##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-Q
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2009
 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 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 RoadSuite 100
    
    48034Southfield, Michigan
    
    (Zip Code)(Address of Principal Executive Offices)
  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




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##### 



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
    
    
    193. Quantitative and Qualitative Disclosures about Market Risk
    
    
    354. Controls and Procedures
    
    
    35PART II  OTHER INFORMATION6. Exhibits
    
    
    36EX-31.AEX-31.BEX-32.AEX-32.B
  2




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FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 PART I.  FINANCIAL INFORMATION
 
 ITEM 1. Condensed Consolidated Financial Statements
 
 Condensed Consolidated Balance Sheets
 March 31,
    
    
    December 31,2009
    
    
    2008(Unaudited)(Dollars in thousands,except share and per share data)ASSETSInvestmentsDebt securities
    
    $
    528,271
    
    
    $
    495,799Equity securities and other
    
    
    24,714
    
    
    
    15,089Short-term
    
    
    38,537
    
    
    
    32,142Total Investments
    
    
    591,522
    
    
    
    543,030Cash and cash equivalents
    
    
    14,586
    
    
    
    31,833Premiums and reinsurance balances receivable
    
    
    56,930
    
    
    
    56,398Accrued investment income
    
    
    5,648
    
    
    
    5,400Accrued profit sharing commissions
    
    
    12,095
    
    
    
    11,315Reinsurance recoverable on paid and unpaid losses
    
    
    145,023
    
    
    
    135,617Prepaid reinsurance premiums
    
    
    51,902
    
    
    
    48,921Deferred acquisition costs
    
    
    27,147
    
    
    
    27,369Intangible assets, net of accumulated amortization
    
    
    38,776
    
    
    
    39,351Goodwill
    
    
    25,483
    
    
    
    25,483Deferred federal income taxes
    
    
    
    
    
    
    2,161Other assets
    
    
    16,529
    
    
    
    16,775Total Assets
    
    $
    985,641
    
    
    $
    943,653LIABILITIES AND STOCKHOLDERS EQUITYLoss and loss adjustment expense reserves
    
    $
    400,152
    
    
    $
    372,721Unearned premium reserves
    
    
    148,137
    
    
    
    147,849Long-term debt
    
    
    67,013
    
    
    
    67,013Funds held under reinsurance treaties
    
    
    55,867
    
    
    
    49,419Premiums payable to insurance companies
    
    
    27,279
    
    
    
    27,831Reinsurance payable on paid losses
    
    
    1,400
    
    
    
    1,167Deferred federal income taxes
    
    
    415
    
    
    
    Accounts payable, accrued expenses, and other liabilities
    
    
    10,994
    
    
    
    16,016Total Liabilities
    
    
    711,257
    
    
    
    682,016Stockholders EquityCommon stock, $0.01 par value; authorized 100,000,000 shares; issued
and outstanding 17,929,837 and 17,836,337 shares
    
    
    179
    
    
    
    178Paid-in-capital
    
    
    162,569
    
    
    
    161,957Accumulated other comprehensive income (loss)
    
    
    426
    
    
    
    (3,027
    )Retained earnings
    
    
    111,709
    
    
    
    103,028Treasury stock; 33,600 and 33,600 shares
    
    
    (499
    )
    
    
    (499
    )Total Stockholders Equity
    
    
    274,384
    
    
    
    261,637Total Liabilities and Stockholders Equity
    
    $
    985,641
    
    
    $
    943,653
  3




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FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Income
 (Unaudited)
 Three Months EndedMarch 31,2009
    
    
    2008(Dollars in thousands, except share and per share data)Operating RevenueNet earned premiums
    
    $
    52,594
    
    
    $
    43,571Commissions and fees
    
    
    6,894
    
    
    
    4,053Net investment income
    
    
    6,434
    
    
    
    4,848Net realized gains on investments
    
    
    1,757
    
    
    
    1Total Operating Revenues
    
    
    67,679
    
    
    
    52,473Operating ExpensesLosses and loss adjustment expenses, net
    
    
    30,493
    
    
    
    23,444Amortization of deferred acquisition expenses
    
    
    13,329
    
    
    
    8,213Underwriting, agency and other expenses
    
    
    9,223
    
    
    
    5,984Amortization of intangible assets
    
    
    575
    
    
    
    399Total Operating Expenses
    
    
    53,620
    
    
    
    38,040Operating Income
    
    
    14,059
    
    
    
    14,433Interest Expense
    
    
    1,416
    
    
    
    1,464Change in Fair Value of Derivative Instruments
    
    
    (106
    )
    
    
    435Income From Continuing Operations Before
Income Taxes
    
    
    12,749
    
    
    
    12,534Income Taxes
    
    
    4,068
    
    
    
    3,898Income From Continuing Operations
    
    
    8,681
    
    
    
    8,636Income From Discontinued Operations, Net of Taxes
    
    
    
    
    
    
    1,085Net Income
    
    $
    8,681
    
    
    $
    9,721Basic Net Income Per Share:Income From Continuing Operations
    
    $
    0.49
    
    
    $
    0.48Income From Discontinued Operations
    
    
    
    
    
