##### 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, 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 Road 
Suite 100
Southfield, Michigan
(Address of Principal Executive Offices)
    
    48034
(Zip Code)
  þ o
 o o
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer o
(Do not check if a smaller reporting company)
    
    Smaller reporting company o
 o þ




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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
    
    253. Quantitative and Qualitative Disclosures about Market Risk
    
    474. Controls and Procedures
    
    47PART II  OTHER INFORMATION1. Legal Proceedings
    
    482. Unregistered Sales of Equity Securities and Use of Proceeds
    
    486. Exhibits
    
    48EX-10.34EX-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 31,2009
    
    
    2008(Unaudited)(Dollars in thousands,except share and per share data)ASSETSInvestmentsDebt securities
    
    $
    631,033
    
    
    $
    495,799Equity securities and other
    
    
    32,224
    
    
    
    15,089Short-term
    
    
    10,754
    
    
    
    32,142Total Investments
    
    
    674,011
    
    
    
    543,030Cash and cash equivalents
    
    
    16,205
    
    
    
    31,833Premiums and reinsurance balances receivable
    
    
    52,468
    
    
    
    56,398Accrued investment income
    
    
    5,940
    
    
    
    5,400Accrued profit sharing commissions
    
    
    13,841
    
    
    
    11,315Reinsurance recoverable on paid and unpaid losses
    
    
    167,802
    
    
    
    135,617Prepaid reinsurance premiums
    
    
    59,784
    
    
    
    48,921Deferred acquisition costs
    
    
    26,310
    
    
    
    27,369Intangible assets, net of accumulated amortization
    
    
    37,642
    
    
    
    39,351Goodwill
    
    
    25,483
    
    
    
    25,483Deferred federal income taxes
    
    
    
    
    
    
    2,161Other assets
    
    
    23,771
    
    
    
    16,775Total Assets
    
    $
    1,103,257
    
    
    $
    943,653LIABILITIES AND STOCKHOLDERS EQUITYLoss and loss adjustment expense reserves
    
    $
    448,265
    
    
    $
    372,721Unearned premium reserves
    
    
    150,655
    
    
    
    147,849Long-term debt
    
    
    67,013
    
    
    
    67,013Funds held under reinsurance treaties
    
    
    67,093
    
    
    
    49,419Premiums payable to insurance companies
    
    
    31,363
    
    
    
    27,831Reinsurance payable on paid losses
    
    
    1,179
    
    
    
    1,167Deferred federal income taxes
    
    
    14,504
    
    
    
    Accounts payable, accrued expenses, and other liabilities
    
    
    15,713
    
    
    
    16,016Total Liabilities
    
    
    795,785
    
    
    
    682,016Stockholders EquityCommon stock, $0.01 par value; authorized 100,000,000 shares; issued
 and outstanding 17,174,906 and 17,836,337 shares
    
    
    172
    
    
    
    178Paid-in-capital
    
    
    153,752
    
    
    
    161,957Accumulated other comprehensive income (loss)
    
    
    16,306
    
    
    
    (3,027
    )Retained earnings
    
    
    139,090
    
    
    
    103,028Treasury stock; 130,600 and 33,600 shares
    
    
    (1,848
    )
    
    
    (499
    )Total Stockholders Equity
    
    
    307,472
    
    
    
    261,637Total Liabilities and Stockholders Equity
    
    $
    1,103,257
    
    
    $
    943,653
  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 30,2009
    
    
    2008
    
    
    2009
    
    
    2008(Dollars in thousands, except share and per share data)Operating RevenueNet earned premiums
    
    $
    51,512
    
    
    $
    49,092
    
    
    $
    155,539
    
    
    $
    139,222Commissions and fees
    
    
    7,445
    
    
    
    4,757
    
    
    
    23,916
    
    
    
    15,896Net investment income
    
    
    7,540
    
    
    
    5,571
    
    
    
    21,105
    
    
    
    15,635Net realized gains (losses) on investments (1)
    
    
    13,766
    
    
    
    (7,128
    )
    
    
    25,204
    
    
    
    (8,714
    )Other-than-temporary impairment losses on
investments (1)
    
    
    (292
    )
    
    
    (3,476
    )
    
    
    (426
    )
    
    
    (3,701
    )Total Operating Revenues
    
    
    79,971
    
    
    
    48,816
    
    
    
    225,338
    
    
    
    158,338Operating ExpensesLosses and loss adjustment expenses, net
    
    
    30,345
    
    
    
    27,537
    
    
    
    96,301
    
    
    
    76,713Amortization of deferred acquisition expenses
    
    
    13,960
    
    
    
    10,798
    
    
    
    40,889
    
    
    
    28,107Underwriting, agency and other expenses
    
    
    10,169
    
    
    
    8,999
    
    
    
    28,919
    
    
    
    26,599Amortization of intangible assets
    
    
    559
    
    
    
    553
    
    
    
    1,709
    
    
    
    1,466Total Operating Expenses
    
    
    55,033
    
    
    
    47,887
    
    
    
    167,818
    
    
    
    132,885Operating Income
    
    
    24,938
    
    
    
    929
    
    
    
    57,520
    
    
    
    25,453Interest Expense
    
    
    1,446
    
    
    
    1,440
    
    
    
    4,278
    
    
    
    4,380Change in Fair Value of Derivative Instruments
    
    
    (171
    )
    
    
    (64
    )
    
    
    (401
    )
    
    
    110Income (Loss) From Continuing Operations Before
Income Taxes
    
    
    23,663
    
    
    
    (447
    )
    
    
    53,643
    
    
    
    20,963Income Taxes
    
    
    8,018
    
    
    
    (948
    )
    
    
    17,707
    
    
    
    5,592Income From Continuing Operations
    
    
    15,645
    
    
    
    501
    
    
    
    35,936
    
    
    
    15,371Income (Loss) From Discontinued Operations,
Net of Income Taxes
    
    
    
    
    
    
    (447
    )
    
    
    
    
    
    
    23,106Net Income
    
    $
    15,645
    
    
    $
    54
    
    
    $
    35,936
    
    
    $
    38,477Basic Net Income Per Share:Income From Continuing Operations
    
    $
    0.90
    
    
    $
    0.03
    
    
    $
    2.03
    
    
    $
    0.84Income (Loss) From Discontinued Operations
    
    
    
    
    
    
    (0.02
    )
    
    
    
    
    
