UNITED
STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
   FORM
10-Q (Mark One)x
Quarterly Report Pursuant to Section 13 or
 15(d) of the Securities Exchange Act of 1934 
 For the quarterly period ended September 30, 2008oro
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.(Exact name of registrant as specified in its charter) Delaware
56-2393241(State or other jurisdiction of incorporation 
 or organization)
(IRS Employer Identification No.) 1501 4th Avenue, Suite 2600
Seattle, WA 98101 (Address of principal executive offices,
including zip code) (206)
269-8500(Registrants telephone number, including area code) Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes x   No o Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of large accelerated filer, accelerated filer and smaller
reporting company in Rule 12b-2 of the Exchange Act. (Check one):
 Large accelerated filer o  Accelerated
filer x  Non-accelerated
filer o  Smaller
reporting company o
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act): 
Yes o   No x Indicate the
number of shares outstanding of each of the issuers classes of common stock,
as of the latest practicable date: Class

Shares outstanding as of November 7, 2008Common Stock, $0.01 Par Value

21,392,854     SeaBright Insurance Holdings, Inc.

Index to Form 10-Q

PagePart I.

Financial InformationItem 1.

Financial
Statements (unaudited)

2Condensed
Consolidated Balance Sheets as of
 September 30, 2008 and December 31, 2007

2Condensed
Consolidated Statements of Operations
 for the Three Months and Nine Months Ended September 30, 2008 and 2007

3Condensed
Consolidated Statements of Cash
 Flows for the Nine Months Ended September 30, 2008 and 2007

4Notes to
Unaudited Condensed Consolidated
 Financial Statements

5Item 2.

Managements Discussion and Analysis of
 Financial Condition and Results of Operations

19Item 3.

Quantitative and
Qualitative Disclosures
 About Market Risk

38Item 4.

Controls and
Procedures

38Part II.

Other
InformationItem 1A.

Risk Factors

39Item 6.

Exhibits

40Signatures

41- 1 -

PART I  FINANCIAL INFORMATION

Item 1. Financial
Statements

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

CONDENSED
CONSOLIDATED BALANCE SHEETS

September 30,
 2008

December 31,
 2007(Unaudited)(in thousands,
 except share and 
 per share amounts)ASSETSFixed income securities
 available for sale, at fair value (amortized cost $511,871 in 2008 and
 $471,131 in 2007)

$
499,726

$
474,756Equity securities available for
 sale, at fair value (cost $11,333 in 2008 and $11,301 in 2007)


11,333


11,193Preferred stock available for
 sale, at fair value (cost $851 in 2008 and $9,485 in 2007)


851


8,488Cash and cash
equivalents


17,497


20,292Accrued investment
income


5,616


5,055Premiums receivable, net of
 allowance


14,661


9,223Deferred premiums


153,302


150,066Service income
receivable





436Reinsurance
recoverables


20,141


14,210Receivable under adverse
 development cover


2,533


2,533Prepaid reinsurance


1,677


1,820Property and equipment,
net


4,752


1,707Deferred income taxes,
net


24,522


16,488Deferred policy acquisition
 costs, net


21,315


19,832Intangible assets, net


1,225


1,233Goodwill


3,386


2,881Other assets


18,154


15,356Total
assets

$
800,691

$
755,569LIABILITIES AND
 STOCKHOLDERS EQUITYLiabilities:Unpaid loss and
loss adjustment
 expense

$
279,656

$
250,085Unearned
premiums


146,745


147,033Reinsurance
funds withheld and
 balances payable


1,829


220Premiums
payable


5,289


4,136Accrued
expenses and other
 liabilities


45,817


47,789Surplus
notes


12,000


12,000Total
liabilities


491,336


461,263Commitments and
contingenciesStockholders
equity:Series A
preferred stock, $0.01
 par value; 750,000 shares authorized; no shares issued and outstanding





Undesignated
preferred stock,
 $0.01 par value; 10,000,000 shares authorized; no shares issued and
 outstanding





Common stock,
$0.01 par value;
 75,000,000 shares authorized; issued and outstanding  21,362,312 shares at
 September 30, 2008 and 20,831,102 shares at December 31, 2007


214


208Paid-in
capital


199,534


194,023Accumulated
other comprehensive
 income (loss)


(7,895
)

1,638Retained
earnings


117,502


98,437Total
stockholders equity


309,355


294,306Total
liabilities and
 stockholders equity

$
800,691

$
755,569See accompanying notes to unaudited condensed
consolidated financial statements.

- 2 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

Three Months
 Ended September 30,

Nine Months
 Ended September 30,2008

2007

2008

2007(in thousands,
 except share and earnings per share information)Revenue:Premiums
earned

$
68,687

$
59,721

$
181,094

$
163,109Claims service
income (loss)


(79
)

432


751


1,331Other service
income


80


55


179


104Net investment
income


5,571


5,174


16,852


14,786Net realized
loss


(11,677
)

(25
)

(13,806
)

(85
)Other
income


2,820


1,376


6,271


3,01865,402


66,733


191,341


182,263Losses and expenses:Loss and loss
adjustment
 expenses


39,154


34,921


101,719


89,851Underwriting,
acquisition and
 insurance expenses


17,350


15,172


50,674


42,495Interest
expense


205


289


666


854Other
expenses


2,793


2,020


7,146


5,22359,502


52,402


160,205


138,423Income before
taxes


5,900


14,331


31,136


43,840Income tax expense
(benefit):Current


4,654


5,438


14,933


15,604Deferred


(535
)

(757
)

(2,862
)

(1,690
)4,119


4,681


12,071


13,914Net
income

$
1,781

$
9,650

$
19,065

$
29,926Basic earnings per
share

$
0.09

$
0.47

$
0.93

$
1.47Diluted earnings per
share

$
0.08

$
0.46

$
0.90

$
1.43Weighted average basic shares
 outstanding


20,581,822


20,350,778


20,466,465


20,336,778Weighted average diluted shares
 outstanding


21,369,033


20,989,481


21,143,263


20,950,968See accompanying notes to unaudited condensed
consolidated financial statements.

- 3 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS
(Unaudited)

Nine Months Ended September 30,2008

2007(in thousands)Cash flows from operating
 activities:Net
income

$
19,065

$
29,926Adjustments to
reconcile net
 income to cash provided by operating activities:Amortization of
deferred policy
 acquisition costs


22,438


26,564Policy
acquisition costs
 deferred


(23,920
)

(29,190
)Provision for
depreciation and
 amortization


2,933


2,058Compensation
cost on restricted
 shares of common stock


3,685


1,617Compensation
cost on stock
 options


734


530Net realized
loss on
 investments


13,806


85Gain on sale of
fixed assets





(1
)Benefit for
deferred income
 taxes


(2,901
)

(1,690
)Changes in
certain assets and
 liabilities:Unpaid loss and
loss adjustment
 expense


29,571


35,360Income tax
payable/receivable


(2,988
)

309Reinsurance
recoverables, net
 of reinsurance withheld


(2,809
)

167Unearned
premiums, net of
 deferred premiums and premiums receivable


(8,768
)

1,453Accrued
investment income


(561
)

(517
)Other assets
and other
 liabilities


(2,232
)

1,297Net cash
provided by operating
 activities


48,053


67,968Cash flows from investing
 activities:Purchases of
investments


(123,129
)

(95,333
)Sales of
investments


18,174


17,758Maturities and
redemption of
 investments


57,208


31,710Purchases of
property and
 equipment


(4,059
)

(1,405
)Payment for
purchase of
 subsidiary, net of cash acquired


(159
)

Net cash used
in investing
 activities


(51,965
)

(47,270
)Cash flows from financing
 activities:Proceeds from
exercise of stock
 options


1,113


310Deferred tax
benefit from
 disqualifying dispositions





83Grant of
restricted shares of
 common stock


4


5Net cash
provided by financing
 activities


1,117


398Net increase
(decrease) in cash
 and cash equivalents


(2,795
)

21,096Cash and cash equivalents at
 beginning of period


20,292


20,412Cash and cash equivalents at
 end of period

$
17,497

$
41,508Supplemental
disclosures:Federal income
taxes paid

$
17,735

$
14,850Interest paid
on surplus notes


690


852The Company
purchased all of
 the capital stock of BWNV for $484. In connection with the acquisition, the
 following liabilities were assumed:Fair value of
assets acquired

$
1,079

$
Cash paid for
capital stock


(484
)

Net liabilities
assumed

$
595

$
See accompanying notes to unaudited condensed
consolidated financial statements.

- 4 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED
CONSOLIDATED FINANCIAL STATEMENTS


1.
OrganizationSeaBright
Insurance Holdings, Inc. (SIH), a Delaware corporation, was formed in June
2003. On July 14, 2003, SIH entered into a purchase agreement, effective
September 30, 2003, with Kemper Employers Group, Inc. (KEG), Eagle Pacific
Insurance Company, Inc. and Pacific Eagle Insurance Company, Inc. (referred to
collectively as Eagle), and Lumbermens Mutual Casualty Company (LMC), the
ultimate owner of KEG and Eagle (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.

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. 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, permission was granted by the Illinois Department
of Financial and Professional Regulation, Division of Insurance (the Illinois
Division of Insurance) for KEIC to change its name to SeaBright Insurance
Company (SBIC). As of September 30, 2008, SBIC is licensed to write workers
compensation insurance in 48 states and the District of Columbia. PointSure is
engaged primarily in administrative and brokerage activities.

In
December 2007, SIH acquired 100% of the outstanding common stock of Total
HealthCare Management, Inc. (THM), a privately held California based provider
of medical bill review, utilization review, nurse case management and other
related services. The total purchase price was $1.5 million, of which $1.2
million was paid at closing. The remaining $0.3 million is scheduled to be paid
in three equal installments on the first three anniversaries of the closing
date, provided that THM achieves certain revenue objectives in 2008, 2009 and
2010. The Company recorded goodwill of $1.4 million in connection with this
acquisition.

In
July 2008, PointSure acquired 100% of the outstanding common stock of
Black/White and Associates, Inc., Black/White and Associates of Nevada and
Black/White Rockridge Insurance Services, Inc. (referred to collectively as
BWNV), a privately held managing general agent and wholesale insurance
broker. Also included in the transaction were a covenant not to compete from
key principals of BWNV and other intangible assets. The preliminary purchase
price paid at closing was $1.7 million, of which $0.5 million was allocated to
the purchase of BWNV capital stock. The stock purchase agreement provides for a
contingent purchase price to be paid by (refunded to) the Company approximately
13 months following the closing date, depending on whether BWNV revenue in the
12 months following closing exceeds (or is less than), respectively, the base
revenue assumed in the preliminary purchase price. The Company recorded
goodwill of approximately $0.5 million in connection with this acquisition.

2. Summary of Significant Accounting Policiesa. Basis of PresentationThe
accompanying unaudited condensed consolidated financial statements include the
accounts of SIH and its wholly owned subsidiaries, SBIC, PointSure, THM and
BWNV (collectively, the Company, we or us). All significant
intercompany transactions among these affiliated entities have been eliminated
in consolidation.

The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with U.S. generally accepted accounting principles
(GAAP) for interim financial information and pursuant to the instructions to
Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of
1934, as amended (the Exchange Act). Accordingly, they do not include all of
the information and notes required by GAAP for complete financial statements.
The condensed consolidated balance sheet at December 31, 2007 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, 2007 included in the Companys
Annual Report on Form 10-K, which was filed with the U.S. Securities and
Exchange Commission (the SEC) on March 17, 2008.

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

- 5 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)

forth therein. Results of operations for the three month and nine month
periods ended September 30, 2008 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. Actual results could differ
from those estimates. The Company has used significant estimates in determining
unpaid loss and loss adjustment expenses, including losses that have occurred
but were not reported to us by the financial reporting date; the amount and
recoverability of reinsurance recoverable balances; deferred policy acquisition
costs; income taxes; the valuation and impairment of investment securities;
earned but unbilled premiums; and retrospective premiums.

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 period). The portion of premium that is applicable to
the unexpired period of a policy in-force is not included in revenue but is
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. While the typical retrospectively rated policy has five annual
adjustment or measurement periods, premium adjustments continue until mutual
agreement to cease future adjustments is reached with the policyholder. For the
three month periods ended September 30, 2008 and 2007, approximately 15.0% and
23.2%, respectively, of direct premiums written related to retrospectively
rated policies. For the nine months ended September 30, 2008 and 2007,
approximately 13.9% and 19.2%, respectively, of direct premiums written related
to retrospectively rated policies.

The
Company estimates the amount of premiums that have been earned but are unbilled
at the end of the period by analyzing historical earned premium adjustments
made at final audit and applying an adjustment percentage against premiums
earned for the period. Included in deferred premiums is an accrual for earned
but unbilled premiums of $182,000 at September 30, 2008 and $44,000 at December
31, 2007.

Service
income generated from various underwriting and claims service agreements with
third parties is recognized in the periods in which the services are performed.
During the quarter ended September 30, 2008, the Company determined that claim
data used to determine billing amounts for claims administration services
provided by the Company had, since August 2006, been incorrectly reported to
the Company by a customer, resulting in an overstatement of claims service
income by $0.5 million. As a result, the financial position and results of
operations for the quarter ended September 30, 2008 reflect a $0.5 million
reduction in service income receivable and claims service income, and a related
decrease of $0.2 million in federal income tax payable and income tax expense
to reflect the correction of this error.

