
            
            
            10,357
            
            
            
            7,14664,040
            
            
            
            59,502
            
            
            
            186,854
            
            
            
            160,205Income
      before taxes
            
            
            8,882
            
            
            
            5,900
            
            
            
            19,988
            
            
            
            31,136Income
      tax expense
            
            
            2,217
            
            
            
            4,119
            
            
            
            5,033
            
            
            
            12,071Net
      income
            
            $
            6,665
            
            
            $
            1,781
            
            
            $
            14,955
            
            
            $
            19,065Basic
      earnings per share
            
            $
            0.32
            
            
            $
            0.09
            
            
            $
            0.72
            
            
            $
            0.93Diluted
      earnings per share
            
            $
            0.31
            
            
            $
            0.08
            
            
            $
            0.70
            
            
            $
            0.90Weighted
      average basic shares outstanding
            
            
            20,732,801
            
            
            
            20,581,822
            
            
            
            20,691,250
            
            
            
            20,466,465Weighted
      average diluted shares outstanding
            
            
            21,502,272
            
            
            
            21,369,033
            
            
            
            21,451,959
            
            
            
            21,143,263





See
accompanying notes to unaudited condensed consolidated financial
statements.


- 3
-
 Index


SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES




CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS


(Unaudited)





Nine Months Ended
      September 30,2009
            
            
            2008(in
      thousands)Cash
      flows from operating activities:Net
      income
            
            $
            14,955
            
            
            $
            19,065Adjustments
      to reconcile net income to cash provided by operating
      activities:Amortization
      of deferred policy acquisition costs
            
            
            33,736
            
            
            
            29,727Policy
      acquisition costs deferred
            
            
            (34,889
            )
            
            
            (31,209
            )Provision
      for depreciation and amortization
            
            
            3,856
            
            
            
            2,933Compensation
      cost on restricted shares of common stock
            
            
            3,229
            
            
            
            3,685Compensation
      cost on stock options
            
            
            548
            
            
            
            734Net
      realized loss on investments
            
            
            42
            
            
            
            13,806Benefit
      for deferred income taxes
            
            
            (1,896
            )
            
            
            (2,901
            )Changes
      in certain assets and liabilities:Unpaid
      loss and loss adjustment expense
            
            
            42,617
            
            
            
            29,571Income
      tax payable
            
            
            (931
            )
            
            
            (2,988
            )Reinsurance
      recoverables, net of reinsurance withheld
            
            
            (14,893
            )
            
            
            (2,809
            )Unearned
      premiums, net of deferred premiums
              and
      premiums receivable
            
            
            7,926
            
            
            
            (8,768
            )Accrued
      investment income
            
            
            (254
            )
            
            
            (561
            )Other
      assets and other liabilities
            
            
            6,481
            
            
            
            (2,232
            )Net
      cash provided by operating activities
            
            ­­­­ 60,527
            
            
            
            48,053Cash
      flows from investing activities:Purchases
      of investments
            
            
            (126,978
            )
            
            
            (123,129
            )Sales
      of investments
            
            
            30,225
            
            
            
            18,174Maturities
      and redemption of investments
            
            
            39,837
            
            
            
            57,208Purchases
      of property and equipment
            
            
            (1,972
            )
            
            
            (4,059
            )Payment
      for purchase of subsidiary, net of cash acquired
            
            
            –
            
            
            
            (159
            )Net
      cash used in investing activities
            
            
            (58,888
            )
            
            
            (51,965
            )Cash
      flows from financing activities:Proceeds
      from exercise of stock options
            
            
            31
            
            
            
            1,113Grant
      of restricted shares of common stock
            
            
            4
            
            
            
            4Surrender
      of stock in connection with restricted stock vesting
            
            
            (473
            )
            
            
            –Net
      cash provided by (used in) financing activities
            
            
            (438
            )
            
            
            1,117Net
      increase (decrease) in cash and cash equivalents
            
            
            1,201
            
            
            
            (2,795
            )Cash
      and cash equivalents at beginning of period
            
            
            22,872
            
            
            
            20,292Cash
      and cash equivalents at end of period
            
            $
            24,073
            
            
            $
            17,497Supplemental
      disclosures:Interest
      paid on surplus notes
            
            $
            488
            
            
            $
            690Federal
      income taxes paid
            
            
            7,500
            
            
            
            17,735Accrued
      expenses for purchases of investments
            
            
            6,793
            
            
            
            –The
      Company purchased all of the capital stock of BWNV for $484. In connection
      with the acquisition, the following liabilities were
    assumed:Fair
      value of assets acquired
            
            $
            –
            
            
            $
            1,079Cash
      paid for capital stock
            
            
            –
            
            
            
            (484
            )Net
      liabilities assumed
            
            $
            −
            
            
            $
            595





See
accompanying notes to unaudited condensed consolidated financial
statements.


- 4
-
 Index


SEABRIGHT INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1.
            Basis
      of Presentation




The
accompanying unaudited condensed consolidated financial statements include the
accounts of SeaBright Insurance Holdings, Inc. (“SIH”) and its wholly owned
subsidiaries, SeaBright Insurance Company (“SBIC”), PointSure Insurance
Services, Inc. (“PointSure”), Total HealthCare Management, Inc. (“THM”), and
Black/White and Associates, Inc., Black/White and Associates of Nevada and
Black/White Rockridge Insurance Services, Inc. (referred to collectively as
“BWNV”) (collectively, the  “Company,” “we” or “us”). All significant
intercompany transactions among these affiliated entities have been eliminated
in consolidation.




The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with U.S. generally accepted accounting principles
(“GAAP”) for interim financial information and pursuant to the instructions to
Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of
1934, as amended (the “Exchange Act”). Accordingly, they do not include all of
the information and notes required by GAAP for complete financial statements.
The condensed consolidated balance sheet at December 31, 2008 has been derived
from the audited financial statements at that date but does not include all of
the information and notes required by GAAP for complete financial statements.
These unaudited condensed consolidated financial statements and notes should be
read in conjunction with the audited financial statements and accompanying notes
as of and for the year ended December 31, 2008 included in the Company’s Annual
Report on Form 10-K, which was filed with the U.S. Securities and Exchange
Commission (the “SEC”) on March 16, 2009.




In the
opinion of management, the unaudited condensed consolidated financial statements
include all adjustments, consisting only of normal recurring adjustments,
necessary to state fairly the financial information set forth therein. Results
of operations for the three month or nine month periods ended September 30, 2009
are not necessarily indicative of the results expected for the full fiscal year
or for any future period.




Certain
reclassifications have been made to the prior years’ financial statements to
conform to classifications used in the current year.




2.
            Summary
      of Significant Accounting Policies




a.  Use
of Estimates




The
preparation of the unaudited condensed consolidated financial statements in
conformity with GAAP requires management of the Company to make a number of
estimates and assumptions relating to the reported amount of assets and
liabilities and the disclosure of contingent assets and liabilities at the date
of the unaudited condensed consolidated financial statements and the reported
amounts of revenues and expenses during the period. Actual results could differ
from those estimates. The Company has used significant estimates in determining
unpaid loss and loss adjustment expenses, including losses that have occurred
but were not reported to us by the financial reporting date; the amount and
recoverability of reinsurance recoverable balances; goodwill and other
intangibles; retrospective premiums; earned but unbilled premiums; deferred
policy acquisition costs; income taxes; and the valuation and
other-than-temporary impairments of investment securities.




b.  Goodwill
and Other Intangible Assets




Goodwill
balances are reviewed for impairment at least annually or more frequently if
events occur or circumstances change that would more likely than not reduce the
fair value of the reporting unit below its carrying value.  A
reporting unit is defined as an operating segment or one level below an
operating segment.




The
goodwill impairment test follows a two step process. In the first step, the fair
value of a reporting unit is compared to its carrying value. If the carrying
value of a reporting unit exceeds its fair value, the second step of the
impairment test is performed for purposes of measuring the impairment. In the
second step, the fair value of the reporting unit is allocated to all of the
assets and liabilities of the reporting unit to determine an implied goodwill
value. If the carrying amount of the reporting unit goodwill exceeds the implied
goodwill value, an impairment loss would be recognized in an amount equal to
that excess, and the charge could have a material adverse effect on the
Company’s results of operations and financial position.




Management’s
determination of the fair value of each reporting unit incorporates multiple
inputs including discounted cash flow calculations, the level of the Company’s
own share price and assumptions that market participants would make in valuing
the reporting unit. Other assumptions include levels of economic capital, future
business growth, earnings projections, assets under management for reporting
units and the discount rate utilized.




- 5
-
 Index





SEABRIGHT
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)






The
Company completed its annual goodwill assessment for the individual reporting
units as of December 31, 2008 and updated the analysis as of September 30, 2009.
The conclusion reached as a result of the goodwill impairment testing was that
the fair value of each reporting unit, for which goodwill had been allocated,
was in excess of the respective reporting unit’s carrying value, and therefore
no impairment was necessary. If current market conditions persist through the
remainder of 2009, in particular if the Company’s share price remains
meaningfully below book value per share, or if the Company’s actions to limit
risk associated with its products or investments causes a significant change in
any one reporting unit’s fair value, subsequent reviews of goodwill could result
in an impairment of goodwill during 2009 or later. The Company will complete its
2009 annual goodwill assessment in the quarter ending December 31,
2009.





c. Earnings
Per Share




The
following table provides the reconciliation of basic and diluted weighted
average shares outstanding used in calculating earnings per share for the three
month and nine month periods ended September 30, 2009 and 2008:




Three Months Ended
      September 30,
            
            
            Nine Months Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008(in
      thousands)Basic
      weighted average shares outstanding
            
            
            20,733
            
            
            
            20,582
            
            
            
            20,691
            
            
            
            20,466Weighted
      average shares issuable upon exercise of outstanding stock options and
      vesting of nonvested restricted stock
            
            
            769
            
            
            
            787
            
            
            
            761
            
            
            
            677Diluted
      weighted average shares outstanding
            
            
            21,502
            
            
            
            21,369
            
            
            
            21,452
            
            
            
            21,143





d.  Stock-Based
Compensation




Total
stock-based compensation expense recognized in the unaudited condensed
consolidated statements of operations for the three month and nine month periods
ended September 30, 2009 and 2008 is shown in the following table. No
compensation cost was capitalized during the periods shown.




Three Months Ended
      September 30,
            
            
            Nine Months Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008(in
      thousands)Stock-based
      compensation expense
              related
      to:Nonvested
      restricted stock
            
            $
            1,085
            
            
            $
            1,007
            
            
            $
            3,229
            
            
            $
            3,685Stock
      options
            
            
            197
            
            
            
            193
            
            
            
            548
            
            
            
            734Total
            
            $
            1,282
            
            
            $
            1,200
            
            
            $
            3,777
            
            
            $
            4,419Total
      related tax benefit
            
            $
            398
            
            
            $
            352
            
            
            $
            1,151
            
            
            $
            1,328




- 6
-
 Index




SEABRIGHT
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)





e.  Comprehensive
Income (Loss)




The
following table summarizes the Company’s comprehensive income (loss) for the
three month and nine month periods ended September 30, 2009 and
2008:




Three Months Ended
      September 30,
            
            
            Nine Months Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008(in
      thousands)Net
      income
            
            $
            6,665
            
            
            $
            1,781
            
            
            $
            14,955
            
            
            $
            19,065Reclassification
      adjustment for net realized (gains) losses recorded into
      income
            
            
            (292
            )
            
            
            11,677
            
            
            
            41
            
            
            
            13,806Tax
      expense (benefit) related to reclassification adjustment gains
      (losses)
            
            
            102
            
            
            
            (4,087
            )
            
            
            (14
            )
            
            
            (4,764
            )Increase
      (decrease) in unrealized gains/losses on investment securities available
      for sale
            
            
            20,709
            
            
            
            (18,947
            )
            
            
            29,702
            
            
            
            (28,471
            )Tax
      benefit (expense) related to unrealized gains (losses)
            
            
            (7,242
            )
            
            
            6,562
            
            
            
            (10,391
            )
            
            
            9,897Tax
      effect of change in deferred tax asset valuation allowance recorded in
      comprehensive income
            
            
            1,204
            
            
            
            –
            
            
            
            2,015
            
            
            
            –Total
      comprehensive income (loss)
            
            $
            21,146
            
            
            $
            (3,014
            )
            
            $
            36,308
            
            
            $
            9,533





f.  Recently
Issued Accounting Pronouncements




In June
2009, the Financial Accounting Standards Board (“FASB”) issued FASB Statement of
Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards
Codification and the
Hierarchy of Generally Accepted Accounting Principles(“SFAS
168”).  SFAS 168 identifies the sources of accounting principles and
the framework for selecting the principles used in preparing the financial
statements of nongovernmental entities that are presented in conformity with
U.S. GAAP.  SFAS 168 further identifies the FASB Accounting Standards
Codification (the “Codification”) as the source of authoritative GAAP recognized
by the FASB to be applied by nongovernmental entities. The Codification does not
change existing U.S. GAAP authoritative literature in place as of July 1,
2009.    SFAS 168 is effective for financial statements
issued for interim and annual periods ending after September 15,
2009.  The Company adopted SFAS 168 as of September 30, 2009, which
did not have a material effect on the Company’s consolidated financial condition
or results of operations.





In April
2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of
Other-Than-Temporary Impairments” (“FSP FAS 115-2/124-2”).  FSP
FAS 115-2/124-2 requires entities to separate an other-than-temporary impairment
of a debt security into two components when there are credit related losses
associated with the impaired debt security for which management asserts that it
does not have the intent to sell the security, and it is more likely than not
that it will not be required to sell the security before recovery of its cost
basis.  The amount of the other-than-temporary impairment related to a
credit loss is recognized in earnings, and the amount of the
other-than-temporary impairment related to other factors is recorded in other
comprehensive loss.  FSP FAS 115-2/124-2 is effective for periods
ending after June 15, 2009.  The Company adopted the provisions of FSP
FAS 115-2/124-2 in the quarter ended June 30, 2009.  There were no
impairments previously recognized on debt securities we owned at
December  31, 2008 and therefore, there was no cumulative effect
adjustment to retained earnings and other comprehensive income (loss) as a
result of adopting this standard.  There were no impairments
recognized on debt securities in the three month and nine month periods ended
September 30, 2009 and therefore, the adoption of FSP FAS 115-2/124-2 had no
effect on the Company’s consolidated financial condition or results of
operations.





In April
2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When Volume
and Level of Activity for the Asset or Liability Have Significantly Decreased
and Identifying Transactions that are Not Orderly” (“FSP FAS
157-4”).  Under FSP FAS 157-4, if an entity determines that there has
been a significant decrease in the volume and level of activity for an asset or
liability in relation to the normal market activity for the asset or liability
(or similar assets or liabilities), then transactions or quoted prices may not
accurately reflect fair value.  In addition, if there is evidence that
the transaction for the asset or liability is not orderly, the entity shall
place little, if any, weight on that transaction price as an indicator of fair
value. FSP FAS 157-4 is effective for periods ending after June 15, 2009. The
Company adopted FSP FAS 157-4 in the quarter ended June 30, 2009, which did not
have a material effect on the Company’s consolidated financial condition and
results of operations.


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INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)






In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value
of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”).  FSP
FAS 107-1 and APB 28-1 requires disclosures about the fair value of financial
instruments in interim and annual financial statements.  FSP FAS 107-1
and APB 28-1 is effective for periods ending after June 15, 2009. The Company
adopted FSP FAS 107-1 and APB 28-1 in the quarter ended June 30,
2009.  Because  FSP FAS 107-1 and APB 28-1 amends only the
disclosure requirements related to the fair value of financial instruments,
adoption of FSP 107-1 and APB 28-1 did not affect the Company’s consolidated
financial condition and results of operations.





In May
2009, the FASB issued FAS No. 165, “Subsequent Events” (“FAS
165”).  FAS 165 establishes general standards of accounting for and
disclosures of events that occur after the balance sheet date but before
financial statements are issued or available to be issued.  FAS 165 is
effective for periods ending after June 15, 2009.  The Company adopted
FAS 165 in the quarter ended June 30, 2009, which did not have a material effect
on the Company’s consolidated financial condition and results of
operations.





3.
            Investments




The
consolidated cost or amortized cost, gross unrealized gains and losses, and
estimated fair value and carrying value of investment securities
available-for-sale at September 30, 2009 were as follows:




Cost
      or Amortized Cost
            
            
            Gross
      Unrealized Gains
            
            
            Gross
      Unrealized Losses
            
            
            Estimated
      Fair Value
            
            
            CarryingValue(in
      thousands)U.S.
      Treasury securities
            
            $
            16,735
            
            
            $
            591
            
            
            $
            (101
            )
            
            $
            17,225
            
            
            $
            17,225Government
      sponsored agency securities
            
            
            30,234
            
            
            
            1,300
            
            
            
            (31
            )
            
            
            31,503
            
            
            
            31,503Corporate
      securities
            
            
            87,633
            
            
            
            3,583
            
            
            
            (120
            )
            
            
            91,096
            
            
            
            91,096Tax-exempt
      municipal securities
            
            
            312,329
            
            
            
            16,694
            
            
            
            (396
            )
            
            
            328,627
            
            
            
            328,627Mortgage
      pass-through securities
            
            
            74,851
            
            
            
            4,169
            
            
            
            –
            
            
            
            79,020
            
            
            
            79,020Collateralized
      mortgage obligations
            
            
            14,131
            
            
            
            132
            
            
            
            (142
            )
            
            
            14,121
            
            
            
            14,121Asset-backed
      securities
            
            
            43,434
            
            
            
            627
            
            
            
            (245
            )
            
            
            43,816
            
            
            
            43,816Total
      fixed income securities available-for-sale
            
            
            579,347
            
            
            
            27,096
            
            
            
            (1,035
            )
            
            
            605,408
            
            
            
            605,408Equity
      securities
            
            
            11,333
            
            
            
            –
            
            
            
            (889
            )
            
            
            10,444
            
            
            
            10,444Total
      investment securities available-for-sale
            
            $
            590,680
            
            
            $
            27,096
            
            
            $
            (1,924
            )
            
            $
            615,852
            
            
            $
            615,852




Equity
securities consist of investments in exchange-traded funds designed to
correspond to the performance of certain indexes based on domestic or
international stocks. The Company had no direct investments in individual equity
securities at September 30, 2009.Approximately
$0.9 of the total unrealized losses at September 30, 2009 were from equity
securities that had been impaired for one year or longer.  Based on
the low severity of the impairments on the Company’s equity securities, and the
significant recent recovery in stock prices, management concluded that the
unrealized losses on these equity securities were temporary due to market
conditions.