    
    0.06Total
    
    $
    0.49
    
    
    $
    0.54Diluted Net Income Per Share:Income From Continuing Operations
    
    $
    0.48
    
    
    $
    0.46Income From Discontinued Operations
    
    
    
    
    
    
    0.06Total
    
    $
    0.48
    
    
    $
    0.52Weighted Average Shares Outstanding:Basic
    
    
    17,775,560
    
    
    
    18,106,063Diluted
    
    
    18,109,331
    
    
    
    18,793,264
  4




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FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Stockholders Equity
 (Unaudited)
 AccumulatedOtherCommon
    
    
    Paid-in
    
    
    Comprehensive
    
    
    Retained
    
    
    TreasuryStock
    
    
    Capital
    
    

Income
    
    
    Earnings
    
    
    Stock
    
    
    Total(Dollars in thousands, except share data)Balance, January 1, 2008
    
    $
    180
    
    
    $
    165,836
    
    
    $
    1,177
    
    
    $
    62,187
    
    
    $
    
    
    
    $
    229,380Exercise of stock options
    
    
    3
    
    
    
    518
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    521Stock-based compensation expense
    
    
    
    
    
    
    327
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    327Common stock repurchased and held in treasury
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (499
    )
    
    
    (499
    )Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,721
    
    
    
    
    
    
    
    9,721Other comprehensive income, net of taxUnrealized holding gains on securities
arising during the period, net of tax of ($436)
    
    
    
    
    
    
    
    
    
    
    809
    
    
    
    
    
    
    
    
    
    
    
    809Change in fair value of interest rate swap, net of tax of $324
    
    
    
    
    
    
    
    
    
    
    (602
    )
    
    
    
    
    
    
    
    
    
    
    (602
    )Less reclassification adjustment for
gains included in net income, net of tax of $92
    
    
    
    
    
    
    
    
    
    
    (170
    )
    
    
    
    
    
    
    
    
    
    
    (170
    )Total other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    37Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,758Balance, March 31, 2008
    
    $
    183
    
    
    $
    166,681
    
    
    $
    1,214
    
    
    $
    71,908
    
    
    $
    (499
    )
    
    $
    239,487Balance, January 1, 2009
    
    $
    178
    
    
    $
    161,957
    
    
    $
    (3,027
    )
    
    $
    103,028
    
    
    $
    (499
    )
    
    $
    261,637Issuance of restricted stock
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock-based compensation expense
    
    
    
    
    
    
    613
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    613Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,681
    
    
    
    
    
    
    
    8,681Other comprehensive income, net of taxUnrealized holding gains on securities
arising during the period, net of tax of ($1,899)
    
    
    
    
    
    
    
    
    
    
    3,527
    
    
    
    
    
    
    
    
    
    
    
    3,527Change in fair value of interest rate swap, net of tax of ($25)
    
    
    
    
    
    
    
    
    
    
    46
    
    
    
    
    
    
    
    
    
    
    
    46Less reclassification adjustment for
gains included in net income, net of tax of $64
    
    
    
    
    
    
    
    
    
    
    (120
    )
    
    
    
    
    
    
    
    
    
    
    (120
    )Total other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,453Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,134Balance, March 31, 2009
    
    $
    179
    
    
    $
    162,569
    
    
    $
    426
    
    
    $
    111,709
    
    
    $
    (499
    )
    
    $
    274,384
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FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Cash Flows
 (Unaudited)
 Three Months EndedMarch 31,2009
    
    
    2008(Dollars in thousands)Cash Flows from Operating ActivitiesNet Income
    
    $
    8,681
    
    
    $
    9,721Less: Income from discontinued operations
    
    
    
    
    
    
    1,085Income from continuing operations
    
    
    8,681
    
    
    
    8,636Adjustments to reconcile income from continuing operations to
net cash provided by operating activitiesDepreciation and amortization
    
    
    998
    
    
    
    750Realized gains on investments
    
    
    (1,757
    )
    
    
    (1
    )Deferrals of acquisition costs, net
    
    
    222
    
    
    
    (5,058
    )Deferred income taxes
    
    
    2,575
    
    
    
    (221
    )Stock-based compensation expense
    
    
    613
    
    
    
    327Increase (decrease) in cash resulting from changes in assets
and liabilitiesPremiums and reinsurance balances receivable
    
    
    (532
    )
    
    
    (1,443
    )Accrued investment income
    
    
    (248
    )
    
    
    47Receivable from related entity
    
    
    
    
    
    
    75Accrued profit sharing commissions
    
    
    (780
    )
    
    
    2,889Reinsurance recoverable on paid and unpaid losses
    
    
    (9,406
    )
    
    
    (9,999
    )Prepaid reinsurance premiums
    
    
    (2,981
    )
    
    
    4,975Loss and loss adjustment expense reserves
    
    
    27,431
    
    
    
    24,459Unearned premium reserves
    
    
    288
    
    
    
    8,802Funds held under reinsurance treaties
    
    
    6,448
    
    
    
    2,547Reinsurance payable on paid losses
    
    
    233
    
    
    
    842Premiums payable to insurance companies
    
    
    (552
    )
    
    
    (3,745
    )Other
    
    
    (5,151
    )
    