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. Loss
adjustment expenses are estimates 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. Liabilities for unpaid loss and loss
adjustment expenses are not discounted to account for the time value of money.

- 6 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)

Due
to 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 and
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 and/or deflation;
the pending
 level of unpaid claims;
the cost of
 claim settlements;
legislative
 reforms affecting workers compensation;
the
 environment in which insurance companies operate; and
trends in
 claim frequency and severity.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 reasonable. The estimates are reviewed periodically and
any necessary adjustments are included in the results of operations of the
period in which the adjustments are determined.

e. Reinsurance

The
Company protects itself from excessive losses by reinsuring certain levels of
risk in various areas of exposure with nonaffiliated reinsurers. Regardless of
type, reinsurance does not legally discharge the ceding insurer from primary
liability for the full amount due under the reinsured policies. Reinsurance
premiums, commissions, expense reimbursements and reserves related to ceded
business are accounted for on a basis consistent with that used in accounting
for original policies issued and the terms of the reinsurance contracts. The
unpaid loss and loss adjustment expense subject to the adverse development
cover with LMC is calculated periodically using generally accepted actuarial
methodologies for estimating unpaid loss and loss adjustment expense
liabilities, including incurred loss and paid loss development methods. Amounts
recoverable in excess of acquired reserves 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
unaudited condensed consolidated 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.

Balances
due from reinsurers on unpaid loss and loss adjustment expenses, including an
estimate of such recoverables related to reserves for incurred-but-not-reported
(IBNR) losses, are reported as assets and are included in reinsurance
recoverables even though amounts due on unpaid loss and loss adjustment
expenses are not recoverable from the reinsurer until such losses are paid.
Should a reinsurer be unable or unwilling to pay such amounts to the Company
when due, the Company would be liable for such obligations. The Company
monitors the financial condition of its reinsurers and does not believe that it
is currently exposed to any material credit risk through its reinsurance
agreements because most of its reinsurance is recoverable from large,
well-capitalized reinsurance companies. Historically, no amounts from
reinsurers have been written-off as uncollectible.

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 estimated to be in
effect when the differences are expected to reverse, net of any applicable
valuation allowances. The Company evaluates the

- 7 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)

necessity of a
deferred tax asset valuation allowance by determining, based on the weight of
available evidence, whether it is more likely than not that some portion or all
of the deferred tax asset will not be realized. When necessary, a valuation
allowance is recorded to reduce the deferred tax asset to the amount that is
more likely than not to be realized.

The
Company adopted the provisions of Financial Accounting Standards Board (FASB)
Interpretation No. 48, Accounting for Uncertainty in Income Taxes  an
Interpretation of FASB Statement No. 109 (FIN 48) on January 1,
2007. At the date of adoption and as of September 30, 2008 and December 31,
2007, the Company had no unrecognized tax benefits and no adjustments to
liabilities or results of operations were required.

The
Company recognizes interest and penalties on tax related matters as income tax
expense. The Company had no interest or penalties expense related to uncertain
tax positions in the three month or nine month periods ended September 30, 2008
and 2007.

The
tax years 2005 through 2007 remain open to examination by the major taxing
jurisdictions to which the Company is subject.

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 nine month periods ended September 30, 2008 and 2007:

Three Months Ended September 30,

Nine Months Ended September 30,2008

2007

2008

2007(in
 thousands)Basic weighted average shares
outstanding


20,582


20,351


20,466


20,337Weighted
average shares issuable upon
 exercise of outstanding stock options and vesting of restricted stock


787


639


677


614Diluted weighted average shares
outstanding


21,369


20,990


21,143


20,951h. Stock-Based
Compensation

The Company
accounts for awards of stock options and nonvested restricted stock according
to the provisions of SFAS No. 123R, Share-Based
Payment. Total stock-based compensation expense recognized in the
unaudited condensed consolidated statements of operations for the three month
and nine month periods ended September 30, 2008 and 2007 is shown in the
following table. No compensation cost was capitalized during the periods shown.

Three Months Ended September 30,

Nine Months Ended September 30,2008

2007

2008

2007(in
 thousands)Stock option compensation
expense related
 to:Nonvested
restricted stock

$
1,007

$
681

$
3,685

$
1,616Stock
options


193


207


734


531Total

$
1,200

$
888

$
4,419

$
2,147Total related tax
benefit

$
352

$
247

$
1,328

$
587i. Comprehensive Income (Loss)

The
following table summarizes the Companys comprehensive income (loss) for the
three month and nine month periods ended September 30, 2008 and 2007:

- 8 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)

Three
 Months Ended September 30,

Nine
 Months Ended September 30,2008

2007

2008

2007(in
 thousands)Net income

$
1,781

$
9,650

$
19,065

$
29,926Reclassification adjustment for
net
 realized losses recorded into income


11,677


25


13,806


85Tax benefit related to
reclassification
 adjustment


(4,087
)

(9
)

(4,764
)

(30
)Decrease (increase) in
unrealized losses on
 investment securities available for sale


(18,947
)

(6,117
)

(28,471
)

276Tax benefit (expense) related to
unrealized
 losses


6,562


2,142


9,897


(96
)Total
comprehensive income (loss)

$
(3,014
)
$
5,691

$
9,533

$
30,161j. Recently Issued Accounting Pronouncements

In
September 2006, the FASB issued SFAS No. 157, Fair
Value Measurements, which defines fair value and establishes a
framework for measuring fair value in GAAP and expands disclosures about fair
value measurements. The provisions for SFAS No. 157 are effective for fiscal
years beginning after November 15, 2007, and interim periods within those
fiscal years. The Company adopted the provisions of SFAS No. 157 as of January
1, 2008, which did not have a material effect on its consolidated financial
condition or results of operations.

In
February 2007, the FASB issued SFAS No. 159, The
Fair Value Option for Financial Assets and Financial Liabilities  Including an
Amendment of FASB Statement No. 115, which permits entities to
choose to measure many financial instruments and certain other items at fair
value in order to mitigate volatility in reported earnings caused by measuring
related assets and liabilities differently and without having to apply complex
hedge accounting provisions. The provisions for SFAS No. 159 are effective for
fiscal years beginning after November 15, 2007, and interim periods within those
fiscal years. The Company adopted the provisions of SFAS No. 159 as of January
1, 2008, which did not have a material effect on its consolidated financial
condition or results of operations.

On
October 10, 2008, the FASB issued FASB Staff Position No. 157-3, Determining the Fair Value of a Financial Asset When
the Market for That Asset Is Not Active,which clarifies the
application of FAS 157, Fair Value
Measurements, in an inactive market and illustrates how an entity
would determine fair value when the market for a financial asset is not active.
FSP 157-3 states that an entity should not automatically conclude that a
particular transaction price is determinative of fair value. In a dislocated
market, judgment is required to evaluate whether individual transactions are
forced liquidations or distressed sales. When relevant observable market
information is not available, a valuation approach that incorporates
managements judgments about the assumptions that market participants would use
in pricing the asset in a current sale transaction would be acceptable. The FSP
also indicates that quotes from brokers or pricing services may be relevant
inputs when measuring fair value, but are not necessarily determinative in the
absence of an active market for the asset. In weighing a broker quote as an
input to a fair value measurement, an entity should place less reliance on
quotes that do not reflect the result of market transactions. Further, the
nature of the quote (for example, whether the quote is an indicative price or a
binding offer) should be considered when weighing the available evidence. FSP
157-3 is effective immediately and applies to prior periods for which financial
statements have not been issued, including interim or annual periods ending on or
before September 30, 2008. Accordingly, the Company adopted FSP 157-3
prospectively, beginning July 1, 2008. The adoption of FSP 157-3 did not have a
material impact on the Companys financial results or fair value
determinations.

- 9 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)

3.
InvestmentsThe
consolidated cost or amortized cost, gross unrealized gains and losses, and
estimated fair value of investment securities available-for-sale at September
30, 2008 are as follows:

Cost or
 Amortized
 Cost

Gross
 Unrealized
 Gains

Gross
 Unrealized
 Losses

Estimated
 Fair Value(in
 thousands)U.S.
 Treasury securities

$
13,535

$
371

$


$
13,906Government
 sponsored agency securities


24,163


323


(89
)

24,397Corporate
 securities


50,862


231


(2,398
)

48,695Tax-exempt
 municipal securities


287,625


786


(9,220
)

279,191Mortgage
 pass-through securities


79,674


711


(304
)

80,081Collateralized
 mortgage obligations


2,696


18


(111
)

2,603Asset-backed
 securities


53,316





(2,463
)

50,853Total fixed
income securities
 available-for-sale


511,871


2,440


(14,585
)

499,726Equity
 securities


11,333








11,333Preferred
 stock


851








851Total
investment securities
 available-for-sale

$
524,055

$
2,440

$
(14,585
)
$
511,910Equity
securities consist of investments in equity indexed securities exchange-traded
funds designed to correspond to the performance of certain indexes based on
domestic or international stocks. The Company had no direct investments in
individual equity securities at September 30, 2008.The
unrealized loss on temporarily impaired investments totaled $14.6 million at
September 30, 2008 for investment securities with a fair value of $306.7
million. Approximately $2.3 million of the total unrealized losses at September
30, 2008 were from securities that had been impaired for more than one year. At
September 30, 2008, five securities, with a book value of approximately $2.3
million and a fair value of approximately $1.7 million, had unrealized losses
that exceeded 20% of their book value. The following table presents information
about investment securities with unrealized losses at September 30, 2008:

Less
 Than 12 Months

12
 Months or More

TotalInvestment
 Category

Aggregate
 Fair Value

Aggregate
 Unrealized
 Loss

Aggregate
 Fair Value

Aggregate
 Unrealized
 Loss

Aggregate
 Fair Value

Aggregate
 Unrealized
 Loss(in
 thousands)Fixed income
securities:U.S. Treasury
securities

$


$


$


$


$


$
Government
sponsored agency securities (1)


6,077


(89
)







6,077


(89
)Corporate
securities


29,796


(1,964
)

3,908


(434
)

33,704


(2,398
)Tax-exempt
municipal securities


180,374


(7,994
)

10,482


(1,226
)

190,856


(9,220
)Mortgage
pass-through securities


23,339


(278
)

1,077


(25
)

24,416


(304
)Collateralized
mortgage obligations


616


(26
)

168


(85
)

784


(111
)Asset-backed
securities


45,318


(1,960
)

5,534


(504
)

50,852


(2,463
)Total fixed
income securities


285,520


(12,311
)

21,169


(2,274
)

306,689


(14,585
)Equity securities

















Preferred stock

















Total

$
285,520

$
(12,311
)
$
21,169

$
(2,274
)
$
306,689

$
(14,585
)(1)
Government
 sponsored agency securities are not backed by the full faith and credit of
 the U.S. Government.The
Company regularly reviews its investment portfolio to evaluate the necessity of
recording impairment losses for other-than-temporary declines in the fair value
of 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

- 10 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)

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, at the end of the quarter and those securities that
have been impaired at some level for six or more consecutive months as of the
end of the quarter. Other-than-temporary impairment (OTTI) losses result in a
permanent reduction of the carrying amount of the underlying investment.
Significant changes in the factors considered when evaluating investments for impairment
losses could result in a significant change in impairment losses reported in
the unaudited financial statements.

The
Company evaluated investment securities with fair values less than amortized
cost at September 30, 2008 and determined that the Companys preferred stock
investments met the criteria for OTTI. These securities, with a total book
value at September 30, 2008 of $9.1 million and a fair value of $0.8 million,
consist primarily of government-sponsored agency fixed and variable preferred
stock with greater volatility and limited upside in the current market
environment. Therefore, the Company recorded an impairment loss of $8.3 million
on these securities in the quarter ended September 30, 2008. In addition, the
Company evaluated its holding of equity indexed securities exchange-traded
funds with a book value of $14.5 million and a fair value of $11.3 million and
determined that these investments met the criteria for OTTI. Therefore, the
Company recorded an impairment loss of $3.2 million on these securities in the
quarter ended September 30, 2008. Total OTTI losses for the three month and
nine month periods ended September 30, 2008 were $11.5 million and $13.4
million, respectively.

The
Company had no direct sub-prime mortgage exposure in its investment portfolio
as of September 30, 2008 and less than $1.0 million of indirect exposure. The
average credit quality of the Companys $283.9 million fixed income municipal
portfolio at September 30, 2008 was AA/AA (AA based on the issuers
underlying ratings). Insured municipal bonds totaled $202.8 million and had a
weighted average credit rating of AA (AA based on the issuers underlying
ratings). The remaining $81.1 million in uninsured municipal bonds carried a
weighted average credit rating of AA/AA. The Company does not expect a
material impact to its investment portfolio or financial position as a result
of the problems currently facing monoline bond insurers.

The
amortized cost and estimated fair value of fixed income securities and
preferred stock available-for-sale at September 30, 2008, by contractual
maturity, are set forth below. Actual maturities may differ from contractual
maturities because certain borrowers have the right to call or prepay obligations
with or without call or prepayment penalties.

