##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934For the quarterly period ended June 30, 2010
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934For the transition period from  to
 Commission File Number 001-33077
 FIRST MERCURY FINANCIAL CORPORATION
  Delaware

38-3164336(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)29110 Inkster Road Suite 100Southfield, Michigan

48034(Address of Principal Executive Offices)

(Zip Code)
  þ o
 o o
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer o
(Do not check if a smaller reporting company)
    
    Smaller reporting company o
 o þ




---



##### 



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 TABLE OF CONTENTS
 Item
    
    PagePART I  FINANCIAL INFORMATION1. Condensed Consolidated Financial StatementsCondensed Consolidated Balance Sheets
    
    
    3Condensed Consolidated Statements of Income
    
    
    4Condensed Consolidated Statements of Stockholders Equity
    
    
    5Condensed Consolidated Statements of Cash Flows
    
    
    6Notes to Condensed Consolidated Financial Statements (Unaudited)
    
    
    72. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    243. Quantitative and Qualitative Disclosures about Market Risk
    
    
    454. Controls and Procedures
    
    
    45PART II  OTHER INFORMATION1. Legal Proceedings
    
    
    466. Exhibits
    
    
    46EX-31.AEX-31.BEX-32.AEX-32.B
  2




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 PART I.  FINANCIAL INFORMATION
 
 ITEM 1. Condensed Consolidated Financial Statements
 
 Condensed Consolidated Balance Sheets
 June 30,
    
    
    December 31,2010
    
    
    2009(Unaudited)(Dollars in thousands,except share and per share data)ASSETSInvestmentsDebt securities
    
    $
    686,705
    
    
    $
    648,522Equity securities and other
    
    
    38,294
    
    
    
    38,752Short-term
    
    
    23,299
    
    
    
    12,216Total Investments
    
    
    748,298
    
    
    
    699,490Cash and cash equivalents
    
    
    23,188
    
    
    
    14,275Premiums and reinsurance balances receivable
    
    
    56,133
    
    
    
    78,544Accrued investment income
    
    
    6,581
    
    
    
    6,248Accrued profit sharing commissions
    
    
    14,588
    
    
    
    14,661Reinsurance recoverable on paid and unpaid losses
    
    
    192,646
    
    
    
    172,711Prepaid reinsurance premiums
    
    
    56,931
    
    
    
    57,374Deferred acquisition costs
    
    
    25,461
    
    
    
    25,654Intangible assets, net of accumulated amortization
    
    
    36,072
    
    
    
    37,104Goodwill
    
    
    25,483
    
    
    
    25,483Other assets
    
    
    25,529
    
    
    
    26,049Total Assets
    
    $
    1,210,910
    
    
    $
    1,157,593LIABILITIES AND STOCKHOLDERS EQUITYLoss and loss adjustment expense reserves
    
    $
    527,042
    
    
    $
    488,444Unearned premium reserves
    
    
    149,271
    
    
    
    146,773Long-term debt
    
    
    67,013
    
    
    
    67,013Line of credit
    
    
    30,000
    
    
    
    4,000Funds held under reinsurance treaties
    
    
    77,866
    
    
    
    71,661Premiums payable to insurance companies
    
    
    28,523
    
    
    
    31,167Reinsurance payable on paid losses
    
    
    2,499
    
    
    
    958Deferred federal income taxes
    
    
    13,404
    
    
    
    13,844Accounts payable, accrued expenses, and other liabilities
    
    
    17,930
    
    
    
    17,649Total Liabilities
    
    
    913,548
    
    
    
    841,509Stockholders EquityCommon stock, $0.01 par value; authorized 100,000,000 shares; issued
and outstanding 17,757,859 and 17,181,106 shares
    
    
    178
    
    
    
    172Paid-in-capital
    
    
    156,898
    
    
    
    154,417Accumulated other comprehensive income
    
    
    21,845
    
    
    
    16,256Retained earnings
    
    
    120,289
    
    
    
    147,087Treasury stock; 130,600 and 130,600 shares
    
    
    (1,848
    )
    
    
    (1,848
    )Total Stockholders Equity
    
    
    297,362
    
    
    
    316,084Total Liabilities and Stockholders Equity
    
    $
    1,210,910
    
    
    $
    1,157,593
  3




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Income

(Unaudited)
 Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009(Dollars in thousands, except share and per share data)Operating RevenueNet earned premiums
    
    $
    51,504
    
    
    $
    51,432
    
    
    $
    103,177
    
    
    $
    104,027Commissions and fees
    
    
    7,857
    
    
    
    9,577
    
    
    
    15,659
    
    
    
    16,471Net investment income
    
    
    8,416
    
    
    
    7,132
    
    
    
    17,085
    
    
    
    13,566Net realized gains (losses) on investments
    
    
    (1,502
    )
    
    
    9,644
    
    
    
    2,683
    
    
    
    11,437Other-than-temporary impairment losses on investments:Total losses
    
    
    (332
    )
    
    
    (832
    )
    
    
    (1,279
    )
    
    
    (869
    )Portion of losses recognized in accumulated
other comprehensive income
    
    
    293
    
    
    
    735
    
    
    
    735
    
    
    
    735Net impairment losses recognized in earnings
    
    
    (39
    )
    
    
    (97
    )
    
    
    (544
    )
    
    
    (134
    )Total Operating Revenues
    
    
    66,236
    
    
    
    77,688
    
    
    
    138,060
    
    
    
    145,367Operating ExpensesLosses and loss adjustment expenses, net
    
    
    31,572
    
    
    
    35,463
    
    
    
    65,584
    
    
    
    65,956Amortization of deferred acquisition expenses
    
    
    13,611
    
    
    
    13,600
    
    
    
    26,754
    
    
    
    26,930Underwriting, agency and other expenses
    
    
    12,696
    
    
    
    9,526
    
    
    
    23,857
    
    
    
    18,750Amortization of intangible assets
    
    
    516
    
    
    
    575
    
    
    
    1,032
    
    
    
    1,149Restructuring
    
    
    
    
    
    
    
    
    
    
    5,018
    
    
    
    Total Operating Expenses
    
    
    58,395
    
    
    
    59,164
    
    
    
    122,245
    
    
    
    112,785Operating Income
    
    
    7,841
    
    
    
    18,524
    
    
    
    15,815
    
    
    
    32,582Interest Expense
    
    
    1,542
    
    
    
    1,417
    
    
    
    2,928
    
    
    
    2,833Change in Fair Value of Derivative Instruments
    
    
    
    
    
    
    (123
    )
    
    
    
    
    
    
    (230
    )Income Before Income Taxes
    
    
    6,299
    
    
    
    17,230
    
    
    
    12,887
    
    
    
    29,979Income Taxes
    
    
    2,154
    
    
    
    5,621
    
    
    