    
    (8,743
    )Net Cash Provided By Operating Activities  Continuing Operations
    
    
    26,082
    
    
    
    25,139Net Cash Provided By Operating Activities  Discontinued Operations
    
    
    
    
    
    
    1,023Net Cash Provided By Operating Activities  Total
    
    
    26,082
    
    
    
    26,162Cash Flows From Investing ActivitiesCost of short-term investments acquired
    
    
    (127,598
    )
    
    
    (135,182
    )Proceeds from disposals of short-term investments
    
    
    121,202
    
    
    
    155,618Cost of debt and equity securities acquired
    
    
    (63,161
    )
    
    
    (52,616
    )Proceeds from debt and equity securities
    
    
    26,228
    
    
    
    27,410Acquisition, net of cash acquired
    
    
    
    
    
    
    (18,466
    )Cost of fixed asset purchases
    
    
    
    
    
    
    (544
    )Net Cash Used In Investing Activities
    
    
    (43,329
    )
    
    
    (23,780
    )Cash Flows From Financing ActivitiesIssuance of common stock, net of issuance costs
    
    
    
    
    
    
    Stock issued on stock options exercised
    
    
    
    
    
    
    521Repurchase of common stock
    
    
    
    
    
    
    (499
    )Issuance of long-term debt
    
    
    
    
    
    
    Net Cash Provided By Financing Activities
    
    
    
    
    
    
    22Net Increase (Decrease) In Cash and Cash Equivalents
    
    
    (17,247
    )
    
    
    2,404Cash and Cash Equivalents, beginning of period
    
    
    31,833
    
    
    
    18,432Cash and Cash Equivalents, end of period
    
    $
    14,586
    
    
    $
    20,836Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest
    
    $
    1,372
    
    
    $
    1,787Income taxes
    
    $
    
    
    
    $
    
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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
 Recognition and Presentation of
Other-Than-Temporary Impairments
 Determining Fair Value When Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that
are Not Orderly (FSP FAS 157-4)
 Interim Disclosures about Fair
Value of Financial Instruments (FSP FAS 107-1 and APB 28-1)
 7




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FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Concluded)
  
    
    SFAS No. 141(R), Business Combinations;
    
    SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements  an
amendment of Accounting Research Bulletin No. 51;
    
    SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities;
    
    FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment
Transactions are Participating Securities; and
    
    FSP FAS No. 157-2, Effective Date of FASB Statement No. 157.
 2. MERGERS AND ACQUISITIONS
 American Management Corporation
    8




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FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 2. MERGERS AND ACQUISITIONS  (Concluded)
  $ in thousandsAssets AcquiredInvestments
    
    $
    8,988Cash and cash equivalents
    
    
    20,012Premiums receivable
    
    
    19,570Other assets
    
    
    1,133Goodwill
    
    
    25,483Intangible assets:Agent relationships
    
    
    9,150Tradename
    
    
    2,130Customer relationships
    
    
    520Total Assets Acquired
    
    $
    86,986Liabilities AssumedPremiums payable to insurance companies
    
    $
    23,218Loss and loss adjustment expense reserves
    
    
    4,490Unearned premium reserves
    
    
    1,734Deferred federal income taxes
    
    
    3,917Accounts payable, accrued expenses, and other liabilities
    
    
    14,745Total Liabilities Assumed
    
    
    48,104Net Assets Acquired
    
    $
    38,882
   3. DISCONTINUED OPERATIONS
   Three Months EndedMarch 31,2009
    
    2008(Dollars in thousands)Revenues
    
    $
    
    
    
    $
    2,976Income Before Income Taxes
    
    $
    
    
    
    $
    1,773
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FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 4. NET INCOME PER SHARE
   Three Months EndedMarch 31,2009
    
    
    2008(Dollars in thousands, except share and per share data)Income from Continuing Operations
    
    $
    8,681
    
    
    $
    8,636Income from Discontinued Operations
    
    
    
    
    
    
    1,085Net income as reported
    
    
    8,681
    
    
    
    9,721Net income allocated to unvested restricted stock shares
    
    
    (28
    )
    
    
    (13
    )Net income available to common
    
    $
    8,653
    
    
    $
    9,708Weighted-average number of common and common equivalent shares outstanding:Basic number of common shares outstanding
    
    
    17,775,560
    
    
    
    18,106,063Dilutive effect of stock options
    
    
    333,669
    
    
    
    686,122Dilutive effect of unvested restricted stock
    
    
    102
    
    
    
    1,079Dilutive number of common and common equivalent shares outstanding
    
    
    18,109,331
    
    
    
    18,793,264Basic Net Income Per Common Share:Income from Continuing Operations
    
    $
    0.49
    
    
    $
    0.48Income from Discontinued Operations
    
    
    
    
    
    
    0.06Total
    
    $
    0.49
    
    
    $
    0.54Diluted Net Income Per Common Share:Income from Continuing Operations
    
    $
    0.48
    
    
    $
    0.46Income from Discontinued Operations
    
    
    
    
    
    
    0.06Total
    
    $
    0.48
    
    
    $
    0.52Anti-dilutive shares excluded from diluted net income per common share
    
    
    1,221,688
    
    
    
