UNITED STATES SECURITIES AND
EXCHANGE COMMISSION


Washington, D.C. 20549





FORM 10-Q




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


For the quarterly period ended September 30, 2006


or


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


For the transition period from ________ to ________


Commission File Number 000-51124


SeaBright Insurance Holdings, Inc.




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


2101 4 th Avenue, Suite 1600
Seattle, Washington 98121


(206) 269-8500


þ o


o o þ


o þ




Class
    
    Shares outstanding as of November 10, 2006Common Stock, $0.01 Par Value
    
    20,549,400






##### Table of Contents










SeaBright Insurance Holdings, Inc.


Index to Form 10-Q


PagePart I. Financial InformationItem 1. Financial Statements (unaudited)
    
    
    2Condensed Consolidated Balance Sheets as of September 30, 2006 and
December 31, 2005
    
    
    2Condensed Consolidated Statements of Operations for the Three Months
and Nine Months Ended September 30, 2006 and 2005
    
    
    3Condensed Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 2006 and 2005
    
    
    4Notes to Unaudited Condensed Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    17Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    26Item 4. Controls and Procedures
    
    
    27Part II. Other InformationItem 1A. Risk Factors
    
    
    27Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    30Item 6. Exhibits
    
    
    30Signatures
    
    
    31Exhibit 31.1Exhibit 31.2Exhibit 32.1Exhibit 32.2 - 1 -


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##### Table of Contents

# PART
I  FINANCIAL INFORMATION

# Item 1.
Financial Statements

# SEABRIGHT INSURANCE
HOLDINGS, INC. AND SUBSIDIARIES

# CONDENSED CONSOLIDATED
BALANCE SHEETS

|                                                                                                                   | September 30,
2006 |  | December 31,
2005 |        
|------------------------------------------------------------------------------------------------------------------ | ------------------ |  | ----------------- | -------
|
|
|
|Investment securities available for sale, at fair value (amortized cost
$372,633 in 2006     and $260,015 in 2005) |                    |  | $                 | 372,310
|Equity securities available for sale, at fair value (amortized cost
$3,037     in 2005)                            |                    |  |                   |       
|Cash and cash equivalents                                                                                          |                    |  |                   | 26,022 
|Accrued investment income                                                                                          |                    |  |                   | 4,077  
|Premiums receivable, net of allowance                                                                              |                    |  |                   | 10,494 
|Deferred premiums                                                                                                  |                    |  |                   | 93,751 
|Federal income tax recoverable                                                                                     |                    |  |                   | 1,114  
|Service income receivable                                                                                          |                    |  |                   | 582    
|Reinsurance recoverables                                                                                           |                    |  |                   | 14,019 
|Receivable under adverse development cover agreement                                                               |                    |  |                   | 3,352  
|Prepaid reinsurance                                                                                                |                    |  |                   | 1,828  
|Property and equipment, net                                                                                        |                    |  |                   | 1,088  
|Deferred federal income taxes, net                                                                                 |                    |  |                   | 11,830 
|Deferred policy acquisition costs, net                                                                             |                    |  |                   | 12,060 
|Intangible assets, net                                                                                             |                    |  |                   | 1,220  
|Goodwill                                                                                                           |                    |  |                   | 1,527  
|Other assets                                                                                                       |                    |  |                   | 8,630  
|Total assets                                                                                                       |                    |  | $                 | 563,904
|
|
|Liabilities:                                                                                                       |                   
|Unpaid loss and loss adjustment expense                                                                            |                    |  | $                 | 184,645
|Unearned premiums                                                                                                  |                    |  |                   | 88,751 
|Reinsurance funds withheld and balances payable                                                                    |                    |  |                   | 240    
|Premiums payable                                                                                                   |                    |  |                   | 2,078  
|Accrued expenses and other liabilities                                                                             |                    |  |                   | 36,330 
|Surplus notes                                                                                                      |                    |  |                   | 12,000 
|Total liabilities                                                                                                  |                    |  |                   | 324,044
|                                                                                                                  
|Commitments and contingencies                                                                                      |                   
|                                                                                                                   |                   
|Stockholders equity:                                                                                              |                    | 
|Series A preferred stock, $0.01 par value; 750,000 shares authorized;                                              |                   
|no shares issued and outstanding                                                                                   |                    |  |                   |       
|Undesignated preferred stock, $0.01 par value; 10,000,000 shares                                                   |                    | 
|authorized; no shares issued and outstanding                                                                       |                    |  |                   |       
|Common stock, $0.01 par value; 75,000,000 shares authorized;                                                       |                   
|issued and outstanding - 20,549,400 shares at September 30, 2006                                                   |                   
|and 16,411,143 shares at December 31, 2005                                                                         |                    |  |                   | 205    
|Paid-in capital                                                                                                    |                    |  |                   | 190,121
|Accumulated other comprehensive loss                                                                               |                    |  |                   | (210   
|Retained earnings                                                                                                  |                    |  |                   | 49,744 
|Total stockholders equity                                                                                         |                    |  |                   | 239,860
|Total liabilities and stockholders equity                                                                         |                    |  | $                 | 563,904

See accompanying
notes to unaudited condensed consolidated financial statements.

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##### Table of Contents

# SEABRIGHT INSURANCE
HOLDINGS, INC. AND SUBSIDIARIES

# CONDENSED CONSOLIDATED
STATEMENTS OF OPERATIONS(Unaudited)

|                                            | Three Months Ended September 30, |  | Nine Months Ended September 30, |           
|------------------------------------------- | -------------------------------- |  | ------------------------------- | ----------
|
|
|Revenue:                                    |                                  |  |                                 |           
|Premiums earned                             |                                  |  | $                               | 47,819    
|Net investment income                       |                                  |  |                                 | 3,970     
|Net realized gain (loss)                    |                                  |  |                                 | (74       
|Claims service income                       |                                  |  |                                 | 497       
|Other service income                        |                                  |  |                                 | 31        
|Other income                                |                                  |  |                                 | 508       
|                                            |                                  |  |                                 | 52,751    
|Losses and expenses:                        |                                  | 
|Loss and loss adjustment expenses           |                                  |  |                                 | 27,829    
|Underwriting, acquisition and insurance     |                                 
|expenses                                    |                                  |  |                                 | 9,704     
|Other expenses                              |                                  |  |                                 | 2,179     
|                                            |                                  |  |                                 | 39,712    
|Income before federal income taxes          |                                  |  |                                 | 13,039    
|                                            |                                 
|Federal income tax expense (benefit):       |                                 
|Current                                     |                                  |  |                                 | 4,521     
|Deferred                                    |                                  |  |                                 | (579      
|                                            |                                  |  |                                 | 3,942     
|Net income                                  |                                  |  | $                               | 9,097     
|                                           
|Basic earnings per share                    |                                  |  | $                               | 0.45      
|Diluted earnings per share                  |                                  |  | $                               | 0.44      
|                                           
|Weighted average basic shares outstanding   |                                  |  |                                 | 20,319,525
|Weighted average diluted shares outstanding |                                  |  |                                 | 20,686,161

See accompanying
notes to unaudited condensed consolidated financial statements.

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##### Table of Contents

# SEABRIGHT INSURANCE
HOLDINGS, INC. AND SUBSIDIARIES

# CONDENSED CONSOLIDATED
STATEMENTS OF CASH FLOWS(Unaudited)

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

See accompanying
notes to unaudited condensed consolidated financial statements.

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##### Table of Contents

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

# 1.  Organization

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

SeaBright
Insurance Company (SBIC), formerly KEIC, is licensed to write workers
compensation insurance in 44 states and the District of Columbia. Domiciled in the
State of Illinois and commercially domiciled in the State of California, SBIC focuses on
employers with complex workers compensation exposures and provides coverage under
multiple state and federal acts, applicable common law or negotiated agreements. Prior to
the Acquisition, beginning in 2000, KEIC wrote business only in California. In May 2002,
KEIC ceased writing business and by December 31, 2003, all premiums related to
business prior to the Acquisition were 100% earned.

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

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

# 2. Summary of
Significant Accounting Policies

a.
Basis of Presentation

The
accompanying unaudited condensed consolidated financial statements include the accounts of
SIH and its wholly owned subsidiaries, SBIC and PointSure (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. Accordingly, they do
not include all of the information and notes required by GAAP for complete financial
statements. The condensed consolidated balance sheet at December 31, 2005 has been derived
from the audited financial statements at that date but does not include all of the
information and notes required by GAAP for complete financial statements. These unaudited
condensed consolidated financial statements and notes should be read in conjunction with
the audited financial statements and accompanying notes as of and for the year ended
December 31, 2005 included in the Companys Annual Report on Form 10-K, which was
filed with the U.S. Securities and Exchange Commission (the SEC) on March 29,
2006.

