##### Table of Contents



UNITED STATES SECURITIES AND
EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q




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


For the quarterly period ended June 30, 2006


or


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


For the transition period from ________ to ________


Commission File Number 000-51124


SeaBright Insurance Holdings, Inc.




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


2101 4 th Avenue, Suite 1600
Seattle, Washington 98121


(206) 269-8500


þ o


o o þ


o þ




Class
    
    Shares outstanding as of August 11, 2006Common Stock, $0.01 Par Value
    
    20,549,400








##### Table of Contents










SeaBright Insurance Holdings, Inc.


Index to Form 10-Q


PagePart I. Financial InformationItem 1. Financial Statements
    
    
    2Condensed Consolidated Balance Sheets as of June 30, 2006 and
December 31, 2005
    
    
    2Condensed Consolidated Statements of Operations for the Three Months
and Six Months Ended June 30, 2006 and 2005
    
    
    3Condensed Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 2006 and 2005
    
    
    4Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    15Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    24Item 4. Controls and Procedures
    
    
    25Part II. Other InformationItem 1A. Risk Factors
    
    
    25Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    27Item 4. Submission of Matters to a Vote of Security Holders
    
    
    27Item 6. Exhibits
    
    
    28Signatures
    
    
    29Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2 - 1 -


---

##### Table of Contents

# PART
I  FINANCIAL INFORMATION

# Item 1.
Financial Statements

# SEABRIGHT INSURANCE
HOLDINGS, INC. AND SUBSIDIARIES

# CONDENSED CONSOLIDATED
BALANCE SHEETS

|                                                                                                                   | June 30,
2006 |  | December 31,
2005 |        
|------------------------------------------------------------------------------------------------------------------ | ------------- |  | ----------------- | -------
|
|
|
|Investment securities available for sale, at fair value (amortized cost
$349,028 in 2006     and $260,015 in 2005) |               |  | $                 | 339,643
|Equity securities available for sale, at fair value (amortized cost
$3,037     in 2005)                            |               |  |                   |       
|Cash and cash equivalents                                                                                          |               |  |                   | 19,742 
|Accrued investment income                                                                                          |               |  |                   | 3,915  
|Premiums receivable, net of allowance                                                                              |               |  |                   | 9,160  
|Deferred premiums                                                                                                  |               |  |                   | 97,653 
|Federal income tax recoverable                                                                                     |               |  |                   |       
|Service income receivable                                                                                          |               |  |                   | 644    
|Reinsurance recoverables                                                                                           |               |  |                   | 14,140 
|Receivable under adverse development cover agreement                                                               |               |  |                   | 3,352  
|Prepaid reinsurance                                                                                                |               |  |                   | 2,156  
|Property and equipment, net                                                                                        |               |  |                   | 995    
|Deferred federal income taxes, net                                                                                 |               |  |                   | 14,423 
|Deferred policy acquisition costs, net                                                                             |               |  |                   | 11,593 
|Intangible assets, net                                                                                             |               |  |                   | 1,301  
|Goodwill                                                                                                           |               |  |                   | 1,527  
|Other assets                                                                                                       |               |  |                   | 13,246 
|Total assets                                                                                                       |               |  | $                 | 533,490
|
|
|Liabilities:                                                                                                       |              
|Unpaid loss and loss adjustment expense                                                                            |               |  | $                 | 169,336
|Unearned premiums                                                                                                  |               |  |                   | 96,979 
|Reinsurance funds withheld and balances payable                                                                    |               |  |                   | 251    
|Premiums payable                                                                                                   |               |  |                   | 2,643  
|Accrued expenses and other liabilities                                                                             |               |  |                   | 27,876 
|Surplus notes                                                                                                      |               |  |                   | 12,000 
|Total liabilities                                                                                                  |               |  |                   | 309,085
|                                                                                                                  
|Commitments and contingencies                                                                                      |              
|                                                                                                                   |              
|Stockholders 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 - 20,549,400 shares at June 30, 2006                                                        |              
|and 16,411,143 shares at December 31, 2005                                                                         |               |  |                   | 205    
|Paid-in capital                                                                                                    |               |  |                   | 189,653
|Accumulated other comprehensive loss                                                                               |               |  |                   | (6,100 
|Retained earnings                                                                                                  |               |  |                   | 40,647 
|Total stockholders equity                                                                                         |               |  |                   | 224,405
|Total liabilities and stockholders equity                                                                         |               |  | $                 | 533,490

See accompanying
notes to condensed consolidated financial statements.

- 2 -

---

##### Table of Contents

# SEABRIGHT INSURANCE
HOLDINGS, INC. AND SUBSIDIARIES

# CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS(Unaudited)

|                                            | Three Months Ended June 30, |  | Six Months Ended June 30, |           
|------------------------------------------- | --------------------------- |  | ------------------------- | ----------
|
|
|Revenue:                                    |                             |  |                           |           
|Premiums earned                             |                             |  | $                         | 41,794    
|Net investment income                       |                             |  |                           | 3,741     
|Net realized gain (loss)                    |                             |  |                           | (88       
|Claims service income                       |                             |  |                           | 533       
|Other service income                        |                             |  |                           | 19        
|Other income                                |                             |  |                           | 869       
|                                            |                             |  |                           | 46,868    
|Losses and expenses:                        |                             | 
|Loss and loss adjustment expenses           |                             |  |                           | 22,015    
|Underwriting, acquisition and insurance     |                            
|expenses                                    |                             |  |                           | 9,364     
|Other expenses                              |                             |  |                           | 1,988     
|                                            |                             |  |                           | 33,367    
|Income before federal income taxes          |                             |  |                           | 13,501    
|                                            |                            
|Federal income tax expense (benefit):       |                            
|Current                                     |                             |  |                           | 4,770     
|Deferred                                    |                             |  |                           | (652      
|                                            |                             |  |                           | 4,118     
|Net income                                  |                             |  | $                         | 9,383     
|                                           
|Basic earnings per share                    |                             |  | $                         | 0.46      
|Diluted earnings per share                  |                             |  | $                         | 0.45      
|                                           
|Weighted average basic shares outstanding   |                             |  |                           | 20,318,726
|Weighted average diluted shares outstanding |                             |  |                           | 20,750,605

See accompanying
notes to condensed consolidated financial statements.

- 3 -

---

##### Table of Contents

# SEABRIGHT INSURANCE
HOLDINGS, INC. AND SUBSIDIARIES

# CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS(Unaudited)

|                                                                              | Six Months Ended June 30, | 
|----------------------------------------------------------------------------- | ------------------------- | 
|
|
|
|
|Cash flows from operating activities:                                         |                           | 
|Net income                                                                    |                           | 
|Adjustments to reconcile net income to cash provided by operating activities:
|Amortization of deferred policy acquisition costs                             |                           | 
|Policy acquisition costs deferred                                             |                           | 
|Provision for depreciation and amortization                                   |                           | 
|Net realized (gain) loss on investments                                       |                           | 
|Benefit for deferred federal income taxes                                     |                           | 
|Stock based compensation                                                      |                           | 
|Changes in certain assets and liabilities:                                   
|Federal income tax payable (recoverable)                                      |                           | 
|Unpaid loss and loss adjustment expense                                       |                           | 
|Reinsurance recoverables, net of reinsurance withheld                         |                           | 
|Unearned premiums, net of deferred premiums                                  
|and premiums receivable                                                       |                           | 
|Accrued investment income                                                     |                           | 
|Other assets and other liabilities                                            |                           | 
|Net cash provided by operating activities                                     |                           | 
|                                                                             
|Cash flows from investing activities:                                         |                           | 
|Purchases of investments                                                      |                           | 
|Sales of investments                                                          |                           | 
|Maturities and other                                                          |                           | 
|Purchases of property and equipment                                           |                           | 
|Net cash used in investing activities                                         |                           | 
|                                                                              |                           | 
|Cash flows from financing activities:                                        
|Issuance of common stock                                                      |                           | 
|Exercise of stock options                                                     |                           | 
|Net cash provided by financing activities                                     |                           | 
|                                                                              |                           | 
|Net increase in cash and cash equivalents                                     |                           | 
|Cash and cash equivalents at beginning of period                              |                           | 
|Cash and cash equivalents at end of period                                    |                           | 
|                                                                              |                           | 
|Supplemental disclosures:                                                    
|Federal income taxes paid                                                     |                           | 
|Interest paid on surplus notes                                                |                           | 

See accompanying
notes to condensed consolidated financial statements.

- 4 -

---

##### Table of Contents

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

# 1.  Organization

SeaBright
Insurance Holdings, Inc. (SIH), a Delaware corporation, was formed in June 2003. On July 14, 2003,
SIH entered into a purchase agreement with Kemper Employers Group, Inc. (KEG), Eagle Pacific Insurance Company,
Inc. and Pacific Eagle Insurance Company, Inc. (collectively Eagle or the Eagle Entities), and Lumbermens
Mutual Casualty Company (LMC) (the Acquisition). Under this agreement, SIH acquired Kemper Employers
Insurance Company (KEIC), PointSure Insurance Services, Inc. (PointSure), and certain assets of Eagle,
primarily renewal rights.