    
    1.27Total
    
    $
    0.90
    
    
    $
    0.01
    
    
    $
    2.03
    
    
    $
    2.11Diluted Net Income Per Share:Income From Continuing Operations
    
    $
    0.89
    
    
    $
    0.03
    
    
    $
    1.99
    
    
    $
    0.82Income (Loss) From Discontinued Operations
    
    
    
    
    
    
    (0.02
    )
    
    
    
    
    
    
    1.23Total
    
    $
    0.89
    
    
    $
    0.01
    
    
    $
    1.99
    
    
    $
    2.05Weighted Average Shares Outstanding:Basic
    
    
    17,144,077
    
    
    
    18,206,904
    
    
    
    17,537,754
    
    
    
    18,190,915Diluted
    
    
    17,486,020
    
    
    
    18,726,246
    
    
    
    17,877,126
    
    
    
    18,778,070
 
 (1)
    
    2008 amounts were reclassified to conform to current periods presentation.  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 (Loss)
    
    
    Earnings
    
    
    Stock
    
    
    Total(Dollars in thousands)Balance, 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 in 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
    )
    
    $
    259,052Balance, January 1, 2009
    
    $
    178
    
    
    $
    161,957
    
    
    $
    (3,027
    )
    
    $
    103,028
    
    
    $
    (499
    )
    
    $
    261,637Issuance of restricted stock
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Exercise of stock options
    
    
    1
    
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9Stock-based compensation expense
    
    
    
    
    
    
    2,288
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,288Stock-based compensation excess tax benefits
    
    
    
    
    
    
    (21
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (21
    )Common stock repurchased and held in treasury
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,349
    )
    
    
    (1,349
    )Common stock repurchased and retired
    
    
    (8
    )
    
    
    (10,479
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (10,487
    )Payment of shareholder dividend
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (873
    )
    
    
    
    
    
    
    (873
    )Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35,936
    
    
    
    
    
    
    
    35,936Cumulative effect of adoption of FASB ASC 320-10 at April 1, 2009
    
    
    
    
    
    
    
    
    
    
    (999
    )
    
    
    999
    
    
    
    
    
    
    
    Other comprehensive income, net of taxUnrealized holding losses on securities arising during
the period having credit losses recognized in the condensed
consolidated statements of income, net of tax $422
    
    
    
    
    
    
    
    
    
    
    (783
    )
    
    
    
    
    
    
    
    
    
    
    (783
    )Unrealized holding gains on securities arising during the
period having no credit losses recognized in the condensed
consolidated statements of income, net of tax ($12,377)
    
    
    
    
    
    
    
    
    
    
    22,986
    
    
    
    
    
    
    
    
    
    
    
    22,986Change in fair value of interest rate swaps, net of tax of $268
    
    
    
    
    
    
    
    
    
    
    (498
    )
    
    
    
    
    
    
    
    
    
    
    (498
    )Less reclassification adjustment for
gains included in net income, net of tax of $739
    
    
    
    
    
    
    
    
    
    
    (1,373
    )
    
    
    
    
    
    
    
    
    
    
    (1,373
    )Total other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    20,332Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    56,268Balance, September 30, 2009
    
    $
    172
    
    
    $
    153,752
    
    
    $
    16,306
    
    
    $
    139,090
    
    
    $
    (1,848
    )
    
    $
    307,472
  5




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
 
 Condensed Consolidated Statements of Cash Flows
(Unaudited)
 Nine Months EndedSeptember 30,2009
    
    
    2008(Dollars in thousands)Cash Flows from Operating ActivitiesNet Income
    
    $
    35,936
    
    
    $
    38,477Less: Income from discontinued operations
    
    
    
    
    
    
    23,106Income from continuing operations
    
    
    35,936
    
    
    
    15,371Adjustments to reconcile income from continuing operations to
net cash provided by operating activitiesDepreciation and amortization
    
    
    3,051
    
    
    
    2,549Realized (gains) losses on investments
    
    
    (25,204
    )
    
    
    8,714Other-than-temporary impairment losses on investments
    
    
    426
    
    
    
    3,701Deferrals of acquisition costs, net
    
    
    1,060
    
    
    
    (10,073
    )Deferred income taxes
    
    
    5,716
    
    
    
    (6,011
    )Stock-based compensation expense
    
    
    2,288
    
    
    
    1,602Increase (decrease) in cash resulting from changes in assets and liabilitiesPremiums and reinsurance balances receivable
    
    
    3,930
    
    
    
    5,740Accrued investment income
    
    
    (540
    )
    
    
    (353
    )Accrued profit sharing commissions
    
    
    (2,526
    )
    
    
    4,649Reinsurance recoverable on paid and unpaid losses
    
    
    (32,185
    )
    
    
    (36,330
    )Prepaid reinsurance premiums
    
    
    (10,863
    )
    
    
    4,234Loss and loss adjustment expense reserves
    
    
    75,544
    
    
    
    79,395Unearned premium reserves
    
    
    2,806
    
    
    
    16,506Funds held under reinsurance treaties
    
    
    17,674
    
    
    
    9,757Reinsurance payable on paid losses
    
    
    12
    
    
    
    (3,236
    )Premiums payable to insurance companies
    
    
    3,532
    
    
    
    (1,206
    )Other
    
    
    (14,051
    )
    
    
    (3,297
    )Net Cash Provided By Operating Activities  Continuing Operations
    
    
    66,606
    
    
    
    91,712Net Cash Provided By Operating Activities  Discontinued Operations
    
    
    
    
    
    
    1,928Net Cash Provided By Operating Activities  Total
    
    
    66,606
    
    
    
    93,640Cash Flows From Investing ActivitiesCost of short-term investments acquired
    
    
    (238,579
    )
    
    
    (425,261
    )Proceeds from disposals of short-term investments
    
    
    259,966
    
    
    
    410,493Cost of debt and equity securities acquired
    
    
    (215,156
    )
    
    
    (207,143
    )Proceeds from debt and equity securities
    
    
    121,256
    
    
    
    113,138Acquisition, net of cash acquired
    
    
    
    
    
    
    (18,869
    )Cost of fixed asset purchases
    
    
    
    
    
    
    (543
    )Net Cash Used In Investing Activities  Continuing Operations
    
    
    (72,513
    )
    
    
    (128,185
    )Net Cash Provided By Investing Activities  Discontinued Operations
    
    
    
    
    
    
    41,830Net Cash Used In Investing Activities  Total
    
    
    (72,513
    )
    
    
    (86,355
    )Cash Flows From Financing ActivitiesStock issued on stock options exercised
    
    
    9
    
    
    