In
the opinion of management, the unaudited condensed consolidated financial statements
include all adjustments, consisting only of normal recurring adjustments, necessary to
state fairly the financial information set forth therein. Results of operations for the
three month and nine month periods ended September 30, 2006 are not necessarily indicative
of the results expected for the full fiscal year or for any future period.

b.
Use of Estimates

The
preparation of the unaudited condensed consolidated financial statements in conformity
with GAAP requires management of the Company to make a number of estimates and assumptions
relating to the reported amount of assets and liabilities and the disclosure of contingent
assets and liabilities at the date of the unaudited condensed consolidated financial
statements and the reported amounts of revenues and expenses during the period. For
example, the Company used significant estimates in determining amounts related to unpaid
loss and loss adjustment expense, goodwill and other intangibles, earned premiums on
retrospectively rated policies, earned but

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##### Table of Contents

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

unbilled premiums, federal income taxes,
reinsurance, stock-based compensation arrangements and other-than-temporary impairment of
investment securities. Actual results could differ from those estimates. Such estimates
and judgments could change in the future as more information becomes known, which could
impact the amounts reported and disclosed herein.

c.
Revenue Recognition

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

Earned
premiums on retrospectively rated policies are based on the Companys estimate of
loss experience as of the measurement date. Loss experience includes known losses
specifically identifiable to a retrospective policy as well as provisions for future
development on known losses and for losses incurred but not yet reported, which are
developed using actuarial loss development factors that are consistent with how the
Company projects losses in general. For retrospectively rated policies, the governing
contractual minimum and maximum rates are established at policy inception and are made a
part of the insurance contract. Premiums from retrospectively rated policies totaled 29.6%
and 21.2% of total premiums written for the three month periods ended September 30, 2006
and 2005, respectively, and 25.7% and 30.8% of total premiums written for the nine month
periods then ended, respectively.

d.
Unpaid Loss and Loss Adjustment Expense

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

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

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

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

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##### Table of Contents

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

e.
Reinsurance

The
Company attempts to protect itself from excessive losses by reinsuring with nonaffiliated
reinsurers certain levels of risk in various areas of exposure. Reinsurance premiums,
commissions, expense reimbursements and liabilities related to ceded business are
accounted for on a basis consistent with that used in accounting for original policies
issued and the terms of the reinsurance contracts. The unpaid loss and loss adjustment
expense subject to the adverse development cover agreement with LMC is estimated on a
quarterly basis using generally accepted actuarial methodology. Amounts estimated to be
recoverable in excess of acquired insurance liabilities at September 30, 2003 are recorded
gross in unpaid loss and loss adjustment expense in accordance with Statement of Financial
Accounting Standards (SFAS) No. 141, Business Combinations, with a
corresponding amount receivable from the seller. Amounts are shown net in the statements
of operations. Premiums ceded to other companies are reported as a reduction of premiums
written and earned. Reinsurance recoverables are determined based on the terms and
conditions of the reinsurance contracts.

f.
Income Taxes

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

g.
Earnings Per Share

The
following table provides the reconciliation of basic and diluted weighted average shares
outstanding used in calculating earnings per share for the three month and nine month
periods ended September 30, 2006 and 2005:

|                                                                                           | Three Months Ended September 30, |  | Nine Months Ended September 30, |           
|------------------------------------------------------------------------------------------ | -------------------------------- |  | ------------------------------- | ----------
|
|Basic weighted average shares outstanding                                                  |                                  |  |                                 | 20,319,525
|Weighted average shares issuable upon:                                                     |                                  |  |                                 |           
|Conversion of preferred stock
           outstanding prior to initial public      offering |                                  |  |                                 |          
|Exercise of stock options and vesting of
           restricted stock                       |                                  |  |                                 | 366,636   
|Diluted weighted average shares outstanding                                                |                                  |  |                                 | 20,686,161

h.
Stock-Based Compensation

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

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

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##### Table of Contents

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

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,
2006 is shown in the following table. No compensation cost was capitalized during the
three month or nine month periods ended September 30, 2006.

|                                             | Three MonthsEnded September 30,2006 |     | Nine MonthsEnded September 30,2006 |  
|-------------------------------------------- | ----------------------------------- | --- | ---------------------------------- | -
|
|Stock based compensation expense related to: |                                     |     |                                    |  
|Stock options                                | $                                   | 134 |                                    | $
|Nonvested stock                              |                                     | 334 |                                    |  
|Total                                        | $                                   | 468 |                                    | $
|                                            
|Total related tax benefit                    | $                                   | 120 |                                    | $

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

|                                                                                        | Three MonthsEnded September 30,2005 |       | Nine MonthsEnded September 30,2005 |  
|--------------------------------------------------------------------------------------- | ----------------------------------- | ----- | ---------------------------------- | -
|
|Information as previously reported:                                                     |                                     |       |                                    |  
|Net income                                                                              | $                                   | 5,067 |                                    | $
|Less SFAS No. 123 compensation costs, net of taxes                                      |                                     | (61   | )                                  |  
|Pro forma net income                                                                    | $                                   | 5,006 |                                    | $
|                                                                                        |                                     |       |                                    |  
|Net income per common share:                                                            |                                     |       |                                    |  
|Basic  as reported                                                                     | $                                   | 0.31  |                                    | $
|Basic  pro forma                                                                       | $                                   | 0.31  |                                    | $
|                                                                                        |                                     |       |                                    |  
|Diluted  as reported                                                                   | $                                   | 0.30  |                                    | $
|Diluted  pro forma                                                                     | $                                   | 0.30  |                                    | $
|                                                                                        |                                     |       |                                    |  
|Information calculated as if the fair value method had been applied
     to all awards: |                                     |       |                                    |  
|Net income                                                                              | $                                   | 5,067 |                                    | $
|Less SFAS No. 123 compensation costs, net of taxes                                      |                                     | (86   | )                                  |  
|Pro forma net income                                                                    | $                                   | 4,981 |                                    | $
|                                                                                        |                                     |       |                                    |  
|Net income per common share:                                                            |                                     |       |                                    |  
|Basic  as reported                                                                     | $                                   | 0.31  |                                    | $
|Basic  pro forma                                                                       | $                                   | 0.30  |                                    | $
|                                                                                        |                                     |       |                                    |  
|Diluted  as reported                                                                   | $                                   | 0.30  |                                    | $
|Diluted  pro forma                                                                     | $                                   | 0.30  |                                    | $

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

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##### Table of Contents

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

i.
Comprehensive Income

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

|                                                                                                 | Three Months Ended September 30, |  | Nine Months Ended September 30, |       
|------------------------------------------------------------------------------------------------ | -------------------------------- |  | ------------------------------- | ------
|
|
|Net income                                                                                       |                                  |  | $                               | 9,097 
|Reclassification adjustment for net
        realized gains (losses) recorded into
        income |                                  |  |                                 | (74   
|Tax (expense) benefit related to
        reclassification adjustment                             |                                  |  |                                 | 26    
|Increase (decrease) in unrealized gain on
        investment securities available for sale       |                                  |  |                                 | 9,135 
|Tax (expense) benefit related to unrealized
        gains (losses)                               |                                  |  |                                 | (3,197
|Total comprehensive income                                                                       |                                  |  | $                               | 14,987

j.
Recently Issued Accounting Pronouncements

In
July 2006, the Financial Accounting Standards Board (the FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes  an
Interpretation of FASB Statement No. 109 (FIN 48), which provides for the
recognition, measurement, presentation and disclosure of uncertain tax positions. A tax
benefit from an uncertain position may be recognized only if it is more likely than not
that the position is sustainable based on its technical merits. The provisions of FIN 48
are effective for fiscal years beginning after December 15, 2006. The Company expects that
FIN 48 will not have a material effect on its consolidated financial condition or results
of operations.

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. The Company expects that
SFAS No. 157 will not have a material effect on its consolidated financial condition or
result of operations.

In
September 2006, the SEC issued Staff Accounting Bulletin No. 108, Considering the
Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year
Financial Statements (SAB 108). SAB 108 provides interpretive guidance on
how the effects of prior-year uncorrected misstatements should be considered when
quantifying misstatements in the current year financial statements. SAB 108 requires
registrants to quantify misstatements using both an income statement
(rollover) and balance sheet (iron curtain) approach and evaluate
whether either approach results in a misstatement that, when all relevant quantitative and
qualitative factors are considered, is material. If prior year errors that had been
previously considered immaterial now are considered material based on either approach, no
restatement is required so long as management properly applied its previous approach and
all relevant facts and circumstances were considered. If prior years are not restated, the
cumulative effect adjustment is recorded in opening accumulated earnings as of the
beginning of the fiscal year of adoption. SAB 108 is effective for fiscal years ending on
or after November 15, 2006, with earlier adoption encouraged. The Company expects that SAB
108 will not have a material effect on its consolidated financial condition or results of
operations.