SeaBright
Insurance Company (SBIC), formerly KEIC, is licensed to write workers compensation insurance in
43 states and the District of Columbia. Domiciled in the State of Illinois and commercially domiciled in the State
of California, SBIC focuses on employers with complex workers compensation exposures and provides coverage under
multiple state and federal acts, applicable common law or negotiated agreements. Prior to the Acquisition,
beginning in 2000, KEIC wrote business only in California. In May 2002, KEIC ceased writing business and by
December 31, 2003, all premiums related to business prior to the Acquisition were 100% earned.

PointSure is
engaged primarily in administrative and wholesale insurance brokerage activities. The Eagle
Entities, from whom the Company purchased certain assets, wrote state act workers compensation insurance and
United States Longshore and Harbor Workers Compensation Act (USL&H) insurance, before their policies went into
run-off on September 30, 2003.

Under new ownership,
KEIC resumed writing business effective October 1, 2003, primarily targeting policy renewals
for former Eagle business in the states of California, Hawaii and Alaska. In November 2003, the Illinois
Department of Financial and Professional Regulation, Division of Insurance (the Illinois Division of Insurance)
granted permission for KEIC to change its name to SeaBright Insurance Company.

# 2.  Summary of
Significant Accounting Policies

# a.  Basis of
Presentation

The
accompanying unaudited condensed consolidated financial statements include the accounts of SIH and its wholly
owned subsidiaries, PointSure and SBIC (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 Regulation S-K. 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, 2005
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, 2005 included in the Companys Annual Report on Form 10-K, which was
filed with the U.S. Securities and Exchange Commission on March 29, 2006.

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 and six month periods ended June 30, 2006 are not necessarily
indicative of the results expected for the full fiscal year or for any future period.

# b.  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. For
example, the Company used significant estimates in determining the unpaid loss and loss adjustment expenses,
goodwill and other intangibles, earned premiums on retrospectively rated policies, earned but unbilled premiums,
federal income taxes and amounts related to reinsurance and stock-based compensation arrangements. Actual results

- 5 -

---

##### Table of Contents

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

could differ from those estimates. Such estimates and judgments could change in the future as more information
becomes known, which could impact the amounts reported and disclosed herein.

# c.  Revenue Recognition

Premiums
for primary and reinsured risks are included in revenue over the lives of the contracts in proportion to
the amount of insurance protection provided (i.e., ratably over the policy periods). The portions of premiums
that are applicable to the unexpired periods of the policies in-force are not included in revenue but are
deferred and recorded as unearned premium in the liability section of the balance sheet. Deferred premiums
represent the unbilled portion of annual premiums.

Earned
premiums on retrospectively rated policies are based on the Companys estimate of loss experience as of
the measurement date. Loss experience includes known losses specifically identifiable to a retrospective policy
as well as provisions for future development on known losses and for losses incurred but not yet reported, which
are developed using actuarial loss development factors that are consistent with how the Company projects losses
in general. For retrospectively rated policies, the governing contractual minimum and maximum rates are
established at policy inception and are made a part of the insurance contract. Premiums from retrospectively
rated policies totaled 20.5% and 41.8% of total premiums written for the three month periods ended June 30, 2006
and 2005, respectively, and 23.9% and 34.6% of total premiums written for the six month periods then ended,
respectively.

# d.  Unpaid Loss and
Loss Adjustment Expense

Unpaid
loss and loss adjustment expense represents an estimate of the ultimate net cost of all unpaid losses
incurred through the specified period. The loss adjustment expense component is an estimate of unpaid expenses to
be incurred in settlement of the claims included in the liability for unpaid losses. These liabilities, which
anticipate salvage and subrogation recoveries and are presented gross of amounts recoverable from reinsurers,
include estimates of future trends in claim severity and frequency and other factors that could vary as the
losses are ultimately settled.

The Company uses an independent actuary to assist in the evaluation of the adequacy of its liability for unpaid
loss and loss adjustment expense. In light of the Companys short operating history and uncertainties concerning
the effects of recent legislative reform specifically as it relates to the Companys California workers
compensation class of business, actuarial techniques are applied that use the historical experience of the
Companys predecessor as well as industry information in the analysis of unpaid loss and loss adjustment expense.
These techniques recognize, among other factors:

| |  | the Companys claims experience and that of its predecessor;
| | - | ------------------------------------------------------------
| |  | the industrys claims experience;                           
| |  | historical trends in reserving patterns and loss payments;  
| |  | the impact of claim inflation;                              
| |  | the pending level of unpaid claims;                         
| |  | the cost of claim settlements;                              
| |  | legislative reforms affecting workers compensation; and    
| |  | the environment in which insurance companies operate.       

Although
it is not possible to measure the degree of variability inherent in such estimates, management believes
that the liability for unpaid loss and loss adjustment expense is adequate. Estimates are reviewed periodically
and any necessary adjustment is included in the results of operations of the period in which the adjustment is
determined.

# e.  Reinsurance

The Company
protects itself from excessive losses by reinsuring with nonaffiliated reinsurers certain levels of
risk in various areas of exposure. Reinsurance premiums, commissions, expense reimbursements and liabilities
related to ceded business are accounted for on a basis consistent with that used in accounting for original
policies

- 6 -

---

##### Table of Contents

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

issued and the terms of the reinsurance contracts. The unpaid loss and loss adjustment expense subject
to the adverse development cover agreement with LMC is calculated on a quarterly basis using generally accepted
actuarial methodology. Amounts recoverable in excess of acquired insurance liabilities at September 30, 2003 are
recorded gross in unpaid loss and loss adjustment expense in accordance with Statement of Financial Accounting
Standards (SFAS) No. 141, Business Combinations, with a corresponding amount receivable from the seller.
Amounts are shown net in the statements of operations. Premiums ceded to other companies are reported as a
reduction of premiums written and earned. Reinsurance recoverables are determined based on the terms and
conditions of the reinsurance contracts.

# f.  Income Taxes

The
asset and liability method is used in accounting for income taxes. Under this method, deferred tax assets and
liabilities are determined based on differences between the financial reporting and tax bases of assets and
liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the
differences are expected to reverse, net of any applicable valuation allowances.

# g.  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 six month periods ended June 30, 2006 and 2005:

|                                                                                           | Three Months Ended June 30, |  | Six Months Ended June 30, |           
|------------------------------------------------------------------------------------------ | --------------------------- |  | ------------------------- | ----------
|
|Basic weighted average shares outstanding                                                  |                             |  |                           | 20,318,726
|Weighted average shares issuable upon:                                                     |                             |  |                           |           
|Conversion of preferred stock
           outstanding prior to initial public      offering |                             |  |                           |          
|Exercise of stock options and vesting of
           restricted stock                       |                             |  |                           | 431,879   
|Diluted weighted average shares outstanding                                                |                             |  |                           | 20,750,605

# h.  Stock-Based
Compensation

The
Company adopted SFAS No. 123R, Share-Based Payment, on January 1, 2006, using the modified-prospective
transition method. Prior to adoption, the Company measured its employee stock-based compensation arrangements
using the provisions outlined in Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued
to Employees, which is an intrinsic value-based method of recognizing compensation costs, and adopted the
disclosure-only provisions of SFAS No. 123, Accounting for Stock-based Compensation. None of the Companys stock
options granted prior to adoption had an intrinsic value at grant date and, accordingly, no compensation cost was
recognized for its stock option plan activity prior to adoption.

Under the
modified-prospective transition method, stock-based compensation cost is recognized in the unaudited
condensed consolidated financial statements for granted, modified, or settled share-based payments. Compensation
cost recognized includes the estimated cost for stock options granted on or after January 1, 2006, based on the
grant date fair value estimated in accordance with the provisions of SFAS No. 123R, and the estimated expense for
the portion of awards granted prior to January 1, 2006 vesting in the current period, based on the grant date
fair value estimated in accordance with the original provisions of SFAS No. 123. Results for prior periods have
not been restated, as provided for under the modified-prospective method.

Total
stock-based compensation expense recognized in the unaudited condensed consolidated statements of
operations for the three month and six month periods ended June 30, 2006 is shown in the following table. No
compensation cost was capitalized during the three month or six month periods ended June 30, 2006.