    600Purchase of common stock
    
    
    (10,487
    )
    
    
    Payment of shareholder dividend
    
    
    (873
    )
    
    
    Cash used for excess tax benefits
    
    
    (21
    )
    
    
    Purchase of treasury stock
    
    
    (1,349
    )
    
    
    (3,722
    )Net borrowings under credit facility
    
    
    3,000
    
    
    
    Net Cash Used In Financing Activities
    
    
    (9,721
    )
    
    
    (3,122
    )Net Increase (Decrease) In Cash and Cash Equivalents
    
    
    (15,628
    )
    
    
    4,163Cash and Cash Equivalents, beginning of period
    
    
    31,833
    
    
    
    18,432Cash and Cash Equivalents, end of period
    
    $
    16,205
    
    
    $
    22,595Supplemental Disclosure of Cash Flow Information:Cash paid during the period for:Interest
    
    $
    4,137
    
    
    $
    4,559Income taxes
    
    $
    8,100
    
    
    $
    18,400
  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
 Generally Accepted Accounting Principles Accounting Standards Codification
   7




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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 (Concluded)
     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
(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 Ended
    
    Nine Months EndedSeptember 30,
    
    September 30,2009
    
    2008
    
    2009
    
    2008(Dollars in thousands)Revenues
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    5,884Income Before
Income Taxes
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    3,533
 9




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 4. NET INCOME PER SHARE
   Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2009
    
    
    2008
    
    
    2009
    
    
    2008(Dollars in thousands, except share and per share data)Income from Continuing Operations
    
    $
    15,645
    
    
    $
    501
    
    
    $
    35,936
    
    
    $
    15,371Income from Discontinued Operations
    
    
    
    
    
    
    (447
    )
    
    
    
    
    
    
    23,106Net income as reported
    
    
    15,645
    
    
    
    54
    
    
    
    35,936
    
    
    
    38,477Net income allocated to unvested restricted stock shares
    
    
    (141
    )
    
    
    (0
    )
    
    
    (316
    )
    
    
    (154
    )Net income available to common
    
    $
    15,504
    
    
    $
    54
    
    
    $
    35,620
    
    
    $
    38,323Weighted-average number of common and common equivalent shares outstanding:Basic number of common shares outstanding
    
    
    17,144,077
    
    
    
    18,206,904
    
    
    
    17,537,754
    
    
    
    18,190,915Dilutive effect of stock options
    
    
    341,943
    
    
    
    516,236
    
    
    
    339,372
    
    
    
    580,948Dilutive effect of unvested restricted stock
    
    
    
    
    
    
    3,106
    
    
    
    
    
    
    
    6,207Dilutive number of common and common equivalent shares outstanding
    
    
    17,486,020
    
    
    
    18,726,246
    
    
    
    17,877,126
    
    
    
    18,778,070Basic Net Income Per Common Share:Income from Continuing Operations
    
    $
    0.90
    
    
    $
    0.03
    
    
    $
    2.03
    
    
    $
    0.84Income from Discontinued Operations
    
    
    
    
    
    
    (0.02
    )
    
    
    
    
    
    
    1.27Total
    
    $
    0.90
    
    
    $
    0.01
    
    
    $
    2.03
    
    
    $
    2.11Diluted Net Income Per Common Share:Income from Continuing Operations
    
    $
    0.89
    
    
    $
    0.03
    
    
    $
    1.99
    
    
    $
    0.82Income from Discontinued Operations
    
    
    
    
    
    
    (0.02
    )
    
    
    
    
    
    
    1.23Total
    
    $
    0.89
    
    
    $
    0.01
    
    
    $
    1.99
    
    
    $
    2.05Anti-dilutive shares excluded from diluted net income per common share
    
    
    1,112,688
    
    
    
    932,188
    
    
    
    1,112,688
    
    
    
    932,188
  10




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 5. INVESTMENTS
  Gross UnrealizedAmortized Cost
    
    
    Gains
    
    
    Losses
    
    
    Market Value(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    3,776
    
    
    $
    146
    
    
    $
    
    
    
    $
    3,922Government agency mortgage-backed securities
    
    
    101,160
    
    
    
    4,491
    
    
    
    (8
    )
    
    
    105,643Government agency obligations
    
    
    989
    
    
    
    39
    
    
    
    
    
    
    
    1,028Collateralized mortgage obligations and other
asset-backed securities
    
    
    109,734
    
    
    
    5,176
    
    
    
    (2,996
    )
    
    
    111,914Obligations of states and political
subdivisions
    
    
    189,101
    
    
    
    11,661
    
    
    
    (60
    )
    
    
    200,702Corporate bonds
    
    
    137,912
    
    
    
    11,317
    
    
    
    (700
    )
    
    
    148,529Total Debt Securities
    
    
    542,672
    
    
    
    32,830
    
    
    
    (3,764
    )
    
    
    571,738Preferred stocks
    
    
    1,416
    
    
    
    50
    
    
    
    (193
    )
    
    
    1,273Short-term investments
    
    
    10,754
    
    
    
    
    
    
    
    
    
    
    
    10,754Total
    
    $
    554,842
    
    
    $
    32,880
    
    
    $
    (3,957
    )
    
    $
    583,765
  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
 Impairment of Investment Securities
   11




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 5. INVESTMENTS  (Continued)
     Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2009
    
    
    2008
    
    
    2009
    
    
    2008(Dollars in thousands)Other-than-temporary impairment losses on
investments:Total losses
    
    $
    (761
    )
    
    $
    (3,476
    )
    
    $
    (1,631
    )
    
    $
    (3,701
    )Portion of
losses recognized in accumulated other comprehensive income
    
    
    469
    
    
    
    
    
    
    
    1,205
    
    
    
    Other-than-temporary impairment losses on
investments
    
    $
    (292
    )
    
    $
    (3,476
    )
    
    $
    (426
    )
    
    $
    (3,701
    )
 12




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 5. INVESTMENTS  (Continued)
  Additions forOTTI
    
    Additions for
    
    
    
    
    
    Adjustments
    
    September 30,July 1, 2009
    
    Securities
    
    OTTI
    
    
    