For debt
securities that are considered other-than-temporarily impaired (“OTTI”) and that
the Company does not intend to sell and more likely than not would not be
required to sell prior to recovery of the amortized cost basis, the Company
recognizes OTTI losses in accordance with the provisions of the Codification.
The amount of the OTTI loss is separated into the amount that is credit related
(credit loss component) and the amount due to all other factors. The credit loss
component is recognized in earnings and is the difference between a security’s
amortized cost basis and the present value of expected future cash flows
discounted at the security’s effective interest rate. The amount due to all
other factors is recognized in other comprehensive
income.    Approximately $0.9 million of the total
unrealized losses at September 30, 2009 were from debt securities that had been
impaired for one year or longer.  Included in these securities is one
security which had an unrealized loss that exceeded 20% of the related
security’s book value at September 30, 2009.  As of September 30,
2009, all payments to date are current on these debt securities and the Company
expects to fully recover its investment in these securities no later than their
scheduled maturities. The Company has no current intent to sell these
securities. Therefore, based on management’s review of the financial strength of
these debt securities and the Company’s expectation regarding future receipt of
principal and interest, management concluded these debt securities were
temporarily impaired as of September 30, 2009. For the three and nine months
ended September 30, 2009, the Company recognized no OTTI losses related to debt
securities.


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INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)




The
following table presents information about investment securities with unrealized
losses at September 30, 2009:




Less Than 12 Months
            
            
            12 Months or More
            
            
            TotalInvestment Category
            
            Aggregate
      Fair Value
            
            
            Aggregate
      Unrealized Loss
            
            
            Aggregate
      Fair Value
            
            
            Aggregate
      Unrealized Loss
            
            
            Aggregate
      Fair Value
            
            
            Aggregate
      Unrealized Loss(in
      thousands)Fixed
      income securities:U.S.
      Treasury securities
            
            $
            2,898
            
            
            $
            (101
            )
            
            $
            –
            
            
            $
            –
            
            
            $
            2,898
            
            
            $
            (101
            )Government
      sponsored   agency securities (1)
            
            
            4,851
            
            
            
            (31
            )
            
            
            –
            
            
            
            –
            
            
            
            4,851
            
            
            
            (31
            )Corporate
      securities
            
            
            9,736
            
            
            
            (43
            )
            
            
            1,454
            
            
            
            (77
            )
            
            
            11,190
            
            
            
            (120
            )Tax-exempt
      municipal securities
            
            
            –
            
            
            
            –
            
            
            
            9,480
            
            
            
            (396
            )
            
            
            9,480
            
            
            
            (396
            )Collateralized
      mortgage obligations
            
            
            1,045
            
            
            
            (10
            )
            
            
            644
            
            
            
            (132
            )
            
            
            1,689
            
            
            
            (142
            )Asset-backed
      securities
            
            
            401
            
            
            
            –
            
            
            
            9,745
            
            
            
            (245
            )
            
            
            10,146
            
            
            
            (245
            )Total
      fixed income securities
            
            
            18,931
            
            
            
            (185
            )
            
            
            21,323
            
            
            
            (850
            )
            
            
            40,254
            
            
            
            (1,035
            )Equity
      securities
            
            
            –
            
            
            
            –
            
            
            
            10,444
            
            
            
            (889
            )
            
            
            10,444
            
            
            
            (889
            )Total
            
            $
            18,931
            
            
            $
            (185
            )
            
            $
            31,767
            
            
            $
            (1,739
            )
            
            $
            50,698
            
            
            $
            (1,924
            )





_____________


(1)
            Government
      sponsored agency securities are not backed by the full faith and credit of
      the U.S. Government.





The
Company regularly reviews its investment portfolio to evaluate the necessity of
recording impairment losses for other-than-temporary declines in the fair value
of its investments. A number of criteria are considered during this process
including, but not limited to:  the current fair value as compared to
amortized cost or cost, as appropriate, of the security; the length of time the
security’s fair value has been below amortized cost or cost; the likelihood that
the Company will be required to sell the security before recovery of its cost
basis; objective information supporting recovery in a reasonable period of time;
specific credit issues related to the issuer; and current economic
conditions.




In
general, the Company reviews all securities that are impaired by 5% or more at
the end of the period.  For securities with no stated maturity date,
the review focuses on securities that were impaired by 20% or more at the end of
the period or had been impaired 10% or more continuously for six months or
longer as of the end of the period.  The Company also analyzes the
entire portfolio for other factors that might indicate a risk of impairment,
including credit ratings and interest rates.  Other-than-temporary
impairment losses result in a permanent reduction of the carrying amount of the
underlying investment.  Significant changes in the factors considered
when evaluating investments for impairment losses could result in a significant
change in impairment losses reported in the unaudited condensed consolidated
financial statements.





The
Company evaluated investment securities with fair values less than amortized
cost at September 30, 2009 and determined that it was not necessary to record
any OTTI losses in the three month period then ended.  For the nine
month period ended September 30, 2009, the Company recognized OTTI losses of
$0.3 million related to its investment in preferred stock issued by Fannie Mae
and Freddie Mac. For the three month and nine month periods ended September 30,
2008, the Company recognized OTTI losses of $8.3 million and $10.2 million,
respectively, related primarily to its investment in preferred stock issued by
Fannie Mae and Freddie Mac.  For the three month period ended
September 30, 2008, the Company recognized OTTI losses of $3.2 million related
to its investment in equity indexed securities exchange-traded
funds.


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SEABRIGHT
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)




The
Company had no direct sub-prime mortgage exposure in its investment portfolio as
of September 30, 2009 and approximately $5.4 million of indirect exposure to
sub-prime mortgages. As of September 30, 2009, the Company’s portfolio included
$211.5 million of insured municipal bonds and $121.9 million of uninsured
municipal bonds.




The
following table provides a breakdown of ratings on the bonds in the Company’s
municipal portfolio:




Insured
      Bonds
            
            
            Uninsured
      Bonds
            
            
            Total
      Municipal Portfolio Based OnRating
            
            
            Insured
      Ratings
            
            
            Underlying
      Ratings
            
            
            Ratings
            
            
            Overall
      Ratings (1)
            
            
            Underlying
      Ratings(in
      thousands)AAA
            
            
            $
            11,562
            
            
            $
            11,562
            
            
            $
            19,460
            
            
            $
            31,022
            
            
            $
            31,022AA+
            
            
            
            24,598
            
            
            
            13,334
            
            
            
            33,669
            
            
            
            58,267
            
            
            
            47,003AA
            
            
            
            47,985
            
            
            
            21,048
            
            
            
            23,508
            
            
            
            71,493
            
            
            
            44,556AA-
            
            
            
            47,329
            
            
            
            44,322
            
            
            
            14,083
            
            
            
            61,412
            
            
            
            58,405A+
            
            
            
            33,339
            
            
            
            50,921
            
            
            
            7,922
            
            
            
            41,261
            
            
            
            58,843A
            
            
            
            13,971
            
            
            
            26,628
            
            
            
            4,358
            
            
            
            18,329
            
            
            
            30,986A-
            
            
            
            8,171
            
            
            
            17,985
            
            
            
            525
            
            
            
            8,696
            
            
            
            18,510BBB+
            
            
            
            -
            
            
            
            -
            
            
            
            8,607
            
            
            
            8,607
            
            
            
            8,607BBB-
            
            
            
            -
            
            
            
            1,155
            
            
            
            -
            
            
            
            -
            
            
            
            1,155BB-
            
            
            
            -
            
            
            
            -
            
            
            
            1,276
            
            
            
            1,276
            
            
            
            1,276Pre-refunded
      (2)
            
            
            
            23,280
            
            
            
            23,280
            
            
            
            8,468
            
            
            
            31,748
            
            
            
            31,748Not
      rated
            
            
            
            1,316
            
            
            
            1,316
            
            
            
            -
            
            
            
            1,316
            
            
            
            1,316Total
            
            
            $
            211,551
            
            
            $
            211,551
            
            
            $
            121,876
            
            
            $
            333,427
            
            
            $
            333,427


__________




(1)
            Represents
      insured ratings on insured bonds and ratings on uninsured
      bonds.




(2)
            These
      bonds have been pre-refunded by the issuer depositing highly rated
      government-issued securities into irrevocable trust funds established for
      payment of principal and interest.




As of
September 30, 2009, the Company had no direct investments in any bond insurer
and only one bond insurer insured more than 10% of the municipal bond
investments in the Company’s portfolio. National Public Finance Guarantee
Corporation (“National”) (formerly MBIA) insured $99.3 million of municipal
bonds the Company owned at September 30, 2009. National’s ratings as of that
date were Baa1 (developing outlook) by Moody’s and A (developing outlook) by
Standard & Poor’s and the average underlying rating on those bonds was
AA-/A+. The Company does not expect a material impact to its investment
portfolio or financial position as a result of the problems currently facing
monoline bond insurers.




The
amortized cost and estimated fair value of fixed income securities
available-for-sale at September  30, 2009, by contractual maturity,
are set forth below. Actual maturities may differ from contractual maturities
because certain borrowers have the right to call or prepay obligations with or
without call or prepayment penalties.




Maturity
            
            Cost
      or Amortized Cost
            
            
            Estimated
      Fair Value(in
      thousands)Due
      in one year or less
            
            $
            25,665
            
            
            $
            26,001Due
      after one year through five years
            
            ­ 
    179,249
            
            
            ­ 
    187,370Due
      after five years through ten years
            
            
            221,251
            
            
            
            232,960Due
      after ten years
            
            
            20,766
            
            
            
            22,120Securities
      not due at a single maturity date
            
            ­132,416
            
            
            ­136,957Total
      fixed income securities
            
            $
            579,347
            
            
            $
            605,408


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 Index


SEABRIGHT
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)


The
consolidated amortized cost of investment securities available-for-sale
deposited with various regulatory authorities at September 30, 2009 was $202.5
million.




4.
            Premiums




Direct
premiums written totaled $56.9 million and $60.9 million for the three month
periods ended September 30, 2009 and 2008, respectively, and $204.4 million and
$187.5 million for the nine month periods ended September 30, 2009 and 2008,
respectively.




Premiums
receivable consisted of the following at September 30, 2009 and December 31,
2008:




September 30,
      2009
            
            
            December 31,
      2008(in
      thousands)Premiums
      receivable
            
            $
            13,420
            
            
            $
            16,864Allowance
      for doubtful accounts
            
            ­(522)
            
            
            ­(490)Premiums
      receivable, net of allowance
            
            $
            12,898
            
            
            $
            16,374





5.
            Reinsurance




a.  Reinsurance
Ceded




Under
reinsurance agreements, the Company cedes various amounts of risk to
nonaffiliated insurance companies for the purpose of limiting the maximum
potential loss arising from the underlying insurance risks. These reinsurance
treaties do not relieve the Company from its obligations to
policyholders.




Effective
October 1, 2009, the Company entered into new reinsurance agreements with
nonaffiliated reinsurers wherein it retains the first $500,000 of each loss
occurrence.  The next $500,000 of losses per occurrence (in excess of
the first $500,000 of losses per occurrence retained by the Company) are 50%
reinsured. The new reinsurance program, which is effective through September 30,
2010, provides coverage up to $85.0 million per loss occurrence. The terms and
structure of the new reinsurance program are similar to those of the program
that expired on September 30, 2009, as more fully described in Note 8 to the
consolidated financial statements in Part II, Item 8 of the Company’s annual
report on Form 10-K for the year ended December 31, 2008, filed with the SEC on
March 16, 2009.




Effective
January 1, 2009, the Company entered into a new  quota-share
reinsurance agreement with a  nonaffiliated reinsurer wherein it cedes
100% of its residual market business assumed from the National Council on
Compensation Insurance (the “NCCI”) for policy year 2009.




b.  Reinsurance
Recoverables and Income Statement Effects




Balances
affected by reinsurance transactions are reported gross of reinsurance in the
accompanying unaudited condensed consolidated balance sheets. Reinsurance
recoverables are comprised of the following amounts at September 30, 2009 and
December 31, 2008:




September 30,
      2009
            
            
            December 31,
      2008(in
      thousands)Reinsurance
      recoverables on unpaid loss and loss adjustment expenses
            
            $
            30,562
            
            
            $
            18,231Reinsurance
      recoverables on paid losses
            
            
            330
            
            
            
            313Total
      reinsurance recoverables
            
            $
            30,892
            
            
            $
            18,544


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 Index




SEABRIGHT
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)





The
effects of reinsurance were as follows for the three month and nine month
periods ended September 30, 2009 and 2008:




Three Months Ended
      September 30,
            
            
            Nine Months Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008(in
      thousands)Reinsurance
      assumed:Written
      premiums
            
            $
            1,862
            
            
            $
            790
            
            
            $
            5,201
            
            
            $
            4,034Earned
      premiums
            
            
            2,071
            
            
            
            1,282
            
            
            
            5,176
            
            
            
            5,181Losses
      and loss adjustment expenses incurred
            
            
            1,558
            
            
            
            872
            
            
            
            2,166
            
            
            
            3,286Commission
      expenses incurred
            
            
            819
            
            
            
            527
            
            
            
            1,932
            
            
            
            2,749Reinsurance
      ceded:Written
      premiums
            
            $
            6,084
            
            
            $
            4,454
            
            
            $
            19,904
            
            
            $
            10,926Earned
      premiums
            
            
            5,520
            
            
            
            4,590
            
            
            
            15,932
            
            
            
            11,074Losses
      and loss adjustment expenses incurred
            
            
            3,110
            
            
            
            4,827
            
            
            
            13,836
            
            
            
            7,324Commissions
      earned
            
            
            697
            
            
            
            571
            
            
            
            1,765
            
            
            
            1,451





6.
            Unpaid
      Loss and Loss Adjustment Expenses




The
following table summarizes the activity in unpaid loss and loss adjustment
expense for the three month and nine month periods ended September 30, 2009 and
2008:




Three Months Ended
      September 30,
            
            
            Nine Months Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008(in
      thousands)Beginning
      balance:Unpaid
      loss and loss adjustment expense
            
            $
            322,728
            
            
            $
            263,708
            
            
            $
            292,027
            
            
            $
            250,085Reinsurance
      recoverables
            
            
            (28,032
            )
            
            
            (15,534
            )
            
            
            (18,231
            )
            
            
            (14,034
            )Net
      balance, beginning of year
            
            
            294,696
            
            
            
            248,174
            
            
            
            273,796
            
            
            
            236,051Incurred
      related to:Current
      period
            
            
            40,783
            
            
            
            44,239
            
            
            
            116,729
            
            
            
            122,660Prior
      periods
            
            
            1,433
            
            
            
            (5,085
            )
            
            
            4,689
            
            
            
            (20,941
            )Receivable
      under adverse development cover
            
            
            −
            
            
            
            −
            
            
            
            574
            
            
            
            −Total
      incurred
            
            
            42,216
            
            
            
            39,154
            
            
            
            121,992
            
            
            
            101,719Paid
      related to:Current
      period
            
            
            (15,588
            )
            
            
            (14,504
            )
            
            
            (31,558
            )
            
            
            (31,048
            )Prior
      periods
            
            
            (17,242
            )
            
            
            (12,725
            )
            
            
            (59,574
            )
            
            
            (46,623
            )Total
      paid
            
            
            (32,830
            )
            
            
            (27,229
            )
            
            
            (91,132
            )
            
            
            (77,671
            )Receivable
      under adverse
      development      cover
            
            
            −
            
            
            
            −
            
            
            
            (574
            )
            
            
            −Net
      balance, end of period
            
            
            304,082
            
            
            
            260,099
            
            
            
            304,082
            
            
            
            260,099Reinsurance
      recoverable
            
            
            30,562
            
            
            
            19,557
            
            
            
            30,562
            
            
            
            19,557Unpaid
      loss and loss adjustment expense
            
            $
            334,644
            
            
            $
            279,656
            
            
            $
            334,644
            
            
            $
            279,656





Loss and
loss adjustment expenses are net of adjustments to prior years’ loss
reserves.  In the three months ended September 30, 2009, the Company
recorded $2.1 million of adverse development of prior years’ loss reserves and a
reinsurance commutation of $0.7 million, compared with $5.1 million of favorable
development in the same period in 2008.  In the nine months ended
September 30, 2009, the Company recorded $5.4 million of adverse development of
prior years’ loss reserves (which excludes the receivable under adverse
development cover) and a reinsurance commutation of $0.7 million, compared with
$20.9 million of favorable development in the same period in 2008.  Of
the $2.1 million of adverse development in third quarter 2009, $2.4 related to
accident year 2007, offset by $0.3 of favorable development in accident years
2003-2006. Approximately 10.5% of the 2007 accident year development related to
the Company’s California book of business, 30.1% to state act business other
than California and 59.4% to United States Longshore and Harbor Workers
Compensation Act (“USL&H”) business.