    706,188
 Determining Whether Instruments Granted
in Share-Based Payment Transactions are Participating Securities (FSP EITF 03-6-1
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FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 5. INVESTMENTS
  Gross UnrealizedAmortized Cost
    
    
    Gains
    
    
    Losses
    
    
    Market Value(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    5,039
    
    
    $
    254
    
    
    $
    
    
    
    $
    5,293Government agency mortgage-backed securities
    
    
    81,037
    
    
    
    3,643
    
    
    
    (12
    )
    
    
    84,668Government agency obligations
    
    
    3,145
    
    
    
    65
    
    
    
    
    
    
    
    3,210Collateralized mortgage obligations and other
asset-backed securities
    
    
    74,406
    
    
    
    929
    
    
    
    (6,316
    )
    
    
    69,019Obligations of states and political
subdivisions
    
    
    204,477
    
    
    
    8,107
    
    
    
    (560
    )
    
    
    212,024Corporate bonds
    
    
    111,061
    
    
    
    2,672
    
    
    
    (4,662
    )
    
    
    109,071Total Debt Securities
    
    
    479,165
    
    
    
    15,670
    
    
    
    (11,550
    )
    
    
    483,285Preferred stocks
    
    
    1,416
    
    
    
    
    
    
    
    (618
    )
    
    
    798Short-term investments
    
    
    38,537
    
    
    
    
    
    
    
    
    
    
    
    38,537Total
    
    $
    519,118
    
    
    $
    15,670
    
    
    $
    (12,168
    )
    
    $
    522,620
  Gross UnrealizedAmortized Cost
    
    
    Gains
    
    
    Losses
    
    
    Market Value(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    5,256
    
    
    $
    307
    
    
    $
    
    
    
    $
    5,563Government agency mortgage-backed securities
    
    
    82,548
    
    
    
    2,422
    
    
    
    (39
    )
    
    
    84,931Government agency obligations
    
    
    3,163
    
    
    
    76
    
    
    
    
    
    
    
    3,239Collateralized mortgage obligations and other
asset-backed securities
    
    
    71,378
    
    
    
    337
    
    
    
    (7,087
    )
    
    
    64,628Obligations of states and political subdivisions
    
    
    205,425
    
    
    
    5,634
    
    
    
    (694
    )
    
    
    210,365Corporate bonds
    
    
    89,383
    
    
    
    1,499
    
    
    
    (3,874
    )
    
    
    87,008Total Debt Securities
    
    
    457,153
    
    
    
    10,275
    
    
    
    (11,694
    )
    
    
    455,734Preferred stocks
    
    
    1,416
    
    
    
    
    
    
    
    (367
    )
    
    
    1,049Short-term investments
    
    
    32,142
    
    
    
    
    
    
    
    
    
    
    
    32,142Total
    
    $
    490,711
    
    
    $
    10,275
    
    
    $
    (12,061
    )
    
    $
    488,925
  Amortized Cost
    
    
    Market Value(Dollars in thousands)Due in one year or less
    
    $
    73,469
    
    
    $
    73,567Due after one year through five years
    
    
    175,422
    
    
    
    179,279Due after five years through ten years
    
    
    108,355
    
    
    
    109,530Due after ten years
    
    
    6,429
    
    
    
    6,557363,675
    
    
    
    368,933Government agency mortgage-backed securities
    
    
    81,037
    
    
    
    84,668Collateralized mortgage obligations and
other asset-backed securities
    
    
    74,406
    
    
    
    69,019Total
    
    $
    519,118
    
    
    $
    522,620
 11




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 5. INVESTMENTS  (Concluded)
 Hybrid Instruments
  Alternative Investments
  6. INCOME TAXES
 Accounting for
Uncertainty in Income Taxes, an Interpretation of SFAS No. 109 Accounting for Income Taxes,
   12




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 7. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
  Three Months EndedMarch 31,2009
    
    
    2008(Dollars in thousands)Balance,beginning of period
    
    $
    372,721
    
    
    $
    272,365Less reinsurance recoverables
    
    
    128,552
    
    
    
    91,444Net Balance,beginning of period
    
    
    244,169
    
    
    
    180,921AUIC net reserves, date of acquisition
    
    
    
    
    
    
    4,490Incurred Related ToCurrent year
    
    
    31,243
    
    
    
    23,444Prior years
    
    
    (750
    )
    
    
    Total Incurred
    
    
    30,493
    
    
    
    23,444Paid Related ToCurrent year
    
    
    906
    
    
    
    334Prior years
    
    
    12,547
    
    
    
    10,275Total Paid
    
    
    13,453
    
    
    
    10,609Net Balance
    
    
    261,209
    
    
    
    198,246Plus reinsurance recoverables
    
    
    138,943
    
    
    
    103,068Balance,end of period
    
    $
    400,152
    
    
    $
    301,314
 8. REINSURANCE
  Three Months EndedMarch 31,2009
    
    
    2008(Dollars in thousands)Written PremiumsDirect
    
    $
    73,120
    
    
    $
    76,214Assumed
    
    
    4,758
    
    
    
    4,993Ceded
    
    
    (28,053
    )
    
    
    (22,704
    )Net Written Premiums
    
    $
    49,825
    
    
    $
    58,503Earned PremiumsDirect
    
    $
    73,304
    
    
    $
    68,653Assumed
    
    
    4,287
    
    
    
