##### 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 September 30, 2008
 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
(State or other jurisdiction of incorporation or organization)
    
    38-3164336
(I.R.S. Employer Identification No.)29110 Inkster Road 
Suite 100
Southfield, Michigan
(Address of Principal Executive Offices)
    
    48034
(Zip Code)
  þ 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
    
    
    183.
    
    Quantitative and Qualitative Disclosures about Market Risk
    
    
    364.
    
    Controls and Procedures
    
    
    36PART II  OTHER INFORMATION2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    376.
    
    Exhibits
    
    
    37EX-31(a)EX-31(b)EX-32(a)EX-32(b)
  2




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 PART I.  FINANCIAL INFORMATION
 
 ITEM 1. Condensed Consolidated Financial Statements
 
 Condensed Consolidated Balance Sheets
 September 30,
    
    
    December 31,2008
    
    
    2007(Unaudited)(Dollars in thousands,except share and per share data)ASSETSInvestmentsDebt securities
    
    $
    464,960
    
    
    $
    402,418Equity securities and other
    
    
    19,463
    
    
    
    4,529Short-term
    
    
    49,799
    
    
    
    52,341Total Investments
    
    
    534,222
    
    
    
    459,288Cash and cash equivalents
    
    
    22,595
    
    
    
    18,432Premiums and reinsurance balances receivable
    
    
    52,109
    
    
    
    38,278Accrued investment income
    
    
    4,835
    
    
    
    4,481Accrued profit sharing commissions
    
    
    9,570
    
    
    
    14,220Reinsurance recoverable on paid and unpaid losses
    
    
    133,325
    
    
    
    96,995Prepaid reinsurance premiums
    
    
    48,484
    
    
    
    52,718Deferred acquisition costs
    
    
    24,330
    
    
    
    14,257Intangible assets, net of accumulated amortization
    
    
    39,924
    
    
    
    36,651Goodwill
    
    
    25,483
    
    
    
    Deferred federal income taxes
    
    
    1,877
    
    
    
    Other assets
    
    
    15,484
    
    
    
    11,964Total Assets
    
    $
    912,238
    
    
    $
    747,284LIABILITIES AND STOCKHOLDERS EQUITYLoss and loss adjustment expense reserves
    
    $
    356,250
    
    
    $
    272,365Unearned premium reserves
    
    
    141,709
    
    
    
    123,469Long-term debt
    
    
    67,013
    
    
    
    67,013Funds held under reinsurance treaties
    
    
    45,556
    
    
    
    35,799Premiums payable to insurance companies
    
    
    24,176
    
    
    
    2,163Reinsurance payable on paid losses
    
    
    722
    
    
    
    3,958Deferred federal income taxes
    
    
    
    
    
    
    217Accounts payable, accrued expenses, and other liabilities
    
    
    17,760
    
    
    
    12,920Total Liabilities
    
    
    653,186
    
    
    
    517,904Stockholders EquityCommon stock, $0.01 par value; authorized 100,000,000 shares; issued
and outstanding 18,121,317 and 17,972,353 shares
    
    
    181
    
    
    
    180Paid-in-capital
    
    
    165,949
    
    
    
    165,836Accumulated other comprehensive income (loss)
    
    
    (7,243
    )
    
    
    1,177Retained earnings
    
    
    100,664
    
    
    
    62,187Treasury stock; 33,600 and 0 shares
    
    
    (499
    )
    
    
    Total Stockholders Equity
    
    
    259,052
    
    
    
    229,380Total Liabilities and Stockholders Equity
    
    $
    912,238
    
    
    $
    747,284
  3




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Income
(Unaudited)
 Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands, except share and per share data)Operating RevenueNet earned premiums
    
    $
    49,092
    
    
    $
    41,155
    
    
    $
    139,222
    
    
    $
    129,655Commissions and fees
    
    
    4,757
    
    
    
    2,226
    
    
    
    15,896
    
    
    
    6,143Net investment income
    
    
    5,571
    
    
    
    4,359
    
    
    
    15,635
    
    
    
    11,523Net realized gains (losses) on investments
    
    
    (10,604
    )
    
    
    355
    
    
    
    (12,415
    )
    
    
    1,117Total Operating Revenues
    
    
    48,816
    
    
    
    48,095
    
    
    
    158,338
    
    
    
    148,438Operating ExpensesLosses and loss adjustment expenses, net
    
    
    27,537
    
    
    
    20,886
    
    
    
    76,713
    
    
    
    67,328Amortization of deferred acquisition expenses
    
    
    10,798
    
    
    
    7,570
    
    
    
    28,107
    
    
    
    23,866Underwriting, agency and other expenses
    
    
    8,999
    
    
    
    3,841
    
    
    
    26,599
    
    
    
    11,148Amortization of intangible assets
    
    
    553
    
    
    
    166
    
    
    
    1,466
    
    
    
    500Total Operating Expenses
    
    
    47,887
    
    
    
    32,463
    
    
    
    132,885
    
    
    
    102,842Operating Income
    
    
    929
    
    
    
    15,632
    
    
    
    25,453
    
    
    
    45,596Interest Expense
    
    
    1,440
    
    
    
    1,054
    
    
    
    4,380
    
    
    
    3,022Change in Fair Value of Derivative Instruments
    
    
    (64
    )
    
    
    295
    
    
    
    110
    
    
    
    275Income (Loss) From Continuing Operations Before
Income Taxes
    
    
    (447
    )
    
    
    14,283
    
    
    
    20,963
    
    
    
    42,299Income Taxes
    
    
    (948
    )
    
    
    4,752
    
    
    
    5,592
    
    
    