- 12
-
 Index


SEABRIGHT
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)






The
majority of the reserve releases in 2008 related to the Company’s California
book of business and reflected a continuation of lower than anticipated patterns
of loss payments in prior accident years as a result of reform legislation
enacted there primarily in 2003 and 2004.




7.
                Contingencies




a.  SBIC is subject
to guaranty fund and other assessments by the states in which it writes
business. Guaranty fund assessments are accrued at the time premiums are
written. Other assessments are accrued either at the time of assessment or in
the case of premium-based assessments, at the time the premiums are written, or
in the case of loss-based assessments, at the time the losses are incurred. As
of September 30, 2009, SBIC had a liability for guaranty fund and other
assessments of $3.5 million and a guaranty fund receivable of $3.4 million.
These amounts represent management’s best estimate based on information received
from the states in which it writes business and may change due to many factors,
including the Company’s share of the ultimate cost of current and future
insolvencies. The majority of assessments are paid out in the year following the
year in which the premium is written or the losses are paid. Guaranty fund
receivables and other surcharge items are generally realized by a charge to new
and renewing policyholders in the year following the year in which the related
assessments were paid.




b.The Company is
involved in various claims and lawsuits arising in the ordinary course of
business. Management believes the outcome of these matters will not have a
material adverse effect on the Company’s consolidated financial position or
results of operations.




8.
            Share-Based
      Payment Arrangements




At
September 30, 2009, the Company had outstanding stock options and nonvested
restricted stock granted according to the terms of two equity incentive plans.
The stockholders and Board of Directors approved the 2003 Stock Option Plan (the
“2003 Plan”) in September 2003, and amended and restated the 2003 Plan in
February 2004 and April 2008, and approved the 2005 Long-Term Equity Incentive
Plan (the “2005 Plan” and, together with the 2003 Plan, the “Stock Option
Plans”) in December 2004, and amended and restated the 2005 Plan in April
2008.




As of
September 30, 2009, options to purchase 371,968 shares of common stock were
outstanding under the 2003 Plan, and no additional shares were reserved for
issuance under the 2003 Plan. As of September 30, 2009, 940,020 shares of
nonvested restricted stock and options to purchase 856,817 shares of common
stock were outstanding under the 2005 Plan and 522,333 shares were reserved for
issuance under the 2005 Plan.




a.  Stock
Options




The fair
values of stock options granted during the three month and nine month periods
ended September 30, 2009 and 2008 were determined on the dates of grant using
the Black-Scholes-Merton (“Black-Scholes”) option valuation model with the
following weighted average assumptions:




Three Months Ended
      September 30,
            
            
            Nine Months Ended
      September 30,2009
            
            
            2008
            
            
            2009
            
            
            2008Expected
      term (years)
            
            
            6.3
            
            
            
            6.3
            
            
            
            6.3
            
            
            
            6.3Expected
      stock price volatility
            
            
            35.6
            %
            
            
            29.4
            %
            
            
            34.0
            %
            
            
            29.4
            %Risk-free
      interest rate
            
            
            2.86
            %
            
            
            3.11
            %
            
            
            2.31
            %
            
            
            3.01
            %Expected
      dividend yield
            
            
            –
            
            
            
            –
            
            
            
            –
            
            
            
            –Estimated
      fair value per option
            
            $
            4.07
            
            
            $
            5.20
            
            
            $
            3.73
            
            
            $
            5.18


- 13
-
 Index


SEABRIGHT
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)




The
following table summarizes stock option activity for the nine months ended
September 30, 2009:




Shares
      Subject to Options
            
            
            Weighted
      Average Exercise Price per
      Share
            
            
            Weighted
      Average Remaining Contractual Life (years)
            
            
            Aggregate
      Intrinsic Value (in thousands)Outstanding
      at December 31, 2008
            
            
            1,053,877
            
            
            $
            11.55
            
            
            
            6.7
            
            
            $
            204Granted
            
            
            216,202
            
            
            
            9.86
            
            
            
            –
            
            
            
            –Forfeited
            
            
            (28,043
            )
            
            
            13.68
            
            
            
            –
            
            
            
            –Exercised
            
            
            (4,750
            )
            
            
            6.54
            
            
            
            –
            
            
            
            –Cancelled
            
            
            (8,501
            )
            
            
            17.13
            
            
            
            –
            
            
            
            –Outstanding
      at September 30, 2009
            
            
            1,228,785
            
            
            
            11.18
            
            
            
            6.5
            
            
            
            293Exercisable
      at September  30, 2009
            
            
            805,575
            
            
            
            10.28
            
            
            
            5.3
            
            
            
            920





The
aggregate intrinsic values in the table above are before applicable income taxes
and are based on the Company’s closing stock price of $11.42 on September 30,
2009.  Proceeds from the exercise of stock options during the quarter
ended September 30, 2009 totaled approximately $31,000.




The
following table presents additional information regarding options outstanding as
of September 30, 2009:




Options Outstanding
            
            
            Options ExercisableRange
      of Exercise Prices
            
            
            Number
      Outstanding
            
            
            Weighted-
      Average Remaining Contractual Life
      (years)
            
            
            Weighted-
      Average Exercise
Price
            
            
            Number
      Outstanding
            
            
            Weighted-
      Average Exercise
Price$6.54-9.90
            
            
            
            499,800
            
            
            5.5
            
            
            $
            7.26
            
            
            
            371,968
            
            
            $
            6.5410.50-12.54
            
            
            
            323,394
            
            
            6.4
            
            
            
            10.63
            
            
            
            239,807
            
            
            
            10.6313.93-15.96
            
            
            
            192,391
            
            
            8.4
            
            
            
            14.65
            
            
            
            60,095
            
            
            
            14.8017.16-18.68
            
            
            
            213,200
            
            
            7.1
            
            
            
            18.08
            
            
            
            133,705
            
            
            
            18.011,228,785
            
            
            6.5
            
            
            
            11.18
            
            
            
            805,575
            
            
            
            10.28





b.
Restricted Stock




The
following table summarizes restricted stock activity for the nine months ended
September 30, 2009:




Number
      of Shares
            
            
            Weighted
      Average Grant Date Fair
      ValueOutstanding
      at December 31, 2008
            
            
            799,722
            
            
            $
            16.11Granted
            
            
            372,315
            
            
            
            10.30Vested
            
            
            (179,625
            )
            
            
            17.57Forfeited
            
            
            (52,392
            )
            
            
            11.41Outstanding
      at September 30, 2009
            
            
            940,020
            
            
            
            13.79





As of
September 30, 2009, there was $6.6 million of total unrecognized compensation
cost related to nonvested restricted stock granted under the 2005 Plan. That
cost is expected to be recognized over a weighted-average period of
approximately 23 months.




9.
            Fair
      Values of Assets and Liabilities




Estimated
fair value amounts, defined as the exit price of willing market participants,
have been determined using available market information and other appropriate
valuation methodologies. However, considerable judgment is required in
developing the estimates of fair value. Accordingly, these estimates are not
necessarily indicative of the amounts that could be realized in a current market
exchange. The use of different market assumptions or estimating methodologies
may have an effect on the estimated fair value amounts.




- 14
-
 Index


SEABRIGHT
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)




The
following methods and assumptions were used by the Company in estimating the
fair value disclosures for financial instruments in the accompanying unaudited
condensed consolidated financial statements and notes:




Cash and cash equivalents, premiums
receivable, accrued expenses, other liabilities and surplus notes: The
carrying amounts for these financial instruments as reported in the accompanying
unaudited condensed consolidated balance sheets approximate their fair
values.




Investment securities: The
Company measures and reports its financial assets and liabilities, including
investment securities, in accordance with the Fair Value Measurement and
Disclosure Topic of the Codification.  The estimated fair values for
available-for-sale securities are generally based on quoted market value prices
for securities traded in the public marketplace. The Company also considers the
impact of a significant decrease in volume and level of activity for an asset or
liability when compared with normal activity. Additional information with
respect to fair values of the Company’s investment securities is disclosed in
Note  3.




Other
financial instruments qualify as insurance-related products and are specifically
exempted from fair value disclosure requirements.




The
Company groups its financial assets and financial liabilities measured at fair
value in three levels, based on the markets in which the assets and liabilities
are traded and the reliability of the assumptions used to determine fair value.
These levels are:




·
            Level
      1 – Valuations for assets and liabilities traded in active exchange
      markets, such as the New York Stock Exchange. Level 1 includes U.S.
      Treasury securities and equity securities that are traded by dealers or
      brokers in active markets. Valuations are obtained from readily available
      pricing sources for market transactions involving identical assets or
      liabilities.




·
            Level
      2– Valuations for assets and liabilities traded in less active dealer or
      broker markets.  Level 2 valuations are based upon quoted prices
      for similar instruments in active markets, quoted prices for identical or
      similar instruments in markets that are not active, and model-based
      valuation techniques for which all significant assumptions are observable
      in the market. Level 2 includes government sponsored agency securities,
      corporate fixed-income securities, municipal bonds, mortgage pass-through
      securities, collateralized mortgage obligations and asset-backed
      securities.




·
            Level
      3– Valuations for assets and liabilities that are derived from other
      valuation methodologies, including discounted cash flow models and similar
      techniques, and not based on market exchange, dealer, or broker traded
      transactions. Level 3 valuations incorporate certain assumptions and
      projections in determining the fair value assigned to such assets or
      liabilities. As of September 30, 2009, the Company had no Level 3
      financial assets or financial
liabilities.




- 15
-
 Index


SEABRIGHT
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)




The table
below presents the September 30, 2009 balances of assets and liabilities
measured at fair value on a recurring basis.




Total
            
            
            Level 1
            
            
            Level 2
            
            
            Level 3(in
      thousands)Fixed
      income securities:U.S.
      Treasury securities
            
            $
            17,225
            
            
            $
            17,225
            
            
            $
            –
            
            
            $
            –Government
      sponsored agency securities
            
            
            31,503
            
            
            
            –
            
            
            
            31,503
            
            
            
            –Corporate
      securities
            
            
            91,096
            
            
            
            –
            
            
            
            91,096
            
            
            
            –Tax-exempt
      municipal securities
            
            
            328,627
            
            
            
            –
            
            
            
            328,627
            
            
            
            –Mortgage
      pass-through securities
            
            
            79,020
            
            
            
            –
            
            
            
            79,020
            
            
            
            –Collateralized
      mortgage obligations
            
            
            14,121
            
            
            
            –
            
            
            
            14,121
            
            
            
            –Asset-backed
      securities
            
            
            43,816
            
            
            
            –
            
            
            
            43,816
            
            
            
            –Total
      fixed income securities
            
            
            605,408
            
            
            
            17,225
            
            
            
            588,183
            
            
            
            –Equity
      securities
            
            
            10,444
            
            
            
            10,444
            
            
            
            –
            
            
            
            –Total
            
            $
            615,852
            
            
            $
            27,669
            
            
            $
            588,183
            
            
            $
            –





Active
markets are those in which transactions occur with sufficient frequency and
volume to provide reliable pricing information on an ongoing
basis.  Inactive markets are those in which there are few transactions
for the asset, prices are not current, or price quotations vary substantially
either over time or among market makers, or in which little information is
released publicly.  When the market for an investment is judged to be
inactive, appropriate adjustments must be made to observable inputs to account
for such inactivity.  As of September 30, 2009, the Company’s
investment portfolio consisted of securities that it considered to be traded in
active markets.  Therefore, no adjustment for market inactivity or
illiquidity was necessary.




The
Company obtains fair value inputs for securities in its investment portfolio
from independent, nationally recognized pricing services.  The Company
obtains one price per instrument from these pricing services.  The
pricing services utilize multidimensional pricing models that vary by asset
class and incorporate relevant inputs such as available trade, bid and quote
market data for identical or similar instruments, model-based valuation
techniques for which significant assumptions were observable and other market
information to arrive at a fair value price for each security.  This
process takes into consideration the relevance of observable inputs based on
factors such as the level of trading activity and the volume and currency of
available prices and includes appropriate adjustments for nonperformance and
liquidity risks. The Company did not obtain any broker quotes as part of the
portfolio valuation process at September 30, 2009.  When broker quotes
are obtained, they are usually non-binding.




The
Company also seeks input from independent portfolio managers and financial
advisors engaged by the Company to assist in the management and oversight of its
investment portfolio.  The Company and an independent portfolio
manager engaged by the Company review such amounts for reasonableness in
relation to the following considerations, among others: recent trades of a
particular security; the Company’s independent observations of recent
developments affecting the economy in general and certain issuers in particular;
and fair values from other sources, such as statements from the Company’s
custodial banks.  When other evidence indicates a fair value that is
significantly different from that provided by an independent pricing service,
the Company may challenge the fair value and request further validation and
support from the independent pricing service, which may result in a revised fair
value from the independent pricing service.  If the Company has
independent evidence indicating that a security’s fair value is significantly
different from the final value provided by an independent pricing service, it
may adjust the fair value accordingly.  The Company did not adjust any
of the September 30, 2009 values it obtained from independent pricing services
and used those values in developing the fair value measurements in the Company’s
unaudited condensed consolidated financial statements as of September 30,
2009.




The
Company may be required, from time to time, to measure certain other financial
assets, such as goodwill, fixed assets and other long-lived assets, at fair
value on a non-recurring basis in accordance with GAAP. These adjustments to
fair value usually result from write-downs of individual assets. None of these
assets have been measured to fair value during 2009.




- 16
-
 Index


SEABRIGHT
INSURANCE HOLDINGS, INC. AND SUBSIDIARIES
 
 NOTES
TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Continued)




10.
            Subsequent
      Events




Management
has evaluated subsequent events from September 30, 2009 to November 9, 2009, the
date which our financial statements have been issued and were available to be
issued, and has concluded there were no subsequent events to be reported during
this period.  Subsequent events that may occur after November 9, 2009
have not been evaluated in the financial statements as of September 30,
2009.




- 17
-
 Index




Item 2.    Management’s Discussion and
Analysis of Financial Condition and Results of Operations




Cautionary
Statement
 
 You
should read the following discussion and analysis in conjunction with our
unaudited condensed consolidated financial statements and the related notes
thereto included in Item  1 of Part  I of this quarterly
report. The information contained in this quarterly report is not a complete
description of our business or the risks associated with an investment in our
common stock. We urge you to carefully review and consider the various
disclosures made by us in this quarterly report and in our other reports filed
with the U.S. Securities and Exchange Commission (the “SEC”), including our
Annual Report on Form  10-K for the year ended December  31,
2008 filed with the SEC on March 16, 2009.


The
discussion under the heading “Risk Factors” in our Annual Report on Form 10-K
for the year ended December 31, 2008, and similar discussions in our other SEC
filings, describe some of the important risk factors that may affect our
business, results of operations and financial condition. You should carefully
consider those risks, in addition to the other information in this report and in
our other filings with the SEC, before deciding to purchase, hold or sell our
common stock.


Some of
the statements in this Item 2 and elsewhere in this quarterly report may include
forward-looking statements that reflect our current views with respect to future
events and financial performance. These statements include forward-looking
statements both with respect to us specifically and the insurance sector in
general. Statements that include the words “expect,” “intend,” “plan,”
“believe,” “project,” “estimate,” “may,” “should,” “anticipate,” “will” and
similar statements of a future or forward-looking nature identify
forward-looking statements for purposes of the federal securities laws or
otherwise.




All
forward-looking statements address matters that involve risks and uncertainties.
Accordingly, there are or will be important factors that could cause our actual
results to differ materially from those indicated in these statements. We
believe that these factors include but are not limited to the
following:




•
            greater
      frequency or severity of claims and loss activity, including as a result
      of catastrophic events, than our underwriting, reserving or investment
      practices anticipate based on historical experience or industry
      data;




•
            our
      dependency on a concentrated geographic
market;




•
            changes
      in the availability, cost or quality of reinsurance and failure of our
      reinsurers to pay claims timely or at
all;




•
            changes
      in regulations or laws applicable to us, our subsidiaries, brokers or
      customers;




•
            potential
      downgrades in our rating or changes in rating agency policies or
      practices;




•
            ineffectiveness
      or obsolescence of our business strategy due to changes in current or
      future market conditions;




•
            unexpected
      issues relating to claims or coverage and changes in legal theories of
      liability under our insurance
policies;




•
            increased
      competition on the basis of pricing, capacity, coverage terms or other
      factors;




•
            developments
      in financial and capital markets that adversely affect the performance of
      our investments;




•
            loss
      of the services of any of our executive officers or other key
      personnel;




•
            our
      inability to raise capital in the
future;




•
            our
      status as an insurance holding company with no direct
      operations;




•
            our
      reliance on independent insurance
brokers;




•
            increased
      assessments or other surcharges by states in which we write
      policies;




- 18
-
 Index




•
            our
      potential exposure to losses if Lumbermens Mutual Casualty Company (“LMC”)
      were to be placed into
receivership;




•
            the
      effects of acquisitions that we may
undertake;




•
            failure
      of our customers to pay additional premium under our retrospectively rated
      policies;




•
            the
      effects of acts of terrorism or
war;




•
            cyclical
      changes in the insurance industry;




•
            changes
      in accounting policies or
practices;




•
            changes
      in general economic conditions, including inflation and other
      factors;




•
            a
      prolonged severe downturn, or continuing recession or sustained loss of
      consumer confidence; and




•
            significant
      declines in interest rates on our investment securities for a sustained
      period of time, deterioration of the underlying issuers’ credit or
      declines in the stock market.




The
foregoing factors should not be construed as exhaustive and should be read in
conjunction with the other cautionary statements that are included in this
quarterly report. We undertake no obligation to publicly update or review any
forward-looking statement, whether as a result of new information, future
developments or otherwise.




If one or
more of these or other risks or uncertainties materialize, or if our underlying
assumptions prove to be incorrect, actual results may vary materially from what
we project. Any forward-looking statements you read in this quarterly report
reflect our views as of the date of this quarterly report with respect to future
events and are subject to these and other risks, uncertainties and assumptions
relating to our operations, results of operations, growth strategy and
liquidity. Before making an investment decision, you should carefully consider
all of the factors identified in this quarterly report that could cause actual
results to differ.