    3,752Ceded
    
    
    (25,072
    )
    
    
    (27,679
    )Earned but unbilled premiums
    
    
    75
    
    
    
    (1,155
    )Net Earned Premiums
    
    $
    52,594
    
    
    $
    43,571
   13




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 8. REINSURANCE (Concluded)
   9. SHARE REPURCHASE PROGRAM
  10. STOCK COMPENSATION PLANS
   14




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 10. STOCK COMPENSATION PLANS (Continued)
  1998 Plan
    
    
    Omnibus PlanNumber of
    
    
    Weighted Average
    
    
    Number of
    
    
    Weighted AverageOptions
    
    
    Exercise Price
    
    
    Options
    
    
    Exercise PriceOustanding at January 1, 2008
    
    
    927,775
    
    
    $
    2.24
    
    
    
    573,688
    
    
    $
    19.10Granted during the period
    
    
    
    
    
    
    
    
    
    
    148,500
    
    
    
    14.93Forfeited during the period
    
    
    
    
    
    
    
    
    
    
    12,700
    
    
    
    18.77Exercised during the period
    
    
    287,960
    
    
    
    1.81
    
    
    
    
    
    
    
    Cancelled during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at March 31, 2008
    
    
    639,815
    
    
    $
    2.48
    
    
    
    709,488
    
    
    $
    18.24Oustanding at January 1, 2009
    
    
    431,050
    
    
    $
    2.82
    
    
    
    932,188
    
    
    $
    17.93Granted during the period
    
    
    
    
    
    
    
    
    
    
    197,500
    
    
    
    13.01Forfeited during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercised during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cancelled during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at March 31, 2009
    
    
    431,050
    
    
    $
    2.82
    
    
    
    1,129,688
    
    
    $
    17.07Exercisable at:March 31, 2008
    
    
    639,815
    
    
    $
    2.48
    
    
    
    150,355
    
    
    $
    18.75March 31, 2009
    
    
    431,050
    
    
    
    2.82
    
    
    
    379,465
    
    
    
    18.43
    Options Outstanding
    
    
    Options ExercisableWeighted-Average
    
    Weighted-Average
    
    
    
    
    
    Weighted-AverageRange
of
    
    Outstanding as of
    
    Remaining
    
    Exercise Price Per
    
    Exercisable as of
    
    Exercise Price PerExercisable
Price
    
    March 31, 2009
    
    Contractual Life
    
    Share
    
    March 31, 2009
    
    Share1998 Plan$1.51 - $1.95
    
    
    319,125
    
    
    3.85 Years
    
    $
    1.71
    
    
    
    319,125
    
    
    $
    1.71$4.86 - $6.49
    
    
    111,925
    
    

    1.55
    
    
    5.97
    
    
    
    111,925
    
    
    
    5.97Total
    
    
    431,050
    
    

    3.25
    
    
    2.82
    
    
    
    431,050
    
    
    
    2.82Omnibus Plan$10.98 - $14.93
    
    
    352,000
    
    
    9.52 Years
    
    $
    13.72
    
    
    
    47,495
    
    
    $
    14.93$17.00 - $20.75
    
    
    777,688
    
    

    7.33
    
    
    18.59
    
    
    
    331,970
    
    
    
    18.94Total
    
    
    1,129,688
    
    

    8.01
    

    
    17.07
    
    
    
    379,465
    
    
    
    18.43
  15




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FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 10. STOCK COMPENSATION PLANS  (Concluded)
  Three Months EndedMarch 31,2009
    
    2008Omnibus PlanExpected term
    
    
    6.0
    
    
    
    6.0Expected stock price volatility
    
    
    41.11
    %
    
    
    29.23
    %Risk-free interest rate
    
    
    2.16
    %
    
    
    2.90
    %Expected dividend yield
    
    
    
    
    
    
    Estimated fair value per option
    
    $
    5.53
    
    
    $
    5.13
 (SAB 110)
  11. FAIR VALUE MEASUREMENTS
 Accounting for Certain
Investments in Debt and Equity Securities
 The Fair Value Option of Financial Assets and Financial
Liabilities
 Fair Value Measurements
  16




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 11. FAIR VALUE MEASUREMENTS (Continued)
  
 
 
   Fair Value Measurements UsingTotal
    
    
    Level 1
    
    
    Level 2
    
    
    Level 3(Dollars in thousands)Available for sale
investments:Fixed maturity securities
    
    $
    483,285
    
    
    $
    5,293
    
    
    $
    477,379
    
    
    $
    613Equity securities
    
    
    798
    
    
    
    
    
    
    
    798
    
    
    
    Short-term investments
    
    
    38,537
    
    
    
    38,537
    
    
    
    
    
    
    
    Hybrid securities
    
    
    51,172
    
    
    
    
    
    
    
    51,172
    
    
    
    Alternative investments
    
    
    17,730
    
    
    
    
    
    
    
    9,831
    
    
    
    7,899Total
    
    $
    591,522
    
    
    $
    43,830
    
    
    $
    539,180
    
    
    $
    8,512
  17




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Concluded)
(Unaudited)
 11. FAIR VALUE MEASUREMENTS  (Concluded)
 Quarter EndedMarch 31, 2009Level 3 investments as of January 1, 2009
    