- 7 -

---

##### Table of Contents

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

|                                             | Three MonthsEnded June 30,2006 |     | Six MonthsEnded June 30,2006 |  
|-------------------------------------------- | ------------------------------ | --- | ---------------------------- | -
|
|Stock based compensation expense related to: |                                |     |                              |  
|Stock options                                | $                              | 126 |                              | $
|Nonvested stock                              |                                | 329 |                              |  
|Total                                        | $                              | 455 |                              | $
|                                            
|Total related tax benefit                    | $                              | 118 |                              | $

The
following table shows the effect on net income and earnings per share for the three month and six month
periods ended June 30, 2005 as if compensation cost had been recognized based upon the estimated fair value on
the grant date of stock options in accordance with SFAS No. 123, as amended by SFAS No. 148, Accounting for
Stock-Based Compensation  Transition and Disclosure, and as if such cost had been determined in accordance with
SFAS No. 123R:

|                                                                                        | Three MonthsEnded June 30,2005 |       | Six MonthsEnded June 30,2005 |  
|--------------------------------------------------------------------------------------- | ------------------------------ | ----- | ---------------------------- | -
|
|Information as previously reported:                                                     |                                |       |                              |  
|Net income                                                                              | $                              | 4,216 |                              | $
|Less SFAS No. 123 compensation costs, net of taxes                                      |                                | (60   | )                            |  
|Pro forma net income                                                                    | $                              | 4,156 |                              | $
|                                                                                        |                                |       |                              |  
|Net income per common share:                                                            |                                |       |                              |  
|Basic  As reported                                                                     | $                              | 0.26  |                              | $
|Basic  Pro forma                                                                       | $                              | 0.25  |                              | $
|                                                                                        |                                |       |                              |  
|Diluted  As reported                                                                   | $                              | 0.25  |                              | $
|Diluted  Pro forma                                                                     | $                              | 0.25  |                              | $
|                                                                                        |                                |       |                              |  
|Information calculated as if the fair value method had been applied
     to all awards: |                                |       |                              |  
|Net income                                                                              | $                              | 4,216 |                              | $
|Less SFAS No. 123 compensation costs, net of taxes                                      |                                | (85   | )                            |  
|Pro forma net income                                                                    | $                              | 4,131 |                              | $
|                                                                                        |                                |       |                              |  
|Net income per common share:                                                            |                                |       |                              |  
|Basic  As reported                                                                     | $                              | 0.26  |                              | $
|Basic  Pro forma                                                                       | $                              | 0.25  |                              | $
|                                                                                        |                                |       |                              |  
|Diluted  As reported                                                                   | $                              | 0.25  |                              | $
|Diluted  Pro forma                                                                     | $                              | 0.25  |                              | $

Disclosures for the three month and six month periods ended June 30, 2006 are not presented because the amounts
are recognized in the unaudited condensed consolidated financial statements. The compensation cost included in
the pro forma net income is not likely to be representative of the effect on reported net income for future years
because options vest over several years and additional awards may be made each year.

# i.  Comprehensive Income

The following table
summarizes the Companys comprehensive income for the three month and six month periods ended
June 30, 2006 and 2005:

- 8 -

---

##### Table of Contents

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

|                                                                                                 | Three Months Ended June 30, |  | Six Months Ended June 30, |       
|------------------------------------------------------------------------------------------------ | --------------------------- |  | ------------------------- | ------
|
|
|Net income                                                                                       |                             |  | $                         | 9,383 
|Reclassification adjustment for net
        realized gains (losses) recorded into
        income |                             |  |                           | (88   
|Tax (expense) benefit related to
        reclassification adjustment                             |                             |  |                           | 31    
|Increase (decrease) in unrealized gain on
        investment securities available for sale       |                             |  |                           | (3,476
|Tax (expense) benefit related to unrealized
        gains (losses)                               |                             |  |                           | 1,217 
|Total comprehensive income                                                                       |                             |  | $                         | 7,067 

# 3.  Investments

The consolidated
cost or amortized cost, gross unrealized gains and losses, and estimated fair value of
investment securities available for sale at June 30, 2006 are as follows:

|                                               | Cost or
     Amortized
     Cost |  | Gross
     Unrealized
     Gains |         | Gross
     Unrealized
     Losses |   | Estimated
     Fair Value | 
|---------------------------------------------- | -------------------------------- |  | -------------------------------- | ------- | --------------------------------- | - | ------------------------- | 
|
|U.S. Treasury securities                       |                                  |  | $                                | 19,237  |                                   | $ | 2                         | 
|Government sponsored agency securities         |                                  |  |                                  | 13,942  |                                   |   |                          | 
|Corporate securities                           |                                  |  |                                  | 29,100  |                                   |   |                          | 
|Tax-exempt municipal securities                |                                  |  |                                  | 203,008 |                                   |   | 3                         | 
|Mortgage pass-through securities               |                                  |  |                                  | 61,908  |                                   |   |                          | 
|Collateralized mortgage obligations            |                                  |  |                                  | 3,077   |                                   |   | 1                         | 
|Asset-backed securities                        |                                  |  |                                  | 18,756  |                                   |   |                          | 
|Total investment securities available for sale |                                  |  | $                                | 349,028 |                                   | $ | 6                         | 

The unrealized
loss on temporarily impaired investments totaled $9.4 million at June 30, 2006 for investment
securities available for sale with a fair value of $336.3 million. Approximately $1.6 million of total unrealized
losses were from securities that had been impaired for more than one year. At June 30, 2006, no unrealized loss
exceeded 20% of the related securitys book value at that date.

The Company
regularly reviews its fixed maturity 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 Companys intent and ability to retain the investment for a period of time sufficient
to allow for an anticipated recovery in value; specific credit issues related to the issuer; and current economic
conditions. In general, the Company focuses on those securities whose fair values were less than 80% of their
amortized cost or cost, as appropriate, for six or more consecutive months. 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 financial statements. The Company evaluated investment securities with June
30, 2006 fair values less than amortized cost and has determined that the decline in value is temporary and is
related to the change in market interest rates since purchase.

The amortized
cost and estimated fair value of fixed income securities available for sale at June 30, 2006, 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.

- 9 -

---

##### Table of Contents

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

|Maturity                                       | Cost orAmortizedCost |  | EstimatedFair Value |        
|---------------------------------------------- | -------------------- |  | ------------------- | -------
|
|Due in one year or less                        |                      |  | $                   | 5,951  
|Due after one year through five years          |                      |  |                     | 70,981 
|Due after five years through ten years         |                      |  |                     | 153,236
|Due after ten years                            |                      |  |                     | 35,119 
|Securities not due at a single maturity date   |                      |  |                     | 83,741 
|Total investment securities available for sale |                      |  | $                   | 349,028

The amortized
cost of investment securities available for sale deposited with various regulatory authorities was
$118.7 million at June 30, 2006.

# 4.  Premiums

Direct
premiums written totaled $48.6 million and $52.8 million for the three month periods ended June 30, 2006
and 2005, respectively, and $99.8 million and $96.9 million for the six month periods then ended, respectively.

Premiums
receivable consisted of the following at June 30, 2006 and December 31, 2005:

|                                | June 30,2006 |  | December 31,2005 |       
|------------------------------- | ------------ |  | ---------------- | ------
|
|Premiums receivable             |              |  | $                | 10,102
|Allowance for doubtful accounts |              |  |                  | (942  
|                                |              |  | $                | 9,160 

# 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. Effective October
1, 2005, the Company entered into reinsurance agreements with nonaffiliated reinsurers that provide coverage up
to $50.0 million per loss occurrence, subject to certain limitations. Under the agreements, the Company retains
the first $500,000 of losses per occurrence. The next $500,000 of losses per occurrence (excess of the first
$500,000 of losses per occurrence retained by the Company) are 50% reinsured, subject to an annual aggregate
deductible of $1.5 million. The next $4.0 million of losses per occurrence (excess of the first $1.0 million of
losses per occurrence) are reinsured, subject to an annual aggregate deductible of $2.0 million. Policies
covering losses per occurrence in excess of $5.0 million up to $50.0 million contain no annual aggregate
deductibles.

As part of
the Acquisition, SIH and LMC entered into an adverse development excess of loss reinsurance agreement
(the Agreement). The Agreement, after taking into account any recoveries from third party reinsurers, requires
LMC to reimburse SBIC 100% of the excess of the actual loss at December 31, 2011 over the initial insurance
liabilities at September 30, 2003. The Agreement also requires SBIC to reimburse LMC 100% of the excess of the
initial insurance liabilities at September 30, 2003 over the actual loss results at December 31, 2011. The amount
of adverse loss development under the Agreement was $3.4 million at June 30, 2006. Any increase or decrease in the amount due
from LMC is included in loss and loss adjustment expenses in the consolidated statements of operations.

As part of
the Agreement, LMC placed into trust (the Trust) an amount equal to 10% of the balance sheet
insurance liabilities of SBIC on the date of the Acquisition. Thereafter, the Trust shall be adjusted each
quarter, if warranted, to an amount equal to at least 102% of LMCs obligations under the Agreement. Initial loss
liabilities were $16.0 million. The balance of the Trust was $5.0 million at June 30, 2006 and $4.9 million at
December 31, 2005.

- 10 -

---

##### Table of Contents

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

# b.  Reinsurance Assumed

The
Company assumes business from the National Council for Compensation Insurance in the states of Alabama,
Alaska, Arizona, Arkansas, Georgia, Illinois, Nevada, New Jersey, New Mexico, Oregon, South Carolina and Virginia
as part of the Residual Market Pool program.