Additional
information concerning these and other factors is contained in our SEC filings,
including, but not limited to, our 2008 Annual Report on Form 10-K.




Overview




We are a
specialty provider of multi-jurisdictional workers’ compensation insurance and,
on a limited basis, commercial general liability insurance. We are domiciled in
Illinois, commercially domiciled in California and headquartered in Seattle,
Washington. We are licensed in 49 states and the District of Columbia to write
workers’ compensation and other lines of insurance. Traditional providers of
workers’ compensation insurance provide coverage to employers under one or more
state workers’ compensation laws, which prescribe benefits that employers are
obligated to provide to their employees who are injured arising out of or in the
course of employment. We focus on employers with complex workers’ compensation
exposures and provide coverage under multiple state and federal acts, applicable
common law or negotiated agreements. We also provide traditional state act
coverage in markets we believe are underserved. Our workers’ compensation
policies are issued to employers who also pay the premiums. The policies provide
payments to covered, injured employees of the policyholder for, among other
things, temporary or permanent disability benefits, death benefits and medical
and hospital expenses. The benefits payable and the duration of such benefits
are set by statute and vary by jurisdiction and with the nature and severity of
the injury or disease and the wages, occupation and age of the
employee.




SeaBright
Insurance Holdings, Inc. (“SIH”) was formed in 2003 by members of our current
management and entities affiliated with Summit Partners, a leading private
equity and venture capital firm, for the purpose of acquiring from LMC and
certain of its affiliates the renewal rights and substantially all of the
operating assets and employees of the Eagle Insurance Companies (“Eagle”) (the
“Acquisition”). Eagle began writing specialty workers’ compensation insurance
policies in the mid-1980’s. The Acquisition gave us renewal rights to an
existing portfolio of business, representing a valuable asset given the renewal
nature of our business, and a fully operational infrastructure that would have
taken many years to develop. These renewal rights gave us access to Eagle’s
customer lists and the right to seek to renew Eagle’s continuing in-force
insurance contracts.




In the
Acquisition, we also acquired 100% of the issued and outstanding capital stock
of Kemper Employers Insurance Company (“KEIC”) and PointSure. We acquired KEIC,
a shell company with no in-force policies or employees, solely for the purpose
of acquiring its workers’ compensation licenses in 43 states and the District of
Columbia and for its certification with the United States Department of Labor.
Subsequent to the Acquisition, KEIC was renamed “SeaBright Insurance Company.”
SeaBright Insurance Company received an “A–” (Excellent) rating from A.M. Best
following the completion of the Acquisition.




- 19
-
 Index




To
minimize our exposure to any past business underwritten by KEIC, we entered into
an adverse development cover agreement in connection with the Acquisition. Under
the terms of this agreement, we and LMC are required to indemnify each other
with respect to the development of KEIC’s insurance liabilities as they existed
at the date of the Acquisition. Accordingly, if KEIC’s insurance liabilities
increase, LMC must indemnify us in the amount of the increase. If KEIC’s
insurance liabilities decrease, we must share with LMC the positive development
of those reserves. To support LMC’s obligations under the adverse development
cover, LMC funded a trust account at the time of the Acquisition in the amount
of $1.6 million as collateral for LMC’s potential future obligations to us under
the adverse development cover. The minimum amount that must be maintained in the
trust account is equal to the greater of (a) $1.6 million or (b) 102% of the
then existing quarterly estimate of LMC’s total obligations under the adverse
development cover. The amount on deposit in the trust account was approximately
$3.8 million at September 30, 2009 and $2.8 million at December 31, 2008. If LMC
is placed into receivership and the amount held in the collateralized
reinsurance trust is inadequate to satisfy the obligations of LMC to us under
the adverse development cover, it is unlikely that we would recover any future
amounts owing by LMC to us.




Our
operations and financial performance may be impacted by changes in the U.S.
economy. The significant downturn in the U.S. economy since 2007 led to lower
reported payrolls, which has had a negative impact on our gross premiums written
and earned premiums. If our customers reduce their workforce levels, the level
of workers’ compensation insurance coverage they require and, as a result the
premiums that we charge, would be reduced, and if our customers cease
operations, they will not renew their policies. It is uncertain if economic
conditions will deteriorate further, or when economic conditions will improve. A
prolonged recession could further reduce payrolls, which could have a
significant negative impact on our business, financial condition or results of
operations.




Principal
Revenue and Expense Items




We derive
our primary revenue from premiums earned, net investment income, net realized
gains and losses from investments and other income. Our primary expense items
are loss and loss adjustment expenses, underwriting, acquisition and insurance
expenses, and interest expense.




Premiums
Earned




Gross
premiums written include all premiums billed and unbilled by an insurance
company during a specified policy period. Premiums are earned over the terms of
the related policies according to reports of actual payroll amounts received
periodically from our insureds. At the end of each accounting period, the
portions of premiums that are not yet earned are included in unearned premiums
and are realized as revenue in subsequent periods over the remaining terms of
the policies. Our policies typically have terms of 12 months. Thus, for example,
for a policy that is written on July 1, 2008 and for which payrolls are earned
ratably throughout the year, one-half of the premiums would be earned in 2008
and the other half would be earned in 2009.




Our gross
premiums written is the sum of both direct premiums and assumed premiums before
the effect of ceded reinsurance. Assumed premiums are premiums that we have
received from an authorized state-mandated pool. Net premiums written is the
difference between gross premiums written and premiums ceded or paid to
reinsurers (ceded premiums written). Premiums earned is the earned portion of
our net premiums written.




There can
be significant variability in our premiums earned. Gross written premium for
each policy is based on estimated payroll, by worker classification, for the
policy period multiplied by the appropriate premium rate per $100 of covered
payroll for each classification. Premium adjustment factors may also be applied
to reflect the historical loss experience of the account or other
considerations. At policy expiration, we perform audits to determine actual
payrolls for the policy period. If audited payrolls equal the payrolls estimated
at inception, there would typically be no audit adjustment. However, if audited
payrolls exceed estimated payrolls, an additional premium would be billed, which
would increase our earned premium. Conversely, if audited payrolls were less
than estimated payrolls, premium would be returned and earned premium would be
reduced. To more accurately track our earned premium during the policy period,
all of our accounts report payroll, typically monthly, which generally results
in actual payrolls being reported for each period. The form and frequency of
payroll reporting are factored into our earned premium calculation. The
estimated annual premium is prorated for any periods for which we do not have
actual reported payrolls. If actual reported payrolls were running significantly
higher (or lower) than estimated payrolls for a period, gross written premium
would be earned faster (or slower) than if premiums were earned on an estimated
daily pro-rata basis. Also, we may endorse a policy mid-term to adjust the
estimated premium for significant changes in the insureds business, either
increasing or decreasing gross written premium and earned premium. We also write
retrospectively rated policies, where the ultimate premium is based on the
insured’s loss experience, which contributes to the volatility of our earned
premiums.




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 Index




We earn
our direct premiums written from our maritime, alternative dispute resolution
(“ADR”) and state act customers. We also earn a small portion of our direct
premiums written from employers who participate in the Washington State United
States Longshore and Harbor Workers Compensation Act (“USL&H”) Assigned Risk
Plan (the “Washington USL&H Assigned Risk Plan”). We immediately cede 100%
of those premiums, net of our expenses, and 100% of the losses in connection
with that business back to the Washington USL&H Assigned Risk Plan.
References to direct premiums written generally exclude premiums from the
Washington USL&H Assigned Risk Plan because such business is not indicative
of our core business or material to our results of
operations.  Effective January 1, 2009, we entered into a new quota
share reinsurance agreement with a non-affiliated reinsurer where we cede 100%
of our assumed premiums related to our National Council on Compensation
Insurance (“NCCI”) book of business. This reinsurance policy is effective for
policy year 2009.




Net
Investment Income and Realized Gains and Losses on Investments




We invest
our statutory surplus and the funds supporting our insurance liabilities
(including unearned premiums and unpaid loss and loss adjustment expense) in
cash, cash equivalents, fixed income securities and, to a lesser degree, in
equity securities. Our investment income includes interest earned on our
invested assets. Realized gains and losses on invested assets are reported
separately from net investment income. We earn realized gains when invested
assets are sold for an amount greater than their amortized cost in the case of
fixed maturity securities and recognize realized losses when investment
securities are written down as a result of an other-than-temporary impairment or
sold for an amount less than their carrying value. Other-than-temporarily
impaired (“OTTI”) losses are reported separately on the statements of operations
and are broken out between those losses with an income statement impact and
those with an impact to accumulated other comprehensive income on the balance
sheet.




Other
Income




Other
income is derived primarily from the operations of our wholly owned subsidiary
companies, including PointSure Insurance Services, Inc. (“PointSure”),
(including Black/White and Associates, Inc.,  Black/White and
Associates of Nevada and Black/White Rockridge Insurance Services, Inc.,
referred to collectively as “BWNV”, its wholly owned subsidiaries), our
wholesale broker and third party administrator, and Total HealthCare Management
(“THM”), a provider of medical bill review, utilization review, nurse case
management and related services.




Loss
and Loss Adjustment Expenses




Loss and
loss adjustment expenses represent our largest expense item and include (1)
claim payments made, (2) estimates for future claim payments and changes in
those estimates for current and prior periods and (3) costs associated with
investigating, defending and adjusting claims. For further information regarding
our loss and loss adjustment expenses, including amounts paid and unpaid, see
discussion under the heading “Critical Accounting Policies, Estimates and
Judgments – Unpaid Loss and Loss Adjustment Expenses” in this Item 2 of Part I
of this quarterly report.




Underwriting,
Acquisition and Insurance Expenses




In our
insurance subsidiary, we refer to the expenses that we incur to underwrite risks
as underwriting, acquisition and insurance expenses. Underwriting expenses
consist of commission expenses, premium taxes and fees and other underwriting
expenses incurred in writing and maintaining our business. We pay commission
expense in our insurance subsidiary to brokers for the premiums that they
produce for us. We pay state and local taxes based on premiums; licenses and
fees; assessments; and contributions to workers’ compensation security funds.
Other underwriting expenses consist of general administrative expenses such as
salaries and employee benefits, rent and all other operating expenses not
otherwise classified separately, and boards, bureaus and assessments of
statistical agencies for policy service and administration items such as rating
manuals, rating plans and experience data. Certain of these costs that vary with
and are primarily related to the acquisition of insurance contracts (“deferred
acquisition costs”) are initially deferred and amortized over the typical policy
term of 12 months. Therefore, with respect to deferred acquisition costs, there
are timing differences between when the costs are incurred or paid and when the
related expense is recognized in our unaudited condensed consolidated statements
of operations.




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 Index




Interest
Expense




We incur
interest expense on $12.0 million in surplus notes that our insurance subsidiary
issued in May 2004. The interest expense is paid quarterly in arrears. The
interest expense for each interest payment period is based on the three-month
LIBOR rate two London banking days prior to the interest payment period plus 400
basis points.  The interest rate at September 30, 2009 was
4.4%.




Results
of Operations




Three
Months and Nine Months Ended September 30, 2009 and 2008




Gross Premiums
Written.  Gross premiums written consists of direct premiums
written and premiums assumed from the NCCI residual markets.  The
number of customers we service, in-force payrolls and in-force premiums
represent some of the factors we consider when analyzing gross premiums
written.





Gross
premiums written for the three months ended September 30, 2009 totaled $58.7
million, a decrease of $3.0 million, or 4.9%, from $61.7 million of gross
premiums written in the same period of 2008.  Gross premiums written
for the nine months ended September 30, 2009 totaled $209.6 million, an increase
of $18.1 million, or 9.5%, over $191.5 million of gross premiums written in the
same period of 2008.  Much of the increase in gross premiums written
resulted from premium growth related to our “program” book of business. Program
business, which includes alternative markets and small maritime programs,
contributed $22.9 million or 126.5% of the total gross premium increase for the
nine months ended September 30, 2009. The increase in program business was
offset by a net $4.8 million decrease in our core product
lines.  Excluding work we perform as the servicing carrier for the
Washington USL&H Assigned Risk Plan, the total number of customers we
serviced increased from over 1,000 at September 30, 2008 to over 1,400 at
September 30, 2009. Approximately 23% of the customer increase related to our
“core” book of business and approximately 77% of the increase related to our
program business. By design, our program business will have a larger number of
customers with a smaller average premium size than our core book of business.
Total in-force payrolls, one of the factors used in determining premium charges,
increased 14.5% from $6.2 billion at September 30, 2008 to $7.1 billion at
September 30, 2009. California continues to be our largest market, accounting
for approximately $119.5 million, or 39.9%, of our in-force premiums at
September 30, 2009. This represents an increase of $9.9 million, or 9.0%, from
approximately $109.6 million of in-force premiums in California, or 39.7%, of
in-force premiums, at September 30, 2008.





The
following is a summary of our top five markets based on direct premiums
written:





Nine Months Ended
      September 30,2009
            
            
            2008Direct
      Premiums Written
            
            
            %
            
            
            Direct
      Premiums Written
            
            
            %($
      in thousands)California
            
            $
            84,496
            
            
            
            41.1
            %
            
            $
            74,454
            
            
            
            39.2
            %Louisiana
            
            
            18,278
            
            
            
            8.9
            
            
            
            14,938
            
            
            
            7.9Illinois
            
            
            17,697
            
            
            
            8.6
            
            
            
            14,954
            
            
            
            7.9Texas
            
            
            13,349
            
            
            
            6.5
            
            
            
            13,628
            
            
            
            7.2Alaska
            
            
            11,626
            
            
            
            5.7
            
            
            
            12,576
            
            
            
            6.6Total
            
            $
            145,446
            
            
            
            70.8
            %
            
            $
            130,550
            
            
            
            68.8
            %





Premiums
assumed from the NCCI residual markets for the three months and nine months
ended September 30, 2009 increased $1.1 million, or 137.5% to $1.9 million from
$0.8 million for the same period in 2008.  For the nine months ended
September 30, 2009, premiums assumed from the NCCI residual markets increased by
$1.2 million, or 30.0% to $5.2 million compared to $4.0 million during the same
period in 2008.





We
experienced significant reductions in our California premium rates from 2003 to
2008. In 2007, in response to continued reductions in California workers’
compensation claim costs, we filed with the California Insurance Commissioner
our new rates reflecting an average reduction of 14.2% from prior rates for new
and renewal insurance policies written in California on or after July 1, 2007.
This action was the eighth California rate reduction we had filed since October
1, 2003, resulting in a net cumulative reduction of our California rates of
approximately 54.8%. On August 15, 2008, the Workers’ Compensation Insurance
Rating Bureau of California (the “WCIRB”) submitted a filing with the California
Insurance Commissioner recommending a 16.0% increase in advisory pure premium
rates on new and renewal policies effective on or after January 1, 2009. The
filing was based on a review of loss and loss adjustment experience through
March 31, 2008. In response to this recommendation, on October 24, 2008, the
California Insurance Commissioner approved a 5.0% increase in advisory pure
premium rates, effective January 1, 2009. With the California Department of
Insurance approval, we adopted this 5.0% increase effective January 1,
2009.




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 Index




On March 27, 2009, the WCIRB submitted
a filing with the California Insurance Commissioner recommending a 24.4%
increase in advisory pure premium rates on new and renewal policies effective on
or after July 1, 2009. On April 23, 2009, the WCIRB amended its filing to reduce
the proposed rate increase to 23.7%. A public hearing on the proposed rate
increase was held on April 28, 2009. Following the hearing, the California
Insurance Commissioner issued a press release in which he urged the WCIRB to
withdraw the portion of its requested rate increase related to recent decisions
by the Workers’ Compensation Appeals Board(estimated to be approximately 6%)
until the judicial process related to these decisions has concluded. A second
hearing on medical treatment costs was held on June 8, 2009. On July 8, 2009,
the California Insurance Commissioner announced his rejection of any increase in
advisory pure premium rates.  Rating decisions made by the California
Insurance Commissioner are advisory only and insurance companies may choose
whether or not to adopt, approved or disapproved rates. After completing an
internal study of our California loss costs,on June 23, 2009, we filed with the
California Department of Insurance revised rates for new and renewal workers'
compensation insurance policies written in the state of California on or after
August 1, 2009. The new rates reflected an average increase of 10.6% from prior
rates and were in response to increased projected medical costs and recent
decisions by the Workers' Compensation Appeals Board.  On July 7,
2009, the California Department of Insurance approved our filing for the rate
increase. We are unable to predict the impact
that  the  rate increase  adopted by us in
California might have on our future financial position and results of
operations. If other insurers do not adopt similar rate increases, this rate
increase may have a negative effect on our ability to compete in California.On August 18, 2009, the
WCIRB submitted a filing with the California Insurance Commissioner recommending
a 22.8% increase in advisory pure premium rates on new and renewal policies
effective on or after January 1, 2010. A public hearing on the proposed rate
increase was held on October 6, 2009. The California Insurance Commissioner is
expected to announce his decision regarding the proposed rate increase by
mid-November 2009.




Rate
reductions have also been adopted in other states in which we operate. For
example, in Alaska we adopted rate decreases of 7.6% and 10.9% effective January
1, 2009 and 2008, respectively. In Louisiana, we adopted commissioner-approved
rate decreases of 17.4% (pending approval) and 8.6% effective May 1, 2009 and
2008, respectively. In Hawaii, we adopted rate decreases of 5.8% and 19.3%
effective February 1, 2009 and 2008, respectively. In Texas, we adopted rate
decreases of 10.0% and 7.7% effective May 1, 2009 and January 1, 2008,
respectively. In Florida, we adopted rate decreases of 18.6% and 18.4% effective
January 1, 2009 and 2008, respectively. We have adopted rate increases of 2.5%,
3.5% and 4.0% in Illinois effective April 1, 2009 and January 1, 2009 and 2008,
respectively. In Arizona we adopted rate increases of 7.9% and 4.1% effective
October 1, 2008 and January 1, 2008, respectively.