    
    
    to Book
    
    2009Cumulative
    
    Where No
    
    Securities
    
    Reductions Due
    
    Value of
    
    CumulativeOTTI Credit
    
    Credit Losses
    
    Where Credit
    
    to Sales or
    
    Credit-
    
    OTTI CreditLosses
    
    Were
    
    Losses Have
    
    Intend/Required
    
    Impaired
    
    LossesRecognized
    
    Recognized
    
    Been
    
    to Sell of
    
    Securities due
    
    Recognizedfor Securities
    
    Prior to
    
    Recognized Prior to
    
    Credit-Impaired
    
    to Changes in
    
    for SecuritiesStill Held
    
    July 1, 2009
    
    July 1, 2009
    
    Securities
    
    Cash Flows
    
    Still Held(Dollars in thousands)Debt securities:Mortgage-backed securities,
collateralized mortgage
obligations
and passthrough securities
    
    $
    261
    
    
    $
    40
    
    
    $
    252
    
    
    $
    
    
    
    $
    
    
    
    $
    553All other corporate bonds
    
    
    569
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    569Total debt securities
    
    $
    830
    
    
    $
    40
    
    
    $
    252
    
    
    $
    
    
    
    $
    
    
    
    $
    1,122
  Additions forOTTI
    
    Additions for
    
    
    
    
    
    Adjustments
    
    September 30,April 1, 2009
    
    Securities
    
    OTTI
    
    
    
    
    
    to Book
    
    2009Cumulative
    
    Where No
    
    Securities
    
    Reductions Due
    
    Value of
    
    CumulativeOTTI Credit
    
    Credit Losses
    
    Where Credit
    
    to Sales or
    
    Credit-
    
    OTTI CreditLosses
    
    Were
    
    Losses Have
    
    Intend/Required
    
    Impaired
    
    LossesRecognized
    
    Recognized
    
    Been
    
    to Sell of
    
    Securities due
    
    Recognizedfor Securities
    
    Prior to
    
    Recognized Prior to
    
    Credit-Impaired
    
    to Changes in
    
    for SecuritiesStill Held
    
    April 1, 2009
    
    April 1, 2009
    
    Securities
    
    Cash Flows
    
    Still Held(Dollars in thousands)Debt securities:Mortgage-backed securities,
collateralized mortgage obligations
and passthrough securities
    
    $
    164
    
    
    $
    389
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    553All other corporate bonds
    
    
    569
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    569Total debt securities
    
    $
    733
    
    
    $
    389
    
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    1,122
 13




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 5. INVESTMENTS  (Continued)
  Less than 12 Months
    
    
    Greater than 12 MonthsFair Value
    
    
    
    
    
    
    Fair Valueof
    
    
    
    
    
    
    ofInvestments
    
    
    
    
    
    
    InvestmentsWith
    
    
    Gross
    
    
    With
    
    
    GrossUnrealized
    
    
    Unrealized
    
    
    Unrealized
    
    
    UnrealizedLosses
    
    
    Losses
    
    
    Losses
    
    
    Losses(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Government agency mortgage-backed securities
    
    
    1,680
    
    
    
    (1
    )
    
    
    194
    
    
    
    (7
    )Government agency obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Collateralized mortgage obligations and other
asset-backed securities
    
    
    6,351
    
    
    
    (262
    )
    
    
    14,157
    
    
    
    (2,734
    )Obligations of states and political
subdivisions
    
    
    
    
    
    
    
    
    
    
    3,645
    
    
    
    (60
    )Corporate bonds
    
    
    1,252
    
    
    
    (1
    )
    
    
    8,542
    
    
    
    (699
    )Total Debt Securities
    
    
    9,283
    
    
    
    (264
    )
    
    
    26,538
    
    
    
    (3,500
    )Preferred Stocks
    
    
    
    
    
    
    
    
    
    
    313
    
    
    
    (193
    )Total
    
    $
    9,283
    
    
    $
    (264
    )
    
    $
    26,851
    
    
    $
    (3,693
    )
  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
    
    
    3,902
    
    
    
    (37
    )
    
    
    326
    
    
    
    (2
    )Government agency obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Collateralized mortgage obligations and other
asset-backed securities
    
    
    48,125
    
    
    
    (5,143
    )
    
    
    5,963
    
    
    
    (1,944
    )Obligations of states and political subdivisions
    
    
    14,063
    
    
    
    (427
    )
    
    
    8,809
    
    
    
    (267
    )Corporate bonds
    
    
    42,402
    
    
    
    (2,549
    )
    
    
    12,824
    
    
    
    (1,325
    )Total Debt Securities
    
    
    108,492
    
    
    
    (8,156
    )
    
    
    27,922
    
    
    
    (3,538
    )Preferred Stocks
    
    
    832
    
    
    
    (78
    )
    
    
    216
    
    
    
    (289
    )Total
    
    $
    109,324
    
    
    $
    (8,234
    )
    
    $
    28,138
    
    
    $
    (3,827
    )
 14




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 5. INVESTMENTS  (Continued)
  UnrealizedLoss atSector
    
    September 30, 2009(Dollars in thousands)Debt SecuritiesU.S. Treasuries
    
    $
    U.S. Agencies
    
    
    U.S. government securities
    
    
    Government agency mortgage-backed securities
    
    
    (8
    )Government agency obligations
    
    
    MBS Passthroughs
    
    
    (23
    )CMOs
    
    
    (1,331
    )Asset Backed Securities
    
    
    (631
    )Commercial MBS
    
    
    (1,011
    )Collateralized mortgage obligations and other
asset-backed securities
    
    
    (2,996
    )Obligations of states and political subdivisions
    
    
    (60
    )Corporate Bonds
    
    
    (700
    )High Yield Bonds
    
    
    Corporate Bonds
    
    
    (700
    )Total Debt Securities
    
    
    (3,764
    )Preferred Stocks
    
    
    (193
    )Short-term investments
    
    
    Total
    
    $
    (3,957
    )
   15




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 5. INVESTMENTS  (Continued)
  % 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
    
    
    19.0
    %
    
    $
    7,615
    
    
    $
    1,859
    
    
    
    24.4
    %
    
    
    98.7
    %Investment Grade
    
    
    81.0
    
    
    
    32,477
    
    
    
    2,098
    
    
    
    6.5
    
    
    
    88.5Total
    
    
    100.0
    %
    
    $
    40,092
    
    
    $
    3,957
    
    
    
    9.9
    %
    
    
    93.3
    %
    Hybrid Instruments
  Alternative Investments
  16




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 5. INVESTMENTS  (Concluded)
  6. INCOME TAXES
    7. LOSS AND LOSS ADJUSTMENT EXPENSE RESERVES
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2009
    
    
    2008
    
    
    2009
    
    
    2008(Dollars in thousands)Balance,beginning of period
    
    $
    426,908
    
    
    $
    324,502
    
    
    $
    372,721
    
    
    $
    272,365Less reinsurance recoverables
    
    
    146,157
    
    
    