    14,352Income From Continuing Operations
    
    
    501
    
    
    
    9,531
    
    
    
    15,371
    
    
    
    27,947Income (Loss) From Discontinued Operations, Net of Taxes
    
    
    (447
    )
    
    
    1,515
    
    
    
    23,106
    
    
    
    3,570Net Income
    
    $
    54
    
    
    $
    11,046
    
    
    $
    38,477
    
    
    $
    31,517Basic Net Income Per Share:Income From Continuing Operations
    
    $
    0.03
    
    
    $
    0.53
    
    
    $
    0.84
    
    
    $
    1.59Income (Loss) From Discontinued Operations
    
    
    (0.02
    )
    
    
    0.08
    
    
    
    1.27
    
    
    
    0.20Total
    
    $
    0.01
    
    
    $
    0.61
    
    
    $
    2.11
    
    
    $
    1.79Diluted Net Income Per Share:Income From Continuing Operations
    
    $
    0.03
    
    
    $
    0.51
    
    
    $
    0.82
    
    
    $
    1.52Income (Loss) From Discontinued Operations
    
    
    (0.02
    )
    
    
    0.08
    
    
    
    1.23
    
    
    
    0.19Total
    
    $
    0.01
    
    
    $
    0.59
    
    
    $
    2.05
    
    
    $
    1.71Weighted Average Shares Outstanding:Basic
    
    
    18,206,904
    
    
    
    18,036,168
    
    
    
    18,190,915
    
    
    
    17,601,271Diluted
    
    
    18,726,246
    
    
    
    18,867,107
    
    
    
    18,778,070
    
    
    
    18,440,128
  4




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Stockholders Equity
(Unaudited)
 AccumulatedOtherCommon
    
    
    Paid-in
    
    
    Comprehensive
    
    
    Retained
    
    
    TreasuryStock
    
    
    Capital
    
    
    Loss
    
    
    Earnings
    
    
    Stock
    
    
    Total(Dollars in thousands, except share data)Balance, January 1, 2007
    
    $
    174
    
    
    $
    153,600
    
    
    $
    (761
    )
    
    $
    20,323
    
    
    $
    (598
    )
    
    $
    172,738Common stock issued, net of issuance costs
    
    
    7
    
    
    
    12,242
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    12,249Cumulative effect adjustment upon
adoption of SFAS 155
    
    
    
    
    
    
    
    
    
    
    (133
    )
    
    
    133
    
    
    
    
    
    
    
    Stock-based compensation expense
    
    
    
    
    
    
    764
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    764Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    31,517
    
    
    
    
    
    
    
    31,517Other comprehensive loss, net of taxUnrealized holding gains on securities
arising during the period, net of tax of ($664)
    
    
    
    
    
    
    
    
    
    
    1,234
    
    
    
    
    
    
    
    
    
    
    
    1,234Change in fair value of interest rate swap, net of tax of $90
    
    
    
    
    
    
    
    
    
    
    (168
    )
    
    
    
    
    
    
    
    
    
    
    (168
    )Less reclassification adjustment for
gains included in net income, net of tax of $230
    
    
    
    
    
    
    
    
    
    
    (427
    )
    
    
    
    
    
    
    
    
    
    
    (427
    )Total other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    639Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    32,156Balance, September 30, 2007
    
    $
    181
    
    
    $
    166,606
    
    
    $
    (255
    )
    
    $
    51,973
    
    
    $
    (598
    )
    
    $
    217,907Balance, January 1, 2008
    
    $
    180
    
    
    $
    165,836
    
    
    $
    1,177
    
    
    $
    62,187
    
    
    $
    
    
    
    $
    229,380Exercise of stock options
    
    
    3
    
    
    
    597
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    600Stock-based compensation expense
    
    
    
    
    
    
    1,602
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,602Stock-based compensation excess tax benefits
    
    
    
    
    
    
    1,135
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,135Common stock repurchased and held treasury
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (499
    )
    
    
    (499
    )Common stock repurchased and retired
    
    
    (2
    )
    
    
    (3,221
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (3,223
    )Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    38,477
    
    
    
    
    
    
    
    38,477Other comprehensive loss, net of taxUnrealized holding losses on securities
arising during the period, net of tax of $5,750
    
    
    
    
    
    
    
    
    
    
    (10,678
    )
    
    
    
    
    
    
    
    
    
    
    (10,678
    )Change in fair value of interest rate swap, net of tax of $35
    
    
    
    
    
    
    
    
    
    
    (65
    )
    
    
    
    
    
    
    
    
    
    
    (65
    )Less reclassification adjustment for
losses included in net income, net of tax of ($1,251)
    
    
    
    
    
    
    
    
    
    
    2,323
    
    
    
    
    
    
    
    
    
    
    
    2,323Total other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (8,420
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    30,057Balance, September 30, 2008
    
    $
    181
    
    
    $
    165,949
    
    
    $
    (7,243
    )
    
    $
    100,664
    
    
    $
    (499
    )
    
    $
    259,052
  5




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Cash Flows
(Unaudited)
 Nine Months EndedSeptember 30,2008
    
    
    2007(Dollars in thousands)Cash Flows from Operating ActivitiesNet Income
    
    $
    38,477
    
    
    $
    31,517Less: Income from discontinued operations
    
    
    23,106
    
    
    
    3,570Income from continuing operations
    
    
    15,371
    
    
    
    27,947Adjustments to reconcile income from continuing operations to
net cash provided by operating activitiesDepreciation and amortization
    
    
    2,549
    
    
    
    1,083Realized (gains) losses on investments
    
    
    12,415
    
    
    
    (1,117
    )Deferrals of acquisition costs, net
    
    
    (10,073
    )
    