    3,529
    
    
    
    9,689Net Income
    
    $
    4,145
    
    
    $
    11,609
    
    
    $
    9,358
    
    
    $
    20,290Net Income Per Share:Basic
    
    $
    0.23
    
    
    $
    0.65
    
    
    $
    0.53
    
    
    $
    1.14Diluted
    
    $
    0.23
    
    
    $
    0.64
    
    
    $
    0.53
    
    
    $
    1.11Weighted Average Shares Outstanding:Basic
    
    
    17,451,657
    
    
    
    17,700,272
    
    
    
    17,279,391
    
    
    
    17,737,708Diluted
    
    
    17,465,715
    
    
    
    18,042,484
    
    
    
    17,412,836
    
    
    
    18,075,668
  4




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Stockholders Equity

(Unaudited)
 AccumulatedOtherCommon
    
    
    Paid-in
    
    
    Comprehensive
    
    
    Retained
    
    
    TreasuryStock
    
    
    Capital
    
    
    Income (Loss)
    
    
    Earnings
    
    
    Stock
    
    
    Total(Dollars in thousands)Balance, January 1, 2009
    
    $
    178
    
    
    $
    161,957
    
    
    $
    (3,027
    )
    
    $
    103,028
    
    
    $
    (499
    )
    
    $
    261,637Issuance of restricted stock
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock-based compensation expense
    
    
    
    
    
    
    1,571
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,571Stock-based compensation excess tax benefits
    
    
    
    
    
    
    (21
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21
    )Common stock repurchased and held in treasury
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (780
    )
    
    
    (780
    )Common stock repurchased and retired
    
    
    (4
    )
    
    
    (5,080
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5,084
    )Payment of shareholder dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (443
    )
    
    
    
    
    
    
    (443
    )Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,290
    
    
    
    
    
    
    
    20,290Cumulative effect of adoption of FASB ASC 320-10 at April 1, 2009
    
    
    
    
    
    
    
    
    
    
    (999
    )
    
    
    999
    
    
    
    
    
    
    
    Other comprehensive income, net of taxUnrealized holding losses on securities arising during the
period having credit losses recognized in the condensed
consolidated statements of income, net of tax of $257
    
    
    
    
    
    
    
    
    
    
    (478
    )
    
    
    
    
    
    
    
    
    
    
    (478
    )Unrealized holding gains on securities arising during the
period having no credit losses recognized in the condensed
consolidated statements of income, net of tax of ($5,822)
    
    
    
    
    
    
    
    
    
    
    10,813
    
    
    
    
    
    
    
    
    
    
    
    10,813Change in fair value of interest rate swaps, net of tax of $84
    
    
    
    
    
    
    
    
    
    
    (156
    )
    
    
    
    
    
    
    
    
    
    
    (156
    )Less reclassification adjustment for gains included in net
income, net of tax of $275
    
    
    
    
    
    
    
    
    
    
    (511
    )
    
    
    
    
    
    
    
    
    
    
    (511
    )Total other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,668Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29,958Balance, June 30, 2009
    
    $
    175
    
    
    $
    158,426
    
    
    $
    5,642
    
    
    $
    123,874
    
    
    $
    (1,279
    )
    
    $
    286,838Balance, January 1, 2010
    
    $
    172
    
    
    $
    154,417
    
    
    $
    16,256
    
    
    $
    147,087
    
    
    $
    (1,848
    )
    
    $
    316,084Issuance of restricted stock
    
    
    2
    
    
    
    (2
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise of stock options
    
    
    4
    
    
    
    1,089
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,093Stock-based compensation expense
    
    
    
    
    
    
    1,384
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,384Stock-based compensation excess tax benefits
    
    
    
    
    
    
    10
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10Payment of shareholder dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (36,156
    )
    
    
    
    
    
    
    (36,156
    )Comprehensive income:
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,358
    
    
    
    
    
    
    
    9,358Other comprehensive income, net of taxUnrealized holding gains on securities arising during
the period having credit losses recognized in the condensed
consolidated statements of income, net of tax ($258)
    
    
    
    
    
    
    
    
    
    
    478
    
    
    
    
    
    
    
    
    
    
    
    478Unrealized holding gains on securities arising during the
period having no credit losses recognized in the condensed
consolidated statements of income, net of tax ($3,974)
    
    
    
    
    
    
    
    
    
    
    7,380
    
    
    
    
    
    
    
    
    
    
    
    7,380Change in fair value of interest rate swaps, net of tax of $187
    
    
    
    
    
    
    
    
    
    
    (346
    )
    
    
    
    
    
    
    
    
    
    
    (346
    )Less reclassification adjustment for
gains included in net income, net of tax of $1,036
    
    
    
    
    
    
    
    
    
    
    (1,923
    )
    
    
    
    
    
    
    
    
    
    
    (1,923
    )Total other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,589Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,947Balance, June 30, 2010
    
    $
    178
    
    
    $
    156,898
    
    
    $
    21,845
    
    
    $
    120,289
    
    
    $
    (1,848
    )
    
    $
    297,362
  5




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Cash Flows

(Unaudited)
 Six Months EndedJune 30,2010
    
    
    2009(Dollars in thousands)Cash Flows from Operating ActivitiesNet Income
    
    $
    9,358
    
    
    $
    20,290Adjustments to reconcile income to net cash provided by operating activitiesDepreciation and amortization
    
    
    2,034
    
    
    
    1,969Net investment income on alternative investments
    
    
    (1,273
    )
    
    
    (950
    )Realized (gains) losses on investments
    
    
    (2,683
    )
    
    
    (11,437
    )Other-than-temporary impairment losses on investments
    
    
    544
    
    
    
    134Deferrals of acquisition costs, net
    
    
    193
    
    
    
    452Deferred income taxes
    
    
    (3,449
    )
    
    
    6,902Stock-based compensation expense
    
    
    1,384
    
    
    
    1,570Increase (decrease) in cash resulting from changes in assets
and liabilitiesPremiums and reinsurance balances receivable
    
    
    22,410
    
    
    
    (2,105
    )Accrued investment income
    
    
    (332
    )
    
    
    (927
    )Accrued profit sharing commissions
    
    
    73
    
    
    
    (1,558
    )Reinsurance recoverable on paid and unpaid losses
    
    
    (19,936
    )
    
    
    (15,202
    )Prepaid reinsurance premiums
    
    
    442
    
    
    
    (5,287
    )Loss and loss adjustment expense reserves
    
    
    38,598
    
    
    
    54,187Unearned premium reserves
    
    
    2,499
    
    
    
    3,434Funds held under reinsurance treaties
    
    
    6,205
    
    
    
    12,519Reinsurance payable on paid losses
    
    
    1,541
    
    
    
    28Premiums payable to insurance companies
    
    
    (2,645
    )
    