    $
    6,282Purchases
    
    
    2,000Increase in market value
    
    
    230Level 3 investments as of March 31, 2009
    
    $
    8,512
  12. ACCUMULATED OTHER COMPREHENSIVE INCOME
  March 31,2009
    
    
    2008(Dollars in thousands)Unrealized holding gains on securities, net of tax
    
    $
    1,956
    
    
    $
    2,440Fair value of interest rate swap, net of tax
    
    
    (1,530
    )
    
    
    (1,226
    )Total accumulated other comprehensive income
    
    $
    426
    
    
    $
    1,214
 18




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##### Table of Contents



ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Overview
 ®
     19




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##### Table of Contents



GAAP and Non-GAAP Financial Performance Metrics
   Gross written premiums.
 Net written premiums.
 Combined ratio.
 Critical Accounting Policies
   20




---



##### Table of Contents



Use of Estimates
  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.
   21




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##### Table of Contents



March 31,
    
    
    December 31,2009
    
    
    2008(Dollars in thousands)GrossCase reserves
    
    $
    95,135
    
    
    $
    91,057IBNR and ULAE reserves
    
    
    305,017
    
    
    
    281,664Total reserves
    
    $
    400,152
    
    
    $
    372,721Net of reinsuranceCase reserves
    
    $
    64,259
    
    
    $
    62,497IBNR and ULAE reserves
    
    
    196,950
    
    
    
    181,672Total
    
    $
    261,209
    
    
    $
    244,169
 Revenue Recognition
 Premiums
 Commissions and Fees
 Investments
 Fair Value Measurements, Accounting
for Certain Hybrid Financial Instruments The Fair Value Option of Financial
Assets and Financial Liabilities
  Impairment of Investment Securities
  22




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##### Table of Contents



Deferred Policy Acquisition Costs
  Goodwill and Intangible Assets
 Goodwill and Other Intangible Assets,
 Accounting for the Impairment or Disposal of Long-lived
Assets
 23




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##### Table of Contents



Results of Operations
 Three Months Ended March 31, 2009 Compared to Three Months Ended March 31, 2008
  Three Months EndedMarch 31,2009
    
    
    2008
    
    
    Change(Dollars in thousands)Operating RevenueNet earned premiums
    
    $
    52,594
    
    
    $
    43,571
    
    
    
    21
    %Commissions and fees
    
    
    6,894
    
    
    
    4,053
    
    
    
    70Net investment income
    
    
    6,434
    
    
    
    4,848
    
    
    
    33Net realized gains on investments
    
    
    1,757
    
    
    
    1
    
    
    
    N/MTotal Operating Revenues
    
    
    67,679
    
    
    
    52,473
    
    
    
    29Operating ExpensesLosses and loss adjustment expenses, net
    
    
    30,493
    
    
    
    23,444
    
    
    
    30Amortization of intangible assets
    
    
    575
    
    
    
    399
    
    
    
    44Other operating expenses
    
    
    22,552
    
    
    
    14,197
    
    
    
    59Total Operating Expenses
    
    
    53,620
    
    
    
    38,040
    
    
    
    41Operating Income
    
    
    14,059
    
    
    
    14,433
    
    
    
    (3
    )Interest Expense
    
    
    1,310
    
    
    
    1,899
    
    
    
    (31
    )Income From Continuing Operations Before
Income Taxes
    
    
    12,749
    
    
    
    12,534
    
    
    
    2Income Taxes
    
    
    4,068
    
    
    
    3,898
    
    
    
    4Income From Continuing Operations
    
    
    8,681
    
    
    
    8,636
    
    
    
    1
    %Income From Discontinued Operations,
Net of Income Taxes
    
    
    
    
    
    
    1,085
    
    
    
    (100
    )Net Income
    
    $
    8,681
    
    
    $
    9,721
    
    
    
    (11
    )%Loss Ratio
    
    
    58.0
    %
    
    
    53.8
    %
    
    4.2 pointsUnderwriting Expense Ratio
    
    
    30.4
    %
    
    
    21.2
    %
    
    9.2 pointsCombined Ratio
    
    
    88.4
    %
    
    
    75.0
    %
    
    13.4 points
 24




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##### Table of Contents



Operating Revenue
 Net Earned Premiums
 Three Months EndedMarch 31,2009
    
    
    2008
    
    
    Change(Dollars in thousands)Written premiumsDirect
    
    $
    73,120
    
    
    $
    76,214
    
    
    
    (4
    )%Assumed
    
    
    4,758
    
    
    
    4,993
    
    
    
    (5
    )Ceded
    
    
    (28,053
    )
    
    
    (22,704
    )
    
    
    24Net written premiums
    
    $
    49,825
    
    
    $
    58,503
    
    
    
    (15
    )%Earned premiumsDirect
    
    $
    73,304
    
    
    $
    68,653
    
    
    
    7
    %Assumed
    
    
    4,287
    
    
    
    3,752
    
    
    
    14Ceded
    
    
    (25,072
    )
    
    
    (27,679
    )
    