    
    6,225Deferred income taxes
    
    
    (6,011
    )
    
    
    (1,675
    )Stock-based compensation expense
    
    
    1,602
    
    
    
    764Increase (decrease) in cash resulting from changes in assets
and liabilitiesPremiums and reinsurance balances receivable
    
    
    5,740
    
    
    
    10,401Accrued investment income
    
    
    (353
    )
    
    
    (1,185
    )Receivable from related entity
    
    
    43
    
    
    
    (15
    )Accrued profit sharing commissions
    
    
    4,649
    
    
    
    (3,068
    )Reinsurance recoverable on paid and unpaid losses
    
    
    (36,330
    )
    
    
    (19,289
    )Prepaid reinsurance premiums
    
    
    4,234
    
    
    
    (41,844
    )Loss and loss adjustment expense reserves
    
    
    79,395
    
    
    
    64,989Unearned premium reserves
    
    
    16,506
    
    
    
    28,922Funds held under reinsurance treaties
    
    
    9,757
    
    
    
    28,780Reinsurance payable on paid losses
    
    
    (3,236
    )
    
    
    4,650Premiums payable to insurance companies
    
    
    (1,206
    )
    
    
    1,327Other
    
    
    (3,340
    )
    
    
    (1,560
    )Net Cash Provided By Operating Activities  Continuing Operations
    
    
    91,712
    
    
    
    105,335Net Cash Provided By Operating Activities  Discontinued Operations
    
    
    1,928
    
    
    
    3,855Net Cash Provided By Operating Activities  Total
    
    
    93,640
    
    
    
    109,190Cash Flows From Investing ActivitiesCost of short-term investments acquired
    
    
    (425,261
    )
    
    
    (325,766
    )Proceeds from disposals of short-term investments
    
    
    410,493
    
    
    
    304,457Cost of debt and equity securities acquired
    
    
    (207,143
    )
    
    
    (149,750
    )Proceeds from debt and equity securities
    
    
    113,138
    
    
    
    48,072Acquisition, net of cash acquired
    
    
    (18,869
    )
    
    
    Cost of fixed asset purchases
    
    
    (543
    )
    
    
    (3,164
    )Net Cash Used In Investing Activities  Continuing Operations
    
    
    (128,185
    )
    
    
    (126,151
    )Net Cash Provided By Investing Activities  Discontinued Operations
    
    
    41,830
    
    
    
    Net Cash Used In Investing Activities  Total
    
    
    (86,355
    )
    
    
    (126,151
    )Cash Flows From Financing ActivitiesIssuance of common stock, net of issuance costs
    
    
    
    
    
    
    12,249Stock issued on stock options exercised
    
    
    600
    
    
    
    Repurchase of common stock
    
    
    (3,722
    )
    
    
    Issuance of long-term debt
    
    
    
    
    
    
    20,619Net Cash Provided By (Used In) Financing Activities
    
    
    (3,122
    )
    
    
    32,868Net Increase In Cash and Cash Equivalents
    
    
    4,163
    
    
    
    15,907Cash and Cash Equivalents, beginning of period
    
    
    18,432
    
    
    
    14,335Cash and Cash Equivalents, end of period
    
    $
    22,595
    
    
    $
    30,242Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest
    
    $
    4,559
    
    
    $
    2,899Income taxes
    
    $
    18,400
    
    
    $
    18,415
  6




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##### 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
 Fair Value Measurements Effective Date of FASB Statement No. 157
 Business Combinations (SFAS 141(R))
 Noncontrolling Interests in Consolidated
Financial Statementsan amendment of Accounting Research Bulletin No. 51 (SFAS 160)
 Disclosures about Derivative Instruments and
Hedging Activities  an amendment of FASB Statement No. 133 (SFAS 161).
 7




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES  (Concluded)
 Determining the Fair Value of a Financial
Asset When the Market For That Asset Is Not Active (FSP FAS 157-3),
 2. MERGERS AND ACQUISITIONS
 American Management Corporation
    8




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##### Table of Contents



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
    Pro Forma for the
    
    Pro Forma for theThree Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2008
    
    2007
    
    2008
    
    2007(Dollars in thousands,
    
    (Dollars in thousands,except per share data)
    
    except per share data)Revenues
    
    $
    48,816
    
    
    $
    57,356
    
    
    $
    161,533
    
    
    $
    176,686Income from continuing operations
    
    
    501
    
    
    
    7,671
    
    
    
    15,398
    
    
    
    27,868Income from continuing operations per basic share
    
    
    0.03
    
    
    
    0.43
    
    
    
    0.85
    
    
    
    1.58Income from continuing operations per diluted share
    
    
    0.03
    
    
    
    0.41
    
    
    
    0.82
    
    
    
    1.51
 9




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 3. DISCONTINUED OPERATIONS
   Three Months Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2008
    
    2007
    
    2008
    
    2007(Dollars in thousands,
    
    (Dollars in thousands,except per share data)
    
    except per share data)Revenues
    
    $
    
    
    
    $
    3,599
    
    
    $
    5,884
    
    
    $
    9,240Income Before
Income Taxes
    
    $
    
    
    
    $
    2,386
    
    
    $
    3,533
    
    
    $
    5,711
 4. NET INCOME PER SHARE
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands, except share and per share data)Income from Continuing Operations
    
    $
    501
    
    
    $
    9,531
    
    
    $
    15,371
    
    
    $
    27,947Income (Loss) from Discontinued Operations
    
    
    (447
    )
    
    
    1,515
    
    
    
    23,106
    
    
    