    
    3,689Other
    
    
    (733
    )
    
    
    (9,583
    )Net Cash Provided By Operating Activities
    
    
    54,230
    
    
    
    58,125Cash Flows From Investing ActivitiesCost of short-term investments acquired
    
    
    (128,800
    )
    
    
    (156,301
    )Proceeds from disposals of short-term investments
    
    
    117,716
    
    
    
    171,522Cost of debt and equity securities acquired
    
    
    (115,610
    )
    
    
    (153,812
    )Proceeds from disposals of debt and equity securities
    
    
    90,430
    
    
    
    78,535Net Cash Used In Investing Activities
    
    
    (36,264
    )
    
    
    (60,056
    )Cash Flows From Financing ActivitiesStock issued on stock options exercised
    
    
    1,093
    
    
    
    Purchase of common stock
    
    
    
    
    
    
    (5,084
    )Payment of shareholder dividends
    
    
    (36,156
    )
    
    
    (443
    )Cash retained on excess tax benefits
    
    
    10
    
    
    
    (21
    )Purchase of treasury stock
    
    
    
    
    
    
    (780
    )Net borrowings under credit facility
    
    
    26,000
    
    
    
    Net Cash Used In Financing Activities
    
    
    (9,053
    )
    
    
    (6,328
    )Net Increase (Decrease) In Cash and Cash Equivalents
    
    
    8,913
    
    
    
    (8,259
    )Cash and Cash Equivalents, beginning of period
    
    
    14,275
    
    
    
    31,833Cash and Cash Equivalents, end of period
    
    $
    23,188
    
    
    $
    23,574Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest
    
    $
    2,852
    
    
    $
    2,734Income taxes
    
    $
    5,500
    
    
    $
    4,750
  6




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Notes to Condensed Consolidated Financial Statements
(Unaudited)
 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 Basis of Presentation
   Use of Estimates
  Recently Issued Accounting Standards
 Accounting Standards Codification
  Prospective Accounting Standards
  7




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 1.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  (Concluded)
      8




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 2. NET INCOME PER SHARE
   Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009(Dollars in thousands, except share and per share data)Net income as reported
    
    $
    4,145
    
    
    $
    11,609
    
    
    $
    9,358
    
    
    $
    20,290Net income allocated to unvested restricted stock shares
    
    
    (68
    )
    
    
    (87
    )
    
    
    (155
    )
    
    
    (152
    )Net income available to common
    
    $
    4,077
    
    
    $
    11,522
    
    
    $
    9,203
    
    
    $
    20,138Weighted-average number of common and common equivalent
shares outstanding:Basic number of common shares outstanding
    
    
    17,451,657
    
    
    
    17,700,272
    
    
    
    17,279,391
    
    
    
    17,737,708Dilutive effect of stock options
    
    
    14,058
    
    
    
    342,212
    
    
    
    133,445
    
    
    
    337,960Dilutive number of common and common equivalent shares
outstanding
    
    
    17,465,715
    
    
    
    18,042,484
    
    
    
    17,412,836
    
    
    
    18,075,668Net Income Per Common Share:Basic
    
    $
    0.23
    
    
    $
    0.65
    
    
    $
    0.53
    
    
    $
    1.14Diluted
    
    $
    0.23
    
    
    $
    0.64
    
    
    $
    0.53
    
    
    $
    1.11Anti-dilutive shares excluded from diluted net income per
common share
    
    
    1,157,188
    
    
    
    1,103,688
    
    
    
    1,157,188
    
    
    
    1,103,688
  3. INVESTMENTS
  Gross UnrealizedAmortized Cost
    
    
    Gains
    
    
    Losses
    
    
    Market Value(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    3,686
    
    
    $
    143
    
    
    $
    
    
    
    $
    3,829Government agency mortgage-backed securities
    
    
    103,862
    
    
    
    6,280
    
    
    
    (1
    )
    
    
    110,141Government agency obligations
    
    
    630
    
    
    
    37
    
    
    
    
    
    
    
    667Collateralized mortgage obligations and other
asset-backed securities
    
    
    116,941
    
    
    
    9,878
    
    
    
    (1,390
    )
    
    
    125,429Obligations of states and political subdivisions
    
    
    208,421
    
    
    
    10,232
    
    
    
    (124
    )
    
    
    218,529Corporate bonds
    
    
    148,512
    
    
    
    13,045
    
    
    
    (476
    )
    
    
    161,081Total Debt Securities
    
    
    582,052
    
    
    
    39,615
    
    
    
    (1,991
    )
    
    
    619,676Preferred stocks
    
    
    1,416
    
    
    
    121
    
    
    
    (129
    )
    
    
    1,408Short-term investments
    
    
    23,299
    
    
    
    
    
    
    
    
    
    
    
    23,299Total
    
    $
    606,767
    
    
    $
    39,736
    
    
    $
    (2,120
    )
    
    $
    644,383
 9




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 3. INVESTMENTS  (Continued)
  Gross UnrealizedAmortized
    
    
    
    
    
    
    
    
    
    
    MarketCost
    
    
    Gains
    
    
    Losses
    
    
    Value(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    4,014
    
    
    $
    110
    
    
    $
    (3
    )
    
    $
    4,121Government agency mortgage-backed securities
    
    
    98,278
    
    
    
    3,820
    
    
    
    (16
    )
    
    
    102,082Government agency obligations
    
    
    986
    
    
    
    30
    
    
    
    
    
    
    
    1,016Collateralized mortgage obligations and other
asset-backed securities
    
    
    120,505
    
    
    
    8,142
    
    
    
    (3,033
    )
    
    
    125,614Obligations of states and political subdivisions
    
    
    198,252
    
    
    
    9,310
    
    
    
    (293
    )
    
    
    207,269Corporate bonds
    
    
    135,549
    
    
    
    10,596
    
    
    
    (505
    )
    
    
    145,640Total Debt Securities
    
    
    557,584
    
    
    
    32,008
    
    
    
    (3,850
    )
    
    
    585,742Preferred stocks
    
    
    1,416
    
    
    
    121
    
    
    
    (131
    )
    
    
    1,406Short-term investments
    
    
    12,216
    
    
    
    
    
    
    
    
    
    
    
    12,216Total
    
    $
    571,216
    
    
    $
    32,129
    
    
    $
    (3,981
    )
    
    $
    599,364
  Amortized Cost
    
    
    Market Value(Dollars in thousands)Due in one year or less
    
    $
    75,217
    
    
    $
    77,776Due after one year through five years
    
    
    151,742
    
    
    
    161,110Due after five years through ten years
    
    
    128,282
    
    
    
    137,893Due after ten years
    
    
    30,723
    
    
    
    32,034385,964
    
    
    
    408,813Government agency mortgage-backed securities
    
    
    103,862
    
    
    