# 3. Investments

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

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##### Table of Contents

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

|                                               | Cost or
     Amortized
     Cost |  | Gross
     Unrealized
     Gains |         | Gross
     Unrealized
     Losses |   | Estimated
     Fair Value | 
|---------------------------------------------- | -------------------------------- |  | -------------------------------- | ------- | --------------------------------- | - | ------------------------- | 
|
|U.S. Treasury securities                       |                                  |  | $                                | 19,250  |                                   | $ | 49                        | 
|Government sponsored agency securities         |                                  |  |                                  | 21,518  |                                   |   | 8                         | 
|Corporate securities                           |                                  |  |                                  | 30,558  |                                   |   | 2                         | 
|Tax-exempt municipal securities                |                                  |  |                                  | 203,438 |                                   |   | 1,676                     | 
|Mortgage pass-through securities               |                                  |  |                                  | 76,790  |                                   |   | 306                       | 
|Collateralized mortgage obligations            |                                  |  |                                  | 2,859   |                                   |   | 2                         | 
|Asset-backed securities                        |                                  |  |                                  | 18,220  |                                   |   | 60                        | 
|Total investment securities available for sale |                                  |  | $                                | 372,633 |                                   | $ | 2,103                     | 

The
unrealized loss on temporarily impaired investments totaled $2.4 million at September 30,
2006 for investment securities available for sale with a fair value of $176.5 million.
Approximately $2.0 million of total unrealized losses were from securities that had been
impaired for more than one year. At September 30, 2006, no unrealized loss exceeded 20% of
the related securitys book value at that date. The following table presents
information about fixed maturity securities with unrealized losses at September 30, 2006:

|Fixed maturity securities
with unrealized losses at September 30, 2006 |  | Aggregate
     Fair Value |         | Aggregate
     Unrealized
     Loss |   | Fair Value
     as % of Cost
     Basis |  
|---------------------------------------------------------------------- |  | ------------------------- | ------- | ----------------------------------- | - | --------------------------------------- | -
|
|Greater than or equal to $50,000 and for:                              |  |                           |         |                                     |   |                                         |  
|Less than one year (1 issue)                                           |  | $                         | 1,560   |                                     | $ | (87                                     | )
|One year or longer (2 issues)                                          |  |                           | 6,282   |                                     |   | (184                                    | )
|Less than $50,000 and for:                                             |  |                           |         |                                     |   |                                         |  
|Less than one year (78 issues)                                         |  |                           | 60,926  |                                     |   | (375                                    | )
|One year or longer (149 issues)                                        |  |                           | 107,704 |                                     |   | (1,780                                  | )
|Total                                                                  |  | $                         | 176,472 |                                     | $ | (2,426                                  | )

---

The
Company regularly reviews its fixed maturity portfolio to evaluate the necessity of
recording impairment losses for other-than-temporary declines in the fair value of
investments. A number of criteria are considered during this process, including, but not
limited to, the following: the current fair value as compared to amortized cost or cost,
as appropriate, of the security; the length of time the securitys fair value has
been below amortized cost; the Companys intent and ability to retain the investment
for a period of time sufficient to allow for an anticipated recovery in value; specific
credit issues related to the issuer; and current economic conditions. In general, the
Company focuses on those securities whose fair values were less than 80% of their
amortized cost or cost, as appropriate, for six or more consecutive months.
Other-than-temporary impairment losses result in a permanent reduction of the carrying
amount of the underlying investment. Significant changes in the factors considered when
evaluating investments for impairment losses could result in a significant change in
impairment losses reported in the financial statements. The Company evaluated investment
securities with September 30, 2006 fair values less than amortized cost and has determined
that the decline in value is temporary and is related primarily to the change in market
interest rates since purchase. Furthermore, the Company has the ability to hold the
impaired investments to maturity and the intent to hold them for a period of time
sufficient for recovery of their carrying amount. Therefore, no other-than-temporary
impairment losses were recorded in the nine months ended September 30, 2006 and 2005.

The
amortized cost and estimated fair value of fixed income securities available for sale at
September 30, 2006, by contractual maturity, are set forth below. Actual maturities may
differ from contractual maturities because certain borrowers have the right to call or
prepay obligations with or without call or prepayment penalties.

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##### Table of Contents

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

|Maturity                                       | Cost orAmortizedCost |  | EstimatedFair Value |        
|---------------------------------------------- | -------------------- |  | ------------------- | -------
|
|Due in one year or less                        |                      |  | $                   | 11,652 
|Due after one year through five years          |                      |  |                     | 72,268 
|Due after five years through ten years         |                      |  |                     | 156,837
|Due after ten years                            |                      |  |                     | 34,007 
|Securities not due at a single maturity date   |                      |  |                     | 97,869 
|Total investment securities available for sale |                      |  | $                   | 372,633

The
amortized cost of investment securities available for sale deposited with various
regulatory authorities was $118.4 million at September 30, 2006.

# 4. Premiums

Direct
premiums written totaled $44.6 million and $37.5 million for the three month periods ended
September 30, 2006 and 2005, respectively, and $144.4 million and $134.4 million for the
nine month periods then ended, respectively.

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

|                                | September 30,2006 |  | December 31,2005 |       
|------------------------------- | ----------------- |  | ---------------- | ------
|
|Premiums receivable             |                   |  | $                | 11,391
|Allowance for doubtful accounts |                   |  |                  | (897  
|                                |                   |  | $                | 10,494

# 5. Reinsurance

a.
Reinsurance Ceded

Under
reinsurance agreements, the Company cedes various amounts of risk to nonaffiliated
insurance companies for the purpose of limiting the maximum potential loss arising from
the underlying insurance risks. For the period from October 1, 2005 through October 1,
2006, the Company entered into reinsurance agreements with nonaffiliated reinsurers
wherein it retains the first $500,000 of each loss occurrence. Losses in excess of
$500,000 up to $50.0 million are reinsured as follows:

|Layer                                                      |  | General Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|---------------------------------------------------------- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|$500,000 excess of $500,000 each loss occurrence           |  | Reinsured 50%, subject to an annual aggregate deductible of
      $1.5 million and an aggregate limit of $10.0 million.                                                                                                                                                                                                                                                                                                                                                                                                            
|$4.0 million excess of $1.0 million each loss occurrence   |  | Fully reinsured, subject to an annual aggregate deductible of
         $2.0 million and an aggregate limit of $16.0 million.                                                                                                                                                                                                                                                                                                                                                                                                       
|$5.0 million excess of $5.0 million each loss occurrence   |  | Fully reinsured, subject to an annual aggregate limit of $15.0 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|$40.0 million excess of $10.0 million each loss occurrence |  | Fully reinsured in two 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 a limit of $7.5 million
         maximum any one loss and an aggregate 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 a
         limit of $5.0 million maximum any one loss and an aggregate
         limit of $60.0 million.

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##### Table of Contents

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

On October 1, 2006, the
Company entered into new reinsurance agreements with nonaffiliated reinsurers wherein it retains the first $1.0 million
of each loss occurrence. The new reinsurance program, which is effective through October 1, 2007, provides coverage up to
$75.0 million per loss occurrence as follows:

|Layer                                                     |  | General Description                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|--------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|$1.0 million excess of $1.0 million each loss occurrence  |  | Fully reinsured, subject to an aggregate annual limit of $8.0 million                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
|$3.0 million excess of $2.0 million each loss occurrence  |  | Fully reinsured, subject to an aggregate annual limit of $12.0 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|$5.0 million excess of $5.0 million each loss occurrence  |  | Fully reinsured, subject to an aggregate annual limit of $15.0 million.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|$65.0 million excess of $10.0 million each los occurrence |  | Fully reinsured in three sub-layers. The first sub-layer
         affords coverage of up to $10.0 million for each loss
         excess of $10.0 million, subject to a limit of $7.5 million
         maximum any one loss and an aggregate 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 aggregate annual limit of $60.0
         million, and the third sub-layer affords coverage up to $25.0
         million for each loss occurrence in excess of $50.0 million. The
         second and third sub-layers are subject to a limit of $5.0
         million maximum any one loss.

The
above coverage is subject to various limitations and exclusions as more fully described in
the reinsurance agreements.

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

As
part of the Agreement, LMC placed into trust (the Trust) an amount equal to
10% of the balance sheet insurance liabilities of SBIC on the date of the Acquisition.
Thereafter, the Trust shall be adjusted each quarter, if warranted, to an amount equal to
at least 102% of LMCs obligations under the Agreement. Initial loss liabilities were
$16.0 million. The balance of the Trust was $5.1 million at September 30, 2006 and $4.9
million at December 31, 2005.

b.
Reinsurance Assumed

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

c.
Reinsurance Recoverables and Income Statement Effects

Balances
affected by reinsurance transactions are reported gross of reinsurance in the accompanying
unaudited condensed consolidated balance sheets. Reinsurance recoverables are comprised of
the following amounts at September 30, 2006 and December 31, 2005:

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##### Table of Contents

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

|                                                                     | September 30,2006 |  | December 31,2005 |       
|-------------------------------------------------------------------- | ----------------- |  | ---------------- | ------
|
|Reinsurance recoverables on unpaid loss and loss adjustment expenses |                   |  | $                | 13,607
|Reinsurance recoverables on paid losses                              |                   |  |                  | 412   
|Total reinsurance recoverables                                       |                   |  | $                | 14,019

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

|                                                  | Three Months Ended September 30, |  | Nine Months Ended September 30, |       
|------------------------------------------------- | -------------------------------- |  | ------------------------------- | ------
|
|
|Reinsurance assumed:                             
|Written premiums                                  |                                  |  | $                               | (1,786
|Earned premiums                                   |                                  |  |                                 | (1,127
|Losses and loss adjustment expenses      incurred |                                  |  |                                 | (1,218
|                                                 
|Reinsurance ceded:                               
|Written premiums                                  |                                  |  | $                               | 3,798 
|Earned premiums                                   |                                  |  |                                 | 4,126 
|Losses and loss adjustment expenses      incurred |                                  |  |                                 | 405   

# 6. Unpaid Loss and Loss
Adjustment Expenses

The
following table summarizes the activity in unpaid loss and loss adjustment expense for the
three month and nine month periods ended September 30, 2006 and 2005:

|                                                                                   | Three Months Ended September 30, |  | Nine Months Ended September 30, |        
|---------------------------------------------------------------------------------- | -------------------------------- |  | ------------------------------- | -------
|
|
|Beginning balance:                                                                 |                                  |  |                                 |        
|Unpaid loss and loss adjustment expense                                            |                                  |  | $                               | 169,336
|Reinsurance recoverables                                                           |                                  |  |                                 | (13,620
|Net                                                                                |                                  |  |                                 | 155,716
|Incurred related to:                                                               |                                  |  |                                 |        
|Current period                                                                     |                                  |  |                                 | 31,306 
|Prior periods                                                                      |                                  |  |                                 | (3,477 
|Total incurred                                                                     |                                  |  |                                 | 27,829 
|Paid related to:                                                                   |                                  |  |                                 |        
|Current period                                                                     |                                  |  |                                 | (7,877 
|Prior periods                                                                      |                                  |  |                                 | (4,630 
|Total paid                                                                         |                                  |  |                                 | (12,507
|Unpaid loss and loss adjustment      expense,
     net of reinsurance recoverables |                                  |  |                                 | 171,038
|Reinsurance recoverables                                                           |                                  |  |                                 | 13,607 
|Unpaid loss and loss adjustment      expense                                       |                                  |  | $                               | 184,645

Loss
and loss adjustment expenses are net of the release of loss reserves totaling
approximately $3.5 million and $13.9 million in the three month and nine month periods
ended September 30, 2006, respectively. These reserve releases reflect the
better-than-expected impacts on losses related primarily to the Companys California
book of business as a result of reform legislation enacted there primarily in 2003 and
2004.