    
    (9
    )Earned but
unbilled premiums
    
    
    75
    
    
    
    (1,155
    )
    
    
    (106
    )Net earned premiums
    
    $
    52,594
    
    
    $
    43,571
    
    
    
    21
    %
     25




---



##### Table of Contents



Commissions and Fees
 Three Months EndedMarch 31,2009
    
    
    2008
    
    
    Change(Dollars in thousands)Insurance underwriting commissions and fees
    
    $
    1,357
    
    
    $
    1,329
    
    
    
    2
    %Insurance services commissions and fees
    
    
    5,537
    
    
    
    2,724
    
    
    
    103Total commissions and fees
    
    $
    6,894
    
    
    $
    4,053
    
    
    
    70
    %
  Net  Investment  Income  and  Realized  Gains  on  Investments
  Operating  Expenses
 Losses  and  Loss  Adjustment  Expenses
 Other  Operating  Expenses
 Three Months EndedMarch 31,2009
    
    
    2008
    
    
    Change(Dollars in thousands)Amortization of deferred acquisition expenses
    
    $
    13,329
    
    
    $
    8,213
    
    
    
    62
    %Ceded reinsurance commissions
    
    
    (10,140
    )
    
    
    (8,483
    )
    
    
    20Other underwriting and operating expenses
    
    
    19,363
    
    
    
    14,467
    
    
    
    34Other operating expenses
    
    $
    22,552
    
    
    $
    14,197
    
    
    
    59
    %
  26




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##### Table of Contents



Interest  Expense
 Income  Taxes
 Discontinued  Operations
 Liquidity and Capital Resources
 Sources  and  Uses  of  Funds
 FMFC
 Insurance  Subsidiaries
  Non-insurance  Subsidiaries
 27




---



##### Table of Contents



CashFlows
  Three Months EndedMarch 31,2009
    
    
    2008(Dollars in thousands)Cash and cash equivalents provided by (used in):Operating activities  continuing operations
    
    $
    26,082
    
    
    $
    25,139Operating activities  discontinued operations
    
    
    
    
    
    
    1,023Investing activities
    
    
    (43,329
    )
    
    
    (23,780
    )Financing activities
    
    
    
    
    
    
    22Change in cash and cash equivalents
    
    $
    (17,247
    )
    
    $
    2,404
      Long-term  debt
 Junior  Subordinated  Debentures
 Credit  Facility
 28




---



##### Table of Contents



Derivative  Financial  Instruments
 Cash  and  Invested  Assets
  March 31, 2009Market Value
    
    
    % of Portfolio(Dollars in thousands)Short Term Investments
    
    $
    38,537
    
    
    
    6.5
    %U.S. Treasuries
    
    
    5,293
    
    
    
    0.9
    %U.S. Agencies
    
    
    3,210
    
    
    
    0.5
    %Municipal Bonds
    
    
    212,024
    
    
    
    35.9
    %Corporate Bonds
    
    
    93,727
    
    
    
    15.8
    %High Yield Bonds
    
    
    15,344
    
    
    
    2.6
    %MBS Passthroughs
    
    
    53,540
    
    
    
    9.1
    %CMOs
    
    
    41,551
    
    
    
    7.0
    %Asset Backed Securities
    
    
    21,472
    
    
    
    3.6
    %Commercial MBS
    
    
    37,124
    
    
    
    6.3
    %Convertible Securities
    
    
    51,172
    
    
    
    8.7
    %High Yield Convertible Fund
    
    
    7,899
    
    
    
    1.3
    %Structured Finance Fund
    
    
    9,831
    
    
    
    1.7
    %Preferred Stocks
    
    
    798
    
    
    
    0.1
    %Common Stocks
    
    
    
    
    
    
    0.0
    %Total
    
    $
    591,522
    
    
    
    100.0
    %
  29




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##### Table of Contents



% of TotalAverage Life
    
    InvestmentLess than one year
    
    
    21.0
    %One to two years
    
    
    15.9
    %Two to three years
    
    
    13.9
    %Three to four years
    
    
    14.0
    %Four to five years
    
    
    12.5
    %Five to seven years
    
    
    8.5
    %More than seven years
    
    
    14.2
    %Total
    
    
    100.0
    %
   % of TotalS&P Rating
    
    InvestmentsAAA
    
    
    50.5
    %AA
    
    
    20.4
    %A
    
    
    12.9
    %BBB
    
    
    7.8
    %BB
    
    
    4.7
    %B
    
    
    1.9
    %CCC
    
    
    0.1
    %NR
    
    
    1.7
    %Total
    
    
    100.0
    %
    30




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##### Table of Contents



Gross Unrealized
    
    
    EstimatedAmortized Cost
    
    
    Gains
    
    
    Losses
    
    
    Market Value(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    5,039
    
    
    $
    254
    
    
    $
    
    
    
    $
    5,293Government agency mortgage-backed securities
    
    
    81,037
    
    
    
    3,643
    
    
    
    (12
    )
    
    
    84,668Government agency obligations
    
    
    3,145
    
    
    
    65
    
    
    
    
    
    
    
    3,210Collateralized mortgage obligations and other
asset-backed securities
    
    
    74,406
    
    
    
    929
    
    
    