Maturity

Cost or
 Amortized
 Cost

Estimated
 Fair Value(in
 thousands)Due in one
 year or less

$
18,303

$
18,144Due after
 one year through five years


146,767


146,533Due after
 five years through ten years


172,000


165,726Due after
 ten years


39,967


36,638Securities
 not due at a single maturity date


135,685


133,536Total
investment securities
 available-for-sale

$
512,722

$
500,577The
consolidated amortized cost of investment securities available-for-sale
deposited with various regulatory authorities at September 30, 2008 was $203.9
million.

4.
PremiumsDirect
premiums written totaled $60.9 million and $65.6 million for the three month
periods ended September 30, 2008 and 2007, respectively, and $187.5 million and
$188.7 million for the nine month periods then ended, respectively.

- 11 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)

Premiums
receivable consist of the following at September 30, 2008 and December 31,
2007:

September
 30,
 2008

December
 31,
 2007(in
 thousands)Premiums
 receivable

$
16,078

$
10,639Allowance
 for doubtful accounts


(1,417
)

(1,416
)$
14,661

$
9,2235.
Reinsurancea. 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. For the period from
October 1, 2007 through September 30, 2008, the Company entered into
reinsurance agreements with nonaffiliated reinsurers wherein it retains the
first $1.0 million of each loss occurrence. Losses in excess of $1.0 million up
to $75.0 million per loss occurrence are reinsured as follows:

Layer

General Description$1.0 million
 for each loss occurrence in excess of $1.0 million for each loss occurrence

Fully
 reinsured, subject to an aggregate annual limit of $8.0million.$3.0 million
 for each loss occurrence in excess of $2.0 million for each loss occurrence

Fully
 reinsured, subject to an aggregate annual limit of $12.0million.$5.0 million
 for each loss occurrence in excess of $5.0 million for each loss occurrence

Fully
 reinsured, subject to an aggregate annual limit of $15.0million.$10.0
 million for each loss occurrence in excess of $10.0 million for each loss
 occurrence

Fully
 reinsured, subject to a limit of $7.5 million maximum for any one loss and an
 aggregate limit of $20.0 million.$55.0
 million for each loss occurrence in excess of $20.0 million for each loss
 occurrence

Fully
 reinsured in two sub-layers. The first sub-layer affords coverage of up to
 $30.0 million for each loss occurrence in excess of $20.0 million, subject to
 an aggregate annual limit of $60.0 million, and the second sub-layer affords
 coverage up to $25.0 million for each loss occurrence in excess of $50.0
 million, subject to an annual aggregate limit of $50.0 million. Both
 sub-layers are subject to a limit of $5.0 million maximum for any one loss.On
October 1, 2008, the Company entered into new reinsurance agreements with
nonaffiliated reinsurers wherein it retains the first $500,000 of each loss
occurrence. The next $500,000 of losses per occurrence (excess of the first
$500,000 of losses per occurrence retained by the Company) are 50% reinsured.
The new reinsurance program, which is effective through September 30, 2009,
provides coverage up to $85.0 million per loss occurrence as follows:

- 12 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)

Layer

General Description$500,000 for
 each loss occurrence in excess of $500,000 for each loss occurrence

50%
 reinsured, subject to an aggregate annual limit of $17.0 million.$1.0 million
 for each loss occurrence in excess of $1.0 million for each loss occurrence

Fully
 reinsured, subject to an aggregate annual limit of $10.0 million. Includes
 general liability coverage limited to 77% recovery of each general liability
 loss occurrence. The remaining 23% of each general liability loss occurrence
 in this layer is retained by the Company.$3.0 million
 for each loss occurrence in excess of $2.0 million for each loss occurrence

Fully
 reinsured, subject to an aggregate annual limit of $12.0 million. Includes
 general liability coverage.$5.0 million
 for each loss occurrence in excess of $5.0 million for each loss occurrence

Fully
 reinsured, subject to an aggregate annual limit of $15.0 million. Includes
 general liability coverage.$75.0
 million for each loss occurrence in excess of $10.0 million for each loss
 occurrence

Fully
 reinsured in three sub-layers. The first sub-layer affords coverage of up to
 $10.0 million for each loss occurrence in excess of $10.0 million, subject to
 an aggregate annual limit of $20.0 million. The second sub-layer affords
 coverage up to $30.0 million for each loss occurrence in excess of $20.0
 million, subject to an annual aggregate limit of $60.0 million. The third
 sub-layer affords coverage up to $35.0 million for each loss occurrence in
 excess of $50.0 million, subject to an annual aggregate limit of $70.0
 million. All sub-layers are subject to a limit of $7.5 million maximum for
 any one loss.All
of the reinsurers participating in our 2008-2009 reinsurance program are rated
either A+ (Superior), A (Excellent) or A (Excellent) by A.M. Best as of
September 30, 2008. The above coverage is subject to various additional
limitations and exclusions as more fully described in the reinsurance
agreements. The Company also enters into facultative reinsurance agreements to
reduce its net retained risk on certain insurance policies it writes.

As
part of the purchase of SBIC, 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, calls for LMC
to reimburse SBIC 100% of the excess of the actual loss at December 31, 2011
over the initial loss reserves at September 30, 2003. The Agreement also calls
for SBIC to reimburse LMC 100% of the excess of the initial loss reserves at
September 30, 2003 over the actual loss results at December 31, 2011. The
amount of adverse loss development under the Agreement recorded in the
accompanying unaudited condensed consolidated balance sheets was $2.5 million
at September 30, 2008 and December 31, 2007. Any increase or decrease in the
amount receivable from LMC is netted against loss and loss adjustment expense
in the accompanying unaudited condensed consolidated statements of operations.

As
part of the Agreement, LMC placed into trust (the Trust) $1.6 million, equal
to 10% of the balance sheet reserves of SBIC at the date of sale. Thereafter,
the Trust shall be adjusted each quarter, if warranted, to an amount equal to
the greater of (a) $1.6 million or (b) 102% of LMCs obligations under the
Agreement. The balance of the Trust, including accumulated interest, was $2.8
million at September 30, 2008 and $3.5 million at December 31, 2007.

b. Reinsurance Assumed

The
Company involuntarily assumes residual market business either directly from
various states that operate their own residual market programs or indirectly
from the National Council for Compensation Insurance (the NCCI), which
operates residual market programs on behalf of some states. The states in which
the Company assumed residual market business at September 30, 2008 include the
following: Alabama, Alaska, Arizona, Arkansas, Connecticut, Delaware, District
of Columbia, Iowa, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas,
Massachusetts, Michigan, Mississippi, Nevada, New Jersey, New Mexico, Oregon,
South Carolina, South Dakota, and Virginia.

- 13 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)

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 September 30, 2008 and
December 31, 2007:

September
 30,
 2008

December
 31,
 2007(in
 thousands)Reinsurance recoverables on
unpaid loss and
 loss adjustment expenses

$
19,557

$
14,034Reinsurance recoverables on paid
losses


584


176Total
reinsurance recoverables

$
20,141

$
14,210The
Company monitors the financial condition of its reinsurers and does not believe
that it is currently exposed to any material credit risk through its
reinsurance agreements because most of its reinsurance is recoverable from
large, well-capitalized reinsurance companies. Of the Companys top ten
reinsurers, based on the net amount recoverable, nine were rated A+ (Superior),
A (Excellent) or A (Excellent) by A.M. Best as of September 30, 2008. One
reinsurer is not formally followed by A.M. Best. Historically, no amounts
recoverable from reinsurers have been written-off as uncollectible.

The
effects of reinsurance are as follows for the three month and nine month
periods ended September 30, 2008 and 2007:

Three
 Months Ended September 30,

Nine
 Months Ended September 30,2008

2007

2008

2007(in
 thousands)Reinsurance assumed:Written
premiums

$
790

$
2,357

$
4,034

$
6,809Earned
premiums


1,282


2,199


5,181


6,389Losses and loss
adjustment expenses
 incurred


872


1,462


3,286


4,106Commission
expenses incurred


527


821


2,749


2,360Reinsurance ceded:Written
premiums

$
4,454

$
4,200

$
10,926

$
11,780Earned
premiums


4,590


4,286


11,074


11,754Losses and loss
adjustment expenses
 incurred


4,827


530


7,324


391Commission
expenses incurred


571


313


1,451


878- 14 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)


6.
Unpaid Loss and Loss Adjustment ExpensesThe
following table summarizes the activity in unpaid loss and loss adjustment
expense for the three month and nine month periods ended September 30, 2008 and
2007:

Three
 Months Ended September 30,

Nine
 Months Ended September 30,2008

2007

2008

2007(in
 thousands)Beginning balance:Unpaid loss and
loss adjustment expense

$
263,708

$
218,679

$
250,085

$
198,356Reinsurance
recoverables


(15,534
)

(12,648
)

(14,034
)

(13,504
)Net


248,174


206,031


236,051


184,852Incurred related to:Current
period


44,239


40,389


122,660


110,302Prior
periods


(5,085
)

(5,468
)

(20,941
)

(20,451
)Total
incurred


39,154


34,921


101,719


89,851Paid related to:Current
period


(14,504
)

(11,749
)

(31,048
)

(24,390
)Prior
periods


(12,725
)

(8,266
)

(46,623
)

(29,376
)Total
paid


(27,229
)

(20,015
)

(77,671
)

(53,766
)Unpaid loss and
loss adjustment expense,
 net of reinsurance recoverables


260,099


220,937


260,099


220,937Reinsurance
recoverables


19,557


12,780


19,557


12,780Unpaid loss and
loss adjustment expense

$
279,656

$
233,717

$
279,656

$
233,717Loss
and loss adjustment expenses are net of the favorable development of prior
years loss reserves totaling approximately $5.1 million and $20.9 million in
the three month and nine month periods ended September 30, 2008, respectively,
compared to $5.5 million and $20.5 million for the same periods in 2007. The
majority of these reserve releases relate to the Companys California book of
business and reflect a continuation of lower than anticipated patterns of loss
payments in recent accident years as a result of reform legislation enacted
there primarily in 2003 and 2004.

7.
Surplus NotesIn
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
three-month LIBOR rate plus 400 basis points, subject to certain limitations.
Interest expense totaled $205,000 and $666,000 for the three month and nine
month periods ended September 30, 2008, respectively, and $289,000 and $854,000
for the three month and nine month periods ended September 30, 2007,
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.
Contingenciesa. SBIC is
subject to guaranty fund and
other assessments by the states in which it writes business. Guaranty fund
assessments are accrued at the time premiums are written. Other assessments are
accrued either at the time of assessment or in the case of premium-based
assessments, at the time the premiums are written, or in the case of loss-based
assessments, at the time the losses are incurred. As of September 30, 2008,
SBIC had a liability for guaranty fund and other assessments of $3.1 million
and a guaranty fund receivable of $3.6 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

- 15 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (Continued)

are paid.
Guaranty fund receivables and other surcharge items are generally realized by a
charge to new and renewing policyholders in the year following the year in
which the related assessments were paid.

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

9.
Share-Based Payment ArrangementsAt
September 30, 2008, the Company had outstanding stock options and nonvested
restricted stock granted according to the terms of two equity incentive plans.
The stockholders and Board of Directors approved the 2003 Stock Option Plan
(the 2003 Plan) in September 2003, and amended and restated the 2003 Plan in
February 2004 and April 2007, and approved the 2005 Long-Term Equity Incentive
Plan (the 2005 Plan and, together with the 2003 Plan, the Stock Option
Plans) in December 2004, and amended and restated the 2005 Plan in April 2007.

As
of September 30, 2008, options to purchase 376,718 shares of common stock were
outstanding under the 2003 Plan, and no additional shares were reserved for
issuance under the 2003 Plan. As of September 30, 2008, 769,180 shares of
nonvested restricted stock were outstanding under the 2005 Plan, options to purchase
701,823 shares of common stock were outstanding under the 2005 Plan and 557,569
shares were reserved for issuance under the 2005 Plan.

a. Stock
Options

The
fair values of stock options granted during the three month and nine month
periods ended September 30, 2008 and 2007 were determined on the dates of grant
using the Black-Scholes-Merton (Black-Scholes) option valuation model with
the following weighted average assumptions:

Three
 Months Ended September 30,

Nine
 Months Ended September 30,2008

2007

2008

2007Expected
 term (years)



6.3




6.3




6.3




6.3Expected
 stock price volatility



29.4
%



26.0
%



29.4
%



26.2
%Risk-free
 interest rate



3.11
%



4.94
%



3.01
%



4.59
%Expected
 dividend yield


















Estimated
 fair value per option


$
5.20



$
6.52



$
5.18



$
6.75The
following table summarizes stock option activity for the nine months ended
September 30, 2008:

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, 2007


1,015,321


$
10.70


7.0



$
4,450Granted


197,566



14.55







Forfeited














Exercised


(134,346
)


8.29







Cancelled














Outstanding
 at September 30, 2008


1,078,541



11.70


7.2




1,398Exercisable
 at September 30, 2008


656,480



9.38


5.9




2,379The
aggregate intrinsic values in the table above are before applicable income
taxes and are based on the Companys closing stock price of $13.00 on September
30, 2008. Proceeds from the exercise of stock options totaled approximately
$1.1 million for the nine months ended September 30, 2008. The total intrinsic
value of stock options exercised during the nine months ended September 30,
2008 was approximately $759,000.