Net Premiums
Written.  Net premiums written totaled $52.7 million for the
three months ended September 30, 2009 compared to $57.2 million in the same
period in 2008, representing a decrease of $4.5 million, or 7.9%. For the nine
months ended September 30, 2009, net premiums written totaled $189.7 million, an
increase of $9.1 million, or 5.0%, from $180.6 million in the same period of
2008. The decrease in net premiums written for the three months ended September
30, 2009 was primarily attributable to an increase in ceded premiums due to the
addition of a new reinsurance treaty under which we cede off the residual market
business, beginning with policy year 2009, that we are obligated to assume from
the NCCI. The increase in net premiums written for the nine months ended
September 30, 2009 was primarily attributable to the increase in gross written
premiums, offset in part by $9.0 million in premiums ceded related to the
increased ceding rate of the 2008 reinsurance contracts due primarily to an
increase in limits at the lower and upper ends of the program, as well as the
addition of a new reinsurance treaty related to the residual market
business.




Net Premiums
Earned.  Net premiums earned totaled $64.4 million for the
three months ended September 30, 2009 compared to $68.7 million for the same
period in 2008, representing a decrease of $4.3 million, or 6.2%. For the nine
months ended September 30, 2009, net premiums earned totaled $182.5 million, an
increase of $1.4 million, or 0.8%, from $181.1 million in the same period of
2008.  We record the entire annual policy premium as unearned premium
when written and earn the premium over the life of the policy, which is
generally twelve months. Consequently, the amount of premiums earned in any
given year depends on when during the current or prior year the underlying
policies were written and the actual reported payroll of the underlying
policies. Our direct premiums earned decreased $4.2 million, or 5.8%, to $67.9
million for the three months ended September 30, 2009 from $72.1 million for the
same period in 2008 due to the decrease in gross premiums written discussed
above as well as reductions in reported payrolls driven mainly by the effects of
the current economic recession. Our direct premiums earned for the nine months
ended September 30, 2009 increased $6.2 million, or 3.3%, to $193.2 million from
$187.0 million for the same period in 2008.  Premiums earned in the
three month and nine month periods of 2009 were also reduced by net adjustments
of $2.5 million and $3.5 million, respectively, on retrospectively rated
policies due to favorable loss results on those policies.




- 23
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 Index




The
following is a summary of our top five markets based on direct premiums
earned:





Nine Months Ended
      September 30,2009
            
            
            2008Direct
      Premiums Earned
            
            
            %
            
            
            Direct
      Premiums Earned
            
            
            %($
      in thousands)California
            
            $
            77,192
            
            
            
            40.0
            %
            
            $
            74,791
            
            
            
            40.0
            %Louisiana
            
            
            19,493
            
            
            
            10.1
            
            
            
            16,331
            
            
            
            8.7Illinois
            
            
            16,357
            
            
            
            8.5
            
            
            
            19,228
            
            
            
            10.3Alaska
            
            
            11,897
            
            
            
            6.2
            
            
            
            12,309
            
            
            
            6.6Texas
            
            
            11,315
            
            
            
            5.9
            
            
            
            10,940
            
            
            
            5.9Total
            
            $
            136,254
            
            
            
            70.7
            %
            
            $
            133,599
            
            
            
            71.5
            %





Net
premiums earned are also affected by premiums ceded under reinsurance
agreements. Ceded premiums earned for the three months ended September 30, 2009
totaled $5.5 million compared to $4.6 million for the same period in 2008,
representing an increase of $0.9 million, or 19.6%.  Ceded premiums
earned for the nine months ended September 30, 2009 totaled $15.9 million
compared to $11.1 million for the same period in 2008, representing an increase
of $4.8 million, or 43.2%.  An increase in ceded premiums earned is a
decrease to our overall net premiums earned. Included in net premiums earned for
the nine months ended September 30, 2009 is an increase in the amount of
premiums we involuntarily assume on residual market business from the NCCI,
which operates residual market programs on behalf of many states. Effective
January 2009, we cede 100% of NCCI assumed business for policy year 2009, which
totaled $1.5 million and $3.1 million for the three months and nine months ended
September 30, 2009, respectively.





Net Investment
Income.  Net investment income was $5.9 million for the three
months ended September 30, 2009 compared to $5.6 million for the same period in
2008, representing an increase of $0.3 million, or 5.7%.  Net
investment income was $17.2 million for the nine months ended September 30, 2009
compared to $16.9 million for the same period in 2008, representing an increase
of $0.3 million, or 2.0%.  Average invested assets for the three
months ended September 30, 2009 increased $82.4 million, or 15.4%, from $534.6
million in 2008 to $617.0 million in 2009.  For the nine months ended
September 30, 2009 average invested assets increased $75.1 million, or 14.4%,
from $522.1 million in 2008 to $597.2 million in 2009.  Our yield on
average invested assets for the three months ended September 30, 2009 was
approximately 3.8% compared to approximately 4.2% for the same period in
2008.  For the nine months ended September 30, 2009, our yield on
average invested assets was 3.8% compared to approximately 4.3% for the same
period in 2008.





Other-Than-Temporary Impairment
Losses.Other-than-temporary impairment losses totaled $0.0
and $0.3 million for the three month and nine month periods ended September 30,
2009, respectively, compared to $11.5 million and $13.4 million for the same
periods in 2008.  The majority of impairment losses in both years
related to our investments in preferred stock issued by Fannie Mae and Freddie
Mac.  In July 2009, we liquidated our holdings of these stocks at a
slight realized gain of $6,000 after considering the lowered cost basis
resulting from the 2008 and 2009 impairment losses.




Service
Income.  Service income totaled $0.3 million for the three
months ended September 30, 2009 compared to no service income for the same
period in 2008. For the nine months ended September 30, 2009, service income
remained flat at $0.9 million from the same period of 2008. Our service income
results primarily from service arrangements we have with LMC and other companies
for claims processing, policy administration, and administrative services that
we perform for them.




Other
Income.  Other income totaled $2.0 million for the three months
ended September 30, 2009 compared to $2.8 million for the same period in 2008,
representing a decrease of $0.8 million, or 29.6%. For the nine months ended
September 30, 2009, other income totaled $6.3 million, flat when compared to the
same period of 2008.  Other income is derived primarily from the
operations of PointSure (including BWNV), our wholesale broker and third party
administrator, and THM, our provider of medical bill review, utilization review,
nurse case management and related services.




- 24
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 Index




Loss and Loss Adjustment
Expenses.  Loss and loss adjustment expenses totaled $42.2
million for the three months ended September 30, 2009 compared to $39.2 million
for the same period in 2008, representing an increase of $3.0 million, or
7.8%.  For the nine months ended September 30, 2009, loss and loss
adjustment expenses totaled $122.0 million, compared to $101.7 million for the
same period in 2008, representing an increase of $20.3 million, or 19.9%. Our
net loss ratio, which is calculated by dividing loss and loss adjustment
expenses less claims service income by premiums earned, for the three months
ended September 30, 2009 was 65.1% compared to 57.1% for the same period in
2008.  Our net loss ratio for the nine months ended September 30, 2009
was 66.4% compared to 55.8% for the same period in 2008.  The increase
in our net loss ratio for the three months ended September 30, 2009 is primarily
attributable to $5.1 million in favorable loss development in the three months
ended September 30, 2008 compared to $2.1 million of unfavorable loss
development (related to accident years 2003 through 2007) in the three months
ended September 30, 2009.  The increase in our net loss ratio for the
nine months ended September 30, 2009 was primarily the result of $20.9 million
in favorable loss development in the nine months ended September 30, 2008
compared to $5.9 million of unfavorable loss development in the nine months
ended September 30, 2009. Our direct net loss reserves are net of reinsurance
and exclude reserves associated with KEIC and the business that we involuntarily
assume from the NCCI.





As
discussed under the heading “Critical Accounting Policies, Estimates and
Judgments – Unpaid Loss and Loss Adjustment Expenses – Actuarial Loss Reserve
Estimation Methods” in this Item 2, we use an expected loss ratio (“ELR”) method
to establish the loss reserves for the current accident
year.   Once the accident year is complete and begins to age, the
ELR method is blended with the actual paid and incurred losses to determine the
revised estimated ultimate losses for the accident year.




Accident
year 2009 is incomplete, as only nine months of the year have been earned as of
September 30, 2009.  An expected loss ratio was established for each
jurisdiction and type of loss (indemnity, medical, ALAE).  The
expected loss ratio was multiplied by the booked accident year earned premium to
produce the ultimate loss to date.  The expected loss ratio selections
are reviewed quarterly with each internal IBNR study.  Given the short
experience period for the current accident year, the expected loss ratios are
usually maintained at least through the first 12 months of the accident year and
revised as the underlying data matures.  There were no changes to the
expected loss ratio selections for accident year 2009 when compared to June 30,
2009 results.




While
there was some movement in the calculated ultimate values related to accident
year 2008, it was not significant and, as a result, the ultimate loss estimates
did not change from the June 30, 2009 estimates.  Due to the relative
immaturity of accident year 2008 (age 21 months as of September 30, 2009), and
the longer tail nature of the workers compensation line of business, the actual
results for this accident year are still subject to volatility.  This
volatility could still result in changes to the ultimate loss estimates, upward
or downward, in the future periods.




For
accident year 2007, the ultimate loss estimates at September 30, 2009 were
higher when compared to June 30, 2009.  The development in the
ultimate loss selections can be attributed to indemnity and medical loss
development results in certain states, both in our State Act and Longshore &
Maritime business.  With each quarterly IBNR study, we monitor actual
versus expected loss development closely, along with claim severity and
frequency changes.  The combination of these results warranted
increases totaling $2.4 million to our indemnity and medical ultimate loss
estimates.  Due to the relative immaturity of accident year 2007 (age
33 months as of September 30, 2009), and the longer tail nature of the workers
compensation line of business, the actual results for this accident year are
still subject to volatility.  This volatility could still result in
changes to the ultimate loss estimates, upward or downward, in the future
periods.




For
accident years 2006 and prior, the ultimate loss estimates at September 30, 2009
were slightly lower when compared to June 30, 2009 and resulted in a net
decrease of our net ultimate loss estimates of $0.3 million for the quarter
ended September 30, 2009.  This was due primarily to an increase in
the salvage and subrogation ultimate estimate for accident year
2006.  The change is supported by a large recovery in the quarter for
this accident year.  An increase to ultimate salvage and subrogation
estimate results in a reduction in net ultimate loss liability.  There
was limited movement in the estimated ultimate losses for other prior accident
years.




As
discussed under the heading “Critical Accounting Policies, Estimates and
Judgments – Unpaid Loss and Loss Adjustment Expenses – Impact of Changes in Key
Assumptions on Reserve Volatility” in this Item 2, our loss reserve estimates
rely heavily on historical reserving and loss payment patterns referred to as
loss development.   To the extent that the actual paid and
incurred losses vary from the historical loss development patterns underlying
the ultimate loss estimates, we will experience  changes in reserves,
either upward or downward, in future periods.   The loss reserve
estimates for prior years are changed when the available information indicates a
reasonable likelihood that the ultimate losses will vary from the prior
estimates.




- 25
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 Index




There is
uncertainty about whether recent lower paid loss trends, which result primarily
from California legislative reforms enacted in 2003 and 2004, will be sustained,
particularly in light of current efforts to change or repeal portions of the
reforms. We are beginning to experience rate increases in California and other
states, following multiple rate decreases over several years. We have
established loss reserves at September 30, 2009 that are based upon our current
best estimate of loss costs, taking into consideration the recent paid loss
claim data, incurred loss trends and the uncertainty regarding the permanence of
recent legislative reforms. For further information regarding our loss and loss
adjustment expenses, including amounts paid and unpaid, see the discussion under
the heading “Critical Accounting Policies, Estimates and Judgments – Unpaid Loss
and Loss Adjustment Expenses” in this Item 2 of Part I of this quarterly
report.




As of
September 30, 2009, we had recorded a receivable of approximately $3.6 million
for loss development under the adverse development cover since the date of the
Acquisition. We do not expect this receivable to have any material adverse
effect on our future cash flows if LMC fails to perform its obligations under
the adverse development cover. At September 30, 2009, we had access to
approximately $3.8 million under the collateralized reinsurance trust in the
event that LMC fails to satisfy its obligations under the adverse development
cover.





Underwriting, Acquisition and
Insurance Expenses.  Underwriting expenses totaled $18.2
million for the three months ended September 30, 2009, compared to $17.4 million
for the same period in 2008, representing an increase of $0.8 million, or
4.6%.  For the nine months ended September 30, 2009, underwriting
expenses totaled $54.0 million, an increase of $3.3 million, or 6.6%, from $50.7
million in the same period of 2008.  Our net underwriting expense
ratio, which is calculated by dividing underwriting, acquisition and insurance
expenses less other service income by premiums earned, for the three months
ended September 30, 2009 was 28.1%, compared to 25.1% for the same period in
2008.  For the nine months ended September 30, 2009, our net
underwriting expense ratio was 29.5%, compared to 27.9% in the same period of
2008. The increase in the expense ratio for the three month and  nine
month periods ended September 30, 2009 was primarily the result of increased
staffing costs and other premium production related expenses as we invest in the
geographic expansion and development of our business, and lower-than-expected
earned premiums when compared to the increase in gross premiums written,
primarily as a result of the impact of the continuing economic recession on
covered payrolls, and adjustments related to retrospectively rated
policies.





Underwriting
expenses for the nine months ended September 30, 2009 include a non-recurring
net reduction of $0.7 million in our accruals to reflect a periodic true-up of
rates for taxes, licenses and fees by the states in which we operate. Backing
those amounts out, our expense ratio for the nine months ended September 30,
2009 would have been approximately 29.2%.  Included in underwriting
expenses for the nine months ended September 30, 2008 were non-recurring or
uncharacteristically high charges totaling approximately $1.9 million or
approximately 1.0 point of the underwriting expense ratio. These charges
included $1.0 million related to the accelerated vesting of stock options and
restricted stock held by Joseph De Vita, our former CFO, at the time of his
passing and approximately $0.9 million of recruitment costs that were higher
than our typical run rate.


`


Interest
Expense.  Interest expense related to the surplus notes issued
by our insurance subsidiary in May 2004 totaled $140,000 for the three months
ended September 30, 2009, compared to $205,000 for the same period in 2008,
representing a decrease of $65,000, or 31.7%. Interest expense for the nine
months ended September 30, 2009 totaled $466,000, compared to $666,000 for the
same period in 2008, representing a decrease of $200,000, or 30.0%. The surplus
notes interest rate, which is calculated at the beginning of each interest
payment period using the 3-month LIBOR rate plus 400 basis points, decreased
from 6.8% at September 30, 2008 to 4.4% at September 30, 2009.





Other
Expenses.Other expenses totaled $3.5 million for
the three months ended September 30, 2009, compared to $2.8 million for same
period in 2008, representing an increase of $0.7 million, or 26.4%.For the nine months ended September 30,
2009, other expenses totaled $10.4 million, an increase of $3.2 million, or
46.5%, from $7.1 million in the same period of 2008. Other expenses result
primarily from the operations of PointSure (including BWNV, which PointSure
acquired in July 2008), which continued to experience direct costs associated
with the expansion of insurance products they offer, and THM, which accounted
for approximately $3.4 million and $9.7 million of expenses for the three months
and nine months ended September 30, 2009, respectively, compared to $2.5 million
and $6.5 million for the same periods in 2008.


- 26
-
 Index




Income Tax Expense. The
effective tax rate for the three months ended September 30, 2009 was 25.0%,
compared to 69.8% for the same period in 2008.  For the nine months
ended September 30, 2009 our effective tax rate was 25.2% compared to 38.8% in
the same period of 2008. Our effective tax rate for the period ended September
30, 2009 was lower than the statutory tax rate of 35.0% primarily as a result of
tax exempt interest income. At September 30, 2009, approximately 52.9% of our
investment portfolio was invested in tax-exempt municipal bonds, compared to
approximately 55.3% at September 30, 2008.  Our effective tax rates
for the three and nine months periods ended September 30, 2008 were higher than
the statutory tax rate of 35.0% primarily as a result of a valuation allowance
established against our deferred tax asset.  The valuation allowance
was necessary primarily as a result of OTTI losses that we incurred in the
second and third quarters of 2008 and, to a lesser degree, incurred losses and
capital loss carry forwards.





Net Income.  Net
income was $6.7 million for the three months ended September 30, 2009, compared
to $1.8 million for the same period in 2008, representing an increase of $4.9
million, or 272.2%.  Net income for the nine months ended September
30, 2009 totaled $15.0 million, a decrease of $4.1 million, or 21.5%, from $19.1
million in the same period of 2008.  The increase in net income for
the three months ended September 30, 2009 was primarily a result of $11.5
million of OTTI losses in the three months ended September 30, 2008 offset by an
increase in loss and loss adjustment expenses in the three months ended
September 30, 2009.  The decrease in net income for the nine months
ended September 30, 2009 was primarily a result of higher loss and loss
adjustment expenses and higher other underwriting expenses in the current period
offset by $13.4 million of OTTI losses in the nine months ended September 30,
2008.





Liquidity
and Capital Resources





Our
principal sources of funds are underwriting operations, investment income and
proceeds from sales and maturities of investments. Our primary uses of funds are
to pay claims and operating expenses and to purchase investments.