    110,141Collateralized mortgage obligations and
other asset-backed securities
    
    
    116,941
    
    
    
    125,429Total
    
    $
    606,767
    
    
    $
    644,383
  Alternative Investments
  10




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 3. INVESTMENTS  (Concluded)
  4. OTHER THAN TEMPORARY IMPAIRMENTS OF INVESTMENT SECURITIES
 Impairment of Investment Securities
     11




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 4. OTHER THAN TEMPORARY IMPAIRMENTS OF INVESTMENT SECURITIES  (Continued)
  Additions forOTTIAdditions for
    
    
    SecuritiesJanuary 1, 2010
    
    
    OTTI Securities
    
    
    Where Credit
    
    
    
    
    
    
    Adjustments
    
    
    June 30, 2010Cumulative
    
    
    Where No
    
    
    Losses Have
    
    
    Reductions Due
    
    
    to Book Value
    
    
    CumulativeOTTI Credit
    
    
    Credit Losses
    
    
    Been
    
    
    to Sales or
    
    
    of Credit-
    
    
    OTTI CreditLosses
    
    
    Were
    
    
    Recognized
    
    
    Intend/Required
    
    
    Impaired
    
    
    LossesRecognized for
    
    
    Recognized
    
    
    Prior to
    
    
    to Sell of
    
    
    Securities due
    
    
    Recognized forSecurities Still
    
    
    Prior to
    
    
    January 1,
    
    
    Credit-Impaired
    
    
    to Changes in
    
    
    Securities StillHeld
    
    
    January 1, 2010
    
    
    2010
    
    
    Securities
    
    
    Cash Flows
    
    
    Held(Dollars in thousands)Debt securities:Mortgage-backed securities,
collateralized mortgage
obligationsand passthrough securities
    
    $
    796
    
    
    $
    
    
    
    $
    434
    
    
    $
    
    
    
    $
    
    
    
    $
    1,230All other corporate bonds
    
    
    569
    
    
    
    110
    
    
    
    
    
    
    
    (57
    )
    
    
    
    
    
    
    622Total debt securities
    
    $
    1,365
    
    
    $
    110
    
    
    $
    434
    
    
    $
    (57
    )
    
    $
    
    
    
    $
    1,852
   Less than 12 Months
    
    
    Greater than 12 MonthsFair Value
    
    
    
    
    
    
    Fair Valueof
    
    
    
    
    
    
    ofInvestments
    
    
    
    
    
    
    InvestmentsWith
    
    
    Gross
    
    
    With
    
    
    GrossUnrealized
    
    
    Unrealized
    
    
    Unrealized
    
    
    UnrealizedLosses
    
    
    Losses
    
    
    Losses
    
    
    Losses(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Government agency mortgage-backed securities
    
    
    841
    
    
    
    (1
    )
    
    
    
    
    
    
    Government agency obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Collateralized mortgage obligations and other
asset-backed securities
    
    
    17,884
    
    
    
    (588
    )
    
    
    6,337
    
    
    
    (802
    )Obligations of states and political
subdivisions
    
    
    4,045
    
    
    
    (33
    )
    
    
    1,734
    
    
    
    (91
    )Corporate bonds
    
    
    11,293
    
    
    
    (476
    )
    
    
    
    
    
    
    Total Debt Securities
    
    
    34,063
    
    
    
    (1,098
    )
    
    
    8,071
    
    
    
    (893
    )Preferred Stocks
    
    
    
    
    
    
    
    
    
    
    377
    
    
    
    (129
    )Total
    
    $
    34,063
    
    
    $
    (1,098
    )
    
    $
    8,448
    
    
    $
    (1,022
    )
 12




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 4. OTHER THAN TEMPORARY IMPAIRMENTS OF INVESTMENT SECURITIES  (Continued)
  Less than 12 Months
    
    
    Greater than 12 MonthsFair Value
    
    
    
    
    
    
    Fair Valueof
    
    
    
    
    
    
    ofInvestments
    
    
    
    
    
    
    InvestmentsWith
    
    
    Gross
    
    
    With
    
    
    GrossUnrealized
    
    
    Unrealized
    
    
    Unrealized
    
    
    UnrealizedLosses
    
    
    Losses
    
    
    Losses
    
    
    Losses(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    359
    
    
    $
    (3
    )
    
    $
    
    
    
    $
    Government agency mortgage-backed securities
    
    
    3,854
    
    
    
    (16
    )
    
    
    
    
    
    
    Government agency obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Collateralized mortgage obligations and other
asset-backed securities
    
    
    8,438
    
    
    
    (1,291
    )
    
    
    9,635
    
    
    
    (1,742
    )Obligations of states and political subdivisions
    
    
    14,044
    
    
    
    (237
    )
    
    
    1,179
    
    
    
    (56
    )Corporate bonds
    
    
    4,551
    
    
    
    (404
    )
    
    
    5,563
    
    
    
    (101
    )Total Debt Securities
    
    
    31,246
    
    
    
    (1,951
    )
    
    
    16,377
    
    
    
    (1,899
    )Preferred Stocks
    
    
    
    
    
    
    
    
    
    
    375
    
    
    
    (131
    )Total
    
    $
    31,246
    
    
    $
    (1,951
    )
    
    $
    16,752
    
    
    $
    (2,030
    )
  13




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 4. OTHER THAN TEMPORARY IMPAIRMENTS OF INVESTMENT SECURITIES  (Continued)
 Amount ofUnrealizedLoss atSector
    
    June 30, 2010(Dollars in thousands)Debt SecuritiesU.S. Treasuries
    
    $
    U.S. Agencies
    
    
    U.S. government securities
    
    
    Government agency mortgage-backed securities
    
    
    (1
    )Government agency obligations
    
    
    MBS Passthroughs
    
    
    (13
    )CMOs
    
    
    (717
    )Asset Backed Securities
    
    
    (291
    )Commercial MBS
    
    
    (369
    )Collateralized mortgage obligations and other
asset-backed securities
    
    
    (1,390
    )Obligations of states and political subdivisions
    
    
    (124
    )Corporate Bonds
    
    
    (398
    )High Yield Bonds
    
    
    (78
    )Corporate Bonds
    
    
    (476
    )Total Debt Securities
    
    
    (1,991
    )Preferred Stocks
    
    
    (129
    )Short-term investments
    
    
    Total
    
    $
    (2,120
    )
    14




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 4. OTHER THAN TEMPORARY IMPAIRMENTS OF INVESTMENT SECURITIES  (Concluded)
 % of Total
    
    
    Total
    
    
    Total
    
    
    Average Unrealized Loss
    
    
    % of LossAmortized Cost
    
    
    Amortized Cost
    
    
    Unrealized Losses
    
    
    as % of Amortized Cost
    
    
    > 12 Months(Dollars in thousands)Non Investment Grade
    
    
    30.3
    %
    
    $
    13,536
    
    
    $
    873
    
    
    