# 7. Surplus Notes

In
a private placement on May 26, 2004, SBIC issued $12.0 million in subordinated
floating rate surplus notes due in 2034. Interest, paid quarterly in arrears, is
calculated at the beginning of the interest payment period using the

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##### Table of Contents

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

3-month LIBOR rate
plus 400 basis points, subject to certain limitations. Interest expense totaled $285,000
and $813,000 for the three month and nine month periods ended September 30, 2006,
respectively, and $233,000 and $641,000 for the three month and nine month periods ended
September 30, 2005, respectively.

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

# 8. Contingencies

a.       
          SBIC is subject to guaranty fund and other assessments by the states in which it
          writes business. Guaranty fund assessments are accrued at the time premiums are
          written. Other assessments are accrued either at the time of assessment or in
          the case of premium-based assessments, at the time the premiums are written, or
          in the case of loss-based assessments, at the time the losses are incurred. As
          of September 30, 2006, SBIC had a liability for guaranty fund and other
          assessments of $2.1 million and a guaranty fund receivable of $3.3 million.
          These amounts represent managements best estimate based on information
          received from the states in which it writes business and may change due to many
          factors, including the Companys share of the ultimate cost of current and
          future insolvencies. The majority of assessments are paid out in the year
          following the year in which the premium is written or the losses are paid.
          Guaranty fund receivables and other surcharge items are generally realized by a
          charge to new and renewing policyholders in the year following the year in which
          the related assessments were paid.

b.        As previously reported, in June 2004, the Company was notified of a claim
          for damages brought by an individual against PointSure. In April 2005, a
          complaint against PointSure in connection with this matter was filed in the
          Superior Court of Washington for King County. The complaint alleged breach and
          unjust enrichment related to the termination of an alleged contract between
          PointSure and the plaintiff and sought a judgment awarding damages to the
          plaintiff in an amount to be proven at trial, plus attorneys fees and
          costs. In July 2006, the court granted plaintiffs motion to file
          an amended complaint adding SIH and SBIC to the complaint. In October 2006,
          the parties agreed to settle the case. A one-time pre-tax charge of $305,000
          related to the settlement of this case was included in net income for the three
          months and nine months ended September 30, 2006.

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

# 9. Follow-on Public
Offering

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

# 10. Share-Based Payment
Arrangements

At
September 30, 2006, the Company had outstanding stock options and nonvested stock granted
according to the terms of two equity incentive plans. The stockholders and Board of
Directors approved the 2003 Stock Option Plan (the 2003 Plan) in September
2003, and amended and restated the 2003 Plan in February 2004, and approved the 2005
Long-Term Equity Incentive Plan (the 2005 Plan and, together with the 2003
Plan, the Stock Option Plans) in December 2004.

The
Board of Directors reserved an initial total of 776,458 shares of common stock under the
2003 Plan and 1,047,755 shares of common stock under the 2005 Plan, plus an automatic
annual increase on the first day of each fiscal year beginning in 2006 and ending in 2015
equal to the lesser of: (i) 2% of the shares of common stock

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##### Table of Contents

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

outstanding on the last day
of the immediately preceding fiscal year or; (ii) such lesser number of shares as
determined by the Board of Directors. At September 30, 2006, the Company reserved 776,458
shares of common stock for issuance under the 2003 Plan, of which options to purchase
487,683 shares had been granted, and 1,375,978 shares for issuance under the 2005 Plan, of
which 667,563 shares had been granted. In January 2006, the Compensation Committee of the
Board of Directors terminated the ability to grant future stock options awards under the
2003 Plan. Therefore, the Company anticipates that all future awards will be made under
the 2005 Plan.

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

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

a.
Stock Options

The
fair values of stock options granted during the three month and nine month periods ended
September 30, 2006 and 2005 were determined on the dates of grant using the
Black-Scholes-Merton option valuation model with the following weighted average
assumptions:

|                                | Three Months Ended September 30, |  | Nine Months Ended September 30, |     
|------------------------------- | -------------------------------- |  | ------------------------------- | ----
|
|Expected term (years)           |                                  |  |                                 | 6.3 
|Expected stock price volatility |                                  |  |                                 | 26.0
|Risk-free interest rate         |                                  |  |                                 | 5.02
|Expected dividend yield         |                                  |  |                                 |    
|                                |                                  |  |                                 |     
|Estimated fair value per option |                                  |  | $                               | 5.86

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

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

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##### Table of Contents

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

The
following table summarizes stock option activity for the nine months ended September 30,
2006:

|                                  | Shares
     Subject to
     Options |  | Weighted
     Average Exer-
     cise Price
     per Share |         | Weighted
     Average Re-
     maining Con-
     tractual Life
     (years) |   | Aggregate
     Intrinsic
     Value
     (in
     thousands) | 
|--------------------------------- | ----------------------------------- |  | ---------------------------------------------------------- | ------- | --------------------------------------------------------------------------- | - | ------------------------------------------------------------ | 
|
|Outstanding at December 31, 2005  |                                     |  |                                                            | 804,524 |                                                                             | $ | 8.13                                                         | 
|Granted                           |                                     |  |                                                            | 124,350 |                                                                             |   | 17.42                                                        | 
|Forfeited                         |                                     |  |                                                            | (5,360  | )                                                                           |   | 8.17                                                         | 
|Exercised                         |                                     |  |                                                            | (4,382  | )                                                                           |   | 7.40                                                         | 
|Cancelled                         |                                     |  |                                                            | (478    | )                                                                           |   | 6.54                                                         | 
|Outstanding at September 30, 2006 |                                     |  |                                                            | 918,654 |                                                                             |   | 9.39                                                         | 
|                                  |                                     |  |                                                            |         |                                                                             |   |                                                              | 
|Exercisable at September 30, 2006 |                                     |  |                                                            | 416,503 |                                                                             |   | 7.34                                                         | 

The
aggregate intrinsic values in the table above are before applicable income taxes and are
based on the Companys closing stock price of $13.97 on September 30, 2006. As of
September 30, 2006, total unrecognized stock-based compensation cost related to nonvested
stock options was approximately $1.3 million, which is expected to be recognized over a
weighted average period of approximately 32.0 months. No stock options were exercised
during the three months ended September 30, 2006.

As
of September 30, 2006, there were 708,415 shares of common stock available for issuance of
future share-based awards. The following table presents additional information regarding
options outstanding as of September 30, 2006:

|            | Options Outstanding |  | Options Exercisable |        
|----------- | ------------------- |  | ------------------- | -------
|
|$ 6.54      |                     |  |                     | 481,922
|10.50-12.54 |                     |  |                     | 312,482
|15.60-18.40 |                     |  |                     | 124,250
|            |                     |  |                     | 918,654

b.
Nonvested Stock

The
following table summarizes nonvested stock activity for the nine months ended September
30, 2006:

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

As
of September30, 2006, there was $3.3 million of total unrecognized compensation
cost related to nonvested stock granted under the 2005 Plan. That cost is expected to be
recognized over a weighted-average period of 29.4 months. No shares vested during the
quarter ended September30, 2006.

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##### Table of Contents

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

# Cautionary Statement

You
should read the following discussion and analysis in conjunction with our unaudited
condensed consolidated financial statements and the related notes thereto included in
Item 1 of this Part I. The information contained in this quarterly report is not
a complete description of our business or the risks associated with an investment in our
common stock. We urge you to carefully review and consider the various disclosures made by
us in this quarterly report and in our other reports filed with the SEC, including our
Annual Report on Form 10-K for the year ended December 31, 2005 filed with the
SEC on March 29, 2006.

The
discussion under the heading Risk Factors in Part II, Item 1A of this
quarterly report, and similar discussions in our other SEC filings, describe some of the
important risk factors that may affect our business, results of operations and financial
condition. You should carefully consider those risks, in addition to the other information
in this report and in our other filings with the SEC, before deciding to purchase, hold or
sell our common stock.

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

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

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

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

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

Additional
information concerning these and other factors is contained in our SEC filings, including,
but not limited to, our 2005 Annual Report on Form 10-K.