    3,570Net income available to common
    
    $
    54
    
    
    $
    11,046
    
    
    $
    38,477
    
    
    $
    31,517Weighted-average number of common and common equivalent shares outstanding:Basic number of common shares outstanding
    
    
    18,206,904
    
    
    
    18,036,168
    
    
    
    18,190,915
    
    
    
    17,601,271Dilutive effect of stock options
    
    
    516,236
    
    
    
    830,939
    
    
    
    580,948
    
    
    
    832,844Dilutive effect of unvested restricted stock
    
    
    3,106
    
    
    
    
    
    
    
    6,207
    
    
    
    6,013Dilutive number of common and common
equivalent shares outstanding
    
    
    18,726,246
    
    
    
    18,867,107
    
    
    
    18,778,070
    
    
    
    18,440,128Basic Net Income Per Common Share:Income from Continuing Operations
    
    $
    0.03
    
    
    $
    0.53
    
    
    $
    0.84
    
    
    $
    1.59Income (Loss) from Discontinued Operations
    
    
    (0.02
    )
    
    
    0.08
    
    
    
    1.27
    
    
    
    0.20Total
    
    $
    0.01
    
    
    $
    0.61
    
    
    $
    2.11
    
    
    $
    1.79Diluted Net Income Per Common Share:Income from Continuing Operations
    
    $
    0.03
    
    
    $
    0.51
    
    
    $
    0.82
    
    
    $
    1.52Income (Loss) from Discontinued Operations
    
    
    (0.02
    )
    
    
    0.08
    
    
    
    1.23
    
    
    
    0.19Total
    
    $
    0.01
    
    
    $
    0.59
    
    
    $
    2.05
    
    
    $
    1.71Anti-dilutive shares excluded from diluted
net income per common share
    
    
    932,188
    
    
    
    75,633
    
    
    
    932,188
    
    
    
    52,444
 10




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 5. INCOME TAXES
 Accounting for
Uncertainty in Income Taxes, an Interpretation of SFAS No. 109 Accounting for Income Taxes,
   6. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands)Balance,beginning of period
    
    $
    324,502
    
    
    $
    235,862
    
    
    $
    272,365
    
    
    $
    191,013Less reinsurance recoverables
    
    
    113,909
    
    
    
    77,385
    
    
    
    91,444
    
    
    
    66,926Net Balance,beginning of period
    
    
    210,593
    
    
    
    158,477
    
    
    
    180,921
    
    
    
    124,087AUIC net reserves, date of acquisition
    
    
    
    
    
    
    
    
    
    
    4,490
    
    
    
    Incurred Related ToCurrent year
    
    
    32,382
    
    
    
    22,314
    
    
    
    81,558
    
    
    
    69,608Prior years
    
    
    (4,845
    )
    
    
    (1,428
    )
    
    
    (4,845
    )
    
    
    (2,280
    )Total Incurred
    
    
    27,537
    
    
    
    20,886
    
    
    
    76,713
    
    
    
    67,328Paid Related ToCurrent year
    
    
    4,010
    
    
    
    1,230
    
    
    
    6,348
    
    
    
    2,384Prior years
    
    
    7,273
    
    
    
    7,719
    
    
    
    28,929
    
    
    
    18,617Total Paid
    
    
    11,283
    
    
    
    8,949
    
    
    
    35,277
    
    
    
    21,001Net Balance
    
    
    226,847
    
    
    
    170,414
    
    
    
    226,847
    
    
    
    170,414Plus reinsurance recoverables
    
    
    129,403
    
    
    
    85,588
    
    
    
    129,403
    
    
    
    85,588Balance,end of period
    
    $
    356,250
    
    
    $
    256,002
    
    
    $
    356,250
    
    
    $
    256,002
 11




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 7. REINSURANCE
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2008
    
    
    2007
    
    
    2008
    
    
    2007(Dollars in thousands)Written PremiumsDirect
    
    $
    72,746
    
    
    $
    62,039
    
    
    $
    224,720
    
    
    $
    195,590Assumed
    
    
    4,253
    
    
    
    4,235
    
    
    
    13,399
    
    
    
    8,602Ceded
    
    
    (27,453
    )
    
    
    (30,796
    )
    
    
    (77,828
    )
    
    
    (90,177
    )Net Written Premiums
    
    $
    49,546
    
    
    $
    35,478
    
    
    $
    160,291
    
    
    $
    114,015Earned PremiumsDirect
    
    $
    70,985
    
    
    $
    60,218
    
    
    $
    209,208
    
    
    $
    170,410Assumed
    
    
    4,422
    
    
    
    535
    
    
    
    12,405
    
    
    
    4,372Ceded
    
    
    (26,566
    )
    
    
    (19,845
    )
    
    
    (82,063
    )
    
    
    (48,319
    )Earned but unbilled premiums
    
    
    251
    
    
    
    247
    
    
    
    (328
    )
    
    
    3,192Net Earned Premiums
    
    $
    49,092
    
    
    $
    41,155
    
    
    $
    139,222
    
    
    $
    129,655
    8. RELATED PARTY TRANSACTIONS
  12




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 9. HYBRID INSTRUMENTS
 Accounting for Certain Hybrid Financial Instruments Accounting for Derivative Instruments and Hedging Activities
  10. SHARE REPURCHASE PROGRAM
  11. STOCK COMPENSATION PLANS
   13




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 11. STOCK COMPENSATION PLANS  (Continued)
   1998 Plan
    
    
    Omnibus PlanNumber of
    
    
    Weighted Average
    
    
    Number of
    
    
    Weighted AverageOptions
    
    
    Exercise Price
    
    
    Options
    
    
    Exercise PriceOustanding at January 1, 2007
    
    
    927,775
    
    
    $
    2.24
    
    
    