Our
investment portfolio is structured so that investments mature periodically over
time in reasonable relation to current expectations of future claim payments.
Since we have a limited claims history, we have derived our expected future
claim payments from industry and predecessor trends and included a provision for
uncertainties. Our investment portfolio as of September 30, 2009 had an
effective duration of 4.68 years with individual maturities extending out to 30
years. Currently, we make claim payments from positive cash flow from operations
and invest excess cash in securities with appropriate maturity dates to balance
against anticipated future claim payments. As these securities mature, we intend
to invest any excess funds in investments with appropriate durations to match
against expected future claim payments.




At
September 30, 2009, approximately 98.3% of our investment portfolio consisted of
investment grade fixed income securities with fair values subject to
fluctuations in interest rates and other factors such as credit. The remainder
of our investment portfolio consisted of investments in equity securities, which
consist of investments in exchange-traded funds designed to correspond to the
performance of certain indexes based on domestic or international stocks. Our
investment policy allows for investment in domestic and international equities
of up to 4.0% and 1.0%, respectively, of our statutory consolidated capital and
surplus. All of the securities in our investment portfolio are accounted for as
“available for sale” securities. While we have structured our investment
portfolio to provide an appropriate matching of maturities with anticipated
claim payments, if we decide or are required in the future to sell securities in
a rising interest rate environment, we would expect to incur losses from such
sales.




We had no
direct sub-prime mortgage exposure in our investment portfolio as of September
30, 2009 and approximately $5.4 million of indirect exposure to sub-prime
mortgages. As of September 30, 2009, our portfolio included $211.5 million of
insured municipal bonds and $121.9 million of uninsured municipal
bonds.




- 27
-
 Index




The
following table provides a breakdown of ratings on the bonds in our municipal
portfolio as of September 30, 2009:




Insured
      Bonds
            
            
            Uninsured
      Bonds
            
            
            Total
      Municipal Portfolio Based OnRating
            
            
            Insured
      Ratings
            
            
            Underlying Ratings
            
            
            Ratings
            
            
            Overall
      Ratings (1)
            
            
            Underlying
      Ratings(in
      thousands)AAA
            
            
            $
            11,562
            
            
            $
            11,562
            
            
            $
            19,460
            
            
            $
            31,022
            
            
            $
            31,022AA+
            
            
            
            24,598
            
            
            
            13,334
            
            
            
            33,669
            
            
            
            58,267
            
            
            
            47,003AA
            
            
            
            47,985
            
            
            
            21,048
            
            
            
            23,508
            
            
            
            71,493
            
            
            
            44,556AA-
            
            
            
            47,329
            
            
            
            44,322
            
            
            
            14,083
            
            
            
            61,412
            
            
            
            58,405A+
            
            
            
            33,339
            
            
            
            50,921
            
            
            
            7,922
            
            
            
            41,261
            
            
            
            58,843A
            
            
            
            13,971
            
            
            
            26,628
            
            
            
            4,358
            
            
            
            18,329
            
            
            
            30,986A-
            
            
            
            8,171
            
            
            
            17,985
            
            
            
            525
            
            
            
            8,696
            
            
            
            18,510BBB+
            
            
            
            -
            
            
            
            -
            
            
            
            8,607
            
            
            
            8,607
            
            
            
            8,607BBB
            
            
            
            -
            
            
            
            1,155
            
            
            
            -
            
            
            
            -
            
            
            
            1,155BB-
            
            
            
            -
            
            
            
            -
            
            
            
            1,276
            
            
            
            1,276
            
            
            
            1,276Pre-refunded
      (2)
            
            
            
            23,280
            
            
            
            23,280
            
            
            
            8,468
            
            
            
            31,748
            
            
            
            31,748Not
      rated
            
            
            
            1,316
            
            
            
            1,316
            
            
            
            -
            
            
            
            1,316
            
            
            
            1,316Total
            
            
            $
            211,551
            
            
            $
            211,551
            
            
            $
            121,876
            
            
            $
            333,427
            
            
            $
            333,427


__________




(1)
            Represents
      insured ratings on insured bonds and ratings on uninsured
      bonds.




(2)
            These
      bonds have been refunded by depositing highly rated government-issued
      securities into irrevocable trust funds established for payment of
      principal and interest.




As of
September 30, 2009, we had no direct investments in any bond insurer and only
one bond insurer insured more than 10% of the municipal bond investments in our
portfolio. National Public Finance Guarantee Corporation (“National”) (formerly
MBIA) insured $99.3 million of municipal bonds we owned at September 30, 2009.
National’s ratings as of that date were Baa1 (developing outlook) by Moody’s and
A (developing outlook) by Standard & Poor’s and the average underlying
rating on those bonds was AA-/A+. We do not expect a material impact to our
investment portfolio or financial position as a result of the problems currently
facing monoline bond insurers.




Our
ability to adequately provide funds to pay claims comes from our disciplined
underwriting and pricing standards and the purchase of reinsurance to protect us
against severe claims and catastrophic events. Effective October 1, 2008 and as
renewed on October 1, 2009, our reinsurance program provides us with reinsurance
protection for each loss occurrence in excess of $0.75 million, up to $85.0
million, subject to various deductibles and exclusions as more fully described
in the reinsurance agreements. Given industry and predecessor trends, we believe
that we are sufficiently capitalized to cover our retained losses.




Our
insurance subsidiary is required by law to maintain a certain minimum level of
surplus on a statutory basis. Surplus is calculated by subtracting total
liabilities from total admitted assets. The National Association of Insurance
Commissioners has a risk-based capital standard designed to identify property
and casualty insurers that may be inadequately capitalized based on inherent
risks of each insurer’s assets and liabilities and its mix of net premiums
written. Insurers falling below a calculated threshold may be subject to varying
degrees of regulatory action. As of December 31, 2008, the last date that we
were required to update the annual risk-based capital calculation, the statutory
surplus of our insurance subsidiary was in excess of the prescribed risk-based
capital requirements that correspond to any level of regulatory
action.




SIH is a
holding company with minimal unconsolidated revenue. Currently, there are no
plans to have SBIC or other subsidiaries pay a dividend to SIH.




Our
unaudited condensed consolidated net cash provided by operating activities for
the nine months ended September 30, 2009 was $60.5 million, compared to our cash
flow from operations of $48.1 million for the same period in 2008. The increase
is mainly attributable to a decrease in paid losses and an increase in premium
collections, partially offset by a decrease in reinsurance
recovered.




- 28
-
 Index




We used
net cash of $58.9 million for investing activities in the nine months ended
September 30, 2009, compared to $52.0 million for the same period in 2008
primarily driven by higher net investment purchase activity (purchases, net of
sales and maturities) partially offset by a reduction in purchases of property
and equipment.




For the
nine months ended September 30, 2009, financing activities used a total of $0.4
million due to the surrender of stock to cover tax withholding obligations
associated with the vesting of restricted stock, compared to $1.1 million of
cash provided in the same period in 2008 in connection with the exercise of
stock options and grant of restricted stock.




Contractual
Obligations and Commitments




The
following table identifies our contractual obligations by payment due period as
of September 30, 2009:




Payments Due by PeriodTotal
            
            
            Less
      than 1 Year
            
            
            1-3 Years
            
            
            3-5 Years
            
            
            More
      than 5 Years(in
      thousands)Long
      term debt obligations:Surplus
      notes
            
            $
            12,000
            
            
            $
            -
            
            
            $
            -
            
            
            $
            -
            
            
            $
            12,000Loss
      and loss adjustment expenses
            
            
            334,644
            
            
            
            110,432
            
            
            
            144,232
            
            
            
            30,787
            
            
            
            49,193Operating
      lease obligations
            
            
            18,051
            
            
            
            2,898
            
            
            
            6,119
            
            
            
            5,041
            
            
            
            3,993Total
            
            $
            364,695
            
            
            $
            113,330
            
            
            $
            150,351
            
            
            $
            35,828
            
            
            $
            65,186




The loss
and loss adjustment expense payments due by period in the table above are based
upon the loss and loss adjustment expense estimates as of September 30, 2009 and
actuarial estimates of expected payout patterns and are not contractual
liabilities as to time certain. Our contractual liability is to provide benefits
under the policies we write. As a result, our calculation of loss and loss
adjustment expense payments due by period is subject to the same uncertainties
associated with determining the level of unpaid loss and loss adjustment
expenses generally and to the additional uncertainties arising from the
difficulty of predicting when claims (including claims that have not yet been
reported to us) will be paid. For a discussion of our unpaid loss and loss
adjustment expense process, see the heading “Critical Accounting Policies,
Estimates and Judgments – Unpaid Loss and Loss Adjustment Expenses” in this Part
I, Item 2 of this quarterly report. Actual payments of loss and loss adjustment
expenses by period will vary, perhaps materially, from the above table to the
extent that current estimates of loss and loss adjustment expenses vary from
actual ultimate claims amounts and as a result of variations between expected
and actual payout patterns.




Off-Balance
Sheet Arrangements




As of
September 30, 2009, we had no off-balance sheet arrangements that have or are
reasonably likely to have a material current or future effect on our financial
condition, changes in financial condition, revenues or expenses, results of
operations, liquidity, capital expenditures or capital resources.




Critical
Accounting Policies, Estimates and Judgments




It is
important to understand our accounting policies in order to understand our
unaudited condensed consolidated financial statements. We consider some of these
policies to be critical to the presentation of our financial results, since they
require management to make estimates and assumptions. These estimates and
assumptions affect the reported amounts of assets, liabilities, revenues,
expenses and related disclosures at the financial reporting date and throughout
the period being reported upon. Some of the estimates result from judgments that
can be subjective and complex, and consequently, actual results reflected in
future periods might differ from these estimates.




The most
critical accounting policies involve the reporting of unpaid loss and loss
adjustment expenses, including losses that have occurred but were not reported
to us by the financial reporting date; the amount and recoverability of
reinsurance recoverable balances; deferred policy acquisition costs; income
taxes; the impairment of investment securities; earned but unbilled premiums;
and retrospective premiums. The following should be read in conjunction with the
notes to our unaudited condensed consolidated financial statements.




Unpaid
Loss and Loss Adjustment Expenses




Unpaid
loss and loss adjustment expenses represent our estimate of the expected cost of
the ultimate settlement and administration of losses, based on known facts and
circumstances. Included in unpaid loss and loss adjustment expenses are amounts
for case-based insurance liabilities, including estimates of future developments
on these claims; claims incurred but not yet reported to us; second injury fund
expenses; allocated claim adjustment expenses; and unallocated claim adjustment
expenses. We use actuarial methodologies to assist us in establishing these
estimates, including judgments relative to estimates of future claims severity
and frequency, length of time to achieve ultimate resolution, judicial theories
of liability and other third-party factors that are often beyond our control.
Due to the inherent uncertainty associated with the cost of unsettled and
unreported claims, the ultimate liability may differ from the original
estimates. These estimates are regularly reviewed and updated and any resulting
adjustments are included in the current period’s operating results.




- 29
-
 Index




Following
is a summary of the gross loss and loss adjustment expense reserves by line of
business as of September 30, 2009 and December 31, 2008. The workers’
compensation line of business comprises over 98% of our total loss reserves as
of both dates.




As of September 30,
    2009
            
            
            As of December 31,
2008Line of Business
            
            Case
            
            
            IBNR
            
            
            Total
            
            
            Case
            
            
            IBNR
            
            
            Total(in
      thousands)Workers’
      Compensation
            
            $
            160,804
            
            
            $
            167,810
            
            
            $
            328,614
            
            
            $
            131,814
            
            
            $
            155,909
            
            
            $
            287,723Ocean
      Marine
            
            
            553
            
            
            
            5,205
            
            
            
            5,758
            
            
            
            1,041
            
            
            
            3,251
            
            
            
            4,292General
      Liability
            
            
            –
            
            
            
            272
            
            
            
            272
            
            
            
            –
            
            
            
            12
            
            
            
            12Total
            
            $
            161,357
            
            
            $
            173,287
            
            
            $
            334,644
            
            
            $
            132,855
            
            
            $
            159,172
            
            
            $
            292,027





Actuarial Loss Reserve
Estimation Methods




We use a
variety of actuarial methodologies to assist us in establishing the reserve for
unpaid loss and loss adjustment expense. We also make judgments relative to
estimates of future claims severity and frequency, length of time to achieve
ultimate resolution, judicial theories of liability and other third-party
factors that are often beyond our control.





For the
current accident year, we establish the initial reserve for claims
incurred-but-not-reported (“IBNR”) using an expected loss ratio (“ELR”) method.
The ELR method is based on an analysis of historical loss ratios adjusted for
current pricing levels, exposure growth, anticipated trends in claim frequency
and severity, the impact of reform activity and any other factors that may have
an impact on the loss ratio. The actual paid and incurred loss data for the
accident year is reviewed each quarter and changes to the ELR may be made based
on the emerging data, although changes are typically not made until the end of
the accident year when the loss data can be analyzed as a complete accident
year. The ELR is multiplied by the year-to-date earned premium to determine the
ultimate losses for the current accident year. The actual paid and case
outstanding losses are subtracted from the ultimate losses to determine the IBNR
for the accident year. As the accident year matures, we incorporate a standard
actuarial reserving methodology referred to as the Bornhuetter-Ferguson method.
This method blends the loss development and expected loss ratio methods by
assigning partial weight to the initial expected losses, calculated from the
expected loss ratio method, with the remaining weight applied to the actual
losses, either paid or incurred. The weights assigned to the initial expected
losses decrease as the accident year matures. A reserve estimate implies a
pattern of expected loss emergence. If this emergence does not occur as
expected, it may cause us to revisit our previous assumptions. We may adjust
loss development patterns, the various method weights or the expected loss
ratios used in our analysis. Management employs judgment in each reserve
valuation as to how to make these adjustments to reflect current
information.





For all
other accident years, the estimated ultimate losses are developed using a
variety of actuarial techniques as described below. In reviewing this
information, we consider the following factors to be especially important at
this time because they increase the variability risk factors in our loss reserve
estimates:




·
            We
      wrote our first policy on October 1, 2003 and, as a result, our total
      reserve portfolio is relatively immature when compared to other industry
      data.




·
            We
      have been growing consistently since we began operations and have entered
      into several new states that are not included in our predecessor’s
      historical data.




·
            At
      September 30, 2009, approximately $128.7 million, or 46.1%, of our direct
      loss reserves were related to business written in
      California.  Over the last several years, three significant
      comprehensive legislative reforms were enacted in California: AB 749 was
      enacted in February, 2002; AB 227 and SB 228 were enacted in September,
      2003; and SB 899 was enacted in April, 2004.  This reform
      activity has resulted in uncertainty regarding the impact of the reforms
      on loss payments, loss development and, ultimately, loss
      reserves.  All four bills enacted structural changes to the
      benefit delivery system in California, in addition to changes in the
      indemnity and medical benefits afforded injured workers.  In
      response to the reform legislation and a continuing drop in the frequency
      of workers’ compensation claims, the pure premium rates approved by the
      California Insurance Commissioner effective January 1, 2009 were 63.4%
      lower than the pure premium rates in effect as of July 1,
      2003.  More recent data has indicated the need for an increase
      in rates in California.  SeaBright filed for a 10.6% rate
      increase to be effective August 1, 2009 which was approved by the
      California Insurance
Department.


- 30
-
 Index




Key
elements of the reforms as they relate to indemnity and medical benefits were as
follows:




Indemnity
Benefits




AB 749
significantly increased most classes of workers’ compensation indemnity benefits
over a four-year period beginning in 2003.




AB 227
and SB 228 repealed the mandatory vocational rehabilitation benefits and
replaced them with a system of non-transferable education vouchers.




SB 899
required the Division of Workers’ Compensation (“DWC”) Administrative Director
to adopt, on or before January 1, 2005, a new permanent disability rating
schedule (“PDRS”) based in part on American Medical Association guidelines.
Also, temporary disability was limited to a duration of two years. SB 899 also
provided that, effective April 19, 2004, apportionment of disability for
purposes of permanent disability determination must be based on
causation.




Medical
Benefits




AB 749
repealed the presumption given to the primary treating physician (except when
the worker has pre-designated a personal physician), effective for injuries
occurring on or after January 1, 2003. (SB 228 and SB 899 later extended this to
all future medical treatment on earlier injuries.)




SB 228
required the DWC Administrative Director to establish, by December 1, 2004, an
Official Medical Treatment Utilization Schedule meeting specific criteria. SB
228 also provided that beginning three months after the publication date of the
updated American College of Occupational and Environmental Medical (“ACOEM”)
Practice Guidelines and continuing until such time as the DWC Administrative
Director establishes an Official Medical Treatment Utilization Schedule, the
ACOEM standards will be presumed to be correct regarding the extent and scope of
all medical treatment. The DWC Administrative Director has subsequently adopted
the ACOEM Guidelines as the Official Medical Treatment Utilization
Schedule.




SB 228
limited the number of chiropractic visits and the number of physical therapy
visits to 24 each per claim.




SB 228
established a prescription medication fee schedule set at 100% of Medi-Cal
Schedule amounts.




SB 228
provided that the maximum facility fee for services performed in an ambulatory
surgical center may not exceed 120% of the Medicare fees for the same service
performed in a hospital outpatient facility.




SB 899
provided that after January 1, 2005, an employer or insurer may establish
medical provider networks meeting certain conditions and, with limited
exceptions, medical treatment can be provided within those
networks.




These
reforms are a source of variability in the reserve estimates as legislative
changes affecting benefit levels not only impact the cost of benefits but also
the rate at which accident year benefits or losses develop over
time.  Ongoing efforts by some system stakeholders to challenge the
reforms, either through legislative, administrative or judicial means, further
adds to the variability.





In the
last three years there have been ongoing challenges to the PDRS, one of the most
significant reforms to emerge from the 2004-2005 legislation.
The  PDRS was  revised effective January 1,
2005.  The revised  schedule  has resulted
in  significantly reduced permanent disability  awards,
leading to concerns  that  injured workers  may
not be  adequately compensated  for their work related
permanent injuries.