# Overview

We
are a specialty provider of multi-jurisdictional workers compensation insurance. We
are domiciled in Illinois, commercially domiciled in California and headquartered in
Seattle, Washington. We are licensed in 44 states and the District of Columbia to write
workers compensation insurance. Traditional providers of workers compensation
insurance provide coverage to employers under one or more state workers compensation
laws, which prescribe benefits that employers are obligated to provide to their employees
who are injured arising out of or in the course of employment. We focus on employers with
complex workers compensation exposures and provide coverage under multiple state and
federal acts, applicable common law or negotiated agreements. We also provide traditional
state act coverage in markets we believe are underserved. Our workers compensation
policies are issued to employers who also pay the premiums. The policies provide payments
to covered, injured employees of the policyholder for, among other things, temporary or
permanent disability benefits, death benefits and medical and hospital expenses. The
benefits payable and the duration of such benefits are set by statute and vary by
jurisdiction and with the nature and severity of the injury or disease and the wages,
occupation and age of the employee.

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

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

To
minimize our exposure to any past business underwritten by KEIC, we entered into an
adverse development cover agreement in connection with the Acquisition. Under the terms of
this agreement, we and LMC are required to indemnify each other with respect to
developments in KEICs insurance liabilities as they existed at the date of the
Acquisition. December 31, 2011 is the date that the parties will look to see whether the
insurance liabilities with respect to KEICs insurance policies in effect at the date
of the Acquisition have increased or decreased from the $16.0 million amount existing at
the date of the Acquisition. Accordingly, if KEICs insurance liabilities increase,
LMC must indemnify us in the amount of the increase. If KEICs insurance liabilities
decrease, we must indemnify LMC in the amount of the decrease. To support LMCs
obligations under the adverse development cover agreement, LMC funded a trust account at
the time of the Acquisition in the amount of $1.6 million as collateral for LMCs
potential future obligations to us under the adverse development cover agreement. The
minimum amount that must be maintained in the trust account is equal to the greater of (a)
$1.6 million or (b) 102% of the then existing quarterly estimate of LMCs total
obligations under the adverse development cover agreement. The amount on deposit in the
trust account at September 30, 2006 was approximately $5.1 million. If LMC is placed into
receivership and the amount held in the collateralized reinsurance trust is inadequate to
satisfy the obligations of

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LMC to us under the adverse development cover agreement, it is
unlikely that we would recover any future amounts owing by LMC to us.

# Principal Revenue and
Expense Items

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

Premiums
Earned

Gross
premiums written include all premiums billed and unbilled by an insurance company during a
specified policy period. Premiums are earned over the terms of the related policies. At
the end of each accounting period, the portions of premiums that are not yet earned are
included in unearned premiums and are realized as revenue in subsequent periods over the
remaining terms of the policies. Our policies typically have terms of 12 months. Thus, for
example, for a policy that is written on July 1, 2005, one-half of the premiums would be
earned in 2005 and the other half would be earned in 2006.

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

We
earn our direct premiums written from our maritime, alternative dispute resolution
(ADR) and state act customers. We also earn a small portion of our direct
premiums written from employers who participate in the Washington USL&H Assigned Risk
Plan. We immediately cede 100% of those premiums, net of our expenses, and 100% of the
losses in connection with that business back to the plan. Premiums from the Washington
USL&H Assigned Risk Plan are included in both direct premiums written and ceded
premiums written.

Net
Investment Income and Realized Gains and Losses on Investments

We
invest our statutory surplus and the funds supporting our insurance liabilities (including
unearned premiums and unpaid loss and loss adjustment expense) in cash, cash equivalents,
fixed income securities and, to a lesser degree, in equity securities. Our investment
income includes interest earned on our invested assets. Realized gains and losses on
invested assets are reported separately from net investment income. We earn realized gains
when invested assets are sold for an amount greater than their amortized cost in the case
of fixed maturity securities and recognize realized losses when investment securities are
written down as a result of an other-than-temporary impairment or sold for an amount less
than their carrying cost.

Claims
Service Income

We
receive claims service income in return for providing claims administration services for
other companies. The claims service income we receive for providing these services
approximates our costs. For the nine months ended September 30, 2006 and 2005,
approximately 65.8% and 86.7%, respectively, of our claims service income was generated by
contracts we have with LMC to provide claims handling services for the policies written by
the Eagle Entities prior to the Acquisition. We expect income from these contracts to
decrease substantially over the next several years as transactions related to the Eagle
Entities diminish.

Other
Service Income

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

Our
expenses consist primarily of:

Loss
and Loss Adjustment Expenses

Loss
and loss adjustment expenses represent our largest expense item and include (1) claim
payments made, (2) estimates for future claim payments and changes in those estimates for
current and prior periods and (3) costs associated with investigating, defending and
adjusting claims.

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Underwriting,
Acquisition and Insurance Expenses

We
refer to the expenses that we incur to underwrite risks as underwriting, acquisition and
insurance expenses. Underwriting expenses consist of commission expenses, premium taxes
and fees and other underwriting expenses incurred in writing and maintaining our business.
Commissions, premium taxes and fees, and the portion of other underwriting expenses that
is associated with the acquisition of new and renewal business are initially deferred and
are recognized as expenses as the related premium is earned.

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

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

Other
Underwriting Expenses.Other underwriting expenses consist of general administrative
expenses such as salaries, rent, office supplies, depreciation and all other operating
expenses not otherwise classified separately, and boards, bureaus and assessments of
statistical agencies for policy service and administration items such as rating manuals,
rating plans and experience data.

Interest
Expense

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

# Results of Operations

Three
Month and Nine Month Periods Ended September 30, 2006 and 2005

Gross
Premiums Written. Gross premiums written for the three months ended September 30, 2006
totaled $42.8 million, an increase of $3.3 million, or 8.4%, from $39.5 million in the
same period of 2005. For the nine months ended September 30, 2006, gross premiums written
totaled $149.9 million, an increase of $9.4 million, or 6.7%, from $140.5 million in the
same period of 2005. As of September 30, 2006, our in-force premium totaled $196.8 million
and we had 573 customers compared to $174.9 million in-force and 428 customers at
September 30, 2005. Our in-force premium increased 5.6% in the quarter ended September 30,
2006 and 8.1% in the nine months then ended. Customer counts increased by 6.9% in the
third quarter of 2006 and 22.4% in the first nine months of 2006.

California
continues to be our largest market, accounting for approximately 57.0% of our in-force
premiums at September 30, 2006. Gross premiums written in California for the three months
ended September 30, 2006 accounted for approximately 49.1% of the total premiums written
in the quarter, down from approximately 59.7% for the same period of 2005. Gross premiums
written in California during the first nine months of 2006 accounted for 53.6% of total
premiums written in the period, down from approximately 59.6% in the same period of 2005.
This reduction is part of our plan to further diversify our book of
business. As of September 30, 2006, our in-force book of business was split as follows
among our three primary market segments: state act  59.5%, ADR  25.8% and
maritime  14.7%. At September 30, 2005, our in-force book of business was split as
follows: state act  55.1%, ADR  29.0% and maritime  15.9%.

On
March 24, 2006, the California Workers Compensation Insurance Rating Bureau (the
WCIRB), an industry-backed private organization that provides statistical
analysis, submitted a filing with the California Insurance Commissioner recommending a
16.4% decrease in advisory pure premium rates on new and renewal policies effective July
1, 2006. Pure premium is that portion of an insurance premium necessary to cover the cost
of paying claims, such as medical and indemnity costs and allocated and unallocated loss
adjustment expenses. The filing was based on an analysis of loss experience valued as of December 31,
2005 and was made in response to continued reductions in workers compensation claim
costs in California as a result of reform legislation enacted primarily in 2003 and 2004.
On May 31, 2006, the Commissioner recommended a 16.4% decrease in rates effective July 1, 2006.
Such decisions of the California Insurance Commissioner are advisory only and insurance
companies may choose whether or not to adopt the new rates. On May 31, 2006,
we filed new rates reflecting an average reduction of 5.8% from prior rates for new and
renewal workers compensation insurance policies written in California on or after
July 1, 2006. The filing was approved on June 21, 2006. This was the sixth California rate
reduction we have filed since October 1, 2003, resulting in a net cumulative reduction of
our California rates of approximately 41.8%, and since October 1, 2005, our California
rates have been reduced by 16.9%.

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On
September 14, 2006, the WCIRB amended a previous filing with the California Insurance
Commissioner to recommend a 6.3% decrease in advisory pure premium rates on new and
renewal policies effective on or after January 1, 2007. The filing was based on a review
of loss and loss adjustment experience through June 30, 2006 and was made in response to
continued reductions in California workers compensation claim costs. On November 2,
2006, the California Insurance Commissioner recommended a 9.5% decrease in workers
compensation advisory pure premium rates for policies incepting on or after January 1,
2007. Rate reductions have also been proposed in other states in which we operate. At this
time, we are unable to predict the impact that the proposed rate reductions, if approved
and adopted by us, might have on our future financial position and results of operations.

Net
Premiums Written. Net premiums written for the three months ended September 30, 2006
totaled $39.0 million, an increase of $5.6 million, or 16.8%, from $33.4 million in the
same period of 2005. For the nine months ended September 30, 2006, net premiums written
totaled $138.0 million, an increase of $15.4 million, or 12.6%, from $122.6 million in the
same period of 2005. The increases in net premiums written for the three month and nine
month periods ended September 30, 2006 are reflective of similar increases in gross
premiums written, offset by reductions in premium rates on our ceded reinsurance
contracts. Net premiums written are affected by premiums ceded under reinsurance
agreements with external reinsurers. For the three months ended September 30, 2006, ceded
written premiums totaled $3.8 million (8.9% of gross premiums written) compared to $6.1
million (15.4% of gross premiums written) in the same period of 2005. Ceded written
premiums for the nine months ended September 30, 2006 totaled $11.9 million (7.9% of gross
premiums written) compared to $17.9 million (12.7% of gross premiums written) in the same
period of 2005. In 2005, certain of our reinsurance contracts provided for the ceding of
premiums on a direct premiums written basis, while others provided for ceding on a direct
premiums earned basis. Our current reinsurance contracts, which we entered into on October
1, 2005, provide for the ceding of premiums on a gross premiums earned basis. This,
coupled with changes in our deductibles and retention limits, accounts for the reductions
in the ceded premiums written percentages noted above.