    250,000
    
    
    $
    17.00Granted during the period
    
    
    
    
    
    
    
    
    
    
    226,188
    
    
    
    20.74Forfeited during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercised during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Cancelled during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at September 30, 2007
    
    
    927,775
    
    
    $
    2.24
    
    
    
    476,188
    
    
    $
    18.78Oustanding at January 1, 2008
    
    
    927,775
    
    
    $
    2.24
    
    
    
    573,688
    
    
    $
    19.10Granted during the period
    
    
    
    
    
    
    
    
    
    
    374,500
    
    
    
    16.38Forfeited during the period
    
    
    5,088
    
    
    
    4.86
    
    
    
    12,700
    
    
    
    18.77Exercised during the period
    
    
    302,575
    
    
    
    1.80
    
    
    
    3,300
    
    
    
    17.00Cancelled during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at September 30, 2008
    
    
    620,112
    
    
    $
    2.49
    
    
    
    932,188
    
    
    $
    18.02Exercisable at:September 30, 2007
    
    
    927,775
    
    
    $
    2.24
    
    
    
    
    
    
    $
    September 30, 2008
    
    
    620,112
    
    
    
    2.49
    
    
    
    152,566
    
    
    
    18.80
    Options Outstanding
    
    Options ExercisableWeighted-Average
    
    Weighted-Average
    
    
    
    
    
    Weighted-AverageRange of
    
    Outstanding as of
    
    Remaining
    
    Exercise Price Per
    
    Exercisable as of
    
    Exercise Price PerExercisable Price
    
    September 30, 2008
    
    Contractual Life
    
    Share
    
    September 30, 2008
    
    Share1998 Plan$1.73  $1.95
    
    
    508,187
    
    
    
    2.88
    Years
    
    $
    1.72
    
    
    
    508,187
    
    
    $
    1.72$4.86  $6.49
    
    
    111,925
    
    
    
    2.04
    
    
    
    5.97
    
    
    
    111,925
    
    
    
    5.97Total
    
    
    620,112
    
    
    
    2.73
    
    
    
    2.49
    
    
    
    620,112
    
    
    
    2.49Omnibus Plan$14.93  $20.75
    
    
    932,188
    
    
    
    8.09
    Years
    
    $
    18.02
    
    
    
    152,566
    
    
    $
    18.80Total
    
    
    932,188
    
    
    
    8.09
    
    
    
    18.02
    
    
    
    152,566
    
    
    
    18.80
 14




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 11. STOCK COMPENSATION PLANS  (Concluded)
   Nine Months EndedSeptember 30,2008
    
    2007Omnibus PlanExpected term
    
    
    6.0
    
    
    
    5.0Expected stock price volatility
    
    
    29.78
    %
    
    
    26.50
    %Risk-free interest rate
    
    
    3.12
    %
    
    
    4.50
    %Expected dividend yield
    
    
    
    
    
    
    Estimated fair value per option
    
    $
    5.79
    
    
    $
    6.71
 (SAB 110)
   12. 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
 15




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Continued)
(Unaudited)
 12. FAIR VALUE MEASUREMENTS  (Continued)
 Effective Date of FASB Statement No. 157
  
    
    Level 1  Valuations based on unadjusted quoted market prices in active markets for
identical securities. The fair values of fixed maturity and equity securities and short-term
investments included in the Level 1 category were based on quoted prices that are readily and
regularly available in an active market. The Level 1 category includes publicly traded equity
securities; highly liquid U.S. Government notes, treasury bills and mortgage-backed securities
issued by the Government National Mortgage Association; highly liquid cash management funds; and
short-term certificates of deposit.
    
    Level 2  Valuations based on observable inputs (other than Level 1 prices), such as quoted
prices for similar assets at the measurement date; quoted prices in markets that are not active; or
other inputs that are observable, either directly or indirectly. The fair value of fixed maturity
and equity securities and short-term investments included in the Level 2 category were based on the
market values obtained from an independent pricing service that were evaluated using pricing models
that vary by asset class and incorporate available trade, bid and other market information and
price quotes from well established independent broker-dealers. The independent pricing service
monitors market indicators, industry and economic events, and for broker-quoted only securities,
obtains quotes from market makers or broker-dealers that it recognizes to be market participants.
The Level 2 category includes corporate bonds, municipal bonds, redeemable preferred stocks and
certain publicly traded common stocks with no trades on the measurement date.
    
    Level 3  Valuations based on inputs that are unobservable and significant to the overall
fair value measurement, and involve management judgment.
  16




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements  (Concluded)
(Unaudited)
 12. FAIR VALUE MEASUREMENTS  (Concluded)
  Fair Value Measurements UsingTotal
    
    
    Level 1
    
    
    Level 2(Dollars in thousands)Available for sale
investments:Fixed maturity securities
    
    $
    430,137
    
    
    $
    5,983
    
    
    $
    424,154Equity securities
    
    
    816
    
    
    
    816
    
    
    
    Short-term investments
    
    
    49,799
    
    
    
    47,628
    
    
    
    2,171Hybrid securities
    
    
    40,039
    
    
    
    
    
    
    
    40,039Alternative investments
    
    
    13,431
    
    
    
    
    
    
    
    13,431Total
    
    $
    534,222
    
    
    $
    54,427
    
    
    $
    479,795
   13. ACCUMULATED OTHER COMPREHENSIVE LOSS
  Nine Months EndedSeptember 30,2008
    
    
    2007(Dollars in thousands)Unrealized holding losses on securities, net of tax
    
    $
    (6,559
    )
    