- 31
-
 Index




In
February of 2009 the California Workers’ Compensation Appeals Board rendered an
en banc decision on a
series of cases, commonly referred to as Almarez, Guzman and Ogilvie, that could
have a material impact by increasing the value of permanent disability
awards.  The en
banc decision led to considerable comment and debate in the Workers’
Compensation community. Given this, the Appeals Board subsequently granted a
petition for reconsideration on the subject cases, allowing interested parties
until May 1, 2009 to provide input via an amicus curiae
brief.  In
September of 2009, the Appeals Board reaffirmed most aspects of its prior work,
with some clarifications to its February decision.  While its decision
is considered final, several aspects are likely to still be determined by case
law and through appeal.  However, it could take two to three years
before review by higher courts is complete.





Workers’
compensation is considered a long-tail line of business, as it takes a
relatively long period of time to finalize claims from a given accident year.
Management believes that it generally takes workers’ compensation losses
approximately 48 to 60 months after the start of an accident year until the data
is viewed as fully credible for paid and incurred reserve evaluation methods.
Workers’ compensation losses can continue to develop beyond 60 months and in
some cases claims can remain open more than 20 years. As indicated above, we
wrote our first policy on October 1, 2003 so our first complete accident year is
2004. As of September 30, 2009, accident year 2004 was 69 months developed,
accident year 2005 was 57 months developed, accident year 2006 was 45 months
developed, accident year 2007 was 33 months developed, and accident year 2008
was 21 months developed. Our loss reserve estimates are subject to considerable
variation due to the relative immaturity of the accident years from a
development standpoint.




We review
the following significant components of loss reserves on a quarterly
basis:




·
            IBNR
      reserves for losses – This includes amounts for the medical and indemnity
      components of the workers’ compensation claim payments, net of subrogation
      recoveries and deductibles;




·
            IBNR
      reserves for defense and cost containment expenses (“DCC”, also referred
      to as allocated loss adjustment expenses (“ALAE”)), net of subrogation
      recoveries and deductibles;




·
            reserve
      for adjusting and other expenses, also known as unallocated loss
      adjustment expenses (“ULAE”); and




·
            reserve
      for loss based assessments, also referred to as the “8F reserve” in
      reference to Section 8, Compensation for Disability, subsection (f),
      Injury increasing disability, of the United States Longshore and Harbor
      Workers’ Compensation Act (“USL&H”)
Act.




The
reserves for losses and DCC are also reviewed gross and net of reinsurance
(referred to as “net”). For gross losses, the claims for the Washington
USL&H Plan, the KEIC claims assumed in the Acquisition and claims assumed
from the NCCI residual market pools are excluded from this
discussion.




IBNR
reserves include a provision for future development on known claims, a reopened
claims reserve, a provision for claims incurred but not reported and a provision
for claims in transit (incurred and reported but not recorded).




Our
analysis is done separately for the indemnity, medical and DCC components of the
total loss reserves within each accident year. In addition, the analysis is
completed separately for the following three categories: California State Act;
State Act excluding California; and USL&H. The business is divided into
these three categories for the determination of ultimate losses due to
differences in the laws that cover each of these categories.




Workers’
compensation insurance is statutorily provided for in all of the states in which
we do business. State laws and regulations provide for the form and content of
policy coverage and the rights and benefits that are available to injured
workers, their representatives and medical providers. Because the benefits are
established by state statute there can be significant variation in these
benefits by state. We refer to this coverage as State Act.




Our
business is also affected by federal laws including the USL&H Act, which is
administered by the Department of Labor, and the Merchant Marine Act of 1920, or
Jones Act. The USL&H Act contains various provisions affecting our business,
including the nature of the liability of employers of longshoremen, the rate of
compensation to an injured longshoreman, the selection of physicians,
compensation for disability and death and the filing of claims. We refer to the
business covered under the USL&H Act and the Jones Act as USL&H
business.




- 32
-
 Index




Because
there are different laws and benefit levels that affect the State Act versus
USL&H business, there is a strong likelihood that these categories will
exhibit different loss development characteristics which will influence the
ultimate loss calculations. Separating the data into the State Act and USL&H
categories allows us to use actuarial methods that contemplate these
differences.




The State
Act category is further split into California and non-California groupings. This
is due to the extensive reform activity that has taken place in California as
discussed above. Since the California data is subject to additional variation
due to the reform activity, separating the data in this fashion allows us to
review the non-California State Act data with no impact from the California
reform activity.




Development
factors, expected loss rates and expected loss ratios are derived from the
combined experience of us and our predecessor in addition to relevant industry
data.




Gross
ultimate loss (indemnity, medical and ALAE separately) for each category is
estimated using the following actuarial methods:




·
            paid
      loss (or ALAE) development;




·
            incurred
      loss (or ALAE) development;




·
            Bornhuetter-Ferguson
      using ultimate premiums and paid loss (or ALAE);
  and




·
            Bornhuetter-Ferguson
      using ultimate premiums and incurred loss (or
  ALAE).




A gross
ultimate value is selected by reviewing the various ultimate estimates and
applying actuarial judgment to achieve a reasonable point estimate of the
ultimate liability. The gross IBNR reserve equals the selected gross ultimate
loss minus the gross paid losses and gross case reserves as of the valuation
date. The selected gross ultimate loss and ALAE are reviewed and updated on a
quarterly basis.




Variation in Ultimate Loss
Estimates




In light
of our short operating history and uncertainties concerning the effects of
legislative reforms, specifically as they relate to our California workers’
compensation experience, the actuarial techniques discussed above use the
historical experience of our predecessor as well as industry information in the
analysis of loss reserves. We are able to effectively draw on the historical
experience of our predecessor because most of the current members of our
management and adjusting staff also served as the management and adjusting staff
of our predecessor. Over time, as we have added to our operating history, we
have placed more reliance on our own developed loss experience and less on our
predecessor’s and industry experience.




These
techniques recognize, among other factors:




·
            our
      claims experience and that of our
predecessor;




·
            the
      industry’s claim experience;




·
            historical
      trends in reserving patterns and loss
payments;




·
            the
      impact of claim inflation and/or
deflation;




·
            the
      pending level of unpaid claims;




·
            the
      cost of claim settlements;




·
            legislative
      reforms affecting workers’ compensation, including
  pricing;




·
            the
      overall environment in which insurance companies operate;
    and




·
            trends
      in claim frequency and severity.




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 Index




In
addition, there are loss and loss adjustment expense risk factors that affect
workers’ compensation claims that can change over time and also cause our loss
reserves to fluctuate. Some examples of these risk factors include, but are not
limited to, the following:




·
            recovery
      time from the injury;




·
            degree
      of patient responsiveness to
treatment;




·
            use
      of pharmaceutical drugs;




·
            type
      and effectiveness of medical
treatments;




·
            frequency
      of visits to healthcare providers;




·
            changes
      in costs of medical treatments;




·
            availability
      of new medical treatments and
equipment;




·
            types
      of healthcare providers used;




·
            availability
      of light duty for early return to
work;




·
            attorney
      involvement;




·
            wage
      inflation in states that index benefits;
and




·
            changes
      in administrative policies of second injury
  funds.




Variation
can also occur in the loss reserves due to factors that affect our book of
business in general.  Some examples of these risk factors include, but
are not limited to, the following:




·
            injury
      type mix;




·
            change
      in mix of business by state;




·
            change
      in mix of business by employer
type;




·
            small
      volume of internal data; and




·
            significant
      exposure growth over recent data
periods.




Impact of Changes in Key
Assumptions on Reserve Volatility




The most
significant factor currently impacting our loss reserve estimates is the
reliance on historical reserving patterns and loss payments from our predecessor
and the industry, also referred to as loss development. This is due to our
limited operating history as discussed above. The actuarial methods that we use
depend at varying levels on loss development patterns based on past information.
Development is defined as the difference, on successive valuation dates, between
observed values of certain fundamental quantities that may be used in the loss
reserve estimation process. For example, the data may be paid losses, case
incurred losses and the change in case reserves or claim counts, including
reported claims, closed claims or reopened claims. Development can be expected,
meaning it is consistent with prior results; favorable (better than expected);
or unfavorable (worse than expected). In all cases, we are comparing the actual
development of the data in the current valuation with what was expected based on
the historical patterns in the underlying data. Favorable development indicates
a basis for reducing the estimated ultimate loss amounts while unfavorable
development indicates a basis for increasing the estimated ultimate loss
amounts. We reflect the favorable or unfavorable development in loss reserves in
the results of operations in the period in which the ultimate loss estimates are
changed.




Estimating
loss reserves is an uncertain and complex process which involves actuarial
techniques and management judgment. Actuarial analysis generally assumes that
past patterns demonstrated in the data will repeat themselves and that the data
provides a basis for estimating future loss reserves.  However, since
conditions and trends that have affected losses in the past may not occur in the
future in the same manner, if at all, future results may not be reliably
predicted by the prior data. Due to the relative immaturity of our book of
business, the challenge has been to give the right weight in the ultimate loss
estimation process to the new data as it becomes available. As discussed above,
management believes that it generally takes workers’ compensation losses
approximately 48 to 60 months after the start of an accident year until the data
is viewed as fully credible for paid and incurred reserve evaluation methods.
Due to our limited operating history, we have five complete accident years that
were developed 69 months, 57 months, 45 months, 33 months and 21 months (2004,
2005, 2006, 2007 and 2008, respectively) at September 30,
2009.   At September 30, 2009, the analysis for accident years
2003 through 2008 utilizes a Bornhuetter-Ferguson approach, which blends the
loss development and expected loss ratio methods, in addition to the paid and
incurred loss development
methods.    For  accident years 2003 through 2008,
the actuarial analysis did show some movement, both upward and downward, when
compared to the prior actuarial estimates at June 30, 2009.   For
accident years 2003 through 2006, the movement was minimal and resulted in a net
decrease of our net ultimate loss estimates of $0.3 million for the quarter
ended September 30, 2009.




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-
 Index




For
accident year 2007, there was unfavorable development in the gross losses for
California State Act which resulted in an increase of our net ultimate loss
estimates of $0.3 million.   For non-California State Act, there
was unfavorable development in the gross losses for accident year 2007 which
resulted in an increase of our net ultimate loss estimates of $0.7
million.   For USL&H, there was unfavorable development in
the gross losses for accident year 2007 which resulted in an increase of our
ultimate loss estimates of $1.4 million.  For California State Act and
USL&H, we placed more reliance on the most recent data points in our loss
development selections than in the prior quarter.   As with the
prior quarter, we did not completely rely on the most recent data points in our
loss development selections.   We believe that our loss
development factor selections are appropriate given the maturity level of our
data. Over time, as the data for these accident years mature and uncertainty
surrounding the ultimate outcome of the claim costs diminish, the full impact of
the actual loss development will be factored into our assumptions and
selections.




Reserve
Sensitivities




Although
many factors influence the actual cost of claims and the corresponding unpaid
loss and loss adjustment expense estimates, we do not measure and estimate
values for all of these variables individually. This is due to the fact that
many of the factors that are known to impact the cost of claims cannot be
measured directly. This is the case for the impact of economic inflation on
claim costs, coverage interpretations and jury determinations. In most
instances, we rely on historical experience or industry information to estimate
values for the variables that are explicitly used in the unpaid loss and loss
adjustment expense analysis. We assume that the historical effect of these
unmeasured factors, which is embedded in our experience or industry experience,
is representative of future effects of these factors. It is important to note
that actual claims costs will vary from our estimate of ultimate claim costs,
perhaps by substantial amounts, due to the inherent variability of the business
written, the potentially significant claim settlement lags and the fact that not
all events affecting future claim costs can be estimated.




As
discussed in the previous section, there are a number of variables that can
impact, individually or in combination, the adequacy of our loss and loss
adjustment expense liabilities. While the actuarial methods employed factor in
amounts for these circumstances, the loss reserves may prove to be inadequate
despite the actuarial methods used. Several examples are provided below to
highlight the potential variability present in our loss reserves. Each of these
examples represents scenarios that are reasonably likely to occur over time. For
example, there may be a number of claims where the unpaid loss and loss
adjustment expense associated with future medical treatment proves to be
inadequate because the injured workers do not respond to medical treatment as
expected by the claims examiner. If we assume this affects 10% of the open
claims and, on average, the unpaid loss and loss adjustment expenses on these
claims are 20% inadequate, this would result in our unpaid loss and loss
adjustment expense liability being inadequate by approximately $6.7 million, or
2.0%, as of September 30, 2009. Another example is claim inflation. Claim
inflation can result from medical cost inflation or wage inflation. As discussed
above, the actuarial methods employed include an amount for claim inflation
based on historical experience. We assume that the historical effect of this
factor, which is embedded in our experience and industry experience, is
representative of future effects for claim inflation. To the extent that the
historical factors, and the actuarial methods utilized, are inadequate to
recognize future inflationary trends, our unpaid loss and loss adjustment
expense liabilities may be inadequate. If our estimate of future medical trend
is two percentage points inadequate (e.g., if we estimate a 9% annual trend and
the actual trend is 11%), our unpaid loss and loss adjustment expense liability
could be inadequate. The amount of the inadequacy would depend on the mix of
medical and indemnity payments and the length of time until the claims are paid.
For example, if we assume that 50% of the unpaid loss and loss adjustment
expense is associated with medical payments and an average payout period of 5
years, our unpaid loss and loss adjustment expense liabilities would be
inadequate by approximately $16.7 million on a pre-tax basis, or 5.0%, as of
September 30, 2009. Under these assumptions, the inadequacy of approximately
$16.7 million represents approximately 4.6% of total stockholders’ equity at
September 30, 2009. The impact of any reserve deficiencies, or redundancies, on
our reported results and future earnings is discussed below.




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 Index




In the
event that our estimates of ultimate unpaid loss and loss adjustment expense
liabilities prove to be greater or less than the ultimate liability, our future
earnings and financial position could be positively or negatively impacted.
Future earnings would be reduced by the amount of any deficiencies in the
year(s) in which the claims are paid or the unpaid loss and loss adjustment
expense liabilities are increased. For example, if we determined our unpaid loss
and loss adjustment expense liability of $334.7 million as of September 30, 2009
to be 5.0% inadequate, we would experience a pre-tax reduction in future
earnings of approximately $16.7 million. This reduction could be realized in one
year or multiple years, depending on when the deficiency is identified. The
deficiency, after tax effects, would also impact our financial position because
our statutory surplus would be reduced by an amount equivalent to the reduction
in net income. Any deficiency is typically recognized in the unpaid loss and
loss adjustment expense liability and, accordingly, it typically does not have a
material effect on our liquidity because the claims have not been paid. Since
the claims will typically be paid out over a multi-year period, we have
generally been able to adjust our investments to match the anticipated future
claim payments. Conversely, if our estimates of ultimate unpaid loss and loss
adjustment expense liabilities prove to be redundant, our future earnings and
financial position would be improved.




Reinsurance
Recoverables




Reinsurance
recoverables on paid and unpaid losses represent the portion of the loss and
loss adjustment expenses that is assumed by reinsurers. These recoverables are
reported on our balance sheet separately as assets, as reinsurance does not
relieve us of our legal liability to policyholders and ceding companies. We are
required to pay losses even if a reinsurer fails to meet its obligations under
the applicable reinsurance agreement. Reinsurance recoverables are determined
based in part on the terms and conditions of reinsurance contracts, which could
be subject to interpretations that differ from ours based on judicial theories
of liability. We calculate amounts recoverable from reinsurers based on our
estimates of the underlying loss and loss adjustment expenses, which themselves
are subject to significant judgments and uncertainties described above under the
heading “Unpaid Loss and Loss Adjustment Expenses.” Changes in the estimates and
assumptions underlying the calculation of our loss reserves may have an impact
on the balance of our reinsurance recoverables. In general, one would expect an
increase in our underlying loss reserves on claims subject to reinsurance to
have an upward impact on our reinsurance recoverables. The amount of the impact
on reinsurance recoverables would depend on a number of considerations
including, but not limited to, the terms and attachment points of our
reinsurance contracts and the incurred amount on various claims subject to
reinsurance. We also bear credit risk with respect to our reinsurers, which can
be significant considering that some claims may remain open for an extended
period of time.





We
periodically evaluate our reinsurance recoverables, including the financial
ratings of our reinsurers, and revise our estimates of such amounts as
conditions and circumstances change. Changes in reinsurance recoverables are
recorded in the period in which the estimate is revised. As of September 30,
2009 and December 31, 2008, we had no reserve for uncollectible reinsurance
recoverables. We assessed the collectability of our period-end receivables and
believe that all amounts are collectible based on currently available
information. As of September 30, 2009, nine of the top ten companies from which
we had reinsurance amounts recoverable had A.M. Best ratings of “A–” or higher.
The tenth company is not rated by A.M. Best.




Deferred
Policy Acquisition Costs




We defer
commissions, premium taxes and certain other costs that vary with and are
primarily related to the acquisition of insurance contracts. These costs are
capitalized and charged to expense in proportion to the recognition of premiums
earned. The method followed in computing deferred policy acquisition costs
limits the amount of these deferred costs to their estimated realizable value,
which gives effect to the premium to be earned, related estimated investment
income, anticipated losses and settlement expenses and certain other costs we
expect to incur as the premium is earned. Judgments regarding the ultimate
recoverability of these deferred costs are highly dependent upon the estimated
future costs associated with our unearned premiums. If our expected claims and
expenses, after considering investment income, exceed our unearned premiums, we
would be required to write-off all or a portion of deferred policy acquisition
costs. To date, we have not needed to write-off all or a portion of our deferred
acquisition costs. If our estimate of anticipated losses and related costs was
10% inadequate, our deferred acquisition costs as of September 30, 2009 would
still be fully recoverable and no write-off would be necessary. We will continue
to monitor the balance of deferred acquisition costs for
recoverability.