    113,909
    
    
    
    128,552
    
    
    
    91,444Net Balance,beginning of period
    
    
    280,751
    
    
    
    210,593
    
    
    
    244,169
    
    
    
    180,921AUIC net reserves, date of acquisition
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,490Incurred Related ToCurrent year
    
    
    31,645
    
    
    
    32,382
    
    
    
    101,972
    
    
    
    81,558Prior years
    
    
    (1,300
    )
    
    
    (4,845
    )
    
    
    (5,671
    )
    
    
    (4,845
    )Total Incurred
    
    
    30,345
    
    
    
    27,537
    
    
    
    96,301
    
    
    
    76,713Paid Related ToCurrent year
    
    
    6,461
    
    
    
    4,010
    
    
    
    10,900
    
    
    
    6,348Prior years
    
    
    13,266
    
    
    
    7,273
    
    
    
    38,201
    
    
    
    28,929Total Paid
    
    
    19,727
    
    
    
    11,283
    
    
    
    49,101
    
    
    
    35,277Net Balance
    
    
    291,369
    
    
    
    226,847
    
    
    
    291,369
    
    
    
    226,847Plus reinsurance recoverables
    
    
    156,896
    
    
    
    129,403
    
    
    
    156,896
    
    
    
    129,403Balance,end of period
    
    $
    448,265
    
    
    $
    356,250
    
    
    $
    448,265
    
    
    $
    356,250
 17




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 8. REINSURANCE
  Three Months Ended
    
    
    Nine Months EndedSeptember 30,
    
    
    September 30,2009
    
    
    2008
    
    
    2009
    
    
    2008(Dollars in thousands)Written PremiumsDirect
    
    $
    77,607
    
    
    $
    72,746
    
    
    $
    228,619
    
    
    $
    224,720Assumed
    
    
    4,201
    
    
    
    4,253
    
    
    
    13,588
    
    
    
    13,399Ceded
    
    
    (35,483
    )
    
    
    (27,453
    )
    
    
    (92,615
    )
    
    
    (77,828
    )Net Written Premiums
    
    $
    46,325
    
    
    $
    49,546
    
    
    $
    149,592
    
    
    $
    160,291Earned PremiumsDirect
    
    $
    77,907
    
    
    $
    70,985
    
    
    $
    226,125
    
    
    $
    209,208Assumed
    
    
    4,529
    
    
    
    4,422
    
    
    
    13,276
    
    
    
    12,405Ceded
    
    
    (29,907
    )
    
    
    (26,566
    )
    
    
    (81,752
    )
    
    
    (82,063
    )Earned but unbilled premiums
    
    
    (1,017
    )
    
    
    251
    
    
    
    (2,110
    )
    
    
    (328
    )Net Earned Premiums
    
    $
    51,512
    
    
    $
    49,092
    
    
    $
    155,539
    
    
    $
    139,222
    9. SHARE REPURCHASE PROGRAM
   18




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 10. STOCK COMPENSATION PLANS
    19




---



##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 10. STOCK COMPENSATION PLANS (Continued)
  1998 Plan
    
    
    Omnibus PlanWeighted Average
    
    
    
    
    
    
    Weighted AverageNumber of Options
    
    
    Exercise Price
    
    
    Number of Options
    
    
    Exercise PriceOustanding 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
    
    
    $
    18.02Oustanding at January 1, 2009
    
    
    431,050
    
    
    $
    2.82
    
    
    
    932,188
    
    
    $
    17.93Granted during the period
    
    
    
    
    
    
    
    
    
    
    222,500
    
    
    
    13.04Forfeited during the period
    
    
    
    
    
    
    
    
    
    
    (42,000
    )
    
    
    16.71Exercised during the period
    
    
    (5,088
    )
    
    
    1.62
    
    
    
    
    
    
    
    Cancelled during the period
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Outstanding at September 30, 2009
    
    
    425,962
    
    
    $
    2.83
    
    
    
    1,112,688
    
    
    $
    17.00Exercisable at:September 30, 2008
    
    
    620,112
    
    
    $
    2.49
    
    
    
    152,566
    
    
    $
    18.80September 30, 2009
    
    
    425,962
    
    
    
    2.83
    
    
    
    447,793
    
    
    
    18.27
    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, 2009
    
    
    Contractual Life
    
    
    Share
    
    
    September 30, 2009
    
    
    Share1998 Plan$1.51 - $1.95
    
    
    314,037
    
    
    3.37 Years
    
    $
    1.71
    
    
    
    314,037
    
    
    $
    1.71$4.86 - $6.49
    
    
    111,925
    
    
    
    1.05
    
    
    
    5.97
    
    
    
    111,925
    
    
    
    5.97Total
    
    
    425,962
    
    
    
    2.76
    
    
    
    2.83
    
    
    
    425,962
    
    
    
    2.83Omnibus Plan$10.98 - $14.93
    
    
    361,000
    
    
    9.07 Years
    
    $
    13.69
    
    
    
    45,829
    
    
    $
    14.93$17.00 - $20.75
    
    
    751,688
    
    
    
    6.77
    
    
    
    18.59
    
    
    
    401,964
    
    
    
    18.65Total
    
    
    1,112,688
    
    
    
    7.52
    
    
    
    17.00
    
    
    
    447,793
    
    
    
    18.27
  20




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 10. STOCK COMPENSATION PLANS (Concluded)
  Nine Months EndedSeptember 30,2009
    
    2008Omnibus PlanExpected term
    
    
    6.0
    
    
    
    6.0Expected stock price volatility
    
    
    41.64
    %
    
    
    29.78
    %Risk-free interest rate
    
    
    2.22
    %
    
    
    3.12
    %Expected dividend yield
    
    
    0.08
    %
    
    
    Estimated fair value per option
    
    $
    5.57
    
    
    $
    5.79
   11. FAIR VALUE MEASUREMENTS
     21




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(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
    
    $
    573,011
    
    
    $
    3,922
    
    
    $
    569,089
    
    
    $
    Short-term investments
    
    
    10,754
    
    
    
    10,754
    
    
    
    
    
    
    
    Hybrid securities
    
    
    66,131
    
    
    
    
    
    
    
    66,131
    
    
    
    Alternative investments
    
    
    24,115
    
    
    
    
    
    
    
    11,814
    
    
    