# c.  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 June
30, 2006 and December 31, 2005:

|                                                                     | June 30,2006 |  | December 31,2005 |       
|-------------------------------------------------------------------- | ------------ |  | ---------------- | ------
|
|Reinsurance recoverables on unpaid loss and loss adjustment expenses |              |  | $                | 13,620
|Reinsurance recoverables on paid losses                              |              |  |                  | 520   
|Total reinsurance recoverables                                       |              |  | $                | 14,140

The
effects of reinsurance on unaudited condensed consolidated statements of operations amounts are as follows
for the three month and six month periods ended June 30, 2006 and 2005:

|                                                  | Three Months Ended June 30, |  | Six Months Ended June 30, |      
|------------------------------------------------- | --------------------------- |  | ------------------------- | -----
|
|
|Reinsurance assumed:                             
|Written premiums                                  |                             |  | $                         | 3,702
|Earned premiums                                   |                             |  |                           | 1,796
|Losses and loss adjustment expenses      incurred |                             |  |                           | 1,212
|                                                 
|Reinsurance ceded:                               
|Written premiums                                  |                             |  | $                         | 4,230
|Earned premiums                                   |                             |  |                           | 3,934
|Losses and loss adjustment expenses      incurred |                             |  |                           | 346  

# 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
six month periods ended June 30, 2006 and 2005:

- 11 -

---

##### Table of Contents

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

|                                                                                   | Three Months Ended June 30, |  | Six Months Ended June 30, |        
|---------------------------------------------------------------------------------- | --------------------------- |  | ------------------------- | -------
|
|
|Beginning balance:                                                                 |                             |  |                           |        
|Unpaid loss and loss adjustment expense                                            |                             |  | $                         | 160,063
|Reinsurance recoverables                                                           |                             |  |                           | (13,777
|Net                                                                                |                             |  |                           | 146,286
|Incurred related to:                                                               |                             |  |                           |        
|Current period                                                                     |                             |  |                           | 29,306 
|Prior periods                                                                      |                             |  |                           | (7,291 
|Total incurred                                                                     |                             |  |                           | 22,015 
|Paid related to:                                                                   |                             |  |                           |        
|Current period                                                                     |                             |  |                           | (4,091 
|Prior periods                                                                      |                             |  |                           | (8,494 
|Total paid                                                                         |                             |  |                           | (12,585
|Unpaid loss and loss adjustment      expense,
     net of reinsurance recoverables |                             |  |                           | 155,716
|Reinsurance recoverables                                                           |                             |  |                           | 13,620 
|Unpaid loss and loss adjustment      expense                                       |                             |  | $                         | 169,336

Loss and loss
adjustment expenses are net of the release of loss reserves totaling approximately $7.3 million and
$9.0 million in the three month and six month periods ended June 30, 2006, respectively. These reserve releases
reflect better-than-expected impacts on losses related primarily to the Companys California book of business as a
result of reform legislation enacted there primarily in 2003 and 2004.

# 7.  Surplus Notes

In a
private placement on May 26, 2004, SBIC issued $12.0 million in subordinated floating rate surplus notes due
in 2034. Interest, paid quarterly in arrears, is calculated at the beginning of the interest payment period using
the 3-month LIBOR rate plus 400 basis points, subject to certain limitations. Interest expense totaled $272,000
and $528,000 for the three month and six month periods ended June 30, 2006, respectively, and $211,000 and
$408,000 for the three month and six month periods ended June 30, 2005, respectively.

The notes
are redeemable prior to 2034 by the Company, in whole or in part, from time to time, on or after
May 24, 2009 on an interest payment date or at any time prior to May 24, 2009, in whole but not in part, upon the
occurrence and continuation of a tax event as defined in the agreement. The Company may not exercise its option
to redeem with respect to a tax event unless it pays a premium in addition to the redemption price.

# 8.  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 June 30, 2006, SBIC had a liability for
guaranty fund and other assessments of $2.0 million and a guaranty fund receivable of $3.8 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.  
          In June 2004, the Company was notified of a claim for damages brought by an individual against PointSure. In
April 2005, a complaint against PointSure in connection with this matter was filed in the Superior Court of
Washington for King County. In July 2006, the court granted plaintiffs motion to file an amended complaint
adding SIH and SBIC to the complaint. The complaint alleges breach and unjust enrichment related to the
termination of an alleged contract between PointSure and the plaintiff and seeks a judgment awarding damages to
the plaintiff in an amount to be proven at trial, plus attorneys fees and costs. The Company disputes the
allegations in the complaint

- 12 -

---

##### Table of Contents

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

and is defending this case vigorously. Management believes the outcome of this
matter will not have a material adverse effect on the Companys financial position.

c.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 financial position.

# 9.  Follow-on Public
Offering

On February 1, 2006,
the Company closed a follow-on public offering of 3,910,000 shares of common stock,
including the underwriters over-allotment option to purchase 510,000 shares of common stock, at a price of
$15.75 per share for net proceeds of approximately $57.6 million, after deducting underwriters fees, commissions
and offering costs totaling approximately $4.0 million. The Company contributed $50.0 million of the net proceeds
to SBIC, which intends to use the capital to expand its business in its core markets and to new territories. The
remaining proceeds will be used for general corporate purposes, including supporting the growth of PointSure. The
use of proceeds from the offering does not represent a material change from the use of proceeds described in the
prospectus that was included in the related Registration Statement on Form S-1. Except for the contribution of
proceeds to SBIC, no proceeds or expenses were paid to the Companys directors, officers, ten percent
shareholders or affiliates.

# 10.  Share-Based Payment Arrangements

At June 30, 2006,
the Company had outstanding stock options and nonvested 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 approved the 2005
Long-Term Equity Incentive Plan (the 2005 Plan and, together with the 2003 Plan, the Stock Option Plans) in
December 2004.

The Board of
Directors reserved an initial total of 776,458 shares of common stock under the 2003 Plan and
1,047,755 shares of common stock under the 2005 Plan, plus an automatic annual increase on the first day of each
fiscal year beginning in 2006 and ending in 2015 equal to the lesser of: (i) 2% of the shares of common stock
outstanding on the last day of the immediately preceding fiscal year or; (ii) such lesser number of shares as
determined by the Board of Directors. At June 30, 2006, the Company reserved 776,458 shares of common stock for
issuance under the 2003 Plan, of which options to purchase 487,683 shares had been granted, and 1,375,978 shares
for issuance under the 2005 Plan, of which 657,663 shares had been granted. In January 2006, the Compensation
Committee of the Board of Directors terminated the ability to grant future stock options awards under the 2003
Plan. Therefore, the Company anticipates that all future awards will be made under the 2005 Plan.

The 2005 Plan
provides for the grant of incentive or non-qualified stock options, restricted stock, restricted
stock units, deferred stock units, performance awards, or any combination of the foregoing. The Board of
Directors has the authority to determine all matters relating to awards granted under the Stock Option Plans,
including designation as incentive or nonqualified stock options, the selection of individuals to be granted
options, the number of shares subject to each grant, the exercise price, the term and vesting period, if any.
Options to purchase the Companys common stock are granted at prices at or above the fair value of the common
stock on the date of grant, generally vest 25% per year on each of the first four anniversaries of the vesting
start date, and expire 10 years from the date of grant. Options granted to non-employee directors generally vest
one-third on the first anniversary of the grant date and the remaining two-thirds monthly over the next 24
months. Nonvested stock issued to employees and directors generally vests on the third anniversary of the grant
date, assuming the holder is still employed by or providing service to the Company and satisfies all other
conditions of the grant. All stock options granted to employees are incentive stock options, while options
granted to non-employee directors are non-qualified stock options.

The Company
issues new shares of common stock upon exercise of stock options or award of nonvested shares.

- 13 -

---

##### Table of Contents

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

a.  Stock Options

The fair
values of stock options granted during the three month and six month periods ended June 30, 2006 and
2005 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 June 30, |  | Six Months Ended June 30, |     
|------------------------------- | --------------------------- |  | ------------------------- | ----
|
|Expected term (years)           |                             |  |                           | 6.2 
|Expected stock price volatility |                             |  |                           | 26.1
|Risk-free interest rate         |                             |  |                           | 4.96
|Expected dividend yield         |                             |  |                           |    
|                                |                             |  |                           |     
|Estimated fair value per option |                             |  | $                         | 6.28

For 2006,
the expected term of options was determined using the simplified method, which averages an awards
weighted average vesting period and its contractual term. For 2006, expected stock price volatility was based on
a weighted average of the Companys historical stock price volatility since the initial public offering of its
common stock in January 2005 and the historical volatility of a peer companys stock for a period of time equal
to the expected term of the option. Prior to the adoption of SFAS No. 123R, expected term was based on the
Companys historical experience and future expectations and price volatility was estimated using the Companys
historical volatility. The risk-free interest rate is based on the yield of U.S. Treasury securities with an
equivalent remaining term. The Company has not paid dividends in the past and does not plan to pay any dividends
in the near future.

The assumptions
used to calculate the fair value of options granted are evaluated and revised, as necessary, to
reflect market conditions and the Companys historical experience and future expectations. The calculated fair
value is recognized as compensation cost in the Companys financial statements over the requisite service period
of the entire award. Compensation cost is recognized only for those options expected to vest, with forfeitures
estimated at the date of grant and evaluated and adjusted periodically to reflect the Companys historical
experience and future expectations. Any change in the forfeiture assumption is accounted for as a change in
estimate, with the cumulative effect of the change on periods previously reported being reflected in the
financial statements of the period in which the change is made.