    $
    (79
    )Fair value of interest rate swap, net of tax
    
    
    (684
    )
    
    
    (176
    )Total accumulated other comprehensive loss
    
    $
    (7,243
    )
    
    $
    (255
    )
 14. STATE REGULATION
  17




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##### Table of Contents



ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Overview
 ®
     18




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##### Table of Contents



Premiums Produced
  Critical Accounting Policies
   Use of Estimates
  19




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##### 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.
    September 30,
    
    
    December 31,2008
    
    
    2007(Dollars in thousands)GrossCase reserves
    
    $
    94,767
    
    
    $
    69,699IBNR and ULAE reserves
    
    
    261,483
    
    
    
    202,666Total reserves
    
    $
    356,250
    
    
    $
    272,365Net of reinsuranceCase reserves
    
    $
    63,261
    
    
    $
    52,668IBNR and ULAE reserves
    
    
    163,586
    
    
    
    128,253Total
    
    $
    226,847
    
    
    $
    180,921
 20




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##### Table of Contents



Revenue Recognition
 Premiums
 Commissions and Fees
 Investments
 Accounting for Certain Hybrid Financial Instruments The Fair
Value Option of Financial Assets and Financial Liabilities
  Deferred Policy Acquisition Costs
  Intangible Assets
 Goodwill and Other Intangible Assets,
 Accounting for the Impairment or Disposal of Long-lived
Assets,
 21




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##### Table of Contents



Results of Operations
 Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007
  Three Months EndedSeptember 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Operating RevenueNet earned premiums
    
    $
    49,092
    
    
    $
    41,155
    
    
    
    19
    %Commissions and fees
    
    
    4,757
    
    
    
    2,226
    
    
    
    114Net investment income
    
    
    5,571
    
    
    
    4,359
    
    
    
    28Net realized gains (losses) on investments
    
    
    (10,604
    )
    
    
    355
    
    
    
    (3,087
    )Total Operating Revenues
    
    
    48,816
    
    
    
    48,095
    
    
    
    1Operating ExpensesLosses and loss adjustment expenses, net
    
    
    27,537
    
    
    
    20,886
    
    
    
    32Amortization of intangible assets
    
    
    553
    
    
    
    166
    
    
    
    233Other operating expenses
    
    
    19,797
    
    
    
    11,411
    
    
    
    73Total Operating Expenses
    
    
    47,887
    
    
    
    32,463
    
    
    
    48Operating Income
    
    
    929
    
    
    
    15,632
    
    
    
    (94
    )Interest Expense
    
    
    1,376
    
    
    
    1,349
    
    
    
    2Income (Loss) From Continuing Operations Before
Income Taxes
    
    
    (447
    )
    
    
    14,283
    
    
    
    (103
    )Income Taxes
    
    
    (948
    )
    
    
    4,752
    
    
    
    (120
    )Income From Continuing Operations
    
    
    501
    
    
    
    9,531
    
    
    
    (95
    )%Income (Loss) From Discontinued Operations,
Net of Income Taxes
    
    
    (447
    )
    
    
    1,515
    
    
    
    (130
    )Net Income
    
    $
    54
    
    
    $
    11,046
    
    
    
    (100
    )%Loss Ratio
    
    
    56.1
    %
    
    
    50.7
    %
    
    5.4 pointsUnderwriting Expense Ratio
    
    
    30.2
    %
    
    
    21.8
    %
    
    8.4 pointsCombined Ratio
    
    
    86.3
    %
    
    
    72.5
    %
    
    13.8 points
 Premiums Produced
  22




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##### Table of Contents



Operating Revenue
 Net Earned Premiums
 Three Months EndedSeptember 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Written premiumsDirect
    
    $
    72,746
    
    
    $
    62,039
    
    
    
    17
    %Assumed
    
    
    4,253
    
    
    
    4,235
    
    
    
    0Ceded
    
    
    (27,453
    )
    
    
    (30,796
    )
    
    
    (11
    )Net written premiums
    
    $
    49,546
    
    
    $
    35,478
    
    
    
    40
    %Earned premiumsDirect
    
    $
    70,985
    
    
    $
    60,218
    
    
    
    18
    %Assumed
    
    
    4,422
    
    
    
    535
    
    
    
    727Ceded
    
    
    (26,566
    )
    
    
    (19,845
    )
    
    
    34Earned but unbilled premiums
    
    
    251
    
    
    
    247
    
    
    
    2Net earned premiums
    
    $
    49,092
    
    
    $
    41,155
    
    
    
    19
    %
     23




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##### Table of Contents



Commissions and Fees
 Three Months EndedSeptember 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Insurance underwriting commissions and fees
    
    $
    (619
    )
    
    $
    2,226
    
    
    
    (128
    )%Insurance services commissions and fees
    
    
    5,376
    
    
    
    
    
    
    
    N/MTotal commissions and fees
    
    $
    4,757
    
    
    $
    2,226
    
    
    
    114
    %
  Net Investment Income and Realized Gains (Losses) on Investments
  Operating Expenses
 Losses and Loss Adjustment Expenses
 Other Operating Expenses
 Three Months EndedSeptember 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Amortization of deferred acquisition expenses
    
    $
    10,798
    
    
    $
    7,570
    
    
    
    43
    %Ceded reinsurance commissions
    
    
    (7,164
    )
    
    
    (9,057
    )
    
    
    (21
    )Other underwriting and operating expenses
    
    
    16,163
    
    
    
    12,898
    
    
    
    25Other operating expenses
    
    $
    19,797
    
    
    $
    11,411
    
    
    