    6.4
    %
    
    
    67.5
    %Investment Grade
    
    
    69.7
    
    
    
    31,094
    
    
    
    1,247
    
    
    
    4.0
    
    
    
    34.7Total
    
    
    100.0
    %
    
    $
    44,630
    
    
    $
    2,120
    
    
    
    4.8
    %
    
    
    48.2
    %
    5. FAIR VALUE MEASUREMENTS
   
 
 15




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 5. FAIR VALUE MEASUREMENTS  (Continued)
  
   Fair Value Measurements UsingTotal
    
    
    Level 1
    
    
    Level 2
    
    
    Level 3(Dollars in thousands)Available for sale investments:Fixed maturity securities
    
    $
    621,084
    
    
    $
    3,829
    
    
    $
    617,255
    
    
    $
    Equity securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Short-term investments
    
    
    23,299
    
    
    
    23,299
    
    
    
    
    
    
    
    Hybrid securities
    
    
    70,937
    
    
    
    
    
    
    
    70,937
    
    
    
    Alternative investments
    
    
    32,978
    
    
    
    
    
    
    
    13,576
    
    
    
    19,402Total
    
    $
    748,298
    
    
    $
    27,128
    
    
    $
    701,768
    
    
    $
    19,402
  Fair Value Measurements UsingTotal
    
    
    Level 1
    
    
    Level 2
    
    
    Level 3(Dollars in thousands)Available for sale investments:Fixed maturity securities
    
    $
    587,148
    
    
    $
    4,121
    
    
    $
    583,027
    
    
    $
    Equity securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Short-term investments
    
    
    12,216
    
    
    
    12,216
    
    
    
    
    
    
    
    Hybrid securities
    
    
    69,525
    
    
    
    
    
    
    
    69,525
    
    
    
    Alternative investments
    
    
    30,601
    
    
    
    
    
    
    
    12,427
    
    
    
    18,174Total
    
    $
    699,490
    
    
    $
    16,337
    
    
    $
    664,979
    
    
    $
    18,174
   16




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 5. FAIR VALUE MEASUREMENTS  (Concluded)
  Three Months Ended
    
    
    Six Months EndedJune 30, 2010
    
    
    June 30, 2010Level 3 investments, beginning of period
    
    $
    19,428
    
    
    $
    18,174Purchases
    
    
    
    
    
    
    Transfers to Level 2
    
    
    
    
    
    
    Transfers to Level 3
    
    
    
    
    
    
    Change in market value
    
    
    (26
    )
    
    
    1,228Level 3 investments as of June 30, 2010
    
    $
    19,402
    
    
    $
    19,402
   6. INCOME TAXES
    17




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 7. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009(Dollars in thousands)Balance,beginning of period
    
    $
    511,828
    
    
    $
    400,152
    
    
    $
    488,444
    
    
    $
    372,721Less reinsurance recoverables
    
    
    175,259
    
    
    
    138,943
    
    
    
    164,488
    
    
    
    128,552Net Balance,beginning of period
    
    
    336,569
    
    
    
    261,209
    
    
    
    323,956
    
    
    
    244,169Incurred Related ToCurrent year
    
    
    31,572
    
    
    
    39,084
    
    
    
    65,584
    
    
    
    70,327Prior years
    
    
    
    
    
    
    (3,621
    )
    
    
    
    
    
    
    (4,371
    )Total Incurred
    
    
    31,572
    
    
    
    35,463
    
    
    
    65,584
    
    
    
    65,956Paid Related ToCurrent year
    
    
    637
    
    
    
    3,533
    
    
    
    4,227
    
    
    
    4,439Prior years
    
    
    23,078
    
    
    
    12,388
    
    
    
    40,887
    
    
    
    24,935Total Paid
    
    
    23,715
    
    
    
    15,921
    
    
    
    45,114
    
    
    
    29,374Net Balance
    
    
    344,426
    
    
    
    280,751
    
    
    
    344,426
    
    
    
    280,751Plus reinsurance recoverables
    
    
    182,616
    
    
    
    146,157
    
    
    
    182,616
    
    
    
    146,157Balance,end of period
    
    $
    527,042
    
    
    $
    426,908
    
    
    $
    527,042
    
    
    $
    426,908
 8. REINSURANCE
  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2010
    
    
    2009
    
    
    2010
    
    
    2009(Dollars in thousands)Written PremiumsDirect
    
    $
    80,039
    
    
    $
    77,892
    
    
    $
    155,197
    
    
    $
    151,012Assumed
    
    
    4,095
    
    
    
    4,629
    
    
    
    12,671
    
    
    
    9,387Ceded
    
    
    (30,631
    )
    
    
    (29,079
    )
    
    
    (61,783
    )
    
    
    (57,132
    )Net Written Premiums
    
    $
    53,503
    
    
    $
    53,442
    
    
    $
    106,085
    
    
    $
    103,267Earned PremiumsDirect
    
    $
    78,102
    
    
    $
    74,913
    
    
    $
    152,844
    
    
    $
    148,218Assumed
    
    
    4,683
    
    
    
    4,460
    
    
    
    12,526
    
    
    
    8,747Ceded
    
    
    (31,700
    )
    
    
    (26,773
    )
    
    
    (62,226
    )
    
    
    (51,845
    )Earned but unbilled premiums
    
    
    419
    
    
    
    (1,168
    )
    
    
    33
    
    
    
    (1,093
    )Net Earned Premiums
    
    $
    51,504
    
    
    $
    51,432
    
    
    $
    103,177
    
    
    $
    104,027
   18




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 8. REINSURANCE  (Concluded)
   9. SHARE REPURCHASE PROGRAM
  10. SPECIAL DIVIDEND
  11. STOCK COMPENSATION PLANS
      19




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 11. STOCK COMPENSATION PLANS  (Continued)
 1998 Plan
    
    
    Omnibus PlanWeighted Average
    
    
    
    
    
    
    Weighted AverageNumber of Options
    
    
    Exercise Price
    
    
    Number of Options
    
    
    Exercise PriceOustanding at January 1, 2009
    
    
    431,050
    
    
    $
    2.82
    
    
    
    932,188
    
    
    $
    17.93Granted during the period
    
    
    
    
    
    
    
    
    
    
    197,500
    
    
    
    13.01Forfeited during the period
    
    
    
    
    
    
    
    
    
    
    (15,000
    )
    
    
    18.78Exercised during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cancelled during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at June 30, 2009
    
    
    431,050
    
    
    $
    2.82
    
    
    
    1,114,688
    
    
    $
    17.05Oustanding at January 1, 2010
    
    
    419,762
    
    
    $
    2.83
    
    
    