The following
table summarizes stock option activity for the six months ended June 30, 2006.

|                                 | Shares
     Subject to
     Options |  | Weighted
     Average Exer-
     cise Price
     per Share |         | Weighted
     Average Re-
     maining Con-
     tractual Life
     (years) |   | Aggregate
     Intrinsic
     Value
     (in
     thousands) | 
|-------------------------------- | ----------------------------------- |  | ---------------------------------------------------------- | ------- | --------------------------------------------------------------------------- | - | ------------------------------------------------------------ | 
|
|Outstanding at December 31, 2005 |                                     |  |                                                            | 804,524 |                                                                             | $ | 8.13                                                         | 
|Granted                          |                                     |  |                                                            | 114,350 |                                                                             |   | 17.60                                                        | 
|Forfeited                        |                                     |  |                                                            | (5,260  | )                                                                           |   | 7.98                                                         | 
|Exercised                        |                                     |  |                                                            | (4,382  | )                                                                           |   | 7.40                                                         | 
|Cancelled                        |                                     |  |                                                            | (478    | )                                                                           |   | 6.54                                                         | 
|Outstanding at June 30, 2006     |                                     |  |                                                            | 908,754 |                                                                             |   | 9.33                                                         | 
|                                 |                                     |  |                                                            |         |                                                                             |   |                                                              | 
|Exercisable at June 30, 2006     |                                     |  |                                                            | 328,886 |                                                                             |   | 7.51                                                         | 

The
aggregate intrinsic values in the table above are before applicable income taxes and are based on the
Companys closing stock price of $16.11 on June 30, 2006. As of June 30, 2006, total unrecognized stock-based
compensation cost related to nonvested stock options was approximately $1.4 million, which is expected to be
recognized over a weighted average period of approximately 34.2 months. During the three months ended June 30,
2006, the total intrinsic value of stock options exercised was approximately $35,500. During the three months
ended June 30, 2006, the Company received approximately $22,400 from the exercise of incentive stock options.
There were no associated tax benefits.

- 14 -

---

##### Table of Contents

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

As of
June 30, 2006, there were 718,315 shares of common stock available for issuance of future share-based
awards. The following table presents additional information regarding options outstanding as of June 30, 2006.

|            | Options Outstanding |  | Options Exercisable |        
|----------- | ------------------- |  | ------------------- | -------
|
|$ 6.54      |                     |  |                     | 481,922
|10.50-12.54 |                     |  |                     | 312,482
|15.60-18.40 |                     |  |                     | 114,350
|            |                     |  |                     | 908,754

a.  Nonvested Stock

The following
table summarizes nonvested stock activity for the six months ended June 30, 2006:

|                                 | Number of
     Shares |  | Weighted
     Average
     Grant Date
     Fair Value
|-------------------------------- | --------------------- |  | -----------------------------------------------------
|Outstanding at December 31, 2005 |                       |  |                                                      
|Granted                          |                       |  |                                                      
|Vested                           |                       |  |                                                      
|Forfeited                        |                       |  |                                                      
|Outstanding at June 30, 2006     |                       |  |                                                      

As of
June 30, 2006, there was $3.6 million of total unrecognized compensation cost related to nonvested stock
granted under the 2005 Plan. That cost is expected to be recognized over a weighted-average period of 32.5
months. No shares vested during the quarter ended June 30, 2006.

# 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 this Part I. 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 (SEC),
including our Annual Report on Form 10-K for the year ended December 31, 2005 filed with the SEC on March 29,
2006.

The
discussion under the heading Risk Factors in Part II, Item 1A of this quarterly report, 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:

- 15 -

---

##### Table of Contents

| |  | ineffectiveness or obsolescence of our business strategy due to changes in current or future market
     conditions;                                                                                                                                       
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | increased competition on the basis of pricing, capacity, coverage terms or other factors;                                                                                                                                                                  
| |  | greater frequency or severity of claims and loss activity, including as a result of natural or man-made
     catastrophic events, than our underwriting, reserving or investment practices anticipate based on
     historical experience or industry data;
| |  | the effects of acts of terrorism or war;                                                                                                                                                                                                                   
| |  | developments in financial and capital markets that adversely affect the performance of our investments;                                                                                                                                                    
| |  | changes in regulations or laws applicable to us, our subsidiaries, brokers or customers;                                                                                                                                                                   
| |  | 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;                                                                                                                             
| |  | decreased demand for our insurance products;                                                                                                                                                                                                               
| |  | loss of the services of any of our executive officers or other key personnel;                                                                                                                                                                              
| |  | the effects of mergers, acquisitions and divestitures that we may undertake;                                                                                                                                                                               
| |  | changes in rating agency policies or practices;                                                                                                                                                                                                            
| |  | changes in legal theories of liability under our insurance policies;                                                                                                                                                                                       
| |  | changes in accounting policies or practices; and                                                                                                                                                                                                           
| |  | changes in general economic conditions, including inflation and other factors.                                                                                                                                                                             

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 2005 Annual Report on Form 10-K.

# Overview

We are a
specialty provider of multi-jurisdictional workers compensation insurance. We are domiciled in
Illinois, commercially domiciled in California and headquartered in Seattle, Washington. We are licensed in 43
states and the District of Columbia to write workers compensation 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

- 16 -

---

##### Table of Contents

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.

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 the Acquisition. In the Acquisition, we
acquired from LMC and certain of its affiliates the renewal rights and substantially all of the operating assets
and employees of Eagle. 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 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.

At
closing of the Acquisition, $4.0 million of the purchase price was placed into escrow for a period of two
years. These funds were available to us as security for various obligations of LMC pursuant to various agreements
entered into in connection with the Acquisition. As of June 30, 2006, the entire balance of the escrow fund,
including accumulated interest, had been returned to KEG.

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 developments in KEICs insurance liabilities as they existed at the date of
the Acquisition. December 31, 2011 is the date that the parties will look to see whether the insurance liabilities with respect
to KEICs insurance policies in effect at the date of the Acquisition have increased or decreased from the $16.0 million
amount existing 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 indemnify LMC in the amount of the decrease.
To support LMCs obligations under the adverse development cover agreement, 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 agreement. 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 agreement. The amount on deposit in the trust account at June 30, 2006 was
approximately $5.0 million. 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 agreement, it
is unlikely that we would recover any future amounts owing by LMC to us.

# Principal Revenue and
Expense Items

We derive
our revenue primarily from premiums earned, net investment income and net realized gains and losses
from investments, and service income.

# 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. 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, 2005, one-half of the premiums would be earned in 2005
and the other half would be earned in 2006.

Premiums earned
are the earned portion of our net premiums written. Net premiums written is the difference
between gross premiums written and premiums ceded or paid to reinsurers (ceded premiums written). 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.

- 17 -

---

##### Table of Contents

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 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 plan. Premiums from the Washington USL&H Assigned Risk
Plan are included in both direct premiums written and ceded premiums written.

# 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 cost.

# Claims Service Income

We receive claims
service income in return for providing claims administration services for other companies. The
claims service income we receive for providing these services approximates our costs. For the six months ended
June 30, 2006 and 2005, approximately 54% and 73%, respectively, of our claims service income was generated by
contracts we have with LMC to provide claims handling services for the policies written by the Eagle Entities
prior to the Acquisition. We expect income from these contracts to decrease substantially over the next several
years as transactions related to the Eagle Entities diminish.

# Other Service Income

Following the
Acquisition, we entered into servicing arrangements with LMC to provide policy administration and
accounting services for the policies written by the Eagle Entities prior to the Acquisition. The fee income we
receive for providing these services approximates our costs and will substantially decrease over the next several
years as transactions related to the Eagle Entities diminish.

Our
expenses consist primarily of:

# 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.

# Underwriting,
Acquisition and Insurance Expenses

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. Commissions, premium taxes and fees, and the portion of other
underwriting expenses that is associated with the acquisition of new and renewal business are initially deferred
and are recognized as expenses as the related premium is earned.

Commission
Expenses.We pay commission expense to our brokers for the premiums that they produce
for us.

Premium
Taxes and Fees.We pay state and local taxes based on premiums, as well as licenses, fees, assessments and contributions to
workers compensation security funds.

Other
Underwriting Expenses.Other underwriting expenses consist of general administrative expenses such as salaries,
rent, office supplies,
depreciation 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.

- 18 -

---

##### Table of Contents

# Interest Expense

Included in
other expense is interest expense we incur on $12.0 million of surplus notes that our insurance
subsidiary issued in May 2004. Interest is based on the three-month LIBOR rate, plus 400 basis points, and is
paid quarterly in arrears.

# Results of Operations

# Three month and six
month periods ended June 30, 2006 and 2005

Gross
Premiums Written. Gross premiums written for the three months ended June 30, 2006 totaled $52.4 million, a decrease of $4.3
million, or 7.6%, from $56.7 million in the same period of 2005. For the six months ended June 30, 2006, gross
premiums written totaled $107.1 million, an increase of $6.1 million, or 6.0%, from $101.0 million in the same
period of 2005. California continues to be our largest market, accounting for approximately 60.5% of our in-force
premiums at June 30, 2006. Gross premiums written in California during the first half of 2006 accounted for 51.9%
of total premiums written in the period, down from approximately 59.4% in the same period of 2005. This reduction
is part of our plan to achieve optimal diversification of our book of business. As of June 30, 2006, our in-force
book of business was split as follows among our three primary market segments: state act  56.0%, ADR  28.6% and
maritime  15.4%. At June 30, 2005, our in-force book of business was split as follows: state act  53.7%, ADR 
29.1% and maritime  17.2%.