- 16 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (continued)

The
following table presents additional information regarding options outstanding
as of September 30, 2008:

Options Outstanding

Options ExercisableRange of
 Exercise Prices

Number
 Outstanding

Weighted-
 Average
 Remaining
 Contractual
 Life (years)

Weighted-
 Average
 Exercise Price

Number
 Outstanding

Weighted-
 Average
 Exercise Price$
6.54


376,718

5.3


$
6.54



376,718


$
6.5410.50-12.54


239,807

6.6



10.63



179,753



10.6713.93-15.96


215,066

9.6



14.64



8,375



15.5817.16-18.68


246,950

8.4



18.06



91,634



17.941,078,541

7.2



11.70



656,480



9.38b.
Restricted Stock

The
following table summarizes restricted stock activity for the nine months ended
September 30, 2008:

Number of
 Shares

Weighted
 Average 
 Grant Date 
 Fair ValueOutstanding
 at December 31, 2007


473,880

$
17.80Granted


398,200


14.54Vested


(102,900
)

16.47Forfeited





Outstanding
 at September 30, 2008


769,180


16.29As
of September 30, 2008, there was $6.8 million of total unrecognized
compensation cost related to nonvested restricted stock granted under the 2005
Plan. That cost is expected to be recognized over a weighted-average period of
25 months.

10.
Fair Values of Assets and LiabilitiesIn
accordance with SFAS 157, the Company groups its financial assets and financial
liabilities measured at fair value in three levels, based on the markets in
which the assets and liabilities are traded and the reliability of the
assumptions used to determine fair value. These levels are:


Level 1 
 Valuations for assets and liabilities traded in active exchange markets, such
 as the New York Stock Exchange. Level 1 includes U.S. Treasury securities and
 equity securities that are traded by dealers or brokers in active markets.
 Valuations are obtained from readily available pricing sources for market
 transactions involving identical assets or liabilities.
Level 2 
 Valuations for assets and liabilities traded in less active dealer or broker
 markets. Level 2 valuations are based upon quoted prices for similar
 instruments in active markets, quoted prices for identical or similar
 instruments in markets that are not active, and model-based valuation
 techniques for which all significant assumptions are observable in the
 market. Level 2 includes government sponsored agency securities, corporate
 fixed-income securities, municipal bonds, mortgage pass-through securities,
 collateralized mortgage obligations, asset-backed securities and preferred
 stocks.
Level 3 
 Valuations for assets and liabilities that are derived from other valuation
 methodologies, including discounted cash flow models and similar techniques,
 and not based on market exchange, dealer, or broker traded transactions.
 Level 3 valuations incorporate certain assumptions and projections in
 determining the fair value assigned to such assets or liabilities.- 17 -

SEABRIGHT INSURANCE HOLDINGS, INC. AND
SUBSIDIARIES

NOTES TO UNAUDITED CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS (continued)

The
table below presents the September 30, 2008 balances of assets and liabilities
measured at fair value on a recurring basis.

Total

Level 1

Level 2

Level 3(in thousands)Fixed income
 securities

$
499,726

$
13,906

$
483,820

$
2,000Equity
 securities


11,333


11,333





Preferred
 stock


851





851


Total

$
511,910

$
25,239

$
484,671

$
2,000The following table presents a
reconciliation of the beginning and ending balances of assets classified as
Level 3 for the quarter ended September 30, 2008:

Auction Rate
 Securities(in thousands)Balance at
 June 30, 2008

$
Transfer
 into Level 3


2,000Balance at
September 30, 2008

$
2,000The
Company may be required, from time to time, to measure certain other financial
assets, such as goodwill, fixed assets and other long-lived assets, at fair
value on a non-recurring basis in accordance with GAAP. These adjustments to
fair value usually result from write-downs of individual assets. None of these
assets were measured to fair value during the three months or nine months ended
September 30, 2008.

- 18 -

Item 2.
Managements Discussion and Analysis of Financial Condition and
 Results of OperationsCautionary Statement

You should
read the following discussion and analysis in conjunction with our unaudited
condensed consolidated financial statements and the related notes thereto
included in Item 1 of Part I of this quarterly report. The
information contained in this quarterly report is not a complete description of
our business or the risks associated with an investment in our common stock. We
urge you to carefully review and consider the various disclosures made by us in
this quarterly report and in our other reports filed with the U.S. Securities
and Exchange Commission (SEC), including our Annual Report on Form 10-K
for the year ended December 31, 2007 filed with the SEC on March 17, 2008.

The
discussion under the heading Risk Factors in our Annual Report on Form 10-K
for the year ended December 31, 2007, as updated by the discussion in Part II,
Item 1A of our quarterly report on Form 10-Q for the quarter ended March 31,
2008 and similar discussions in our other SEC filings, describe some of the
important risk factors that may affect our business, results of operations and
financial condition. You should carefully consider those risks, in addition to
the other information in this report and in our other filings with the SEC,
before deciding to purchase, hold or sell our common stock.

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

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


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 and/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- 19 -


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 2007 Annual Report on Form 10-K.

Overview

We
are primarily 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 48
states and the District of Columbia to write workers compensation and other
lines of insurance. Traditional providers of workers compensation insurance
provide coverage to employers under one or more state workers compensation
laws, which prescribe benefits that employers are obligated to provide to their
employees who are injured arising out of or in the course of employment. We
focus on employers with complex workers compensation exposures and provide
coverage under multiple state and federal acts, applicable common law or
negotiated agreements. We also provide traditional state act coverage in
markets we believe are underserved. Our workers compensation policies are
issued to employers who also pay the premiums. The policies provide payments to
covered, injured employees of the policyholder for, among other things,
temporary or permanent disability benefits, death benefits and medical and
hospital expenses. The benefits payable and the duration of such benefits are
set by statute and vary by jurisdiction and with the nature and severity of the
injury or disease and the wages, occupation and age of the employee.

SIH
was formed in 2003 by certain 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.

To minimize
our exposure to any past business underwritten by KEIC, we entered into an
adverse development cover agreement in connection with the Acquisition. Under
the terms of this agreement, we and LMC are required to indemnify each other
with respect to the development of KEICs insurance liabilities as they existed
at the date of the Acquisition. Accordingly, if KEICs insurance liabilities
increase, LMC must indemnify us in the amount of the increase. If KEICs
insurance liabilities decrease, we must share with LMC the positive development
of those reserves. To support LMCs obligations under the adverse development
cover, LMC funded a trust account at the time of the Acquisition in the amount
of $1.6 million as collateral for LMCs potential future obligations to us under
the adverse development cover. The minimum amount that must be maintained in
the trust account is equal to the greater of (a) $1.6 million or (b) 102% of
the then existing quarterly estimate of LMCs total obligations under the
adverse development cover. The amount on deposit in the trust account was
approximately $2.8 million at
September 30, 2008 and $3.5 million at December 31, 2007. If LMC is placed into
receivership and the amount held

- 20 -

in the collateralized reinsurance trust is inadequate to satisfy the
obligations of LMC to us under the adverse development cover, it is unlikely
that we would recover any future amounts owing by LMC to us.

Principal Revenue and Expense Items

We derive
our revenue primarily from premiums earned, net investment income and net
realized gains and losses from investments, the operations of our non-insurance
subsidiaries 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, 2008, one-half of the premiums would be
earned in 2008 and the other half would be earned in 2009.

Premiums
earned is 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.

We earn our
direct premiums written from our maritime, alternative dispute resolution
(ADR) and state act customers. We also earn a small portion of our direct
premiums written from employers who participate in the Washington State United
States Longshore and Harbor Workers Compensation Act Assigned Risk Plan (the Washington
USL&H Assigned Risk Plan). We immediately cede 100% of those premiums, net
of our expenses, and 100% of the losses in connection with that business back
to the Washington USL&H Assigned Risk Plan. References to
direct premiums written generally exclude premiums from the Washington
USL&H Assigned Risk Plan because such business is not indicative of our
core business or material to our results of operations.

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 and preferred stocks. Our investment income includes interest
and dividends 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 OTTI or
sold for an amount less than their carrying value.

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 nine months ended September 30, 2008 and 2007, approximately 34.2% and
51.9%, respectively, of our claims service income was generated by contracts we
have with LMC to provide claims handling services for the policies written by
Eagle prior to the Acquisition. We expect income from these contracts to
decrease substantially over the next several years as transactions related to
Eagle 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. For further information
regarding our loss and loss adjustment expenses, including amounts paid and
unpaid, see the discussion under the heading Critical Accounting Policies,
Estimates and Judgments  Unpaid Loss and Loss Adjustment Expenses in this
Item 2 of Part I of this quarterly report.

- 21 -

Underwriting,
Acquisition and Insurance Expenses

In
our insurance subsidiary, we refer to the expenses that we incur to underwrite
risks as underwriting, acquisition and insurance expenses. Such expenses
consist of commission expenses, premium taxes and fees and other underwriting
expenses incurred in writing and maintaining our business. We pay commission
expense in our insurance subsidiary to our brokers for the premiums that they
produce for us. We pay state and local taxes based on premiums; licenses and
fees; assessments; and contributions to workers compensation security funds.
Other underwriting expenses consist of general administrative expenses such as
salaries and employee benefits, rent and all other operating expenses not otherwise
classified separately, and boards, bureaus and assessments of statistical
agencies for policy service and administration items such as rating manuals,
rating plans and experience data.

Interest
Expense

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

Results of
Operations

Three Months
and Nine Months Ended
September 30, 2008 and 2007

Gross Premiums
Written. Gross premiums
written for the three months ended September 30, 2008 totaled $61.7 million, a
decrease of $6.3 million, or 9.3%, from $68.0 million in the same period of
2007. Premiums assumed from the NCCI residual markets decreased $1.6 million,
or 66.7%, from $2.4 million in the three months ended September 30, 2007 to
$0.8 million for the same period in 2008. For the nine months ended September
30, 2008, gross premiums written totaled $191.5 million, a decrease of $4.0
million, or 2.0%, from $195.5 million in the same period of 2007. Premiums
assumed from the NCCI residual markets in the nine months ended September 30,
2008 totaled $4.0 million compared to $6.8 million for the same period in 2007,
representing a decrease of $2.8 million, or 41.2%. The decline in gross
premiums written for the three and nine months ended September 30, 2008
resulted primarily from the continuing soft market, competitor pricing
pressure, and general economic conditions. We continued to experience rate
reductions in California, our largest market, as well as in other states.
Excluding work we perform as the servicing carrier for the Washington USL&H
Assigned Risk Plan, the number of customers we serviced increased 19.1% from
896 at September 30, 2007 to 1,067 at September 30, 2008 and in-force payrolls,
one of the factors used in determining premium charges, increased 19.2% from
$5.2 billion at September 30, 2007 to $6.2 billion one year later. California
in-force payrolls increased 20.2% between September 30, 2007 and September 30,
2008 and non-California in-force payrolls increased 18.4% over the same period.
The following is a summary of our top five markets based on in-force premiums
at September 30, 2008:

September 30, 2008

September 30, 2007In-Force
 Premium

%

In-Force
 Premium

%($ in thousands)California

$
109,643


40.2
%
$
109,823


42.5
%Illinois


28,554


10.5
%

24,761


9.6
%Louisiana


23,405


8.6
%

21,677


8.4
%Alaska


17,696


6.5
%

21,482


8.3
%Texas


15,650


5.7
%

11,669


4.5
%Total

$
194,948


71.5
%
$
189,412


73.3
%We
have experienced significant reductions in our California premium rates over
the past four years. In 2007, in response to continued reductions in California
workers compensation claim costs, we reduced our rates by an average of 14.2%
for new and renewal insurance policies written in California on or after July
1, 2007. This was the eighth California rate reduction we have filed since
October 1, 2003, resulting in a net cumulative reduction of our California
rates of approximately 54.8%. On August 15, 2008, the Workers Compensation
Insurance Rating Bureau of California (the WCIRB) submitted a filing with the
California Insurance Commissioner recommending a 16.0% increase in advisory
pure premium rates on new and renewal policies effective on or after January 1,
2009. The filing was based on a review of loss and loss adjustment experience
through March 31, 2008. On October 24, 2008, the California Insurance
Commissioner approved a 5.0% increase in advisory pure premium rates effective
January 1, 2009. The California Insurance Commissioners decision is advisory
only and insurance companies may choose

- 22 -

whether or not
to adopt the new rates. At this time, we are unable to predict the impact that
the proposed rate increase, if adopted by us, might have on our future
financial position and results of operations.

In
addition to the significant rate reductions in California over the last five
years, rate reductions have also been adopted in other states in which we
operate. For example, effective January 1, 2008, we adopted the following rate
decreases recommended by the NCCI: 10.9% in Alaska, 19.3% in Hawaii and 18.4%
in Florida. Effective July 1, 2007, we adopted the Louisiana Insurance
Commissioners recommendation of a 15.8% reduction in Louisiana, which was 2.0%
more than the 13.8% decrease recommended by the NCCI. On March 7, 2008, we
adopted a further 8.6% rate reduction approved by the Louisiana Insurance Commissioner
for new and renewal workers compensation insurance policies written in
Louisiana on or after May 1, 2008. We have also recently adopted rate increases
in some states. For example, effective October 1, 2007, we adopted a 4.1% rate
increase in Arizona and on January 1, 2008, we adopted a 4.0% rate increase in
Illinois.