As
further described below under Liquidity and Capital Resources, on October 1,
2006, we entered into new reinsurance agreements that provide for reinsurance coverage up
to $75.0 million per loss occurrence, subject to certain limitations, as opposed to the
$50.0 million limit of coverage provided under our October 1, 2005 to October 1, 2006
treaty year reinsurance program.

Net
Premiums Earned. Net premiums earned for the three months ended September 30, 2006
totaled $47.8 million, an increase of $7.1 million, or 17.4%, over $40.7 million in the
same period of 2005. For the nine months ended September 30, 2006, net premiums earned
totaled $133.6 million, an increase of $24.1 million, or 22.0%, from $109.5 million in the
same period of 2005. As previously discussed, these increases are due to the increase in
net premiums written in 2005 and 2006. We record the entire annual policy premium as
unearned premium when written and earn the premium over the life of the policy, which is
generally twelve months. Net premiums earned in the first nine months of 2006 reflect a
reduction of approximately $1.8 million related to our retrospectively rated policies,
reflective of improved loss ratios that generate return premiums. Retrospectively rated
policies currently account for approximately 30.0% of our book of business.

Net
Investment Income. Net investment income for the three months ended September 30, 2006
totaled $4.0 million, an increase of $1.9 million, or 90.5%, over $2.1 million in the same
period of 2005. For the nine months ended September 30, 2006, net investment income
totaled $10.8 million, an increase of $5.6 million, or 107.7%, from $5.2 million in the
same period of 2005. These increases are due primarily to the addition of $57.6 million of
net proceeds from the follow-on offering in February 2006, continued positive cash flow
from operations and the higher interest rate environment. Our yield on average invested
assets for the three months ended September 30, 2006 was approximately 4.2% compared to
approximately 3.5% for the same period in 2005. For the nine months ended September 30,
2006, our yield on average invested assets was 4.3% compared to approximately 3.8% for the
same period in 2005.

Service
Income. Service income for the three months ended September 30, 2006 totaled $528,000,
a decrease of $36,000, or 6.4%, from $564,000 in the same period of 2005. For the nine
months ended September 30, 2006, service income totaled $1.6 million, a decrease of $0.3
million, or 15.8%, from $1.9 million in the same period of 2005. Our service income
results primarily from service arrangements we have with LMC and other companies for
claims processing services, policy administration and administrative services we perform
for them. Average monthly fees from arrangements with LMC for services we provide in
connection with the Eagle Entities insurance policies are declining as the volume of
work decreases as a result of the run off of our predecessors business.

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Approximately 46.4% of our service income in the three-month period ended September 30,
2006 came from third party claims administration services that we provide to independent,
unrelated companies, compared to 18.5% in the same period of 2005. For the nine-month
period ended September 30, 2006, approximately 34.2% of our service income came from third
party claims administration services that we provide to independent, unrelated companies,
compared to approximately 13.3% in the same period of 2005.

Other
Income. Other income for the three months ended September 30, 2006 totaled $508,000, a
decrease of $366,000, or 41.9%, from $874,000 in the same period of 2005. For the nine
months ended September 30, 2006, other income totaled $2.1 million, a decrease of $0.8
million, or 27.6%, from $2.9 million in the same period of 2005. Other income results
primarily from the operations of PointSure, our wholesale insurance broker and third party
claims administrator subsidiary. The decrease in other income for the three month and nine
month periods ended September 30, 2006 resulted primarily from a decrease in
PointSures agency and direct billed commission income from SeaBright due to the
direct appointment in 2005 and 2006 of PointSure agents by SeaBright, thereby reducing the
amount of commissions SeaBright paid to PointSure in 2006 compared to 2005 for those same
agents. PointSures agency and direct billed commission income totaled approximately
$508,000 and $2.1 million for the three month and nine month period ended September 30,
2006, respectively, compared to $871,000 and $2.9 million in the same periods of 2005,
respectively, representing a decrease of $363,000, or 41.7% and $0.8 million or 27.6%,
respectively. Most of this income is passed through as commission expense to brokers and
producers.

Loss
and Loss Adjustment Expenses. Loss and loss adjustment expenses for the three months
ended September 30, 2006 totaled $27.8 million, an increase of $0.7 million, or 2.6%, from
$27.1 million in the same period of 2005. For the nine months ended September 30, 2006,
loss and loss adjustment expenses totaled $78.3 million, an increase of $3.9 million, or
5.2%, from $74.4 million in the same period of 2005. Our net loss ratio, which is
calculated by dividing loss and loss adjustment expenses less claims service income by
premiums earned, for the three months ended September 30, 2006 was 57.2% compared to 65.3%
for the same period in 2005. Our net loss ratio for the nine months ended September 30,
2006 was 57.4% compared to 66.2% for the same period in 2005. Paid losses for the three
month and nine month period ended September 30, 2006 totaled $12.5 million and $35.7
million, respectively, compared to $9.1 million and $23.5 million in the same periods of
2005, respectively.

Loss
and loss adjustment expenses for the three month and nine month periods ended September
30, 2006 are net of the release of prior accident years loss reserves totaling
approximately $3.5 million and $13.9 million, respectively. The reserve releases reflect
the better-than-expected paid loss trends related primarily to the Companys
California book of business as a result of reform legislation enacted there primarily in
2003 and 2004. The recorded loss reserves at September 30, 2006 represent
managements estimate of amounts the Company expects to pay in connection with
policies it has written. Reserves are reviewed quarterly and adjustments are made as
necessary to reflect managements current expectations in light of developing trends.

As
of September 30, 2006, we had recorded a receivable of approximately $3.4 million for
adverse loss development under the adverse development cover agreement since the date of
the Acquisition. We do not expect this receivable to have any material adverse effect on
our future cash flows if LMC fails to perform its obligations under the adverse
development cover agreement. At September 30, 2006, we have access to approximately $5.1
million under the collateralized reinsurance trust in the event that LMC fails to satisfy
its obligations under the adverse development cover agreement.

Underwriting
Expenses. Underwriting expenses for the three months ended September 30, 2006 totaled
$9.7 million, an increase of $1.6 million, or 19.8%, from $8.1 million in the same period
of 2005. For the nine months ended September 30, 2006, underwriting expenses totaled $28.7
million, an increase of $5.6 million, or 24.2%, from $23.1 million in the same period of
2005. Our net underwriting expense ratio for the three months ended September 30, 2006,
which is calculated by dividing underwriting, acquisition and insurance expenses less
other service income by premiums earned, was 20.2%, compared to 19.7% for the same period
in 2005. For the nine months ended September 30, 2006, our net underwriting expense ratio
was 21.4%, compared to 20.9% for the same period of 2005. The increases in the net
underwriting expense ratio resulted primarily from an increase in staffing costs. The
number of employees grew from 144 at September 30, 2005 to 174 at September 30, 2006,
representing an increase of 20.8%.

Other
Expenses. Other expenses for the three months ended September 30, 2006 totaled $2.2
million, an increase of $0.8 million, or 57.1%, over $1.4 million in the same period of
2005. For the nine months ended September 30, 2006, other expenses totaled $5.7 million,
an increase of $1.1 million, or 23.9%, from $4.6 million in the same period of 2005. The
increase in other expenses resulted primarily from compensation costs associated with

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the
implementation of SFAS No. 123R, which totaled approximately $468,000 for the three months
and $1.1 million for the nine months ended September 30, 2006, offset by a reduction in
amortization expense of approximately $34,000 in the three months and $237,000 in the nine
months ended September 30, 2006 related to intangible assets we acquired from the
predecessor and other reductions. Other expenses for the three months and nine months
ended September 30, 2006 included a one-time charge of $305,000 related to a legal
settlement.

Federal
Income Tax Expense. The effective tax rate for the three months ended September 30,
2006 was 30.2%, compared to 34.3% for the same period in 2005. For the nine months ended
September 30, our effective tax rate was 30.4% in 2006 and 31.6% in 2005. The reductions
in our effective tax rate are primarily attributable to an increase in the proportion of
tax-exempt municipal securities in our portfolio. At September 30, 2006, approximately
55.0% of our portfolio was invested in tax-exempt municipal securities, compared to
approximately 53.3% at September 30, 2005.

Net
Income. Net income was $9.1 million for the three months ended September 30, 2006,
compared to $5.1 million for the same period in 2005, representing an increase of $4.0
million, or 78.4%. Net income for the nine months ended September 30, 2006 totaled $24.4
million, an increase of $12.4 million, or 103.3%, from $12.0 million in the same period of
2005. The increase in net income for the three and nine months ended September 30, 2006
resulted primarily from increases in premiums earned and investment income for the period
and the release of loss reserves, offset by increases in loss and loss adjustment expenses
and underwriting, acquisition and insurance expenses.