    1,112,688
    
    
    $
    17.00Granted during the period
    
    
    
    
    
    
    
    
    
    
    140,500
    
    
    
    13.12Forfeited during the period
    
    
    (27,562
    )
    
    
    2.04
    
    
    
    (89,667
    )
    
    
    16.22Exercised during the period
    
    
    (371,850
    )
    
    
    2.78
    
    
    
    (4,500
    )
    
    
    13.01Cancelled during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at June 30, 2010
    
    
    20,350
    
    
    $
    4.86
    
    
    
    1,159,021
    
    
    $
    16.63Exercisable at:June 30, 2009
    
    
    431,050
    
    
    $
    2.82
    
    
    
    453,125
    
    
    $
    18.26June 30, 2010
    
    
    20,350
    
    
    
    4.86
    
    
    
    759,301
    
    
    
    17.80
    Options Outstanding
    
    
    Options ExercisableWeighted-Average
    
    
    Weighted-Average
    
    
    
    
    
    
    Weighted-AverageRange of
    
    Outstanding as of
    
    
    Remaining
    
    
    Exercise Price Per
    
    
    Exercisable as of
    
    
    Exercise Price PerExercisable Price
    
    June 30, 2010
    
    
    Contractual Life
    
    
    Share
    
    
    June 30, 2010
    
    
    Share1998 Plan$4.86 - $6.49
    
    
    20,350
    
    
    
    4.39 Years
    
    
    $
    4.86
    
    
    
    20,350
    
    
    $
    4.86Omnibus Plan$10.98 - $14.93
    
    
    460,833
    
    
    
    8.74 Years
    
    
    $
    13.64
    
    
    
    615,856
    
    
    $
    18.64$17.00 - $20.75
    
    
    698,188
    
    
    
    5.90
    
    
    
    18.61
    
    
    
    143,445
    
    
    
    14.16Total
    
    
    1,159,021
    
    
    
    7.03
    
    
    
    16.63
    
    
    
    759,301
    
    
    
    17.80
 20




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 11. STOCK COMPENSATION PLANS  (Concluded)
  Number ofRestricted SharesOutstanding at January 1, 2009
    
    
    62,166Shares granted
    
    
    113,204Shares vested
    
    
    (38,238
    )Shares forfeited
    
    
    (3,300
    )Outstanding at June 30, 2009
    
    
    133,832Outstanding at January 1, 2010
    
    
    155,499Shares granted
    
    
    237,400Shares vested
    
    
    (64,734
    )Shares forfeited
    
    
    (36,997
    )Outstanding at June 30, 2010
    
    
    291,168
  Six Months EndedJune 30,2010
    
    
    2009Omnibus PlanExpected term
    
    6 years
    
    6 yearsExpected stock price volatility
    
    
    43.20
    %
    
    
    41.11
    %Risk-free interest rate
    
    
    3.04
    %
    
    
    2.16
    %Expected dividend yield
    
    
    0.75
    %
    
    
    Estimated fair value per option
    
    $
    5.67
    
    
    $
    5.53
    21




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 12. ACCUMULATED OTHER COMPREHENSIVE INCOME
  June 30,2010
    
    
    2009(Dollars in thousands)Unrealized holding losses on securities having
credit losses recognized in the condensed consolidated
statements of income, net of tax
    
    $
    (1,009
    )
    
    $
    (478
    )Unrealized holding gains on securities having no
credit losses recognized in the condensed consolidated
statements of income, net of tax
    
    
    24,985
    
    
    
    7,852Fair value of interest rate swaps, net of tax
    
    
    (2,131
    )
    
    
    (1,732
    )Total accumulated other comprehensive income
    
    $
    21,845
    
    
    $
    5,642
 13. INSURANCE REGULATION
  14. RESTRUCTURING
  15. CREDIT AGREEMENT
  16. SUBSEQUENT EVENT
  22




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 16. SUBSEQUENT EVENT  (Concluded)
  23




---



##### Table of Contents



ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Overview
 ®
     24




---



##### Table of Contents



GAAP and Non-GAAP Financial Performance Metrics
   Gross written premiums.
 Net written premiums.
 Combined ratio.
 Critical Accounting Policies
   Use of Estimates
  25




---



##### Table of Contents



Loss and Loss Adjustment Expense Reserves
    
    
    actuarial projections of what we, at a given time, expect to be the cost of the
ultimate settlement and administration of claims reflecting facts and circumstances then
known;
    
    estimates of future trends in claims severity and frequency;
    
    assessment of asserted theories of liability; and
    
    analysis of other factors, such as variables in claims handling procedures,
economic factors, and judicial and legislative trends and actions.
    June 30,
    
    
    December 31,2010
    
    
    2009(Dollars in thousands)GrossCase reserves
    
    $
    159,222
    
    
    $
    125,561IBNR and ULAE reserves
    
    
    367,820
    
    
    
    362,883Total reserves
    
    $
    527,042
    
    
    $
    488,444Net of reinsuranceCase reserves
    
    $
    105,951
    
    
    $
    83,911IBNR and ULAE reserves
    
    
    238,475
    
    
    
    240,045Total
    
    $
    344,426
    
    
    $
    323,956
 26




---



##### Table of Contents



Revenue Recognition
 Premiums
  Commissions and Fees
 Investments
   
 
 27




---



##### Table of Contents




   Impairment of Investment Securities
     28




---



##### Table of Contents



Deferred Policy Acquisition Costs
  Goodwill and Intangible Assets
    29




---



##### Table of Contents



Results of Operations
 Three Months Ended June 30, 2010 Compared to Three Months Ended June 30, 2009
  Three Months EndedJune 30,2010
    
    
    2009
    
    
    Change(Dollars in thousands)Operating RevenueNet earned premiums
    
    $
    51,504
    
    
    $
    51,432
    
    
    
    0
    %Commissions and fees
    
    
    7,857
    
    
    
    9,577
    
    
    
    (18
    )Net investment income
    
    
    8,416
    
    
    
    7,132
    
    
    
    18Net realized gains (losses) on investments
    
    
    (1,502
    )
    
    
    9,644
    
    
    
    (116
    )Other-than-temporary impairment losses on
investments
    
    
    (39
    )
    
    
    (97
    )
    
    
    (60
    )Total Operating Revenues
    
    
    66,236
    
    
    
    77,688
    
    
    
    (15
    )Operating ExpensesLosses and loss adjustment expenses, net
    
    
    31,572
    
    
    
    35,463
    
    
    
    (11
    )Amortization of intangible assets
    
    
    516
    
    
    
    575
    
    
    
    (10
    )Other operating expenses
    
    
    26,307
    
    
    
    23,126
    
    
    
    14Total Operating Expenses
    
    
    58,395
    
    
    