    73
    %
 24




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##### Table of Contents



Interest Expense
  Income taxes
 Discontinued Operations
 25




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##### Table of Contents



Nine Months Ended September 30, 2008 Compared to Nine Months Ended September 30, 2007
  Nine Months EndedSeptember 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Operating RevenueNet earned premiums
    
    $
    139,222
    
    
    $
    129,655
    
    
    
    7
    %Commissions and fees
    
    
    15,896
    
    
    
    6,143
    
    
    
    159Net investment income
    
    
    15,635
    
    
    
    11,523
    
    
    
    36Net realized gains (losses) on investments
    
    
    (12,415
    )
    
    
    1,117
    
    
    
    1,211Total Operating Revenues
    
    
    158,338
    
    
    
    148,438
    
    
    
    7Operating ExpensesLosses and loss adjustment expenses, net
    
    
    76,713
    
    
    
    67,328
    
    
    
    14Amortization of intangible assets
    
    
    1,466
    
    
    
    500
    
    
    
    193Other operating expenses
    
    
    54,706
    
    
    
    35,014
    
    
    
    56Total Operating Expenses
    
    
    132,885
    
    
    
    102,842
    
    
    
    29Operating Income
    
    
    25,453
    
    
    
    45,596
    
    
    
    (44
    )Interest Expense
    
    
    4,490
    
    
    
    3,297
    
    
    
    36Income From Continuing Operations Before
Income Taxes
    
    
    20,963
    
    
    
    42,299
    
    
    
    (50
    )Income Taxes
    
    
    5,592
    
    
    
    14,352
    
    
    
    (61
    )Income from Continuing Operations
    
    
    15,371
    
    
    
    27,947
    
    
    
    (45
    )Income from Discontinued Operations,
Net of Income Taxes
    
    
    23,106
    
    
    
    3,570
    
    
    
    547Net Income
    
    $
    38,477
    
    
    $
    31,517
    
    
    
    22
    %Loss Ratio
    
    
    55.1
    %
    
    
    51.9
    %
    
    3.2 pointsUnderwriting Expense Ratio
    
    
    26.9
    %
    
    
    21.5
    %
    
    5.4 pointsCombined Ratio
    
    
    82.0
    %
    
    
    73.4
    %
    
    8.6 points
 Premiums Produced
  26




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##### Table of Contents



Operating Revenue
 Net Earned Premiums
 Nine Months EndedSeptember 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Written premiumsDirect
    
    $
    224,720
    
    
    $
    195,590
    
    
    
    15
    %Assumed
    
    
    13,399
    
    
    
    8,602
    
    
    
    56Ceded
    
    
    (77,828
    )
    
    
    (90,177
    )
    
    
    (14
    )Net written premiums
    
    $
    160,291
    
    
    $
    114,015
    
    
    
    41
    %Earned premiumsDirect
    
    $
    209,208
    
    
    $
    170,410
    
    
    
    23
    %Assumed
    
    
    12,405
    
    
    
    4,372
    
    
    
    184Ceded
    
    
    (82,063
    )
    
    
    (48,319
    )
    
    
    70Earned but unbilled premiums
    
    
    (328
    )
    
    
    3,192
    
    
    
    (110
    )Net earned premiums
    
    $
    139,222
    
    
    $
    129,655
    
    
    
    7
    %
     27




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##### Table of Contents



Commissions and Fees
 Nine Months EndedSeptember 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Insurance underwriting commissions and fees
    
    $
    2,136
    
    
    $
    6,143
    
    
    
    (65
    )%Insurance services commissions and fees
    
    
    13,760
    
    
    
    
    
    
    
    N/MTotal commissions and fees
    
    $
    15,896
    
    
    $
    6,143
    
    
    
    159
    %
  Net Investment Income and Realized Gains (Losses) on Investments
  Operating Expenses
 Losses and Loss Adjustment Expenses
 28




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##### Table of Contents



Other Operating Expenses
 Nine Months EndedSeptember 30,2008
    
    
    2007
    
    
    Change(Dollars in thousands)Amortization of deferred acquisition expenses
    
    $
    28,107
    
    
    $
    23,866
    
    
    
    18
    %Ceded reinsurance commissions
    
    
    (23,959
    )
    
    
    (27,155
    )
    
    
    (12
    )Other underwriting and operating expenses
    
    
    50,558
    
    
    
    38,303
    
    
    
    32Other operating expenses
    
    $
    54,706
    
    
    $
    35,014
    
    
    
    56
    %
  Interest Expense
  Income taxes
 Discontinued Operations
 Liquidity and Capital Resources
 Sources and Uses of Funds
 FMFC
 Insurance Subsidiaries
  29




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##### Table of Contents



Non-insurance Subsidiaries
 Cash Flows
  Nine Months EndedSeptember 30,2008
    
    
    2007(Dollars in thousands)Cash and cash equivalents provided by (used in):Operating activities  continuing operations
    
    $
    91,712
    
    
    $
    105,335Operating activities  discontinued operations
    
    
    1,928
    
    
    
    3,855Investing activities  continuing operations
    
    
    (128,185
    )
    
    
    (126,151
    )Investing activities  discontinued operations
    
    
    41,830
    
    
    
    Financing activities
    
    
    (3,122
    )
    
    
    32,868Change in cash and cash equivalents
    
    $
    4,163
    
    
    $
    15,907
      30




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##### Table of Contents



Long-term debt
 Junior Subordinated Debentures
 Credit Facility
 Derivative Financial Instruments
 31




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##### Table of Contents



Cash and Invested Assets
  September 30, 2008Market Value
    
    
    % of Portfolio(Dollars in thousands)Money Market Funds
    
    $
    47,628
    
    
    
    8.9
    %Certificates of Deposit
    
    
    2,171
    
    
    