# Liquidity and Capital
Resources

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

Our
investment portfolio is structured so that investments mature periodically over time in
reasonable relation to current expectations of future claim payments. Since we have a
limited claims history, we have derived our expected future claim payments from industry
and predecessor trends and included a provision for uncertainties. Our investment
portfolio as of September 30, 2006 has an effective duration of 5.1 years with individual
maturities extending out to 30 years. Currently, we make claim payments from positive cash
flow from operations and invest excess cash in securities with appropriate maturity dates
to balance against anticipated future claim payments. As these securities mature, we
intend to invest any excess funds in investments with appropriate durations to match
against expected future claim payments.

At
September 30, 2006, our investment portfolio was made up almost entirely of investment
grade fixed income securities with fair values subject to fluctuations in interest rates.
While we have structured our investment portfolio to provide an appropriate matching of
maturities with anticipated claim payments, if we decide or are required in the future to
sell securities in a rising interest rate environment, we would expect to incur losses
from such sales.

Our
ability to adequately provide funds to pay claims comes from our disciplined underwriting
and pricing standards and the purchase of reinsurance to protect us against severe claims
and catastrophic events. For the period from October 1, 2005 through October 1, 2006, our
reinsurance program provided reinsurance coverage up to $50.0 million per loss occurrence,
subject to retentions, annual aggregate deductibles and other limitations. On October 1,
2006, we entered into new reinsurance contracts that are effective through October 1,
2007. The new program provides reinsurance coverage up to $75.0 million per loss
occurrence, subject to retentions, annual aggregate deductibles and other limitations. Our
reinsurance programs are more fully described in note 5.a. to the condensed consolidated
financial statements in Part I, Item 1 of this quarterly report and in the reinsurance
agreements. We believe that we are sufficiently capitalized to retain the losses described
above.

Our
insurance subsidiary is required by law to maintain a certain minimum level of surplus on
a statutory basis. Surplus is calculated by subtracting total liabilities from total
admitted assets. The National Association of Insurance Commissioners has a risk-based
capital standard designed to identify property and casualty insurers that may be
inadequately capitalized based on inherent risks of each insurers assets and
liabilities and its mix of net premiums written. Insurers falling below a calculated
threshold may be subject to varying degrees of regulatory action. As of December 31, 2005,
the last date that we were required to update the annual risk-based capital calculation,
the statutory surplus of our insurance subsidiary was in excess of the prescribed
risk-based capital requirements that correspond to any level of regulatory action.

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

Our
unaudited consolidated net cash provided by operating activities for the nine months ended
September 30, 2006 was $59.9 million, compared to $57.6 million for the same period in
2005. Net cash provided by operations in the nine months ended September 30, 2006 resulted
primarily from net income of $24.4 million and increases in unpaid loss and loss
adjustment expense of $42.4 million and amortization of deferred policy acquisition costs
of $21.1 million, offset by policy acquisition costs deferred of $22.8 million, unearned
premiums net of deferred premiums and premiums receivable of $3.5 million and deferred
federal income taxes of $3.1 million, all as a result of the growth of our business.

We
used net cash of $103.6 million for investing activities in the nine months ended
September 30, 2006, compared to $130.6 million for the same period in 2005. The difference
between periods is primarily attributable to a reduction in funds available for investing
activities. In 2005, we invested net proceeds totaling approximately $80.4 million
resulting from the sale of 8,625,000 shares of common stock in our initial public
offering. In 2006, we invested net proceeds totaling approximately $57.6 million resulting
from a follow-on public offering of 3,910,000 shares of our common stock described below.

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

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

# Contractual Obligations
and Commitments

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

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

The
loss and loss adjustment expense payments due by period in the table above are based upon
the loss and loss adjustment expense estimates as of September 30, 2006 and actuarial
estimates of expected payout patterns and are not contractual liabilities as to time
certain. Our contractual liability is to provide benefits under the policies. As a result,
our calculation of loss and loss adjustment expense payments due by period is subject to
the same uncertainties associated with determining the level of unpaid loss and loss
adjustment expenses generally and to the additional uncertainties arising from the
difficulty of predicting when claims (including claims that have not yet been reported to
us) will be paid. Actual payments of loss and loss adjustment expenses by period will
vary, perhaps materially, from the above table to the extent that current estimates of
loss and loss adjustment expenses vary from actual ultimate claims amounts and as a result
of variations between expected and actual payout patterns.

# Off-Balance Sheet
Arrangements

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

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# Critical Accounting
Policies, Estimates and Judgments

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

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

Unpaid
Loss and Loss Adjustment Expenses

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

Reinsurance
Recoverables

Reinsurance
recoverables on paid and unpaid losses represent the portion of the loss and loss
adjustment expenses that is assumed by reinsurers. These recoverables are reported on our
unaudited condensed consolidated balance sheets separately as assets, as reinsurance does
not relieve us of our legal liability to policyholders and ceding companies. We are
required to pay losses even if a reinsurer fails to meet its obligations under the
applicable reinsurance agreement. Reinsurance recoverables are determined based in part on
the terms and conditions of reinsurance contracts, which could be subject to
interpretations that differ from ours based on judicial theories of liability. In
addition, we bear credit risk with respect to the reinsurers, which can be significant
considering that some of the unpaid loss and loss adjustment expenses remain outstanding
for an extended period of time.

Adverse
Development Cover Agreement

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

Deferred
Policy Acquisition Costs

We
defer commissions, premium taxes and certain other costs that vary with and are primarily
related to the acquisition of insurance contracts. These costs are capitalized and
amortized to expense in proportion to the recognition of premiums earned. The method
followed in computing deferred policy acquisition costs limits the amount of these
deferred costs to their estimated realizable value, which gives effect to the premium to
be earned, related investment income, anticipated losses and settlement expenses and
certain other costs that we expect to incur as the premium is earned. Judgments as to
ultimate recoverability of these deferred costs are highly dependent upon estimated future
loss costs associated with the premiums written.

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Deferred
Taxes

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

In
assessing the realizability of deferred tax assets, management considers whether it is
more likely than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets is dependent upon the generation
of future taxable income during the periods in which those temporary differences become
deductible. Management considers the scheduled reversal of deferred tax liabilities,
projected future taxable income and tax planning strategies in making this assessment. If
necessary, we would establish a valuation allowance to reduce the deferred tax assets to
the amounts more likely than not to be realized.

Goodwill
and Other Intangible Assets

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

Retrospective
Premiums

Retrospective
premiums for primary and reinsured risks are included in income as earned on a pro rata
basis over the effective period of the respective policies. Earned premiums on
retrospectively rated policies are based on the Companys estimate of loss experience
as of the measurement date. Unearned premiums are deferred and include that portion of
premiums written that is applicable to the unexpired period of the policies in force and
estimated adjustments of premiums on policies that have retrospective rating endorsements.

Earned
But Unbilled Premiums

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

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 or cost;
our intent and ability to retain the investment for a period of time sufficient to allow
for an anticipated recovery in value; specific credit issues related to the issuer; and
current economic conditions. In general, we focus on those securities whose fair values
were less than 80% of their amortized cost or cost, as appropriate, for six or more
consecutive months. Other-than-temporary impairment losses result in permanent reductions
of the carrying amount of the underlying investments. Significant changes in the factors
considered when evaluating investments for impairment losses could result in a significant
change in impairment losses reported in the financial statements.

# Item 3. Quantitative and
Qualitative Disclosures About Market Risk

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

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# 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 manager, 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 $372.3 million at September 30, 2006
that are subject to interest rate risk. We manage the exposure to interest rate risk
through a disciplined asset/liability matching and capital management process. In the
management of this risk, the characteristics of duration, credit and variability of cash
flows are critical elements. These risks are assessed regularly and balanced within the
context of the liability and capital position.

The
table below summarizes our interest rate risk. It illustrates the sensitivity of the fair
value of fixed-income investments to selected hypothetical changes in interest rates as of
September 30, 2006. The selected scenarios are not predictions of future events, but
rather illustrate the effect that such events may have on the fair value of our
fixed-income portfolio.

Hypothetical Change in Interest Rates
    
    EstimatedChange inFair Value
    
    Fair Value
    
    HypotheticalPercentageIncrease(Decrease) in
        ShareholdersEquity($ in thousands)200 basis point increase
    
    $
    (31,381
    )
    $
    340,929
    
    
    (8.4
    )%100 basis point increase
    
    
    (15,518
    )
    
    356,792
    
    
    (4.2
    )%No change
    
    
    
    
    
    372,310
    
    
    100 basis point decrease
    
    
    15,172
    
    
    387,482
    
    
    4.1
    %200 basis point decrease
    
    
    29,997
    
    
    402,307
    
    
    8.1
    %


# Item 4. Controls and
Procedures

Under
the supervision and with the participation of management, including our Chief Executive
Officer and our Chief Financial Officer, we have carried out an evaluation of our
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the Exchange Act)). Based on that
evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our
disclosure controls and procedures were effective as of the end of the period covered by
this report to ensure that information we are required to disclose in reports that are
filed or submitted under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in the rules and forms specified by the Securities and
Exchange Commission. There were no changes in our internal control over financial
reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) that occurred
during the period covered in this report that have materially affected, or are reasonably
likely to materially affect, our internal control over financial reporting.

# PART II  OTHER
INFORMATION

# Item 1A. Risk Factors

You
should carefully consider the risks described below and in the Companys Annual
Report on Form 10-K filed with the SEC on March 29, 2006, together with all of the other
information included in this quarterly report. The risks and uncertainties described below
are not the only ones facing the Company. If any of the following risks actually occurs,
our business, financial condition or operating results could be harmed. Any of the risks
described below could result in a significant or material adverse effect on our financial
condition or results of operations, and a corresponding decline in the market price of our
common stock. You could lose all or part of your investment. The risks discussed below
also include forward-looking statements and our actual results may differ substantially
from those discussed in those forward-looking statements. Please refer to the discussion
under the heading Cautionary Statement in Part I, Item 2.