On March 24,
2006, the Workers Compensation Insurance Rating Bureau (the WCIRB), an industry-backed private
organization that provides statistical analysis, submitted a filing with the California Insurance Commissioner
recommending a 16.4% decrease in advisory pure premium rates on new and renewal policies effective July 1, 2006.
The filing was based on an analysis of loss experience valued as of December 31, 2005 and was made in response to
continued reductions in workers compensation claim costs in California as a result of reform legislation enacted
primarily in 2003 and 2004. On May 31, 2006, the Commissioner recommended a 16.4% decrease in rates, and on that
date, we filed new rates reflecting an average reduction of 5.8% from prior rates for new and renewal workers
compensation insurance policies written in California on or after July 1, 2006. The filing was approved on June
21, 2006. This is the sixth California rate reduction we have filed since October 1, 2003, resulting in a net
cumulative reduction of our California rates of approximately 41.8%.

Net
Premiums Written. Net premiums written for the three months ended June 30, 2006 totaled $48.2 million, a decrease of $2.0 million,
or 4.0%, from $50.2 million in the same period of 2005. For the six months ended June 30, 2006, net premiums
written totaled $99.0 million, an increase of $9.8 million, or 11.0%, from $89.2 million in the same period of
2005. The changes in net premiums written for the three month and six month periods ended June 30, 2006 are
reflective of similar changes in gross premiums written. Net premiums written are affected by premiums ceded
under reinsurance agreements with external reinsurers. For the three months ended June 30, 2006, ceded written
premiums totaled $4.2 million (8.0% of gross premiums written) compared to $6.6 million (11.6% of gross premiums
written) in the same period of 2005. Ceded written premiums for the six months ended June 30, 2006 totaled $8.1
million (7.6% of gross premiums written) compared to $11.8 million (11.7% of gross premiums written) in the same
period of 2005. In 2005, certain of our reinsurance contracts provided for the ceding of premiums on a direct
premiums written basis, while others provided for ceding on a direct premiums earned basis. Our current
reinsurance contracts, which we entered into on October 1, 2005, provide for the ceding of premiums on a gross
premiums earned basis. This, coupled with changes in our deductibles and retention limits, accounts for the reductions in the ceded
premiums written percentages noted above.

Net
Premiums Earned. Net premiums earned for the three months ended June 30, 2006 totaled $41.8 million, an increase of $2.2 million,
or 5.6%, over $39.6 million in the same period of 2005. For the six months ended June 30, 2006, net premiums
earned totaled $85.8 million, an increase of $17.0 million, or 24.7%, from $68.8 million in the same period of
2005. As previously discussed, these increases are due to the increase in net premiums written in 2005 and 2006.
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. Net premiums earned in the first half of 2006 reflect a reduction
of approximately $2.3 million related to our retrospectively rated policies, reflective of improved loss ratios
that generate return premiums. Retrospectively rated policies currently account for approximately 29% of our book
of business.

Net
Investment Income. Net investment income for the three months ended June 30, 2006 totaled $3.7 million, an increase of $1.9 million,
or 105.6%, over $1.8 million in the same period of 2005. For the six months ended June 30, 2006, net investment
income totaled $6.9 million, an increase of $3.8 million, or 122.6%, from $3.1 million in

- 19 -

---

##### Table of Contents

the same period of
2005. These increases are due primarily to the addition of $57.6 million of net proceeds from the follow-on
offering in February 2006, continued positive cash flow from operations and the higher interest rate environment.
Our yield on average invested assets for the three months ended June 30, 2006 was approximately 4.2% compared to
approximately 3.2% for the same period in 2005. For the six months ended June 30, 2006, our yield on average
invested assets was 4.3% compared to approximately 3.5% for the same period in 2005.

Service
Income. Service income for the three months ended June 30, 2006 totaled $552,000, a decrease of $192,000, or 25.8%, from
$744,000 in the same period of 2005. For the six months ended June 30, 2006, service income totaled $1.1 million,
a decrease of $0.3 million, or 21.4%, from $1.4 million in the same period of 2005. Our service income results
primarily from service arrangements we have with LMC and other companies for claims processing services, policy
administration and administrative services we perform for them. Average monthly fees from arrangements with LMC
for services we provide in connection with the Eagle Entities insurance policies are declining as the volume of
work decreases as a result of the run off of our predecessors business. Approximately 66% of our service income
in the three-month period ended June 30, 2006 came from third party claims administration services that we
provide to independent, unrelated companies, compared to 39% in the same period of 2005. For the six-month period
ended June 30, 2006, approximately 46% of our service income came from third party claims administration services
that we provide to independent, unrelated companies, compared to approximately 27% in the same period of 2005.

Other
Income. Other income for the three months ended June 30, 2006 totaled $869,000, an increase of $57,000, or 7.0%, over
$812,000 in the same period of 2005. For the six months ended June 30, 2006, other income totaled $1.6 million, a
decrease of $0.4 million, or 20.0%, from $2.0 million in the same period of 2005. Other income results primarily
from the operations of PointSure, our wholesale insurance broker and third party claims administrator subsidiary.
The decrease in other income for the six month period ended June 30, 2006 resulted primarily from a decrease in
PointSures agency and direct billed commission income in the first quarter of the year. PointSures agency and
direct billed commission income totaled approximately $756,000 for the three months ended March 31, 2006 compared
to $1.2 million in the same period of 2005, representing a decrease of $444,000, or 37.0%. Most of this income is
passed through as commission expense to brokers and producers.

Loss
and Loss Adjustment Expenses. Loss and loss adjustment expenses for the three months ended June 30, 2006 totaled
$22.0 million, a decrease of
$5.0 million, or 18.5%, from $27.0 million in the same period of 2005. For the six months ended June 30, 2006,
loss and loss adjustment expenses totaled $50.5 million, an increase of $3.2 million, or 6.8%, from $47.3 million
in the same period of 2005. 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 June 30, 2006 was 51.4% compared to
66.3% for the same period in 2005. Our net loss ratio for the six months ended June 30, 2006 was 57.6% compared to
66.8% for the same period in 2005. Paid losses for the six months ended June 30, 2006 totaled $18.6 million,
compared to $10.5 million in the same period of 2005.

Loss and loss
adjustment expenses are net of the release of loss reserves totaling approximately $7.3 million and
$9.0 million in the three month and six month periods ended June 30, 2006, respectively. These reserve releases
reflect better-than-expected impacts on losses related primarily to the Companys California book of business as a
result of reform legislation enacted there primarily in 2003 and 2004. The recorded loss reserves at June 30, 2006
represent managements estimate of amounts the Company expects to pay in connection with policies it has written.
Reserves are reviewed quarterly and adjustments are made as necessary to reflect managements current
expectations in light of developing trends.

As of June 30,
2006, we had recorded a receivable of approximately $3.4 million for adverse loss development
under the adverse development cover agreement 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 agreement. At June 30, 2006, we have access to approximately $5.0 million under the
collateralized reinsurance trust in the event that LMC fails to satisfy its obligations under the adverse
development cover agreement.

Underwriting
Expenses. Underwriting expenses for the three months ended June 30, 2006 totaled $9.4 million, an increase of $0.8 million,
or 9.3%, from $8.6 million in the same period of 2005. For the six months ended June 30, 2006, underwriting
expenses totaled $19.0 million, an increase of $4.0 million, or 26.7%, from $15.0 million in the same period of
2005. 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 June 30, 2006 was 22.4%,
compared to 21.7% for the same period in 2005. For the six months ended June 30, 2006, our

- 20 -

---

##### Table of Contents

net underwriting
expense ratio was 22.1%, compared to 21.7% for the same period of 2005. The increases in the net underwriting
expense ratio resulted primarily from an increase in commission expense. Direct commissions as a percentage of
direct earned premiums increased from 5.9% in the first half of 2005 to 6.9% in the same period of 2006.

Other
Expenses. Other expenses for the three months ended June 30, 2006 totaled $2.0 million, an increase of $0.5 million, or
33.3%, over $1.5 million in the same period of 2005. For the six months ended June 30, 2006, other expenses
totaled $3.5 million, an increase of $0.3 million, or 9.4%, from $3.2 million in the same period of 2005. The
increase in other expenses resulted primarily from compensation costs associated with the implementation of SFAS
No. 123R, which totaled approximately $615,000 at June 30, 2006, offset by a reduction of approximately $203,000
in amortization expense related to intangible assets we acquired from the predecessor and other reductions.

Federal
Income Tax Expense. The effective tax rate for the six months ended June 30, 2006 was 30.5%, compared to 31.6% for the same period in
2005. At June 30, 2006, approximately 58.2% of our portfolio was invested in tax-exempt municipal securities,
compared to approximately 55.4% at June 30, 2005.