    12,301Total
    
    $
    674,011
    
    
    $
    14,676
    
    
    $
    647,034
    
    
    $
    12,301
 22




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 11. FAIR VALUE MEASUREMENTS (Concluded)
  Three Months Ended
    
    
    Nine Months EndedSeptember 30, 2009
    
    
    September 30, 2009Level 3 investments, beginning of period
    
    $
    10,633
    
    
    $
    6,282Purchases
    
    
    
    
    
    
    2,000Transfer to Level 2
    
    
    (660
    )
    
    
    (660
    )Increase in market value
    
    
    2,328
    
    
    
    4,679Level 3 investments as of September 30, 2009
    
    $
    12,301
    
    
    $
    12,301
   23




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##### Table of Contents



FIRST MERCURY FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(Unaudited)
 12. ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
  September 30,2009
    
    
    2008(Dollars in thousands)Unrealized holding losses on securities having
credit losses recognized in the condensed consolidated
statements of income, net of tax
    
    $
    (1,782
    )
    
    $
    Unrealized holding gains (losses) on securities having no
credit losses recognized in the condensed consolidated
statements of income, net of tax
    
    
    20,163
    
    
    
    (6,559
    )Fair value of interest rate swaps, net of tax
    
    
    (2,075
    )
    
    
    (684
    )Total accumulated other comprehensive income (loss)
    
    $
    16,306
    
    
    $
    (7,243
    )
 13. INSURANCE REGULATION
  24




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##### Table of Contents



ITEM 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
   Overview
 ®
     25




---



##### Table of Contents



GAAP and Non-GAAP Financial Performance Metrics
   Gross written premiums.
 Net written premiums.
 Combined ratio.
 Critical Accounting Policies
  26




---



##### 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.
   27




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##### Table of Contents



September 30,
    
    
    December 31,2009
    
    
    2008(Dollars in thousands)GrossCase reserves
    
    $
    107,137
    
    
    $
    91,057IBNR and ULAE reserves
    
    
    341,128
    
    
    
    281,664Total reserves
    
    $
    448,265
    
    
    $
    372,721Net of reinsuranceCase reserves
    
    $
    73,651
    
    
    $
    62,497IBNR and ULAE reserves
    
    
    217,718
    
    
    
    181,672Total
    
    $
    291,369
    
    
    $
    244,169
 Revenue Recognition
 Premiums
 Commissions and Fees
 Investments
   Impairment of Investment Securities
  28




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##### Table of Contents



Deferred Policy Acquisition Costs
  Goodwill and Intangible Assets
   29




---



##### Table of Contents



Results of Operations
 Three Months Ended September 30, 2009 Compared to Three Months Ended September 30, 2008
  Three Months EndedSeptember 30,2009
    
    
    2008
    
    
    Change(Dollars in thousands)Operating RevenueNet earned premiums
    
    $
    51,512
    
    
    $
    49,092
    
    
    
    5
    %Commissions and fees
    
    
    7,445
    
    
    
    4,757
    
    
    
    57Net investment income
    
    
    7,540
    
    
    
    5,571
    
    
    
    35Net realized gains (losses) on investments
    
    
    13,766
    
    
    
    (7,128
    )
    
    
    293Other-than-temporary impairment losses on
investments
    
    
    (292
    )
    
    
    (3,476
    )
    
    
    92Total Operating Revenues
    
    
    79,971
    
    
    
    48,816
    
    
    
    64Operating ExpensesLosses and loss adjustment expenses, net
    
    
    30,345
    
    
    
    27,537
    
    
    
    10Amortization of intangible assets
    
    
    559
    
    
    
    553
    
    
    
    1Other operating expenses
    
    
    24,129
    
    
    
    19,797
    
    
    
    22Total Operating Expenses
    
    
    55,033
    
    
    
    47,887
    
    
    
    15Operating Income
    
    
    24,938
    
    
    
    929
    
    
    
    2,584Interest Expense
    
    
    1,275
    
    
    
    1,376
    
    
    
    (7
    )Income
(Loss) From Continuing Operations Before Income Taxes
    
    
    23,663
    
    
    
    (447
    )
    
    
    5,394Income Taxes
    
    
    8,018
    
    
    
    (948
    )
    
    
    946Income From Continuing Operations
    
    
    15,645
    
    
    
    501
    
    
    
    3,023Income
(Loss) From Discontinued Operations, Net of Income Taxes
    
    
    
    
    
    
    (447
    )
    
    
    n/mNet Income
    
    $
    15,645
    
    
    $
    54
    
    
    
    28,872
    %Loss Ratio
    
    
    58.9
    %
    
    
    56.1
    %
    
    2.8 pointsUnderwriting Expense Ratio
    
    
    33.6
    %
    
    
    30.2
    %
    

    3.4 pointsCombined Ratio
    
    
    92.5
    %
    
    
    86.3
    %
    
    6.2 points
 30




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##### Table of Contents



Operating Revenue
 Net Earned Premiums
 Three Months EndedSeptember 30,2009
    
    
    2008
    
    
    Change(Dollars in thousands)Written premiumsDirect
    
    $
    77,607
    
    
    $
    72,746
    
    
    
    7
    %Assumed
    
    
    4,201
    
    
    
    4,253
    
    
    
    (1
    )Ceded
    
    
    (35,483
    )
    
    
    (27,453
    )
    
    
    29Net written premiums
    
    $
    46,325
    
    
    $
    49,546
    
    
    
    (7
    )%Earned premiumsDirect
    
    $
    77,907
    
    
    $
    70,985
    
    
    
    10
    %Assumed
    
    
    4,529
    
    
    
    4,422
    
    
    
    2Ceded
    
    
    (29,907
    )
    
    
    (26,566
    )
    
    
    13Earned but
unbilled premiums
    
    
    (1,017
    )
    
    
    251
    
    
    
    (505
    )Net earned premiums
    
    $
    51,512
    
    
    $
    49,092
    
    
    
    5
    %
     31




---



##### Table of Contents



Commissions and Fees
 Three Months EndedSeptember 30,2009
    
    
    2008
    
    
    Change(Dollars in thousands)Insurance underwriting commissions and fees
    
    $
    1,272
    
    
    $
    (619
    )
    
    
    305
    %Insurance services commissions and fees
    
    
    6,173
    
    
    
    5,376
    
    
    
    15Total commissions and fees
    
    $
    7,445
    
    
    $
    4,757
    
    
    
    57
    %
  Net Investment Income and Realized Gains (Losses) on Investments
  Other-than-temporary Impairment Losses on Investments.
 Operating Expenses
 Losses and Loss Adjustment Expenses
 32