Net
Premiums Written. Net premiums written for the three
months ended September 30, 2008 totaled $57.2 million, a decrease of $6.6
million, or 10.3%, from $63.8 million in the same period of 2007. For the nine
months ended September 30, 2008, net premiums written totaled $180.6 million, a
decrease of $3.1 million, or 1.7%, from $183.7 million in the same period of
2007. As discussed above, the decline in net premiums written for the three and
nine months ended September 30, 2008 was primarily attributable to the soft
market and general economic conditions. Contributing to the decrease in net
premiums written for the three month and nine month periods ended September 30,
2008 was a $1.6 million decrease in premiums assumed from the NCCI residual
markets.

Net
Premiums Earned. Net premiums earned for the three
months ended September 30, 2008 totaled $68.7 million, an increase of $9.0
million, or 15.1%, over $59.7 million in the same period of 2007. For the nine
months ended September 30, 2008, net premiums earned totaled $181.1 million, an
increase of $18.0 million, or 11.0%, from $163.1 million in the same period of
2007. We record the entire annual policy premium as unearned premium when
written and earn the premium over the life of the policy, which is generally
twelve months. Consequently, the amount of premiums earned in any given year
depends on when during the current or prior year the underlying policies were written.
Our direct premiums earned for the three months ended September 30, 2008
increased $10.3 million, or 16.7%, to $72.1 million from $61.8 million in 2007.
Our direct premiums earned for the nine months ended September 30, 2008
increased $18.5 million, or 11.0%, to $187.0 million from $168.5 million for
the same period in 2007.

Net
premiums earned are also affected by premiums ceded under reinsurance
agreements. Ceded premiums earned for the three month and nine month periods
ended September 30, 2008 totaled $4.6 and $11.1 million, respectively,
representing an increase of $0.3 million, or 7.0%, from $4.3 million in the
three months ended September 30, 2007 and a decrease of $0.7 million, or 5.9%,
from $11.8 million in the nine months ended September 30, 2007. A decrease in
ceded premiums earned is an increase to our overall net premiums earned.
Offsetting the decrease in ceded premiums earned (and resulting increase in net
premiums earned) for the nine months ended September 30, 2008 was a decrease in
the amount of premiums we involuntarily assume on residual market business from
the NCCI, which operates residual market programs on behalf of many states.
Assumed premiums earned decreased $1.2 million from $6.4 million for the nine
months ended September 30, 2007 to $5.2 million at September 30, 2008.

Net Investment
Income. Net investment
income for the three months ended September 30, 2008 totaled $5.6 million, an
increase of $0.4 million, or 7.7%, over $5.2 million in the same period of
2007. For the nine months ended September 30, 2008, net investment income
totaled $16.9 million, an increase of $2.1 million, or 14.2%, from $14.8
million in the same period of 2007. Average invested assets and cash for the
three months ended September 30, 2008 increased $66.6 million, or 14.2%, from
$468.0 million in 2007 to $534.6 million in 2008. For the nine months ended
September 30, average invested assets and cash increased $69.2 million, or
15.3%, from $452.9 million in 2007 to $522.1 million in 2008. The increase in
our investment portfolio was due primarily to strong cash flow from operations
of $94.6 million for the year ended December 31, 2007 and $48.1 million for the
nine months ended September 30, 2008. Offsetting the increases in the investment
portfolio attributable to cash from operations were OTTI charges of $11.5
million and $13.4 million for the three month and nine month periods ended
September 30, 2008, respectively, as well as increases in net unrealized losses
of $7.3 million and $14.7 million for the three month and nine month periods
ended September 30, 2008. Our yield on average invested assets for the three
months ended September 30, 2008 was approximately 4.2% compared to
approximately 4.4% for the same period in 2007. For the nine months ended
September 30, 2008, our yield on average invested assets was 4.3% compared to
approximately 4.4% for the same period in 2007.

- 23 -

Net Realized
Losses. Net realized losses
for the three month and nine month periods ended September 30, 2008 totaled
$11.7 million and $13.8 million, respectively, compared to $0 net realized
losses and $0.1 million, respectively, in the same periods in 2007. The
increases in realized losses were primarily the result of $13.4 million of OTTI
charges we recorded in connection with our investments in government-sponsored
agency and corporate preferred stock ($10.2 million charge) and equity indexed
securities exchange-traded funds ($3.2 million charge). Approximately $1.9
million of the total charge was recorded in the second quarter and the
remaining $11.5 million was recorded in the third quarter. The OTTI charges
were recorded following thorough reviews of our investment portfolio and a
determination by management that these investments met the criteria for OTTI
primarily due to the extent and duration of the impairments and the inability
to forecast a complete recovery of their book values within a reasonable period
of time or, in the case of the government-sponsored entity preferred stocks, a significant
decline in the underlying credit fundamentals of the securities.

Service
Income. Service income for the
three months ended September 30, 2008 was $0 compared to $0.5 million in the
same period of 2007. For the nine months ended September 30, 2008, service
income totaled $0.9 million, a decrease of $0.5, or 35.7%, from $1.4 million in
the same period of 2007. Our service income results primarily from service
arrangements we have with LMC and other companies for claims processing, policy
administration and administrative services that we perform for them. The
services we provide LMC in connection with Eagle insurance policies resulted in
a loss of $327,000 for the three months ended September 30, 2008 and income of
$139,000 (14.9% of total service income) for the nine months then ended. During
the quarter ended September 30, 2008, we determined that claim data used to
determine billing amounts for claims administration services provided by us
had, since August 2006, been incorrectly reported to us by a customer,
resulting in an overstatement of claims service income by $0.5 million. As a
result, the financial position and results of operations for the quarter ended
September 30, 2008 reflect a $0.5 million reduction in service income receivable
and claims service income, and a related decrease of $0.2 million in federal
income tax payable and income tax expense to reflect the correction of this
error. Average monthly fees from our arrangements with LMC are declining as the
volume of work decreases due to the run off of our predecessors business.

Other Income.
Other income totaled $2.8
million for the three months ended September 30, 2008 compared to $1.4 million
for the same period in 2007, representing an increase of $1.4 million, or
100.0%. For the nine months ended September 30, 2008, other income totaled $6.3
million, representing an increase of $3.3 million, or 110.0%, from $3.0 million
in the same period of 2007. Other income is derived primarily from the
operations of PointSure (including BWNV), our wholesale broker and third party
administrator subsidiary which, due to the expansion of its portfolio of
insurance products during 2007, has been able to increase the amount of income
from external sources and the December 2007 acquisition of THM, a
provider of medical bill review, utilization review, nurse case management and
related services.

Loss and Loss
Adjustment Expenses. Loss
and loss adjustment expenses totaled $39.2 million for the three months ended
September 30, 2008 compared to $34.9 million for the same period in 2007,
representing an increase of $4.3 million, or 12.3%. For the nine months ended
September 30, 2008, loss and loss adjustment expenses totaled $101.7 million,
compared to $89.9 for the same period in 2007, representing an increase of
$11.8 million, or 13.1%. Our net loss ratio, which is calculated by dividing
loss and loss adjustment expenses less claims service income by premiums
earned, for the three months ended September 30, 2008 was 57.1% compared to
57.8% for the same period in 2007. Our net loss ratio for the nine months ended
September 30, 2008 was 55.8% compared to 54.3% for the same period in 2007.
Included in the loss ratios for the three month and nine month periods ended
September 30, 2008 were favorable development of prior years loss reserve
estimates of approximately $5.1 million and $20.9 million, respectively,
reflecting a continuation of deflation trends in the paid loss data for recent
accident years. Our direct net loss reserves are net of reinsurance and exclude
reserves associated with KEIC and the business that we involuntarily assume
from the NCCI. For the three months ended September 30, 2008, approximately
$2.0 million of the favorable development of prior years loss reserve
estimates related to accident year 2007, approximately $1.0 million related to
accident year 2006 and approximately $2.1 million related to accident years
2005 and 2004. For the nine months ended September 30, 2008, approximately
$11.7 million of the reserve adjustment related to accident year 2007,
approximately $5.8 million related to accident year 2006 and approximately $3.4
million related to accident years 2005 and prior.

Included
in the loss ratios for the three month and nine month periods ended September
30, 2007 were reductions of approximately $5.5 million and $20.5 million,
respectively, of previously recorded direct net loss reserves to reflect a
continuation of lower than anticipated patterns of loss payments in recent
accident years. For the three months ended September 30, 2007, approximately
$4.0 million of the reserve adjustment related to accident year 2006 and
approximately $1.9 million related to accident year 2005 with an offset of
approximately $0.4 million

- 24 -

related to
accident years 2004 and 2005. For the nine months ended September 30, 2007,
approximately $12.5 million of the reserve adjustment related to accident year
2006 and approximately $9.3 million related to accident year 2005 with an
offset of approximately $1.3 million related to accident years 2004 and prior.

Following
eight recommended California rate reductions totaling 65.1%, on October 24,
2008, the California Insurance Commissioner approved a 5.0% increase in
advisory pure premium rates effective January 1, 2009. At this time, the
Company is unable to predict the impact that the proposed rate increase, if
adopted by us, might have on the Companys future financial position, results
of operations or reserve adequacy.

There
is uncertainty about whether recent lower paid loss trends, which result
primarily from California legislative reforms enacted in 2003 and 2004, will be
sustained, particularly in light of current efforts to change or repeal
portions of the reforms. We will not know the full impact of these reforms with
a high degree of confidence for several years. We have established loss
reserves at September 30, 2008 that are based upon our current best estimate of
loss costs, taking into consideration the recent lower paid loss claim data,
incurred loss trends and the uncertainty regarding the permanence of recent
legislative reforms. For further information regarding our loss and loss
adjustment expenses, including amounts paid and unpaid, see the discussion
under the heading Critical Accounting Policies, Estimates and Judgments 
Unpaid Loss and Loss Adjustment Expenses in this Item 2 of Part I of this
quarterly report.

As
of September 30, 2008, we had recorded a receivable of approximately $2.5
million for adverse loss development under the adverse development cover since
the date of the Acquisition. We do not expect this receivable to have any
material adverse effect on our future cash flows if LMC fails to perform its
obligations under the adverse development cover. At September 30, 2008, we had
access to approximately $2.8 million under the collateralized reinsurance trust
in the event that LMC fails to satisfy its obligations under the adverse
development cover.

Underwriting
Expenses. Underwriting
expenses for the three months ended September 30, 2008 totaled $17.4 million,
an increase of $2.2 million, or 14.5%, from $15.2 million in the same period of
2007. For the nine months ended September 30, 2008, underwriting expenses
totaled $50.7 million, an increase of $8.2 million, or 19.3%, from $42.5
million in the same period of 2007. Our net underwriting expense ratio for the
three months ended September 30, 2008, which is calculated by dividing
underwriting, acquisition and insurance expenses less other service income by
premiums earned, was 25.1%, compared to 25.3% for the same period in 2007. For
the nine months ended September 30, 2008, our net underwriting expense ratio
was 27.9%, compared to 26.0% for the same period of 2007. The increase in the
net underwriting expense ratio for the nine month period ended September 30,
2008 was primarily the result of increased staffing costs and other premium
production-related expenses as we invest in the expansion and development of
our business. The number of employees grew from 215 at September 30, 2007 to
300 at September 30, 2008, representing an increase of 39.5%. Of the 85
employee increase from September 30, 2007 to September 30, 2008, 30 employees
were related to our acquisitions of THM and BWNV. For the three month and nine
month periods ended September 30, 2008, the number of employees grew 7.1% and
33.3%, respectively. The slight decrease in the net underwriting expense ratio
for the quarter ended September 30, 2008 was driven more by an increase in
earned premium in the period. Total underwriting expenses in the quarter ended
September 30, 2008 increased approximately 14.4% from the same period in 2007.

Interest
Expense. Interest expense related
to the surplus notes issued by our insurance subsidiary in May 2004 totaled
$0.2 million for the three months ended September 30, 2008, compared to $0.3
for the same period in 2007, representing a decrease of $0.1 million, or 33.3%.
Interest expense for the nine months ended September 30, 2008 totaled $0.7
million, compared to $0.9 for the same period in 2007, representing a decrease
of $0.2 million, or 22.2%. The surplus notes interest rate, which is calculated
at the beginning of each interest payment period using the three-month LIBOR
rate plus 400 basis points, decreased from 9.5% at September 30, 2007 to 6.8%
at September 30, 2008.

Other
Expenses. Other expenses for the
three months ended September 30, 2008 totaled $2.8 million, an increase of $0.8
million, or 40.0%, from $2.0 million in the same period of 2007. For the nine
months ended September 30, 2008, other expenses totaled $7.1 million, an
increase of $1.9 million, or 36.5%, from $5.2 million in the same period of
2007. Other expenses result primarily from the operations of PointSure
(including BWNV), our non-insurance subsidiary which continued to experience
direct costs associated with the expansion of insurance products they offer
and, to a lesser extent, from the acquisition of THM.