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 Index




Income
Taxes




We use
the asset and liability method of accounting for income taxes. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carry-forwards. Deferred tax assets and
liabilities are measured using tax rates expected to apply to taxable income in
the years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in the statement of operations in the period that includes
the enactment date.




In
assessing the realizability of deferred tax assets, management considers whether
it is more likely than not that some portion or all of the deferred tax assets
will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. This analysis requires
management to make various estimates and assumptions, including the scheduled
reversal of deferred tax liabilities, the consideration of operating versus
capital items, projected future taxable income and the effect of tax planning
strategies. If actual results differ from management’s estimates and
assumptions, we may be required to establish a valuation allowance to reduce the
deferred tax assets to the amounts more likely than not to be realized. The
establishment of a valuation allowance could have a significant impact on our
financial position and results of operations in the period in which it is deemed
necessary. As of September 30, 2009, no valuation allowance was
recorded.  We established a valuation allowance of
approximately  $2.0 million at December 31, 2008 (of which $976,000
was recorded in tax expense and $1.0 million was recorded in accumulated other
comprehensive income) and reversed the $2.0 million allowance through
accumulated other comprehensive income in 2009.




The
Company applies a recognition threshold and measurement process for financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return, and also provides guidance on the derecognition of
previously recorded benefits and their classification, as well as the proper
recording of interest and penalties, accounting in interim periods, disclosures
and transition. As of September 30, 2009 and December 31, 2008, we had no
unrecognized tax benefits. We do not anticipate that the amount of unrecognized
tax benefits will significantly increase in the next 12 months. Our policy is to
recognize interest and penalties on unrecognized tax benefits as an element of
income tax expense (benefit) in our consolidated statements of operations. We
file consolidated U.S. federal and state income tax returns. The tax years which
remain subject to examination by the taxing authorities are the years ended
December 31, 2006, 2007 and 2008.




Impairment
of Investment Securities




Impairment
of investment securities results in a charge to operations when the fair value
of a security declines below our cost and is deemed to be other-than-temporary.
We regularly review our investment portfolio to evaluate the necessity of
recording impairment losses for other-than-temporary declines in the fair value
of investments. A number of criteria are considered during this process,
including but not limited to the following: the current fair value as compared
to amortized cost or cost, as appropriate, of the security; the length of time
the security’s fair value has been below amortized cost; the likelihood that we
will be required to sell the security before recovery of its cost basis;
objective information supporting recovery in a reasonable period of time;
specific credit issues related to the issuer; and current economic conditions,
including interest rates.




We
regularly review our investment portfolio for declines in value. In general, we
review all securities that are impaired by 5% or more at the end of the period.
We focus our review of securities with no stated maturity date on securities
that were impaired by 20% or more at the end of the period or have been impaired
10% or more continuously for six months or longer as of the end of the period.
We also analyze the entire portfolio for other factors that might indicate a
risk of impairment, including credit ratings and interest rates. It is possible
that we could recognize future impairment losses on some securities we owned at
September 30, 2009 if future events, information and the passage of time result
in a determination that a decline in value is other-than-temporary.





Please
refer to the tables in Note 3 of the unaudited condensed consolidated financial
statements in Part I, Item 1 of this quarterly report for additional information
on unrealized losses on our investment securities. Please refer to Part I, Item
3 of this quarterly report for tables showing the sensitivity of the fair value
of our fixed-income investments to selected hypothetical changes in interest
rates.




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 Index




Earned
But Unbilled Premiums




Shortly
following the expiration of an insurance policy, we perform a final payroll
audit of each insured party to determine the final premium to be billed and
earned. These final audits generally result in an audit adjustment, either
increasing or decreasing the estimated premium earned and billed to date. We
estimate the amount of premiums that have been earned but are unbilled at the
end of a reporting period by analyzing historical earned premium adjustments
made at final audit for the preceding 12 month period, applying the average
adjustment percentage against our in-force earned premium for the period. These
estimates are subject to changes in policyholders’ payrolls due to growth,
economic conditions, seasonality and other factors and to fluctuations in our
in-force premium. For example, the amount of our accrual for premiums earned but
unbilled fluctuated between ($611,000) and $182,000 in 2008 and between zero and
$1.2 million in 2007. The balance of our accrual for premiums earned but
unbilled was $(497,000) and ($611,000) at September 30, 2009 and December 31,
2008, respectively. Although considerable variability is inherent in such
estimates, management believes that the accrual for earned but unbilled premiums
is reasonable. The estimates are reviewed quarterly and adjusted as necessary as
experience develops or new information becomes known. Any such adjustments are
included in current operations.





Retrospective
Premiums




The
premiums for our retrospectively rated loss sensitive plans are reflective of
the customer’s loss experience because, beginning six months after the
expiration of the relevant insurance policy, and annually thereafter, we
recalculate the premium payable during the policy term based on the current
value of the known losses that occurred during the policy term. While the
typical retrospectively rated policy has around five annual adjustment or
measurement periods, premium adjustments continue until mutual agreement to
cease future adjustments is reached with the policyholder. Retrospective
premiums for primary and reinsured risks are included in income as earned on a
pro rata basis over the effective period of the respective policies. Earned
premiums on retrospectively rated policies are based on our estimate of loss
experience as of the measurement date. Unearned premiums are deferred and
include that portion of premiums written that is applicable to the unexpired
period of the policies in force and estimated adjustments of premiums on
policies that have retrospective rating endorsements.





We bear
credit risk with respect to retrospectively rated policies. Because of the long
duration of our loss sensitive plans, there is a risk that the customer will
fail to pay the additional premium. Accordingly, we obtain collateral in the
form of letters of credit or deposits to mitigate credit risk associated with
our loss sensitive plans. If we are unable to collect future retrospective
premium adjustments from an insured, we would be required to write-off the
related amounts, which could impact our financial position and results of
operations. To date, there have been no such
write-offs.  Retrospectively rated policies accounted for
approximately 6.8% and 15.0% of direct premiums written in the three month
periods ended September 30, 2009 and 2008, respectively, and 7.5% and 13.9% of
direct premiums written in the nine month periods then ended,
respectively.




Recent
Accounting Pronouncements




In June
2009, the Financial Accounting Standards Board (“FASB”) issued FASB Statement of
Financial Accounting Standards (“SFAS”) No. 168, The FASB Accounting Standards
Codification and the
Hierarchy of Generally Accepted Accounting Principles(“SFAS
168”).  SFAS 168 identifies the sources of accounting principles and
the framework for selecting the principles used in preparing the financial
statements of nongovernmental entities that are presented in conformity with
U.S. generally accepted accounting principles (“GAAP”).  SFAS 168
further identifies the FASB Accounting Standards Codification (“the
Codification”) as the source of authoritative GAAP recognized by the FASB to be
applied by nongovernmental entities. The Codification does not change existing
U.S. GAAP authoritative literature in place as of July 1,
2009.    SFAS 168 is effective for financial statements
issued for interim and annual periods ending after September 15,
2009.  We adopted SFAS 168 as of September 30, 2009 which did not have
a material effect on our consolidated financial condition or results of
operations.





In April
2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of
Other-Than-Temporary Impairments” (“FSP FAS 115-2/124-2”).  FSP
FAS 115-2/124-2 requires entities to separate an other-than-temporary impairment
of a debt security into two components when there are credit related losses
associated with the impaired debt security for which management asserts that it
does not have the intent to sell the security, and it is more likely than not
that it will not be required to sell the security before recovery of its cost
basis.  The amount of the other-than-temporary impairment related to a
credit loss is recognized in earnings, and the amount of the
other-than-temporary impairment related to other factors is recorded in other
comprehensive loss.  FSP FAS 115-2/124-2 is effective for periods
ending after June 15, 2009.  We adopted the provisions of FSP FAS
115-2/124-2 in the quarter ended June 30, 2009.  There were no
impairments previously recognized on debt securities we owned at
December  31, 2008 and therefore, there was no cumulative effect
adjustment to retained earnings and other comprehensive income (loss) as a
result of adopting this standard.  There were no impairments
recognized on debt securities in the three and nine months ended September 30,
2009 and therefore, the adoption of FSP FAS 115-2/124-2 had no effect on our
consolidated financial condition or results of operations.


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 Index




In April
2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When Volume
and Level of Activity for the Asset or Liability Have Significantly Decreased
and Identifying Transactions that are Not Orderly” (“FSP FAS
157-4”).  Under FSP FAS 157-4, if an entity determines that there has
been a significant decrease in the volume and level of activity for the asset or
the liability in relation to the normal market activity for the asset or
liability (or similar assets or liabilities), then transactions or quoted prices
may not accurately reflect fair value.  In addition, if there is
evidence that the transaction for the asset or liability is not orderly, the
entity shall place little, if any, weight on that transaction price as an
indicator of fair value. FSP FAS 157-4 is effective for periods ending after
June 15, 2009. We adopted FSP FAS 157-4 in the quarter ended June 30, 2009,
which did not have a material effect on our consolidated financial condition and
results of operations.





In April
2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value
of Financial Instruments” (“FSP FAS 107-1 and APB 28-1”).  FSP
FAS 107-1 and APB 28-1 requires disclosures about the fair value of financial
instruments in interim and annual financial statements.  FSP FAS 107-1
and APB 28-1 is effective for periods ending after June 15, 2009. We adopted FSP
FAS 107-1 and APB 28-1 in the quarter ended June 30,
2009.  Because  FSP FAS 107-1 and APB 28-1 amends only the
disclosure requirements related to the fair value of financial instruments,
adoption of FSP 107-1 and APB 28-1 did not affect our consolidated financial
condition and results of operations.





In May
2009, the FASB issued FAS No. 165, “Subsequent Events” (“FAS
165”).  FAS 165 establishes general standards of accounting for and
disclosures of events that occur after the balance sheet date but before
financial statements are issued or available to be issued.  FAS 165 is
effective for periods ending after June 15, 2009.  We adopted FAS 165
in the quarter ended June 30, 2009, which did not have a material effect on our
consolidated financial condition and results of operations.




Item 3.    Quantitative and Qualitative
Disclosures About Market Risk





In 2008
and 2009, a series of crises occurred in the U.S. financial and capital markets,
as well as in housing and global credit markets. These conditions accelerated
into a global economic recession, as evidenced by declining consumer confidence,
lower consumer spending, bankruptcies and significant job losses. The declining
economic conditions worsened over the last half of 2008 and have continued into
2009.During
this period, equity and debt markets experienced major declines in market prices
on a worldwide basis, as evidenced in small part by the $13.4 million of OTTI
losses that we recorded in the nine months ended September 30, 2008. However,
the equity and debt markets began to show improvement in mid-2009. For example,
the net unrealized gain on our investment portfolio increased from $1.4 million
at March 31, 2009 to $25.2 million at September 31, 2009. The disruptions in the
financial markets in 2008 and 2009 have resulted in a lack of liquidity within
the credit markets, which has increased credit risk in the financial markets and
resulted in the widening of credit spreads.





Our
unaudited condensed consolidated balance sheets include a substantial amount of
assets and liabilities whose fair values are subject to market risks, including
credit and interest rate risks. Market risk is the potential economic loss
principally arising from adverse changes in the fair value of financial
instruments. In 2008 and 2009, conditions in the public debt and equity markets
declined significantly, resulting in exceptional volatility in debt and equity
prices. In the nine months ended September 30, 2008, we recognized, on a pre-tax
basis, approximately $13.4 million of other-than-temporary impairment charges
related primarily to our investments in exchange-traded funds and
government-sponsored-entity preferred stock. In the nine months ended September
30, 2009 we recognized, on a pre-tax basis, approximately $0.3 million of
other-than-temporary impairment charges related to our investments in
government-sponsored-entity preferred stock.  The impact of actions
taken recently by governmental bodies in response to the current economic crisis
is difficult to predict, particularly over the short term, and we cannot predict
the timing or magnitude of a recovery. The fair value of our investment
portfolio remains subject to considerable volatility, particularly over the
short term. The following sections address the significant market risks
associated with our business activities.




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 Index




Credit
Risk




Credit
risk is the potential economic loss principally arising from adverse changes in
the financial condition of a specific debt issuer. We address this risk by
investing primarily in fixed-income securities which are rated “A” or higher by
Standard & Poor’s or another major rating agency. We also independently, and
through our outside investment managers, monitor the financial condition of all
of the issuers of fixed-income securities in our portfolio. To limit our
exposure to risk, we employ stringent diversification rules that limit the
credit exposure to any single issuer or business sector.




Interest
Rate Risk




We had
fixed-income investments with a fair value of $605.4 million at September 30,
2009 that are subject to interest rate risk, compared with $522.3 million at
December 31, 2008. We manage the exposure to interest rate risk through a
disciplined asset/liability matching and capital management process. In the
management of this risk, the characteristics of duration, credit and variability
of cash flows are critical elements. These risks are assessed regularly and
balanced within the context of the liability and capital position.




The table
below summarizes our interest rate risk as of September 30, 2009 and December
31, 2008. It illustrates the sensitivity of the fair value of fixed-income
investments to selected hypothetical changes in interest rates as of September
30, 2009 and December 31, 2008. The selected scenarios are not predictions of
future events, but rather illustrate the effect that such events may have on the
fair value of our fixed-income portfolio and shareholders’ equity.




Interest Rate Risk as of
September 30, 2009





Hypothetical Change in Interest
      Rates
            
            Estimated
      Change in Fair Value
            
            
            Fair Value
            
            
            Hypothetical
      Percentage Increase (Decrease) in Portfolio Value($
      in thousands)200
      basis point increase
            
            $
            (51,058
            )
            
            $
            554,350
            
            
            
            (8.4
            )%100
      basis point increase
            
            
            (25,152
            )
            
            
            580,256
            
            
            
            (4.2
            )%No
      change
            
            
            –
            
            
            
            605,408
            
            
            
            –100
      basis point decrease
            
            
            24,399
            
            
            
            629,807
            
            
            
            4.0
            %200
      basis point decrease
            
            
            48,045
            
            
            
            653,453
            
            
            
            7.9
            %





Interest Rate Risk as of
December 31, 2008





Hypothetical Change in Interest
      Rates
            
            Estimated
      Change in Fair Value
            
            
            Fair Value
            
            
            Hypothetical
      Percentage Increase (Decrease) in Portfolio Value($
      in thousands)200
      basis point increase
            
            $
            (39,352
            )
            
            $
            482,937
            
            
            
            (7.5
            )%100
      basis point increase
            
            
            (19,662
            )
            
            
            502,627
            
            
            
            (3.8
            )%No
      change
            
            
            –
            
            
            
            522,289
            
            
            
            –100
      basis point decrease
            
            
            19,635
            
            
            
            541,924
            
            
            
            3.8
            %200
      basis point decrease
            
            
            39,243
            
            
            
            561,532
            
            
            
            7.5
            %




Item 4.    Controls and
Procedures




Disclosure
Controls and Procedures




Under the
supervision and with the participation of management, including our Chief
Executive Officer and our Principal Accounting Officer (acting principal
financial officer), we have carried out an evaluation of our disclosure controls
and procedures (as defined in Rule 13a-15(e) under the Exchange Act). Based on
that evaluation, our Chief Executive Officer and our Principal Accounting
Officer (acting principal financial officer) concluded that our disclosure
controls and procedures were effective as of the end of the period covered by
this report to ensure that information we are required to disclose in reports
that are filed or submitted under the Exchange Act is recorded, processed,
summarized and reported within the time periods specified in the rules and forms
specified by the SEC and is accumulated and communicated to our management,
including our Chief Executive Officer and Principal Accounting Officer (acting
principal financial officer), as appropriate to allow timely decisions regarding
required disclosure.




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 Index




Changes
in Internal Control over Financial Reporting




There
have not been any changes in our internal control over financial reporting (as
such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)
during our third fiscal quarter of 2009 that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.




PART
II – OTHER INFORMATION




Item 1A.  Risk Factors




During
the quarter ended September 30, 2009, there were no material changes to the risk
factors disclosed in Item 1A of our Annual Report on Form 10-K for the year
ended December 31, 2008, filed with the SEC on March 16, 2009, or in Part II,
Item 1A of our Quarterly Report on Form 10-Q for the quarter ended June 30,
2009, filed with the SEC on August 10, 2009.




Item 6.     Exhibits




The list
of exhibits in the Exhibit Index to this quarterly report is incorporated herein
by reference.


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 Index




SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.




SEABRIGHT
INSURANCE HOLDINGS, INC.




Date:
      November 9, 2009By:
            /s/ John G. PasqualettoJohn
      G. PasqualettoChairman,
      President and Chief Executive Officer(Principal
      Executive Officer)By:
            /s/ M. Philip RomneyM.
      Philip RomneyVice
      President – Finance, Principal AccountingOfficer
      and Assistant Secretary(Chief
      Accounting Officer)


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 Index


EXHIBIT
INDEX





The list
of exhibits in the Exhibit Index to this quarterly report on Form 10-Q is
incorporated herein by reference. Exhibits 31.1 and 31.2 are being filed as part
of this quarterly report on Form 10-Q. Exhibits 32.1 and 32.2 are being
furnished with this quarterly report on Form 10-Q.





Exhibit
      Number
            
            Description10.1
            
            Employment
      Agreement with M. Philip Romney, dated November 3, 2009 (incorporated by
      reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K,
      filed November 6, 2009)31.1
            
            Rule
      13a-14(a) Certification (Chief Executive Officer)31.2
            
            Rule
      13a-14(a) Certification (Principal Financial Officer)32.1
            
            Section
      1350 Certification (Chief Executive Officer)32.2
            
            Section
      1350 Certification (Principal Financial
Officer)






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