    59,164
    
    
    
    (1
    )Operating Income
    
    
    7,841
    
    
    
    18,524
    
    
    
    (58
    )Interest Expense
    
    
    1,542
    
    
    
    1,294
    
    
    
    19Income Before Income Taxes
    
    
    6,299
    
    
    
    17,230
    
    
    
    (63
    )Income Taxes
    
    
    2,154
    
    
    
    5,621
    
    
    
    62Net Income
    
    $
    4,145
    
    
    $
    11,609
    
    
    
    (64
    )%Loss Ratio
    
    
    61.3
    %
    
    
    69.0
    %
    
    -7.7 pointsUnderwriting Expense Ratio
    
    
    35.2
    %
    
    
    30.9
    %
    
    4.3 pointsCombined Ratio
    
    
    96.5
    %
    
    
    99.9
    %
    
    -3.4 points
 30




---



##### Table of Contents



Operating Revenue
 Net Earned Premiums
 Three Months EndedJune 30,2010
    
    
    2009
    
    
    Change(Dollars in thousands)Written premiumsDirect
    
    $
    80,039
    
    
    $
    77,892
    
    
    
    3
    %Assumed
    
    
    4,095
    
    
    
    4,629
    
    
    
    (12
    )Ceded
    
    
    (30,631
    )
    
    
    (29,079
    )
    
    
    5Net written premiums
    
    $
    53,503
    
    
    $
    53,442
    
    
    
    0
    %Earned premiumsDirect
    
    $
    78,102
    
    
    $
    74,913
    
    
    
    4
    %Assumed
    
    
    4,683
    
    
    
    4,460
    
    
    
    5Ceded
    
    
    (31,700
    )
    
    
    (26,773
    )
    
    
    18Earned but unbilled premiums
    
    
    419
    
    
    
    (1,168
    )
    
    
    136Net earned premiums
    
    $
    51,504
    
    
    $
    51,432
    
    
    
    0
    %
     31




---



##### Table of Contents



Commissions and Fees
 Three Months EndedJune 30,2010
    
    
    2009
    
    
    Change(Dollars in thousands)Insurance underwriting commissions and
fees
    
    $
    1,320
    
    
    $
    1,360
    
    
    
    (3
    )%Insurance services commissions and fees
    
    
    6,537
    
    
    
    8,217
    
    
    
    (20
    )Total commissions and fees
    
    $
    7,857
    
    
    $
    9,577
    
    
    
    (18
    )%
  Net Investment Income and Realized Gains (Losses) on Investments
  Other-Than-Temporary Impairment Losses on Investments.
 Operating Expenses
 Losses and Loss Adjustment Expenses
 32




---



##### Table of Contents



Other Operating Expenses
 Three Months EndedJune 30,2010
    
    
    2009
    
    
    Change(Dollars in thousands)Amortization of deferred acquisition
expenses
    
    $
    13,611
    
    
    $
    13,600
    
    
    
    0
    %Other underwriting and operating expenses
    
    
    12,696
    
    
    
    9,526
    
    
    
    33Other operating expenses
    
    $
    26,307
    
    
    $
    23,126
    
    
    
    14
    %
  Interest Expense
 Income Taxes
 33




---



##### Table of Contents



Results of Operations
 Six Months Ended June 30, 2010 Compared to Six Months Ended June 30, 2009
  Six Months EndedJune 30,2010
    
    
    2009
    
    
    Change(Dollars in thousands)Operating RevenueNet earned premiums
    
    $
    103,177
    
    
    $
    104,027
    
    
    
    (1
    )%Commissions and fees
    
    
    15,659
    
    
    
    16,471
    
    
    
    (5
    )Net investment income
    
    
    17,085
    
    
    
    13,566
    
    
    
    26Net realized gains on investments
    
    
    2,683
    
    
    
    11,437
    
    
    
    (77
    )Other-than-temporary impairment losses
on investments
    
    
    (544
    )
    
    
    (134
    )
    
    
    306Total Operating Revenues
    
    
    138,060
    
    
    
    145,367
    
    
    
    (5
    )Operating ExpensesLosses and loss adjustment expenses, net
    
    
    65,584
    
    
    
    65,956
    
    
    
    (1
    )Amortization of intangible assets
    
    
    1,032
    
    
    
    1,149
    
    
    
    (10
    )Other operating expenses
    
    
    50,611
    
    
    
    45,680
    
    
    
    11Restructuring
    
    
    5,018
    
    
    
    
    
    
    
    100Total Operating Expenses
    
    
    122,245
    
    
    
    112,785
    
    
    
    8Operating Income
    
    
    15,815
    
    
    
    32,582
    
    
    
    (51
    )Interest Expense
    
    
    2,928
    
    
    
    2,603
    
    
    
    12Income Before Income Taxes
    
    
    12,887
    
    
    
    29,979
    
    
    
    (57
    )Income Taxes
    
    
    3,529
    
    
    
    9,689
    
    
    
    64Net Income
    
    $
    9,358
    
    
    $
    20,290
    
    
    
    (54
    )%Loss Ratio
    
    
    63.6
    %
    
    
    63.4
    %
    
    0.2 pointsUnderwriting Expense Ratio
    
    
    39.2
    %
    
    
    30.6
    %
    
    8.6 pointsCombined Ratio
    
    
    102.8
    %
    
    
    94.0
    %
    
    8.8 points
 34




---



##### Table of Contents



Operating Revenue
 Net Earned Premiums
 Six Months EndedJune 30,2010
    
    
    2009
    
    
    Change(Dollars in thousands)Written premiumsDirect
    
    $
    155,197
    
    
    $
    151,012
    
    
    
    3
    %Assumed
    
    
    12,671
    
    
    
    9,387
    
    
    
    35Ceded
    
    
    (61,783
    )
    
    
    (57,132
    )
    
    
    8Net written premiums
    
    $
    106,085
    
    
    $
    103,267
    
    
    
    3
    %Earned premiumsDirect
    
    $
    152,844
    
    
    $
    148,218
    
    
    
    3
    %Assumed
    
    
    12,526
    
    
    
    8,747
    
    
    
    43Ceded
    
    
    (62,226
    )
    
    
    (51,845
    )
    
    
    20Earned but unbilled
premiums
    
    
    33
    
    
    
    (1,093
    )
    
    
    103Net earned premiums
    
    $
    103,177
    
    
    $
    104,027
    
    
    
    (1
    )%
     35




---



##### Table of Contents



Commissions and Fees
 Six Months EndedJune 30,2010
    
    
    2009
    
    
    Change(Dollars in thousands)Insurance underwriting commissions and
fees
    
    $
    2,789
    
    
    $
    2,717
    
    
    
    3
    %Insurance services commissions and fees
    
    
    12,870
    
    
    
    13,754
    
    
    