- 25 -

Income Tax
Expense. The effective tax rate
for the three months ended September 30, 2008 was 69.8%, compared to 32.7% for
the same period in 2007. For the nine months ended September 30, 2008 our
effective tax rate was 38.8% compared to 31.7% in the same period of 2007. Our
effective rate for the three month and nine month periods ended September 30,
2008 was higher than the statutory rate of 35.0% primarily as a result of a
valuation allowance established against our deferred tax assets. The valuation
allowance was necessary primarily as a result of the OTTI charges we incurred
in the second and third quarters of 2008 and, to a lesser degree, as a result
of incurred losses and capital loss carry forwards. The valuation allowance was
accounted for under the effective-rate methodology, which treats it as if it
was a permanent difference, thus increasing our projected effective tax rate
for the year. Tax expense for the three months ended September 30, 2008
includes not only the effect of the higher effective tax rate on third quarter
pre-tax income, but also the effect on pre-tax income for the first six months
of 2008, as required by GAAP.

The
increase in our effective rate from the deferred tax asset valuation allowance
was offset by changes in the proportion of tax-exempt municipal securities in
our portfolio. At September 30, 2008, approximately 55.3% of our investment
portfolio was invested in tax-exempt municipal securities, compared to
approximately 50.0 % at September 30, 2007.

Net Income.
Net income was $1.8 million
for the three months ended September 30, 2008, compared to $9.7 million for the
same period in 2007, representing a decrease of $7.9 million, or 81.4%. Net
income for the nine months ended September 30, 2008 totaled $19.1 million, a
decrease of $10.8 million, or 36.1%, from $29.9 million in the same period of
2007. The decrease in net income for the three month and nine month periods
ended September 30, 2008 resulted primarily from the OTTI charge discussed
previously and increases in loss and loss adjustment and underwriting expenses
and net realized losses, offset by increases in premiums earned and net
investment income. The after-tax effect of OTTI charges recognized in the three
month and nine month periods ended September 30, 2008, after taking into
consideration the associated deferred tax asset valuation allowance, was
approximately $10.1 million and $11.4 million, respectively.

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 in part from industry and predecessor trends and included a
provision for uncertainties. Our fixed income portfolio as of September 30,
2008 has an effective duration of 4.78 years and a weighted average life of
5.62 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 and have the intent and
ability to hold any securities with unrealized losses for a sufficient period
of time to allow full recovery of their value. As these securities mature, we intend
to invest any excess funds in investments with appropriate durations to match
against expected future claim payments.

At
September 30, 2008, our portfolio was made up almost entirely of investment
grade fixed income securities with fair values subject to fluctuations in
interest rates. The remainder of our investment portfolio consisted of
investments in equity securities, which consist of investments in equity
indexed securities exchange-traded funds designed to correspond to the performance
of certain indexes based on domestic or international stocks, and preferred
stocks. Our investment policy allows for investment in domestic and
international equities of up to 4% and 1%, respectively, of our statutory
consolidated capital and surplus. All of the securities in our investment
portfolio are accounted for as available for sale securities. Although we
have structured our investment portfolio to provide an appropriate matching of
maturities with anticipated claim payments and have the intent and ability to
hold any securities with unrealized losses for a sufficient period of time to
allow full recovery of their value, if we decide or are required in the future
to sell securities in a rising interest environment, we would expect to incur
losses from such sales.

We
had no direct sub-prime mortgage exposure in its investment portfolio as of
September 30, 2008 and less than $1.0 million of indirect exposure. The average
credit quality of our $283.9 million fixed income municipal portfolio at
September 30, 2008 was AA/AA (AA based on the issuers underlying ratings).
Insured municipal bonds totaled $202.8 million and had a weighted average
credit rating of AA (AA based on the issuers underlying ratings). The
remaining $81.1 million in uninsured municipal bonds carried a weighted average
credit rating of

- 26 -

AA/AA.
Consequently, we do not expect a material impact to our investment portfolio or
financial position as a result of the problems currently facing monoline bond
insurers.

Our
ability to adequately provide funds to pay claims comes from our disciplined
underwriting and pricing standards and the purchase of reinsurance to protect
us against severe claims and catastrophic events. Effective October 1, 2008,
our reinsurance program provides us with reinsurance protection for each loss
occurrence in excess of $0.75 million, up to $85.0 million, subject to various
additional limitations and exclusions as more fully described in Note 5.a. to
our unaudited condensed consolidated financial statements in Part I, Item 1 of
this quarterly report and in the reinsurance agreements. Given industry and
predecessor trends, we believe that we are sufficiently capitalized to cover
our retained losses.

Our
insurance subsidiary is required by law to maintain a certain minimum level of
surplus on a statutory basis. Surplus is calculated by subtracting total
liabilities from total admitted assets. The National Association of Insurance
Commissioners has a risk-based capital standard designed to identify property
and casualty insurers that may be inadequately capitalized based on inherent
risks of each insurers assets and liabilities and its mix of net premiums
written. Insurers falling below a calculated threshold may be subject to
varying degrees of regulatory action. As of December 31, 2007, the last date
that we were required to update the annual risk-based capital calculation, the
statutory surplus of our insurance subsidiary was in excess of the prescribed
risk-based capital requirements that correspond to any level of regulatory
action.

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

Our
unaudited consolidated net cash provided by operating activities for the nine
months ended September 30, 2008 was $48.1 million, compared to our cash flow
from operations of $68.0 million for the same period in 2007. The decrease was
primarily attributable to increases of $17.7 million in paid losses, $2.6
million in income taxes paid and $5.4 million in other general expenses paid,
partially offset by a $5.8 million increase in premiums collected.

We
used net cash of $52.0 million for investing activities in the nine months
ended September 30, 2008, compared to $47.3 million for the same period in
2007. The difference between periods is primarily attributable to maintaining a
lower overall cash balance.

For
the nine months ended September 30, 2008, financing activities provided cash of
$1.1 million, compared to $0.4 million in the same period in 2007.

Contractual Obligations and Commitments

The
following table identifies our contractual obligations by payment due period as
of September 30, 2008:

Payments Due by PeriodTotal

Less than
 1 Year

1-3 Years

4-5 Years

More than
 5 Years(in thousands)Long term debt
obligations:Surplus
notes

$
12,000

$


$


$


$
12,000Loss and loss adjustment
expenses


279,656


92,286


120,533


25,728


41,109Operating lease
obligations


14,971


2,978


6,672


1,789


3,532Total

$
306,627

$
95,264

$
127,205

$
27,517

$
56,641The
loss and loss adjustment expense payments due by period in the table above are
based upon the loss and loss adjustment expense estimates as of September 30,
2008 and actuarial estimates of expected payout patterns and are not
contractual liabilities as to time certain. Our contractual liability is to
provide benefits under the policies we write. As a result, our calculation of
loss and loss adjustment expense payments due by period is subject to the same
uncertainties associated with determining the level of unpaid loss and loss
adjustment expenses generally and to the additional uncertainties arising from
the difficulty of predicting when claims (including claims that have not yet
been reported to us) will be paid. For a discussion of our unpaid loss and loss
adjustment expense process, see the heading Critical Accounting Policies,
Estimates and Judgments  Unpaid Loss and Loss Adjustment Expenses in this
Part I, Item 2 of this quarterly report. Actual payments of loss and loss
adjustment expenses by period will vary, perhaps materially, from the above
table to the extent that current estimates of loss and loss adjustment expenses
vary from actual ultimate claims amounts and as a result of variations between
expected and actual payout patterns.

- 27 -

Off-Balance Sheet Arrangements

As
of September 30, 2008, we had no off-balance sheet arrangements that have or
are reasonably likely to have a material current or future effect on our
financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital resources.

Critical Accounting Policies, Estimates and
Judgments

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

The
most critical accounting policies involve the reporting of unpaid loss and loss
adjustment expenses, including losses that have occurred but were not reported
to us by the financial reporting date; the amount and recoverability of
reinsurance recoverable balances; deferred policy acquisition costs; income
taxes; the valuation and impairment of investment securities; earned but
unbilled premiums; and retrospective premiums. 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 expenses; allocated claim adjustment expenses; and
unallocated claim adjustment expenses. We use actuarial methodologies to assist
us in establishing these estimates, including judgments relative to estimates
of future claims severity and frequency, length of time to achieve ultimate
resolution, judicial theories of liability and other third-party factors that
are often beyond our control. Due to the inherent uncertainty associated with
the cost of unsettled and unreported claims, the ultimate liability may differ
from the original estimates. These estimates are regularly reviewed and updated
and any resulting adjustments are included in the current periods operating
results.

Following
is a summary of the gross loss and loss adjustment expense reserves by line of
business as of September 30, 2008 and December 31, 2007. The workers
compensation line of business comprises over 99% of our total loss reserves as
of both dates.

As of September 30, 2008

As of December 31, 2007Line of Business

Case

IBNR

Total

Case

IBNR

Total(in thousands)Workers
Compensation

$
121,838

$
154,075

$
275,913

$
93,457

$
155,042

$
248,499Ocean Marine


1,161


2,582


3,743


564


1,022


1,586Total

$
122,999

$
156,657

$
279,656

$
94,021

$
156,064

$
250,085Actuarial Loss
Reserve Estimation Methods

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

For
the current accident year, we establish the initial reserve for claims
incurred-but-not-reported (IBNR) using an expected loss ratio (ELR) method.
The ELR method is based on an analysis of historical loss ratios adjusted for
current pricing levels, exposure growth, anticipated trends in claim frequency
and severity, the impact of reform activity and any other factors that may have
an impact on the loss ratio. The actual paid and incurred loss data for the
accident year is reviewed each quarter and changes to the ELR may be made based
on the emerging data, although changes are typically not made until the end of
the accident year when the loss data can be analyzed as a complete accident
year. The ELR is multiplied by the year-to-date earned premium to determine the
ultimate losses for the current accident year. The actual paid and case
outstanding losses are subtracted from the ultimate losses to determine the
IBNR for the accident year. As the accident year matures, we incorporate a
standard actuarial

- 28 -

reserving
methodology referred to as the Bornhuetter-Ferguson method. This method blends
the loss development and expected loss ratio methods by assigning partial
weight to the initial expected losses, calculated from the expected loss ratio
method, with the remaining weight applied to the actual losses, either paid or
incurred. The weights assigned to the initial expected losses decrease as the
accident year matures. A reserve estimate implies a pattern of expected loss
emergence. If this emergence does not occur as expected, it may cause us to
revisit our previous assumptions. We may adjust loss development patterns, the
various method weights or the expected loss ratios used in our analysis.
Management employs judgment in each reserve valuation as to how to make these
adjustments to reflect current information.

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


We wrote our
 first policy on October 1, 2003 and, as a result, our total reserve portfolio
 is relatively immature when compared to other industry data.
We have been
 growing consistently since we began operations and have entered into several
 new states that are not included in our predecessors historical data.
At September
 30, 2008, approximately $151.1 million, or 48.9%, of our direct loss reserves
 were related to business written in California. Over the last several years,
 three significant comprehensive legislative reforms were enacted in
 California: AB 749 was enacted in February 2002; AB 227 and SB 228 were
 enacted in September 2003; and SB 899 was enacted in April 2004. This reform
 activity has resulted in uncertainty regarding the impact of the reforms on
 loss payments, loss development and, ultimately, loss reserves, making
 historical data less reliable as an indicator of future loss. All four bills
 enacted structural changes to the benefit delivery system in California, in
 addition to changes in the indemnity and medical benefits afforded injured
 workers. In response to the reform legislation and a continuing drop in the
 frequency of workers compensation claims, the pure premium rates approved by
 the California Insurance Commissioner effective January 1, 2008 were 65.1%
 lower than the pure premium rates in effect as of July 1, 2003.Key elements of the
 reforms as they relate to indemnity and medical benefits were as follows:Indemnity BenefitsAB 749 significantly
 increased most classes of workers compensation indemnity benefits over a
 four-year period beginning in 2003.AB 227 and SB 228 repealed
 the mandatory vocational rehabilitation benefits and replaced them with a
 system of non-transferable education vouchers.SB 899 required the
 Division of Workers Compensation (DWC) Administrative Director to adopt,
 on or before January 1, 2005, a new permanent disability rating schedule
 (PDRS) based in part on American Medical Association guidelines. Also,
 temporary disability was limited to a duration of two years.SB 899 provided that,
 effective April 19, 2004, apportionment of disability for purposes of
 permanent disability determination must be based on causation.Medical BenefitsAB 749 repealed the
 presumption given to the primary treating physician (except when the worker
 has pre-designated a personal physician), effective for injuries occurring on
 or after January 1, 2003. (SB 228 and SB 899 later extended this to all
 future medical treatment on earlier injuries.)SB 228 required the DWC
 Administrative Director to establish, by December 1, 2004, an Official
 Medical Treatment Utilization Schedule meeting specific criteria. SB 228 also
 provided that beginning three months after the publication date of the
 updated American College of Occupational and Environmental Medical (ACOEM)
 Practice Guidelines and continuing until such time as the DWC Administrative
 Director establishes an Official Medical Treatment Utilization Schedule, the
 ACOEM standards will be presumed to- 29 -

be correct regarding the
 extent and scope of all medical treatment. The DWC Administrative Director
 has subsequently adopted the ACOEM Guidelines as the Official Medical
 Treatment Utilization Schedule.SB 228 limited the number
 of chiropractic visits and the number of physical therapy visits to 24 each
 per claim.SB 228 established a
 prescription medication fee schedule set at 100% of Medi-Cal Schedule
 amounts.SB 228 provided that the
 maximum facility fee for services performed in an ambulatory surgical center
 may not exceed 120% of the Medicare fees for the same service performed in a
 hospital outpatient facility.SB 899 provided that after
 January 1, 2005, an employer or insurer may establish medical provider
 networks meeting certain conditions and, with limited exceptions, medical
 treatment can be provided within those networks.These
reforms are a source of variability in the reserve estimates as legislative
changes affecting benefit levels not only impact the cost of benefits but also
the rate at which accident year benefits or losses develop over time. Ongoing
efforts by some system stakeholders to challenge the reforms, either through
legislative, administrative or judicial means, further adds to the variability.