---



##### Table of Contents



Other Operating Expenses
 Three Months EndedSeptember 302009
    
    
    2008
    
    
    Change(Dollars in thousands)Amortization of deferred acquisition expenses
    
    $
    13,960
    
    
    $
    10,798
    
    
    
    29
    %Ceded reinsurance commissions
    
    
    (8,340
    )
    
    
    (7,164
    )
    
    
    16Other underwriting and operating expenses
    
    
    18,509
    
    
    
    16,163
    
    
    
    15Other operating expenses
    
    $
    24,129
    
    
    $
    19,797
    
    
    
    22
    %
  Interest Expense
 Income Taxes
 Discontinued Operations
 33




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##### Table of Contents



Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008
  Nine Months EndedSeptember 30,2009
    
    
    2008
    
    
    Change(Dollars in thousands)Operating RevenueNet earned premiums
    
    $
    155,539
    
    
    $
    139,222
    
    
    
    12
    %Commissions and fees
    
    
    23,916
    
    
    
    15,896
    
    
    
    50Net investment income
    
    
    21,105
    
    
    
    15,635
    
    
    
    35Net realized gains (losses) on investments
    
    
    25,204
    
    
    
    (8,714
    )
    
    
    389Other-than-temporary impairment losses on investments
    
    
    (426
    )
    
    
    (3,701
    )
    
    
    88Total Operating Revenues
    
    
    225,338
    
    
    
    158,338
    
    
    
    42Operating ExpensesLosses and loss adjustment expenses, net
    
    
    96,301
    
    
    
    76,713
    
    
    
    26Amortization of intangible assets
    
    
    1,709
    
    
    
    1,466
    
    
    
    17Other operating expenses
    
    
    69,808
    
    
    
    54,706
    
    
    
    28Total Operating Expenses
    
    
    167,818
    
    
    
    132,885
    
    
    
    26Operating Income
    
    
    57,520
    
    
    
    25,453
    
    
    
    126Interest Expense
    
    
    3,877
    
    
    
    4,490
    
    
    
    (14
    )Income
From Continuing Operations Before Income Taxes
    
    
    53,643
    
    
    
    20,963
    
    
    
    156Income Taxes
    
    
    17,707
    
    
    
    5,592
    
    
    
    217Income From Continuing Operations
    
    
    35,936
    
    
    
    15,371
    
    
    
    134Income
From Discontinued Operations, Net of Income Taxes
    
    
    
    
    
    
    23,106
    
    
    
    n/mNet Income
    
    $
    35,936
    
    
    $
    38,477
    
    
    
    (7
    )%Loss Ratio
    
    
    61.9
    %
    
    
    55.1
    %
    
    6.8 pointsUnderwriting Expense Ratio
    
    
    31.6
    %
    
    
    26.9
    %
    
4.7 pointsCombined Ratio
    
    
    93.5
    %
    
    
    82.0
    %
    
    11.5 points
 34




---



##### Table of Contents



Operating Revenue
 Net Earned Premiums
 Nine Months EndedSeptember 30,2009
    
    
    2008
    
    
    Change(Dollars in thousands)Written premiumsDirect
    
    $
    228,619
    
    
    $
    224,720
    
    
    
    2
    %Assumed
    
    
    13,588
    
    
    
    13,399
    
    
    
    1Ceded
    
    
    (92,615
    )
    
    
    (77,828
    )
    
    
    19Net written premiums
    
    $
    149,592
    
    
    $
    160,291
    
    
    
    (7
    )%Earned premiumsDirect
    
    $
    226,125
    
    
    $
    209,208
    
    
    
    8
    %Assumed
    
    
    13,276
    
    
    
    12,405
    
    
    
    7Ceded
    
    
    (81,752
    )
    
    
    (82,063
    )
    
    
    (0
    )Earned but unbilled premiums
    
    
    (2,110
    )
    
    
    (328
    )
    
    
    543Net earned premiums
    
    $
    155,539
    
    
    $
    139,222
    
    
    
    12
    %
     35




---



##### Table of Contents



Commissions and Fees
 Nine Months EndedSeptember 30,2009
    
    
    2008
    
    
    Change(Dollars in thousands)Insurance underwriting commissions and
fees
    
    $
    3,989
    
    
    $
    2,136
    
    
    
    87
    %Insurance services commissions and fees
    
    
    19,927
    
    
    
    13,760
    
    
    
    45Total commissions and fees
    
    $
    23,916
    
    
    $
    15,896
    
    
    
    50
    %
  Net Investment Income and Realized Gains (Losses) on Investments
  Other-than-temporary Impairment Losses on Investments.
 Operating Expenses
 Losses and Loss Adjustment Expenses
 36




---



##### Table of Contents



Other Operating Expenses
 Nine Months EndedSeptember 302009
    
    
    2008
    
    
    Change(Dollars in thousands)Amortization of deferred acquisition
expenses
    
    $
    40,889
    
    
    $
    28,107
    
    
    
    45
    %Ceded reinsurance commissions
    
    
    (24,767
    )
    
    
    (23,959
    )
    
    
    3Other underwriting and operating expenses
    
    
    53,686
    
    
    
    50,558
    
    
    
    6Other operating expenses
    
    $
    69,808
    
    
    $
    54,706
    
    
    
    28
    %
  Interest Expense
 Income Taxes
 Discontinued Operations
 Liquidity and Capital Resources
 Sources and Uses of Funds
 FMFC
 37




---



##### Table of Contents



Insurance Subsidiaries
  Non-insurance Subsidiaries
 Cash Flows
  Nine Months EndedSeptember 30,2009
    
    
    2008(Dollars in thousands)Cash and cash equivalents provided by (used in):Operating activities  continuing operations
    
    $
    66,606
    
    
    $
    91,712Operating activities  discontinued operations
    
    
    
    
    
    
    1,928Investing activities  continuing operations
    
    
    (72,513
    )
    
    
    (128,185
    )Investing activities  discontinued operations
    
    
    
    
    
    
    41,830Financing activities
    
    
    (9,721
    )
    
    
    (3,122
    )Change in cash and cash equivalents
    
    $
    (15,628
    )
    
    $
    4,163
      38




---



##### Table of Contents



Stockholders Equity
  September 30,
    
    
    December 31,2009
    
    
    2008(Dollars in thousands, except share and per share data)Total stockholders equity
    
    $
    307,472
    
    
    $
    261,637Intangible assets, net
    
    
    (37,642
    )
    