Net
Income. Net income was $9.4 million for the three months ended June 30, 2006, compared to $4.2 million for the same
period in 2005, representing an increase of $5.2 million. Net income for the six months ended June 30, 2006
totaled $15.4 million, an increase of $8.5 million from $6.9 million in the same period of 2005. The increase in
net income for the six months ended June 30, 2006 resulted primarily from increases in premiums earned and
investment income for the period and the release of loss reserves, offset by increases in loss and loss
adjustment expenses and underwriting, acquisition and insurance expenses

# Liquidity and Capital
Resources

Our principal
sources of funds are underwriting operations, investment income and proceeds from sales and
maturities of investments. Our primary use of funds is 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 June 30, 2006 has an effective duration of 5.5 years with individual maturities
extending out to 26 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 June 30, 2006,
our investment portfolio is made up almost entirely of investment grade fixed income securities
with fair values subject to fluctuations in interest rates. 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.

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. On October
1, 2005, we entered into new reinsurance contracts that are effective through October 1, 2006. The contracts
provide reinsurance coverage up to $50.0 million per loss occurrence, subject to certain limitations. We retain
the first $500,000 of losses per loss occurrence. The next $500,000 of losses per occurrence (excess of the first
$500,000 of losses per occurrence that we retain) are 50% reinsured, subject to an annual aggregate deductible of
$1.5 million. The next $4.0 million of losses per occurrence (excess of the first $1.0 million of losses per
occurrence) are reinsured, subject to an annual aggregate deductible of $2.0 million. Policies covering losses
per occurrence in excess of $5.0 million up to $50.0 million contain no annual aggregate deductibles. We believe
that we are sufficiently capitalized to retain the losses described above.

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, 2005, the last date that we were required to update the annual risk-based
capital calculation, the

- 21 -

---

##### Table of Contents

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
operates as a holding company and has minimal revenue and expenses. Currently, there are no plans to have our
insurance subsidiary or PointSure pay a dividend to SIH.

Our
unaudited consolidated net cash provided by operating activities for the six months ended June 30, 2006 was
$36.3 million, compared to $32.8 million for the same period in 2005. The increase resulted primarily from the
increase in net income and increases in unpaid loss and loss adjustment expense, amortization of deferred policy
acquisition costs and unearned premiums net of deferred premiums and premiums receivable, offset by increases in
policy acquisition costs deferred, deferred federal income tax benefit, balances related to reinsurance
recoverables and other assets and liabilities, all as a result of the growth of our business.

We used
net cash of $86.2 million for investing activities in the six months ended June 30, 2006, compared to
$93.7 million for the same period in 2005. The difference between periods is primarily attributable to a reduction
in funds available for investing activities. In 2005, we invested net proceeds totaling approximately $80.4
million resulting from the sale of 8,625,000 shares of common stock in our initial public offering. In 2006, we
invested net proceeds totaling approximately $57.6 million resulting from a follow-on public offering of
3,910,000 shares of our common stock described below.

For
the six months ended June 30, 2006, financing activities provided cash of $57.6 million, compared to $80.8
million in the same period in 2005. As described below, the majority of cash provided by financing activities
resulted from the sale of our common stock and, to a much lesser degree, from the exercise of common stock
options by our employees.

On
February 1, 2006, we closed a follow-on public offering of 3,910,000 shares of our common stock, including the
underwriters over-allotment option to purchase 510,000 shares of our common stock, at a price of $15.75 per
share for net proceeds of approximately $57.6 million, after deducting underwriters fees, commissions and
offering costs totaling approximately $4.0 million. We contributed $50.0 million of the net proceeds to SBIC,
which is using the capital to expand its business in its core markets and to new territories. The remaining
proceeds will be used for general corporate purposes, including supporting the growth of PointSure.

# Contractual Obligations
and Commitments

The
following table identifies our contractual obligations due by period as of June 30,
2006:

|                                  | Payments Due by Period | 
|--------------------------------- | ---------------------- | 
|
|
|Long term debt obligations:       |                        | 
|Surplus notes                     |                        | 
|Loss and loss adjustment expenses |                        | 
|Operating lease obligations       |                        | 
|Total                             |                        | 

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 June 30, 2006 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.
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. 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 June
30, 2006, we had no off-balance sheet arrangements that have or are reasonably likely to have a
current or future effect on our financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital resources.

- 22 -

---

##### Table of Contents

# Critical Accounting
Policies, Estimates and Judgments

It is important
to understand our accounting policies in order to understand our 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; accounting for our adverse development cover agreement; deferred policy
acquisition costs; deferred taxes; goodwill and other intangible assets; retrospective premiums; earned but
unbilled premiums; and the impairment of investment securities. The following should be read in conjunction with
the notes to our 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 assessments; 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 materially from the original estimates. These estimates are regularly reviewed
and updated and any resulting adjustments are included in the current periods operating results. Because of the
relative immaturity of our unpaid loss and loss adjustment expense data, actuarial techniques are applied that
use the historical experience of our predecessor as well as industry information in the analysis of our unpaid
loss and loss adjustment expenses.

# 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 unaudited condensed consolidated balance
sheets 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. In addition, we bear credit risk with respect to the reinsurers, which can be
significant considering that some of the unpaid loss and loss adjustment expenses remain outstanding for an
extended period of time.

# Adverse Development
Cover Agreement

The unpaid
loss and loss adjustment expense subject to the adverse development cover agreement with LMC is
calculated on a quarterly basis using generally accepted actuarial methodologies. Amounts recoverable in excess
of acquired insurance liabilities at September 30, 2003 are recorded gross in unpaid loss and loss adjustment
expense in accordance with SFAS No. 141, Business Combinations, with a corresponding amount receivable from the
seller. Amounts are shown net in the statement of operations.

# 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 amortized 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 investment income, anticipated losses and settlement expenses and certain other costs that we
expect to incur as the premium is earned. Judgments as to ultimate recoverability of these deferred costs are
highly dependent upon estimated future loss costs associated with the premiums written.

- 23 -

---

##### Table of Contents

# Deferred 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 dates 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. Management considers the scheduled reversal of deferred tax liabilities, projected
future taxable income and tax planning strategies in making this assessment. If necessary, we would establish a
valuation allowance to reduce the deferred tax assets to the amounts more likely than not to be realized.

# Goodwill and Other
Intangible Assets

Goodwill
represents the excess of costs over fair value of assets of businesses acquired. Goodwill and other
intangible assets acquired in a purchase business combination and determined to have an indefinite useful life
are not amortized, but are instead tested for impairment at least annually. Intangible assets with estimable
useful lives are amortized over their respective estimated useful lives to their estimated residual values, and
reviewed for impairment in accordance with SFAS No. 144, Accounting for Impairment or Disposal of Long-Lived
Assets.

# Retrospective Premiums

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
the Companys 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.

# Earned But Unbilled
Premiums

We estimate
the amount of premiums that have been earned but are unbilled at the end of the period by analyzing
historical earned premium adjustments made and applying an adjustment percentage against premiums earned for the
period.

# Impairment of
Investment Securities

Impairment of
investment securities results in a charge to operations when the fair value of a security declines
to below our cost and is deemed to be other-than-temporary. We regularly review our fixed maturity 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; our intent and ability to retain the
investment for a period of time sufficient to allow for an anticipated recovery in value; specific credit issues
related to the issuer; and current economic conditions. In general, we focus on those securities whose fair
values were less than 80% of their amortized cost or cost, as appropriate, for six or more consecutive months.
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 financial statements.

# Item 3.  Quantitative and
Qualitative Disclosures About Market Risk

Market
risk is the potential economic loss principally arising from adverse changes in the fair value of
financial instruments. The major components of market risk affecting us are credit risk and interest rate risk.

- 24 -

---

##### Table of Contents

# 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. We also independently, and through our outside investment managers, monitor
the financial condition of all of the issuers of fixed-income securities in the 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 $339.6 million at June 30, 2006 that are subject to interest
rate risk. 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. It illustrates the sensitivity of the fair value of
fixed-income investments to selected hypothetical changes in interest rates as of June 30, 2006. 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.

Hypothetical Change in Interest Rates
    
    EstimatedChange inFair Value
    
    Fair Value
    
    HypotheticalPercentageIncrease(Decrease) in
        ShareholdersEquity($ in thousands)200 basis point increase
    
    $
    (29,882
    )
    $
    309,761
    
    
    (8.8
    )%100 basis point increase
    
    
    (15,123
    )
    
    324,520
    
    
    (4.5
    )%No change
    
    
    
    
    
    339,643
    
    
    100 basis point decrease
    
    
    15,487
    
    
    355,130
    
    
    4.6
    %200 basis point decrease
    
    
    31,338
    
    
    370,981
    
    
    9.2
    %


# Item 4.  Controls and
Procedures

Under
the supervision and with the participation of management, including our Chief Executive Officer and our
Chief Financial Officer, we have carried out an evaluation of our disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act)).
Based on that evaluation, our Chief Executive Officer and our Chief 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 Securities and Exchange Commission. There were no changes in our internal control over financial reporting
(as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred during the period covered in this
report 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

You
should carefully consider the risks described below, together with all of the other information included in
this quarterly report. The risks and uncertainties described below are not the only ones facing our company. If
any of the following risks actually occurs, our business, financial condition or operating results could be
harmed. Any of the risks described below could result in a significant or material adverse effect on our
financial condition or results of operations, and a corresponding decline in the market price of our common
stock. You could lose all or part of your investment. The risks discussed below also include forward-looking
statements and our actual results may differ substantially from those discussed in those forward-looking
statements. Please refer to the discussion under the heading Cautionary Statement in Part I, Item 2.