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

On
the administrative front, the California Division of Workers Compensation has
recommended changes to the formula used to determine permanent disability
compensation awards for dates of injury on or after January 1, 2009. Although a
series of public hearings were held to solicit public feedback on the proposed
changes, there has been no further formal communication from the Division. It
remains unclear if and when the changes will be implemented. On the legislative
front, on September 30, 2008 Governor Schwarzenegger vetoed a Workers
Compensation bill that would have substantially increased the permanent
disability indemnity benefits to qualified injured workers by increasing the
number of weeks such benefits are paid. The Governor also vetoed bills that
would have:


Removed the
 December 31, 2009 sunset date permitting employees to pre-designate their
 personal physician for on the job injuries,
Required
 physicians performing utilization review to be licensed in California, and
Prohibited
 race, religious creed, color, national origin or various other factors from
 being considered in the apportionment of permanent disability.Finally,
recent court decisions continue to lend uncertainty to the interpretation and
application of the PDRS. Despite the above, we expect ongoing pressure on the
reforms as the various stakeholders continue to assert their agendas.

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

- 30 -

We review
 the following significant components of loss reserves on a quarterly basis:
IBNR
 reserves for losses  This includes amounts for the medical and indemnity
 components of the workers compensation claim payments, net of subrogation
 recoveries and deductibles;
IBNR
 reserves for defense and cost containment expenses (DCC, also referred to
 as allocated loss adjustment expenses (ALAE)), net of subrogation
 recoveries and deductibles;
reserve for
 adjusting and other expenses, also known as unallocated loss adjustment
 expenses (ULAE); and
reserve for
 loss based assessments, also referred to as the 8F reserve in reference to
 Section 8, Compensation for Disability, subsection (f), Injury increasing
 disability, of the United States Longshore and Harbor Workers Compensation
 Act (USL&H) Act.The
reserves for losses and DCC are also reviewed gross and net of reinsurance
(referred to as net). For gross losses, the claims for the Washington
USL&H Plan, the KEIC claims assumed in the Acquisition and claims assumed
from the NCCI residual market pools are excluded from this discussion.

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

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

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

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

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

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

Development
factors, expected loss rates and expected loss ratios are derived from the combined
experience of us and our predecessor.

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


paid loss
 (or ALAE) development;
incurred
 loss (or ALAE) development;
Bornhuetter-Ferguson
 using ultimate premiums and paid loss (or ALAE); and- 31 -

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

Variation
in Ultimate Loss Estimates

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

These
techniques recognize, among other factors:


our claims
 experience and that of our predecessor;
the
 industrys claim experience;
historical
 trends in reserving patterns and loss payments;
the impact
 of claim inflation and/or deflation;
the pending
 level of unpaid claims;
the cost of
 claim settlements;
legislative
 reforms affecting workers compensation;
the overall
 environment in which insurance companies operate; and
trends in
 claim frequency and severity.In
addition, there are loss and loss adjustment expense risk factors that affect
workers compensation claims that can change over time and also cause our loss
reserves to fluctuate. Some examples of these risk factors include, but are not
limited to, the following:


recovery
 time from the injury;
degree of
 patient responsiveness to treatment;
use of
 pharmaceutical drugs;
type and
 effectiveness of medical treatments;
frequency of
 visits to healthcare providers;
changes in
 costs of medical treatments;
availability
 of new medical treatments and equipment;
types of
 healthcare providers used;
availability
 of light duty for early return to work;
attorney
 involvement;- 32 -


wage
 inflation in states that index benefits; and
changes in
 administrative policies of second injury funds.Variation
can also occur in the loss reserves due to factors that affect our book of
business in general. Some examples of these risk factors include, but are
not limited to, the following:

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

Due
to the relative immaturity of our book of business, the challenge has been to
give the right weight in the ultimate loss estimation process to the new data
as it becomes available. As discussed above, management believes that it
generally takes workers compensation losses approximately 48 to 60 months
after the start of an accident year until the data is viewed as fully credible
for paid and incurred reserve evaluation methods. Due to our limited operating
history, we have four complete accident years that were developed 57 months, 45
months, 33 months and 21 months (2004, 2005, 2006 and 2007, respectively) at
September 30, 2008. Our oldest complete accident year was 57 months old as of
September 30, 2008. For accident years 2003 through 2007, we are using a
Bornhuetter-Ferguson approach, which blends the loss development and expected
loss ratio methods. Due to the favorable development exhibited by the data for
accident years 2004 and 2005 at 17 to 18 months of development, management
began to place more weight on the results of the Bornhuetter-Ferguson method in
its ultimate loss estimates for accident years 2005, 2006 and 2007. As new data
emerges and continues to demonstrate favorable development, this adds
credibility to the existing data which enables management to reflect it more
fully in its estimation process. For all accident years, we have not completely
relied on the most recent data points in our loss development selections.
Because of recent favorable development trends, we believe this has the effect
of increasing our estimated reserves as compared to reserves calculated with
complete reliance on these data points. Estimating loss reserves is an
uncertain and complex process which involves actuarial techniques and
management judgment. Actuarial analysis generally assumes that past patterns
demonstrated in the data will repeat themselves and that the data provides a
basis for estimating future loss reserves. However, since conditions and trends
that have affected losses in the past may not occur in the future in the same
manner, if at all, future results may not be reliably predicted by the prior
data.

Our
paid loss data for state act indemnity, both California and excluding
California, displayed decreasing, or deflationary, trends over recent
valuations. The decreasing trends are exhibited in the paid loss development
data for the 15 months to 57 months development period. The decisions to
decrease the estimated ultimate losses for accident years 2005, 2006 and 2007
at September 30, 2008 were made, as the underlying loss data showed sustained
and continued improvement over the prior twelve months, which we determined was
an appropriate amount of time to be considered reliable for our estimate. We
believe that our loss development factor selections are appropriate

- 33 -

given the
relative immaturity of our data. Over time, as the data for these accident
years mature and uncertainty surrounding the ultimate outcome of the claim
costs diminishes, the full impact of the actual loss development will be
factored into our assumptions and selections.

In
the third quarter of 2008, we experienced development in all three categories.
For State Act California, there was favorable development for accident years
2005 through 2007 that resulted in the following reductions of our accident
year gross ultimate loss estimates: $1.7 million for 2005, $1.4 million for
2006 and 1.8 million for 2007. Accident year 2004 experienced unfavorable
development of $2.5 million. For non-California State Act, there was
favorable development of $0.1 million for accident year 2004 and $0.5 million
for accident year 2007, while accident year 2005 experienced unfavorable
development of $0.3 million. For USL&H, there was unfavorable development
for accident years 2004 through 2007 that resulted in the following increases
in our accident year gross ultimate loss estimates: $0.1 million for 2004, $0.4
million for 2005, $0.7 million for 2006 and $0.3 million for 2007. For all
other accident years, the development was at expected levels which did not
warrant a change to our gross ultimate loss estimates. There was no change in
ceded loss reserves for accident years 2003 through 2007 in the third quarter
of 2008.

Reserve
Sensitivities

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

As
discussed in the previous section, there are a number of variables that can
impact, individually or in combination, the adequacy of our loss and loss
adjustment expense liabilities. While the actuarial methods employed factor in amounts
for these circumstances, the loss reserves may prove to be inadequate despite
the actuarial methods used. Several examples are provided below to highlight
the potential variability present in our loss reserves. Each of these examples
represents scenarios that are reasonably likely to occur over time. For
example, there may be a number of claims where the unpaid loss and loss
adjustment expense associated with future medical treatment proves to be
inadequate because the injured workers do not respond to medical treatment as
expected by the claims examiner. If we assume this affects 10% of the open
claims and, on average, the unpaid loss and loss adjustment expenses on these
claims are 20% inadequate, this would result in our unpaid loss and loss adjustment
expense liability being inadequate by approximately $5.6 million, or 2.0%, as
of September 30, 2008. Another example is claim inflation. Claim inflation can
result from medical cost inflation or wage inflation. As discussed above, the
actuarial methods employed include an amount for claim inflation based on
historical experience. We assume that the historical effect of this factor,
which is embedded in our experience and industry experience, is representative
of future effects for claim inflation. To the extent that the historical
factors, and the actuarial methods utilized, are inadequate to recognize future
inflationary trends, our unpaid loss and loss adjustment expense liabilities
may be inadequate. If our estimate of future medical trend is two percentage
points inadequate (e.g., if we estimate a 9% annual trend and the actual trend
is 11%), our unpaid loss and loss adjustment expense liability could be
inadequate. The amount of the inadequacy would depend on the mix of medical and
indemnity payments and the length of time until the claims are paid. For
example, if we assume that 50% of the unpaid loss and loss adjustment expense
is associated with medical payments and an average payout period of 5 years,
our unpaid loss and loss adjustment expense liabilities would be inadequate by
approximately $14.0 million on a pre-tax basis, or 5.0%, as of September 30,
2008. Under these assumptions, the inadequacy of approximately $14.0 million
represents approximately 4.5% of total stockholders equity at September 30,
2008. The impact of any reserve deficiencies, or redundancies, on our reported
results and future earnings is discussed below.

In
the event that our estimates of ultimate unpaid loss and loss adjustment
expense liabilities prove to be greater or less than the ultimate liability,
our future earnings and financial position could be positively or negatively
impacted. Future earnings would be reduced by the amount of any deficiencies in
the year(s) in which the claims are paid or the unpaid loss and loss adjustment
expense liabilities are increased. For example, if we determined our unpaid
loss and loss adjustment expense liability of $279.7 million as of September
30, 2008 to be 5.0% inadequate, we would experience a pre-tax reduction in future
earnings of approximately $14.0 million. This reduction could be

- 34 -

realized in
one year or multiple years, depending on when the deficiency is identified. The
deficiency, after tax effects, would also impact our financial position because
our GAAP stockholders equity and statutory surplus would be reduced by an
amount equivalent to the reduction in net income. Any deficiency is typically
recognized in the unpaid loss and loss adjustment expense liability and,
accordingly, it typically does not have a material effect on our liquidity
because the claims have not been paid. Since the claims will typically be paid
out over a multi-year period, we have generally been able to adjust our
investments to match the anticipated future claim payments. Conversely, if our
estimates of ultimate unpaid loss and loss adjustment expense liabilities prove
to be redundant, our future earnings and financial position would be improved.

Reinsurance
Recoverables

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

We
periodically evaluate our reinsurance recoverables, including the financial
ratings of our reinsurers, and revise our estimates of such amounts as conditions
and circumstances change. Of our top ten reinsurers, based on the net amount
recoverable, nine were rated A+ (Superior), A (Excellent) or A (Excellent) by A.M. Best as of September 30,
2008. One reinsurer is not formally followed by A.M. Best. Changes in
reinsurance recoverables are recorded in the period in which the estimate is
revised. As of September 30, 2008 and December 31, 2007, we had no reserve for
uncollectible reinsurance recoverables. We assessed the collectibility of our
period-end receivables and believe that all amounts are collectible based on
currently available information.

Deferred
Policy Acquisition Costs

We
defer commissions, premium taxes and certain other costs that vary with and are
primarily related to the acquisition of insurance contracts. These costs are
capitalized and charged to expense in proportion to the recognition of premiums
earned. The method followed in computing deferred policy acquisition costs
limits the amount of these deferred costs to their estimated realizable value,
which gives effect to the premium to be earned, related estimated investment
income, anticipated losses and settlement expenses and certain other costs we
expect to incur as the premium is earned. Judgments regarding the ultimate
recoverability of these deferred costs are highly dependent upon the estimated
future costs associated with our unearned premiums. If our expected claims and
expenses, after considering investment income, exceed our unearned premiums, we
would be required to write-off a portion of deferred policy acquisition costs.
To date, we have not needed to write-off any portion of our deferred
acquisition costs. If our estimate of anticipated losses and related costs was
10% inadequate, we believe our deferred acquisition costs as of September 30,
2008 would still be fully recoverable and no write-off would be necessary. We
will continue to monitor the balance of deferred acquisition costs for
recoverability.

Income
Taxes

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

- 35 -

In
assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. This analysis requires
management to make various estimates and assumptions, including the scheduled
reversal of deferred tax liabilities, projected future taxable income and the
effect of tax planning strategies. If actual results differ from managements
estimates and assumptions, we may be required to establish a valuation
allowance to reduce the deferred tax assets to the amounts more likely than not
to be realized. The establishment of a valuation allowance could have a
significant impact on our financial position and results of operations in the
period in which it is deemed necessary. As discussed in Managements Discussion
and Analysis of Financial Condition and Results of Operations above, as of
September 30, 2008, we recorded a valuation allowance of approximately $4.3
million against a portion of our deferred tax assets. We anticipate that our
deferred tax assets will increase as our business continues to grow. We will
continue to monitor the balance of our deferred tax assets for realizability.