    (6,316
    )
    
    
    69,019Obligations of states and political subdivisions
    
    
    204,477
    
    
    
    8,107
    
    
    
    (560
    )
    
    
    212,024Corporate bonds
    
    
    111,061
    
    
    
    2,672
    
    
    
    (4,662
    )
    
    
    109,071Total Debt Securities
    
    
    479,165
    
    
    
    15,670
    
    
    
    (11,550
    )
    
    
    483,285Preferred stocks
    
    
    1,416
    
    
    
    
    
    
    
    (618
    )
    
    
    798Short-term investments
    
    
    38,537
    
    
    
    
    
    
    
    
    
    
    
    38,537Total
    
    $
    519,118
    
    
    $
    15,670
    
    
    $
    (12,168
    )
    
    $
    522,620
  31




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##### Table of Contents



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
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Government agency obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Collateralized mortgage obligations and other
asset-backed securities
    
    
    22,235
    
    
    
    (1,507
    )
    
    
    17,818
    
    
    
    (4,821
    )Obligations of states and political subdivisions
    
    
    7,005
    
    
    
    (301
    )
    
    
    8,274
    
    
    
    (259
    )Corporate bonds
    
    
    34,734
    
    
    
    (2,470
    )
    
    
    13,284
    
    
    
    (2,192
    )Total Debt Securities
    
    
    63,974
    
    
    
    (4,278
    )
    
    
    39,376
    
    
    
    (7,272
    )Preferred Stocks
    
    
    642
    
    
    
    (267
    )
    
    
    155
    
    
    
    (351
    )Total
    
    $
    64,616
    
    
    $
    (4,545
    )
    
    $
    39,531
    
    
    $
    (7,623
    )
  Amount ofUnrealized LossSector
    
    at March 31, 2009(Dollars in thousands)Short Term Investments
    
    $
    U.S. Treasuries
    
    
    U.S. Agencies
    
    
    Municipal Bonds
    
    
    (560
    )Corporate Bonds
    
    
    (4,231
    )High Yield Bonds
    
    
    (431
    )MBS Passthroughs
    
    
    (47
    )CMOs
    
    
    (1,575
    )Asset Backed Securities
    
    
    (571
    )Commercial MBS
    
    
    (4,135
    )Convertible Securities
    
    
    High Yield Convertible Fund
    
    
    Structured Finance Fund
    
    
    Preferred Stocks
    
    
    (618
    )Common Stocks
    
    
    $
    (12,168
    )
  32




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##### Table of Contents



% 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
    
    
    4.5
    %
    
    $
    5,273
    
    
    $
    652
    
    
    
    12.4
    %
    
    
    41.6
    %Investment Grade
    
    
    95.5
    
    
    
    111,044
    
    
    
    11,516
    
    
    
    10.4
    
    
    
    63.8Total
    
    
    100.0
    %
    
    $
    116,317
    
    
    $
    12,168
    
    
    
    10.5
    %
    
    
    62.6
    %
     Deferred  Policy  Acquisition  Costs
  33




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##### Table of Contents



Reinsurance
  Three Months EndedMarch 31,2009
    
    
    2008(Dollars in thousands)Direct written premiums
    
    $
    73,120
    
    
    $
    76,214Ceded written premiums
    
    
    28,053
    
    
    
    22,704Net written premiums
    
    $
    45,067
    
    
    $
    53,510Ceded written premiums as percentage of direct written premiums
    
    
    38.4
    %
    
    
    29.8
    %
  Three Months EndedMarch 31,2009
    
    
    2008(Dollars in thousands)Ceded written premiums
    
    $
    28,053
    
    
    $
    22,704Ceded premiums earned
    
    
    25,072
    
    
    
    27,679Losses and loss adjustment expenses ceded
    
    
    17,608
    
    
    
    14,893Ceding commissions
    
    
    6,666
    
    
    
    10,866
    Recent  Accounting  Pronouncements
 Recognition and Presentation of
Other-Than-Temporary Impairments
 34




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##### Table of Contents



, Determining Fair Value When Volume and Level of
Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that
are Not Orderly (FSP FAS 157-4)
 Interim Disclosures about Fair
Value of Financial Instruments (FSP FAS 107-1 and APB 28-1)
  
    
    SFAS No. 141(R), Business Combinations;
    
    SFAS No. 160, Noncontrolling Interests in Consolidated Financial Statements  an
amendment of Accounting Research Bulletin No. 51;
    
    SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities;
    
    FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment
Transactions are Participating Securities; and
    
    FSP FAS No. 157-2, Effective Date of FASB Statement No. 157.
 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
  35




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##### Table of Contents



PART II.  OTHER INFORMATION
 
 Item 6. Exhibits
  36




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##### Table of Contents



SIGNATURES
  FIRST MERCURY FINANCIAL CORPORATIONBy:
    
    /s/ RICHARD H. SMITH

Richard H. SmithChairman, President and Chief Executive OfficerBy:
    
    /s/ JOHN A. MARAZZA

John A. MarazzaExecutive Vice President and Chief Financial OfficerDate:
    
    May 7, 2009
 37




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##### Table of Contents



INDEX OF EXHIBITS
 ExhibitNumber
    
    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 38