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The
following risk factors have been updated to reflect developments that occurred during the
quarter ended September 30, 2006.

# Risks Related to Our
Business

The
insurance business is subject to extensive regulation and legislative changes, which
impact the mannerin which we operate our business.

Our
insurance business is subject to extensive regulation by the applicable state agencies in
the jurisdictions in which we operate, perhaps most significantly by the Illinois Division
of Insurance and the California Department of Insurance. These state agencies have broad
regulatory powers designed to protect policyholders, not stockholders or other investors.
These powers include, among other things, the ability to:

| |  | place limitations on our ability to transact business with our affiliates;                                                                                                              
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | regulate mergers, acquisitions and divestitures involving our insurance company subsidiary;                                                                                             
| |  | require SeaBright Insurance Company and PointSure to comply with various licensing requirements and
     approvals that affect our ability to do business;                              
| |  | approve or reject our policy coverage and endorsements;                                                                                                                                 
| |  | place limitations on our investments and dividends;                                                                                                                                     
| |  | set standards of solvency to be met and maintained;                                                                                                                                     
| |  | regulate rates pertaining to our business;                                                                                                                                              
| |  | require assessments for the provision of funds necessary for the settlement of covered claims under
     certain policies provided by impaired, insolvent or failed insurance companies;
| |  | require us to comply with medical privacy laws; and                                                                                                                                     
| |  | prescribe the form and content of, and examine, our statutory financial statements.                                                                                                     

In
September 2006, we were notified by the Illinois Division of Insurance that our insurance
subsidiary was due for a routine comprehensive examination of its 2005 statutory annual
statement. We are in the process of gathering and providing information in response to
this notification. The field work portion of the comprehensive financial examination began
in October 2006.

Our
ability to transact business with our affiliates and to enter into mergers, acquisitions
and divestitures involving our insurance company subsidiary is limited by the requirements
of the insurance holding company laws of Illinois and California. To comply with these
laws, we are required to file notices with the Illinois Division of Insurance and the
California Department of Insurance to seek their respective approvals at least 30 days
before engaging in any intercompany transactions, such as sales, purchases, exchanges of
assets, loans, extensions of credit, cost sharing arrangements and extraordinary dividends
or other distributions to stockholders. Under these holding company laws, any change of
control transaction also requires prior notification and approval. Because these
governmental agencies may not take action or give approval within the 30 day period, these
notification and approval requirements may subject us to business delays and additional
business expense. If we fail to give these notifications, we may be subject to significant
fines and penalties and damaged working relations with these governmental agencies.

In
addition, 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. For example, in California, on
January 1, 2003, workers compensation legislation became effective that provided for
increases in the benefits payable to injured workers. Also, in California, workers
compensation legislation intended to reduce certain costs was enacted in September 2003
and April 2004. Among other things, this legislation established an independent medical
review process for resolving medical disputes, tightened standards for determining
impairment ratings by applying specific medical treatment guidelines, capped temporary
total disability payments to 104 weeks from first payment and enabled injured workers to
access immediate medical care up to $10,000 but required them to get

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medical care through
a network of doctors chosen by the employer. The implementation of these reforms affects
the manner in which we coordinate medical care costs with employers and the manner in
which we oversee treatment plans. However, the reforms are subject to continuing
opposition in the California legislature, in the courts and by ballot initiatives, any of
which could overturn or substantially amend the reforms and regulatory rules applicable to
the legislation. We cannot predict the ultimate impact of the reforms.

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. Currently, builders of recreational boats over 65 feet in length
are subject to the USL&H Act. A proposed amendment to the USL&H Act would
eliminate builders of recreational boats from the reach of the USL&H Act. If this
proposed amendment is adopted, we expect that we could lose a total of approximately $1.7
million in annual direct written premiums from policies currently providing USL&H Act
coverage. The proposed amendment would not have a material impact on our policies
providing coverage under the Jones Act, which gives certain employees at sea the right to
sue their employers if such employees are injured. Moreover, changes in federal tax laws
could also impact our business.

In
addition, we are impacted by the Terrorism Risk Insurance Act of 2002, as extended and
amended by the Terrorism Risk Insurance Extension Act of 2005 (collectively referred to in
this quarterly report as the Terrorism Risk Act) and by the Gramm-Leach-Bliley
Act of 2002 related to disclosure of personal information. The Terrorism Risk Act requires
that commercial property and casualty insurance companies offer coverage for certain acts
of terrorism and has established a federal assistance program through the end of 2007 to
help insurers cover claims arising out of such acts. The Terrorism Risk Act only covers
certified acts of terrorism, and the U.S. Secretary of the Treasury must declare the act
to be a certified act of terrorism for it to be covered under this federal
program. In addition, no federal compensation will be paid under the Terrorism Risk Act
unless aggregate insured losses from the act for the entire insurance industry exceed
certain threshold amounts ($5.0 million for terrorism losses occurring prior to April 1,
2006, $50.0 million for terrorism losses occurring from April 1, 2006 to December 31,
2006, and $100.0 million for terrorism losses occurring in 2007). Under this program, the
federal government covers 90% of the losses from covered certified acts of terrorism (85%
for terrorism losses occurring in 2007) on commercial risks in the United States only, in
excess of the applicable deductible amount. This deductible is calculated based on a
percentage of an affiliated insurance groups prior year direct earned premiums on
commercial lines policies (except for certain excluded lines such as commercial auto)
covering risks in the United States. This deductible amount is 17.5% of such premiums for
losses occurring in 2006 and 20.0% of such premiums for losses occurring in 2007. The
Terrorism Risk Act is scheduled to expire on December 31, 2007 and may not be renewed, or
if it is renewed, it may provide reduced protection against the financial impact of acts
of terrorism by, among other things, increasing the aggregate loss event trigger and the
amount of statutory deductible insurers would be required to pay.

This
extensive regulation of our business may affect the cost or demand for our products and
may limit our ability to obtain rate increases or to take other actions that we might
desire to increase our profitability. In addition, we may be unable to maintain all
required approvals or comply fully with the wide variety of applicable laws and
regulations, which are continually undergoing revision, or the relevant authoritys
interpretation of such laws and regulations.

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

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

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

On
March 24, 2006, the WCIRB submitted a filing with the California Insurance Commissioner
recommending a 16.4% decrease in advisory pure premium rates on new and renewal policies
effective July 1, 2006. Pure premium is that portion of an insurance premium necessary to
cover the cost of paying claims, such as medical and indemnity costs and allocated and
unallocated loss adjustment expenses. The filing was based on an analysis of loss
experience valued as of December 31, 2005 and was made in response to continued reductions
in workers compensation claim costs in California as a result of reform legislation
enacted primarily in 2003 and 2004. On May 31, 2006, the Commissioner recommended a 16.4%
decrease in rates effective July 1, 2006. Such decisions of the California Insurance Commissioner are advisory
only and insurance companies may choose whether or not to adopt the new rates. On May 31,
2006, we filed new rates reflecting an average reduction of 5.8% from prior rates for new
and renewal workers compensation insurance policies written in California on or
after July 1, 2006. The filing was approved on June 21, 2006. This was the sixth
California rate reduction we have filed since October 1, 2003, resulting in a net
cumulative reduction of our California rates of approximately 41.8%.

On
September 14, 2006, the WCIRB amended a previous filing with the California Insurance
Commissioner to recommend a 6.3% decrease in advisory pure premium rates on new and
renewal policies effective on or after January 1, 2007. The filing was based on a review
of loss and loss adjustment experience through June 30, 2006 and was made in response to
continued reductions in California workers compensation claim costs. On November 2,
2006, the California Insurance Commissioner recommended a 9.5% decrease in workers
compensation advisory pure premium rates for policies incepting on or after January 1,
2007. Rate reductions have also been proposed in other states in which we operate. At this
time, we are unable to predict the impact that the proposed rate reductions, if approved
and adopted by us, might have on our future financial position and results of operations.

If
any of our competitors adopt premium rate reductions that are greater than ours, we may be
unable to compete effectively and our business, financial condition and results of
operations could be materially adversely affected.

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

On
January 19, 2005, the SEC declared effective SIHs Registration Statement on Form
S-1, as amended (Registration No. 333-119111), as filed with the SEC in connection with
the initial public offering of 8,625,000 shares of SIHs common stock. Our use of the
proceeds from the offering does not represent a change in the use of proceeds described in
the Companys Quarterly Report on Form 10-Q for the period ended June 30, 2006 filed
with the SEC on August 14, 2006.

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

# Item 6. Exhibits

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

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##### Table of Contents

# SIGNATURES

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

|                         |                                    |                                                                                                      |  | 
|------------------------ | ---------------------------------- | ---------------------------------------------------------------------------------------------------- |  | 
|                         | SEABRIGHT INSURANCE HOLDINGS, INC.
|Date:  November 13, 2006 |                                    |                                                                                                      | 
|                         | By:                                | /s/  Joseph S. De Vita                                                                               | 
|                         |                                    | Joseph S. De Vita                                                                                    | 
|                         |                                    | Senior Vice President, Chief Financial Officer
and Assistant Secretary (Principal Financial Officer)
|                        

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##### Table of Contents

# EXHIBIT INDEX

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

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