Effective
January 1, 2007, we adopted FASB
Interpretation No. 48, Accounting for Uncertainties in Income Taxes, an
Interpretation of FASB Statement No. 109 (FIN 48), and it did not
have a significant impact on our financial position or results of operations.
FIN 48 prescribes a recognition threshold and measurement process for financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return, and also provides guidance on the derecognition of
previously recorded benefits and their classification, as well as the proper
recording of interest and penalties, accounting in interim periods, disclosures
and transition. As of September 30, 2008 and December 31, 2007, we had no
unrecognized tax benefits. We do not anticipate that the amount of unrecognized
tax benefits will significantly increase in the next 12 months. Our policy is
to recognize interest and penalties on unrecognized tax benefits as an element
of income tax expense (benefit) in our consolidated statements of operations.
We file consolidated U.S. federal and state income tax returns. The tax years
which remain subject to examination by the taxing authorities are the years
ending December 31, 2005, 2006 and 2007.

Impairment of
Investment Securities

Impairment
of investment securities results in a charge to operations when the fair value
of a security declines below our cost and is deemed to be other-than-temporary.
We regularly review our investment portfolio to evaluate the necessity of
recording impairment losses for other-than-temporary declines in the fair value
of investments. A number of criteria are considered during this process,
including but not limited to the following: the current fair value as compared
to amortized cost or cost, as appropriate, of the security; the length of time
the securitys fair value has been below amortized cost; 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, including interest rates.

In
general, we focus on those securities whose fair values were less than 80% of
their amortized cost or cost, as appropriate, at the end of the quarter and
those securities that have been impaired at some level for six or more
consecutive months as of the end of the quarter. We also analyze the entire
portfolio for other factors that might indicate a risk of impairment. OTTI
losses result in a permanent reduction of the carrying value of the underlying
investment. In the quarter ended September 30, 2008, we recorded an OTTI loss
of $11.5 million related to our investments in government-sponsored agency and
corporate preferred stocks and equity indexed securities exchange-traded funds.
Please refer to the tables in Note 3 of the unaudited condensed consolidated
financial statements in Part I, Item 1 of this quarterly report for additional information
on unrealized losses on our investment securities. Please refer to Part I, Item
3 of this quarterly report for tables showing the sensitivity of the fair value
of our fixed-income investments to selected hypothetical changes in interest
rates.

Earned But
Unbilled Premiums

Shortly
following the expiration of insurance policies we issue, we perform a final
payroll audit of our insureds to determine the final premium to be billed and
earned. These final audits generally result in an audit adjustment, either
increasing or decreasing the estimated premium earned and billed to date. We
estimate the amount of premiums that have been earned but are unbilled at the
end of a reporting period by analyzing historical earned premium adjustments
made at final audit for the preceding 12 months and applying the average
adjustment percentage against our in-force earned premium for the period. These
estimates are subject to changes in policyholders payrolls due to growth,
economic conditions, seasonality and other factors and to fluctuations in our
in-force premium. For example, the amount of our accrual for premiums earned
but unbilled fluctuated between $0 and $1.2 million in 2007 and between $1.2
million and $1.8 million in 2006. The balance of our accrual for premiums
earned but unbilled was $182,000 and $44,000 at September 30, 2008 and December
31, 2007,

- 36 -

respectively.
Although considerable variability is inherent in such estimates, management
believes that the accrual for earned but unbilled premiums is reasonable. The
estimates are reviewed quarterly and adjusted as necessary as experience
develops or new information becomes known. Any such adjustments are included in
current operations.

Retrospective
Premiums

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

We
bear credit risk with respect to retrospectively rated policies. Because of the
long duration of our loss sensitive plans, there is a risk that the customer will
fail to pay the additional premium. Accordingly, we obtain collateral in the
form of letters of credit or deposits to mitigate credit risk associated with
our loss sensitive plans. If we are unable to collect future retrospective
premium adjustments from an insured, we would be required to write-off the
related amounts, which could impact our financial position and results of
operations. To date, there have been no such write-offs. Retrospectively rated
policies accounted for approximately 15.0% and 23.2% of direct premiums written
in the three month periods ended September 30, 2008 and 2007, respectively, and
13.9% and 19.2% of direct premiums written in the nine month periods then
ended, respectively.

Recent
Accounting Pronouncements

In
September 2006, the FASB issued SFAS No. 157, Fair Value Measurements,
which defines fair value and establishes a framework for measuring fair value
in GAAP and expands disclosures about fair value measurements. The provisions
for SFAS No. 157 are effective for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. We adopted the provisions
of SFAS No. 157 as of January 1, 2008, which did not have a material effect on
our consolidated financial condition or results of operations.

In February
2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and
Financial Liabilities  Including an Amendment of FASB Statement No. 115,
which permits entities to choose to measure many financial instruments and
certain other items at fair value in order to mitigate volatility in reported
earnings caused by measuring related assets and liabilities differently and
without having to apply complex hedge accounting provisions. The provisions for
SFAS No. 159 are effective for fiscal years beginning after November 15, 2007,
and interim periods within those fiscal years. We adopted the provisions of
SFAS No. 159 as of January 1, 2008, which did not have a material effect on our
consolidated financial condition or results of operations.

On
October 10, 2008, the FASB issued FASB Staff Position No. 157-3, Determining
the Fair Value of a Financial Asset When the Market for That Asset Is Not
Active,which clarifies the application of FAS 157, Fair Value
Measurements, in an inactive market and illustrates how an entity
would determine fair value when the market for a financial asset is not active.
FSP 157-3 states that an entity should not automatically conclude that a
particular transaction price is determinative of fair value. In a dislocated
market, judgment is required to evaluate whether individual transactions are
forced liquidations or distressed sales. When relevant observable market
information is not available, a valuation approach that incorporates
managements judgments about the assumptions that market participants would use
in pricing the asset in a current sale transaction would be acceptable. The FSP
also indicates that quotes from brokers or pricing services may be relevant
inputs when measuring fair value, but are not necessarily determinative in the
absence of an active market for the asset. In weighing a broker quote as an
input to a fair value measurement, an entity should place less reliance on
quotes that do not reflect the result of market transactions. Further, the
nature of the quote (for example, whether the quote is an indicative price or a
binding offer) should be considered when weighing the available evidence. FSP
157-3 is effective immediately and applies to prior periods for which financial
statements have not been issued, including interim or annual periods ending on
or before September 30, 2008. Accordingly, we adopted FSP 157-3 prospectively,
beginning July 1, 2008. The adoption of FSP 157-3 did not have a material
impact on our financial results or fair value determinations.

- 37 -

Item 3.
Quantitative and Qualitative Disclosures About Market RiskMarket
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.

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 $499.7 million at September
30, 2008 that are subject to interest rate risk, compared with $474.8 million
at December 31, 2007. We manage the exposure to interest rate risk through a
disciplined asset/liability matching and capital management process. In the
management of this risk, the characteristics of duration, credit and
variability of cash flows are critical elements. These risks are assessed
regularly and balanced within the context of the liability and capital
position.

The
table below summarizes our interest rate risk as of September 30, 2008 and
December 31, 2007. It illustrates the sensitivity of the fair value of
fixed-income investments to selected hypothetical changes in interest rates as
of September 30, 2008 and December 31, 2007. The selected scenarios are not
predictions of future events, but rather illustrate the effect that such events
may have on the fair value of our fixed-income portfolio and shareholders
equity.

Interest Rate Risk as of September 30, 2008

Hypothetical Change in Interest
 Rates

Estimated
 Change in
 Fair Value

Fair
 Value

Hypothetical
 Percentage
 Increase
 (Decrease)
 in Portfolio
 Value($ in
 thousands)200 basis
 point increase

$
(48,750
)
$
450,976

(9.8
)%100 basis
 point increase


(24,246
)

475,480

(4.9
)%No change





499,726

100 basis
 point decrease


23,988


523,714

4.8
%200 basis
 point decrease


47,717


547,443

9.5
%Interest Rate Risk as of December 31, 2007

Hypothetical Change in Interest
 Rates

Estimated
 Change in Fair Value

Fair
 Value

Hypothetical
 Percentage
 Increase
 (Decrease) in
 Portfolio
 Value($ in
 thousands)200 basis
 point increase

$
(40,927
)
$
433,829

(8.6
)%100 basis
 point increase


(20,041
)

454,715

(4.2
)%No change





474,756

100 basis
 point decrease


19,195


493,951

4.0
%200 basis
 point decrease


37,545


512,301

7.9
%Item 4.
Controls and ProceduresDisclosure
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 Rule
13a-15(e) under 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

- 38 -

under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the rules and forms specified by the SEC and is
accumulated and communicated to our management, including our Chief Executive
Officer and our Chief Financial Officer, as appropriate to allow timely
decisions regarding required disclosure.

Changes in
Internal Control over Financial Reporting

There have not
been any changes in our internal control over financial reporting (as such term
is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during our
second fiscal quarter of 2008 that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.

PART II 
OTHER INFORMATION

Item 1A.
Risk FactorsYou
should carefully consider the risks described below and in Item 1A of our
Annual Report on Form 10-K for the fiscal year ended December 31, 2007, filed
with the SEC on March 17, 2008, together with all of the other information
included in this quarterly report. Such risks and uncertainties are not the
only ones facing us. If any such risks actually occur, our business, financial
condition or operating results could be harmed. Any such risks 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. Such risks 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 of this
quarterly report.

The
disclosure set forth below updates specific risk factors previously disclosed
in Item 1A of our Annual Report on Form 10-K for the fiscal year ended December
31, 2007. Other than as described below, there were no material changes to the
risk factors set forth in such report.

Under
the heading Item 1A. Risk Factors  Risk Related to Our Business  We could be
adversely affected by the loss of one or more principal employees or by an
inability to attract or retain staff, in our Annual Report on Form 10-K for the
fiscal year ended December 31, 2007, we included a discussion about the
potential adverse impact to our business of losing a member of our senior
management team. Under the heading Item 1A. Risk Factors in our Quarterly
Report on Form 10-Q for the quarter ended March 31, 2008, filed with the SEC on
May 12, 2008, we included a discussion about the unexpected passing of our
senior vice president and chief financial officer, Joseph S. De Vita. On
October 13, 2008, we announced the appointment of Robert P. Cuthbert, CPA, as
senior vice president and chief financial officer. As a result, the specific
references to selecting a new chief financial officer and the duties of that
position no longer apply.

Under
the heading Item 1A. Risk Factors  Risk Related to Our Business  The
insurance business is subject to extensive regulation and legislative changes,
which impact the manner in which we operate our business, in our Annual Report
on Form 10-K for the fiscal year ended December 31, 2007, we included a
discussion about the extensive regulation and legislative changes that impact
our insurance business. Recently, the financial markets have experienced a
period of extreme turmoil, including the bankruptcy, restructuring or sale of
certain financial institutions, which resulted in unprecedented intervention by
the U.S. federal government. While the ultimate outcome of governmental
initiatives intended to alleviate the recent financial crisis cannot be
predicted, it is likely that governmental authorities may seek to exercise
their supervisory or enforcement power in new or more robust ways, which could
affect our business and the way we manage our capital, and may require us to
satisfy increased capital requirements or impose additional restrictions on us
that may limit our ability to take actions designed to increase our
profitability.

Under
the heading Item 1A. Risk Factors  Risk Related to Our Business  If we are
unable to realize our investment objectives, our financial condition may be
adversely affected, in our Annual Report on Form 10-K for the year ended
December 31, 2007, we included a discussion about the impact of general market
conditions on our financial condition. Recently, the capital markets in the
United States and elsewhere have been experiencing extreme volatility and
disruption. We are exposed to significant capital markets risk, including
changes in interest rates, credit spreads, equity prices and foreign exchange
rates. Our investment portfolio is affected by these recent changes in the
capital markets. For example, for the three months ended September 30, 2008, we
recorded an impairment charge of $11.5 million for other-than-temporary losses
related principally to our preferred stock investments and holdings of equity
indexed securities exchange-traded funds. In addition, changes in interest
rates

- 39 -

and credit
quality may result in fluctuations in the income derived from, or the valuation
of, our fixed income securities. Our investment portfolio is also subject to
credit and cash flow risk, including risks associated with our investment in
asset-backed and mortgage-backed securities. Further adverse changes in the
capital markets could result in additional other-than-temporary impairments in
the future, which may affect our financial condition, or could reduce our
investment income, which would affect our results of operations.

Item 6.
ExhibitsThe
list of exhibits in the Exhibit Index to this quarterly report is incorporated
herein by reference.

- 40 -

SIGNATURES

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

SEABRIGHT
 INSURANCE HOLDINGS, INC.Date:
 November 10, 2008By:
/s/ Robert
 P. CuthbertRobert P.
 CuthbertSenior Vice
 President, Chief Financial Officer andAssistant
 Secretary (Principal Financial Officer)- 41 -

EXHIBIT INDEX

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

Exhibit
 Number

Description10.1

Employment
 offer letter for Robert P. Cuthbert dated August 13, 2008 (incorporated by
 reference to Exhibit 10.1 to the registrants current report on Form 8-K
 (File No. 000-51124) filed on October 17, 2008).31.1

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)