    0.4
    %Treasury Securities
    
    
    5,983
    
    
    
    1.1
    %Agency Securities
    
    
    3,973
    
    
    
    0.7
    %Corp / Preferred
    
    
    70,361
    
    
    
    13.2
    %Municipal Bonds
    
    
    198,693
    
    
    
    37.2
    %Asset backed Securities
    
    
    49,878
    
    
    
    9.3
    %Mortgages
    
    
    101,249
    
    
    
    19.0
    %Convertible Securities
    
    
    40,039
    
    
    
    7.5
    %High Yield Convertible Fund
    
    
    8,414
    
    
    
    1.6
    %Structured Finance Fund
    
    
    5,017
    
    
    
    0.9
    %Common Stock
    
    
    816
    
    
    
    0.2
    %Total
    
    $
    534,222
    
    
    
    100.0
    %
  Average Life
    
    % of Total InvestmentLess than one year
    
    
    19.2
    %One to two years
    
    
    12.3
    %Two to three years
    
    
    13.3
    %Three to four years
    
    
    16.6
    %Four to five years
    
    
    13.9
    %Five to seven years
    
    
    11.2
    %More than seven years
    
    
    13.5
    %Total
    
    
    100.0
    %
   32




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##### Table of Contents



S&P Rating
    
    % of Total InvestmentsAAA
    
    
    59.5
    %AA
    
    
    18.7
    %A
    
    
    10.6
    %BBB
    
    
    6.2
    %BB
    
    
    1.9
    %B
    
    
    1.7
    %CCC
    
    
    0.1
    %C
    
    
    0.1
    %D
    
    
    0.1
    %NR
    
    
    1.1
    %Total
    
    
    100.0
    %
       33




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##### Table of Contents



Gross Unrealized
    
    
    EstimatedAmortized Cost
    
    
    Gains
    
    
    Losses
    
    
    Market Value(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    5,763
    
    
    $
    220
    
    
    $
    
    
    
    $
    5,983Government agency mortgage-backed securities
    
    
    85,495
    
    
    
    646
    
    
    
    (206
    )
    
    
    85,935Government agency obligations
    
    
    3,976
    
    
    
    19
    
    
    
    (22
    )
    
    
    3,973Collateralized mortgage obligations and other
asset-backed securities
    
    
    69,063
    
    
    
    34
    
    
    
    (3,906
    )
    
    
    65,191Obligations of states and political subdivisions
    
    
    200,317
    
    
    
    1,183
    
    
    
    (2,754
    )
    
    
    198,746Corporate bonds
    
    
    74,376
    
    
    
    87
    
    
    
    (4,996
    )
    
    
    69,467Total Debt Securities
    
    
    438,990
    
    
    
    2,189
    
    
    
    (11,884
    )
    
    
    429,295Preferred stocks
    
    
    910
    
    
    
    
    
    
    
    (68
    )
    
    
    842Short-term investments
    
    
    49,799
    
    
    
    
    
    
    
    
    
    
    
    49,799Total
    
    $
    489,699
    
    
    $
    2,189
    
    
    $
    (11,952
    )
    
    $
    479,936
   Deferred Policy Acquisition Costs
  34




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##### Table of Contents



Reinsurance
  Nine Months EndedSeptember 30,2008
    
    
    2007(Dollars in thousands)Direct written premiums
    
    $
    224,720
    
    
    $
    195,590Ceded written premiums
    
    
    77,828
    
    
    
    90,177Net written premiums
    
    $
    146,892
    
    
    $
    105,413Ceded written premiums as percentage of direct written premiums
    
    
    34.6
    %
    
    
    46.1
    %
  Nine Months EndedSeptember 30,2008
    
    2007(Dollars in thousands)Ceded written premiums
    
    $
    77,828
    
    
    $
    90,177Ceded premiums earned
    
    
    82,063
    
    
    
    48,319Losses and loss adjustment expenses ceded
    
    
    46,536
    
    
    
    25,531Ceding commissions
    
    
    27,470
    
    
    
    15,119
    Recent Accounting Pronouncements
 Fair Value Measurements Effective Date of FASB Statement No. 157
 35




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##### Table of Contents



Business Combinations (SFAS 141(R))
 Noncontrolling Interests in Consolidated
Financial Statementsan amendment of Accounting Research Bulletin No. 51 (SFAS 160)
 Disclosures about Derivative Instruments and
Hedging Activities  an amendment of FASB Statement No. 133 (SFAS 161).
 Determining the Fair Value of a Financial
Asset When the Market For That Asset Is Not Active (FSP FAS 157-3),
 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
  36




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##### Table of Contents



PART II.  OTHER INFORMATION
 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
   Total Number of
    
    Maximum Number (orShares (or Units)
    
    Approximate Dollar Value) ofTotal Number of
    
    Average Price
    
    Purchased as Part of
    
    Shares (or Units) that MayShares (or Units)
    
    as Paid per
    
    Publicly Announced
    
    Yet Be Purchased Under theMonth
    
    Purchased
    
    Share (or Unit)
    
    Plans or Programs
    
    Plan or ProgramsJuly
    
    
    
    
    
    $
    
    
    
    
    
    
    
    
    August
    
    
    122,225
    
    
    
    14.01
    
    
    
    122,225
    
    
    
    1,377,775September
    
    
    102,310
    
    
    
    14.76
    
    
    
    102,310
    
    
    
    1,275,465Total
    
    
    224,535
    
    
    $
    14.35
    
    
    
    224,535
    
    
    
    1,275,465
 
 Item 6. Exhibits
  37




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##### 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:
    November 10, 2008 38




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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 39