The
following risk factor has been updated to reflect developments that occurred during the
quarter ended June 30, 2006.

- 25 -

---

##### Table of Contents

# Risks Related to Our
Business

| | Intense competition could adversely affect our
ability to sell policies at rates we deem adequate.
| | --------------------------------------------------------------------------------------------------

In most
of the states in which we operate, we face significant competition which, at times, is intense. If we are
unable to compete effectively, our business and financial condition could be materially adversely affected.
Competition in our businesses is based on many factors, including premiums charged, services provided, financial
strength ratings assigned by independent rating agencies, speed of claims payments, reputation, perceived
financial strength and general experience. We compete with regional and national insurance companies and
state-sponsored insurance funds, as well as potential insureds that have decided to self-insure. Our principal
competitors include AIG, Alaska National Insurance Company, Signal Mutual Indemnity Association Ltd., Zurich and
the State Compensation Insurance Fund of California. Many of our competitors have substantially greater financial
and marketing resources than we do, and some of our competitors, including the State Compensation Insurance Fund
of California, benefit financially by not being subject to federal income tax. Intense competitive pressure on
prices can result from the actions of even a single large competitor, such as the State Compensation Insurance
Fund of California or AIG.

In addition,
our competitive advantage may be limited due to the small number of insurance products that we
offer. Some of our competitors, such as AIG, have additional competitive leverage because of the wide array of
insurance products that they offer. For example, it may be more convenient for a potential customer to purchase
numerous different types of insurance products from one insurance carrier. We do not offer a wide array of
insurance products due to our targeted market niches, and we may lose potential customers to our larger, more
diverse competitors as a result.

On May 31, 2005,
the California Insurance Commissioner issued a decision adopting an advisory pure premium rate
reduction of 18% for California workers compensation policies incepting on or after July 1, 2005. Pure premium
is that portion of an insurance premium necessary to cover the cost of paying claims, such as medical and
indemnity costs and allocated and unallocated loss adjustment expenses. The decision was issued in response to
reductions in 2004 workers compensation claim costs in California, as well as anticipated future claim cost
reductions, as a result of reform legislation enacted primarily in 2003 and 2004. Such decisions of the
California Insurance Commissioner are advisory only and insurance companies may choose whether or not to adopt the
new rates. On June 6, 2005, after completing a study of our California loss data, we filed with the California
Department of Insurance our rates for new and renewal workers compensation insurance policies written in
California on or after July 1, 2005. The filing was approved on June 28, 2005. The new rates reflected an average
reduction of 14.2% from prior rates and are in response to emerging favorable trends in loss costs resulting from
reform legislation.

On
September 15, 2005, the WCIRB, an industry-backed private organization that provides statistical analysis,
submitted an amended filing to the California Insurance Commissioner recommending a 15.9% decrease in advisory
pure premium rates on new and renewal policies effective January 1, 2006. As described above, such rates, if
adopted by the California Insurance Commissioner, are advisory only and insurance companies may choose whether or
not to adopt the new rates. The rate decrease was proposed following the WCIRBs review of accident year
experience valued as of June 30, 2005 and the cost impact of the January 1, 2005 permanent disability rating
schedule. On November 10, 2005, the Commissioner recommended a 15.3% decrease in rates, and on November 28, 2005
we filed new rates reflecting an average reduction of 11.8% from prior rates for new and renewal workers
compensation insurance policies written in California on or after January 1, 2006. The filing was approved on
December 22, 2005.

On
March 24, 2006, the WCIRB submitted a filing with the California Insurance Commissioner recommending a 16.4%
decrease in advisory pure premium rates on new and renewal policies effective July 1, 2006. The filing was based
on an analysis of loss experience valued as of December 31, 2005 and was made in response to continued reductions
in workers compensation claim costs in California as a result of reform legislation enacted primarily in 2003
and 2004. On May 31, 2006, the Commissioner recommended a 16.4% decrease in rates, and on that date, we filed new
rates reflecting an average reduction of 5.8% from prior rates for new and renewal workers compensation
insurance policies written in California on or after July 1, 2006. The filing was approved on June 21, 2006. This
is the sixth California rate reduction we have filed since October 1, 2003, resulting in a net cumulative
reduction of our California rates of approximately 41.8%.

If any
of our competitors adopt premium rate reductions that are greater than ours, we may be unable to compete
effectively and our business, financial condition and results of operations could be materially adversely
affected. Rate reductions have also been proposed in other states in which we operate. At this time, we are
unable to

- 26 -

---

##### Table of Contents

predict the impact that the proposed rate reductions, if approved and adopted by us, might have on our
future financial position and results of operations.

# Risks Related to Our
Common Stock

| | Entities affiliated with Summit Partners
have the ability to influence our business, which may be
disadvantageous to other stockholders and adversely affect the trading price of SIHs common stock.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Following
the completion of a secondary offering of SIHs common stock in February 2006, entities affiliated with
Summit Partners, collectively, beneficially owned approximately 20.2% of SIHs outstanding common stock.
Distributions within Summit during May and June of 2006 reduced Summits beneficial ownership percentage to
approximately 10.2% at June 30, 2006. As a result, these stockholders, acting together, will have the ability to
exert influence over all matters requiring approval by SIHs stockholders, including the election and removal of
directors and any proposed merger, consolidation or sale of all or substantially all of our assets and other
corporate transactions. In addition, these stockholders may have interests that are different from ours. Under
SIHs amended and restated certificate of incorporation, none of the Summit entities or any director, officer,
stockholder, member, manager or employee of the Summit entities has any duty to refrain from engaging directly or
indirectly in the same or similar business activities or lines of business that we do. In the event that any
Summit entity acquires knowledge of a potential transaction or matter which may be a corporate opportunity for
itself and us, the Summit entity will not have any duty to communicate or offer such opportunity to us and will
not be liable to us or our stockholders for breach of any fiduciary duty relating to such corporate opportunity.
One of SIHs directors, Peter Y. Chung, is affiliated with Summit Partners. Our officers, directors and principal
stockholders could delay or prevent an acquisition or merger even if the transaction would benefit other
stockholders.

# Item 2.  Unregistered
Sales of Equity Securities and Use of Proceeds

On
January 19, 2005, the SEC declared effective SIHs Registration Statement on Form S-1, as amended
(Registration No. 333-119111), as filed with the SEC in connection with the initial public offering of 8,625,000
shares of SIHs common stock. Proceeds to SIH, after accounting for approximately $6.3 million in underwriting
discounts and commissions and approximately $3.9 million in other expenses of the offering, were approximately
$80.4 million. The offering closed on January 26, 2005.

On
January 26, 2005, SIH contributed approximately $74.8 million of the net proceeds to SBIC. We are using the
remaining net proceeds for general corporate purposes, including supporting the growth of PointSure. Except for
the capital contribution to SBIC, as of June 30, 2006, we had not used any of the remaining net proceeds from the
offering. Our use of the proceeds from the offering does not represent a material change in the use of proceeds
described in the prospectus included as part of the Registration Statement.

We
did not purchase any of our equity securities during the six months ended June 30,
2006.

# Item 4.  Submission of Matters to a Vote
of Security Holders

The 2006 annual
meeting of stockholders of SIH was held on May 25, 2006. At the annual meeting, our stockholders
were asked to elect six directors to the Board of Directors and to ratify the Audit Committees appointment of
KPMG LLP as SIHs independent auditors for the year ending December 31, 2006. Following are the results of the
election:

# Proposal I:  
Election of six directors to the Board of Directors

| |                     | Votes For |            | Votes Withheld | 
| | ------------------- | --------- | ---------- | -------------- | 
| | John G. Pasqualetto |           | 19,468,622 |                | 
| | J. Scott Carter     |           | 19,411,801 |                | 
| | Peter Y. Chung      |           | 19,412,221 |                | 
| | William M. Feldman  |           | 19,742,047 |                | 
| | Mural R. Josephson  |           | 19,741,947 |                | 
| | George M. Morvis    |           | 19,412,601 |                | 

- 27 -

---

##### Table of Contents

| | Proposal II:  
Ratification of the Audit Committees appointment of KPMG LLP as independent auditor for the year ending December 31, 2006
| | -----------------------------------------------------------------------------------------------------------------------------------------

| | Votes for     | 19,957,798 | 
| | ------------- | ---------- | 
| | Votes against | 23,768     | 
| | Abstentions   | 57,374     | 

# Item 6.  Exhibits

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

- 28 -

---

##### Table of Contents

# 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:  August 14, 2006 |                                    |                                                                                                      | 
|                       | By:                                | /s/  Joseph S. De Vita                                                                               | 
|                       |                                    | Joseph S. De Vita                                                                                    | 
|                       |                                    | Senior Vice President, Chief Financial Officer
and Assistant Secretary (Principal Financial Officer)
|                      

- 29 -

---

##### Table of Contents

# 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.

ExhibitNumber
    
    Description31.1
    
    Rule 13a-14(a) Certification (Chief Executive Officer)31.2
    
    Rule 13a-14(a) Certification (Chief Financial Officer)32.1
    
    Section 1350 Certification (Chief Executive Officer)32.2
    
    Section 1350 Certification (Chief Financial Officer)