    (6
    )Total commissions and fees
    
    $
    15,659
    
    
    $
    16,471
    
    
    
    (5
    )%
  Net Investment Income and Realized Gains on Investments
  Other-Than-Temporary Impairment Losses on Investments.
 Operating Expenses
 Losses and Loss Adjustment Expenses
 36




---



##### Table of Contents



Other Operating Expenses
 Six Months EndedJune 30,2010
    
    
    2009
    
    
    Change(Dollars in thousands)Amortization of deferred acquisition
expenses
    
    $
    26,754
    
    
    $
    26,930
    
    
    
    (1
    )%Other underwriting and operating expenses
    
    
    23,857
    
    
    
    18,750
    
    
    
    27Other operating expenses
    
    $
    50,611
    
    
    $
    45,680
    
    
    
    11
    %
  Restructuring .
 Interest Expense
 Income Taxes
 Liquidity and Capital Resources
 Sources and Uses of Funds
 FMFC
 Insurance Subsidiaries
  37




---



##### Table of Contents



Non-insurance Subsidiaries
 Cash Flows
  Six Months EndedMarch 31,2010
    
    
    2009(Dollars in thousands)Cash and cash equivalents provided by (used
in):Operating activities
    
    $
    54,230
    
    
    $
    58,125Investing activities
    
    
    (36,264
    )
    
    
    (60,056
    )Financing activities
    
    
    (9,053
    )
    
    
    (6,328
    )Change in cash and cash equivalents
    
    $
    8,913
    
    
    $
    (8,259
    )
     Stockholders Equity
  38




---



##### Table of Contents



June 30,
    
    
    December 31,2010
    
    
    2009(Dollars in thousands, except share and per share data)Total stockholders equity
    
    $
    297,362
    
    
    $
    316,084Intangible assets, net
    
    
    (36,072
    )
    
    
    (37,104
    )Deferred tax liability  intangible assets, net
    
    
    12,251
    
    
    
    12,613Goodwill
    
    
    (25,483
    )
    
    
    (25,483
    )Tangible stockholders equity attributable to common shareholders
    
    $
    248,058
    
    
    $
    266,110Common shares outstanding
    
    
    17,757,859
    
    
    
    17,181,106Book value per share
    
    $
    16.75
    
    
    $
    18.40Tangible book value per share
    
    $
    13.97
    
    
    $
    15.49
  Long-term debt
 Junior Subordinated Debentures
 Credit Agreement
 Derivative Financial Instruments
 39




---



##### Table of Contents



Cash and Invested Assets
  Market Value
    
    
    % of Portfolio(Dollars in thousands)Short Term Investments
    
    $
    23,299
    
    
    
    3.1%U.S. Treasuries
    
    
    3,829
    
    
    
    0.5%U.S. Agencies
    
    
    667
    
    
    
    0.1%Municipal Bonds
    
    
    209,645
    
    
    
    28.0%Taxable Municipal Bonds
    
    
    8,884
    
    
    
    1.2%Corporate Bonds
    
    
    140,656
    
    
    
    18.8%High Yield Bonds
    
    
    20,425
    
    
    
    2.7%MBS Passthroughs
    
    
    53,356
    
    
    
    7.1%CMOs
    
    
    97,512
    
    
    
    13.0%Asset Backed Securities
    
    
    25,645
    
    
    
    3.4%Commercial MBS
    
    
    59,057
    
    
    
    7.9%Convertible Securities
    
    
    70,937
    
    
    
    9.5%High Yield Convertible Fund
    
    
    19,402
    
    
    
    2.6%Structured Finance Fund
    
    
    13,576
    
    
    
    1.8%Preferred Stocks
    
    
    1,408
    
    
    
    0.3%Total
    
    $
    748,298
    
    
    
    100.0%
  Average Life
    
    % of Total InvestmentLess than one year
    
    
    15.5%One to two years
    
    
    11.2%Two to three years
    
    
    16.6%Three to four years
    
    
    17.3%Four to five years
    
    
    10.9%Five to seven years
    
    
    11.2%More than seven years
    
    
    17.3%Total
    
    
    100.0%
   40




---



##### Table of Contents



S&P Rating
    
    % of Total InvestmentsAAA
    
    
    45.5%AA
    
    
    14.3%A
    
    
    14.6%BBB
    
    
    10.8%BB
    
    
    6.8%B
    
    
    1.9%CCC
    
    
    5.6%CC
    
    
    0.3%C
    
    
    0.1%D
    
    
    0.1%Total
    
    
    100.0%
      41




---



##### Table of Contents



Deferred Policy Acquisition Costs
  Reinsurance
  Six Months EndedJune 30,2010
    
    
    2009(Dollars in thousands)Direct written premiums
    
    $
    155,197
    
    
    $
    151,012Ceded written premiums
    
    
    61,783
    
    
    
    57,132Net written premiums
    
    $
    93,414
    
    
    $
    93,880Ceded written premiums as
percentage of direct written
premiums
    
    
    39.8
    %
    
    
    37.8
    %
  Six Months EndedJune 30,2010
    
    
    2009(Dollars in thousands)Ceded written premiums
    
    $
    61,783
    
    
    $
    57,132Ceded premiums earned
    
    
    62,226
    
    
    
    51,845Losses and loss adjustment expenses ceded
    
    
    35,780
    
    
    
    37,507Ceding commissions
    
    
    15,978
    
    
    
    14,183
   42




---



##### Table of Contents



Recent Accounting Pronouncements
 Accounting Standards Codification
  Prospective Accounting Standards
    43




---



##### Table of Contents



44




---



##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
  45




---



##### Table of Contents



PART II.  OTHER INFORMATION
 
 Item 1. Legal Proceedings
   
 Item 6. Exhibits
  46




---



##### Table of Contents



SIGNATURES
  FIRST MERCURY FINANCIAL CORPORATIONBy:
    /s/ RICHARD  H. SMITHRichard H. SmithChairman, President and Chief Executive OfficerBy:
    /s/ JOHN A. MARAZZAJohn A. MarazzaExecutive Vice President and Chief Financial OfficerDate: August 6, 2010 47




---



##### Table of Contents



INDEX OF EXHIBITS
 Exhibit Number
    
    Note
    
    Description31 (a)
    
    
    (1
    )
    
    Certification of Chief Executive Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act of 193431 (b)
    
    
    (1
    )
    
    Certification of Chief Financial Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act of 193432 (a)
    
    
    (1
    )
    
    Certification of Chief Executive Officer, pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of the Securities Exchange Act of 193432 (b)
    
    
    (1
    )
    
    Certification of Chief Financial Officer, pursuant to 18 U.S.C. Section 1350 and Rule 13a-14(b) of the Securities Exchange Act of 1934
 
 (1)
    
     Filed herewith 48