    
    (39,351
    )Deferred tax liability  intangible assets, net
    
    
    12,801
    
    
    
    13,399Goodwill
    
    
    (25,483
    )
    
    
    (25,483
    )Tangible stockholders equity attributable to common shareholders
    
    $
    257,148
    
    
    $
    210,202Common shares outstanding
    
    
    17,174,906
    
    
    
    17,836,337Book value per share
    
    $
    17.90
    
    
    $
    14.67Tangible book value per share
    
    $
    14.97
    
    
    $
    11.79
  Long-term debt
 Junior Subordinated Debentures
 Credit Facility
 39




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##### Table of Contents



Derivative Financial Instruments
 Cash and Invested Assets
  Market Value
    
    
    % of Portfolio(Dollars in thousands)Short Term Investments
    
    $
    10,754
    
    
    
    1.6
    %U.S. Treasuries
    
    
    3,922
    
    
    
    0.6
    %U.S. Agencies
    
    
    1,028
    
    
    
    0.2
    %Municipal Bonds
    
    
    197,257
    
    
    
    29.2
    %Taxable Municipal Bonds
    
    
    3,445
    
    
    
    0.5
    %Corporate Bonds
    
    
    129,254
    
    
    
    19.2
    %High Yield Bonds
    
    
    19,275
    
    
    
    2.9
    %MBS Passthroughs
    
    
    61,532
    
    
    
    9.1
    %CMOs
    
    
    74,226
    
    
    
    11.0
    %Asset Backed Securities
    
    
    22,875
    
    
    
    3.4
    %Commercial MBS
    
    
    58,924
    
    
    
    8.7
    %Convertible Securities
    
    
    66,131
    
    
    
    9.8
    %High Yield Convertible Fund
    
    
    12,301
    
    
    
    1.8
    %Structured Finance Fund
    
    
    11,814
    
    
    
    1.8
    %Preferred Stocks
    
    
    1,273
    
    
    
    0.2
    %Common Stocks
    
    
    
    
    
    
    0.0
    %Total
    
    $
    674,011
    
    
    
    100.0
    %
  40




---



##### Table of Contents



% of TotalAverage Life
    
    InvestmentLess than one year
    
    
    15.2
    %One to two years
    
    
    13.5
    %Two to three years
    
    
    15.6
    %Three to four years
    
    
    15.5
    %Four to five years
    
    
    13.6
    %Five to seven years
    
    
    11.1
    %More than seven years
    
    
    15.5
    %Total
    
    
    100.0
    %
   % of TotalS&P Rating
    
    InvestmentsAAA
    
    
    47.6
    %AA
    
    
    14.6
    %A
    
    
    14.8
    %BBB
    
    
    12.9
    %BB
    
    
    5.7
    %B
    
    
    1.7
    %CCC
    
    
    2.7
    %C
    
    
    0.0
    %NR
    
    
    0.0
    %Total
    
    
    100.0
    %
    41




---



##### Table of Contents



Gross UnrealizedAmortized Cost
    
    
    Gains
    
    
    Losses
    
    
    Market Value(Dollars in thousands)Debt SecuritiesU.S. government securities
    
    $
    3,776
    
    
    $
    146
    
    
    $
    
    
    
    $
    3,922Government agency mortgage-backed securities
    
    
    101,160
    
    
    
    4,491
    
    
    
    (8
    )
    
    
    105,643Government agency obligations
    
    
    989
    
    
    
    39
    
    
    
    
    
    
    
    1,028Collateralized mortgage obligations and other
asset-backed securities
    
    
    109,734
    
    
    
    5,176
    
    
    
    (2,996
    )
    
    
    111,914Obligations of states and political subdivisions
    
    
    189,101
    
    
    
    11,661
    
    
    
    (60
    )
    
    
    200,702Corporate bonds
    
    
    137,912
    
    
    
    11,317
    
    
    
    (700
    )
    
    
    148,529Total Debt Securities
    
    
    542,672
    
    
    
    32,830
    
    
    
    (3,764
    )
    
    
    571,738Preferred stocks
    
    
    1,416
    
    
    
    50
    
    
    
    (193
    )
    
    
    1,273Short-term investments
    
    
    10,754
    
    
    
    
    
    
    
    
    
    
    
    10,754Total
    
    $
    554,842
    
    
    $
    32,880
    
    
    $
    (3,957
    )
    
    $
    583,765
  42




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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
    
    
    1,680
    
    
    
    (1
    )
    
    
    194
    
    
    
    (7
    )Government agency obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Collateralized mortgage obligations and other
asset-backed securities
    
    
    6,351
    
    
    
    (262
    )
    
    
    14,157
    
    
    
    (2,734
    )Obligations of states and political
subdivisions
    
    
    
    
    
    
    
    
    
    
    3,645
    
    
    
    (60
    )Corporate bonds
    
    
    1,252
    
    
    
    (1
    )
    
    
    8,542
    
    
    
    (699
    )Total Debt Securities
    
    
    9,283
    
    
    
    (264
    )
    
    
    26,538
    
    
    
    (3,500
    )Preferred Stocks
    
    
    
    
    
    
    
    
    
    
    313
    
    
    
    (193
    )Total
    
    $
    9,283
    
    
    $
    (264
    )
    
    $
    26,851
    
    
    $
    (3,693
    )
  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
    
    
    3,902
    
    
    
    (37
    )
    
    
    326
    
    
    
    (2
    )Government agency obligations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Collateralized mortgage obligations and other
asset-backed securities
    
    
    48,125
    
    
    
    (5,143
    )
    
    
    5,963
    
    
    
    (1,944
    )Obligations of states and political
subdivisions
    
    
    14,063
    
    
    
    (427
    )
    
    
    8,809
    
    
    
    (267
    )Corporate bonds
    
    
    42,402
    
    
    
    (2,549
    )
    
    
    12,824
    
    
    
    (1,325
    )Total Debt Securities
    
    
    108,492
    
    
    
    (8,156
    )
    
    
    27,922
    
    
    
    (3,538
    )Preferred Stocks
    
    
    832
    
    
    
    (78
    )
    
    
    216
    
    
    
    (289
    )Total
    
    $
    109,324
    
    
    $
    (8,234
    )
    
    $
    28,138
    
    
    $
    (3,827
    )
  43




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##### Table of Contents



Amount ofUnrealized Loss atSector
    
    September 30, 2009(Dollars in thousands)Short Term Investments
    
    $
    U.S. Treasuries
    
    
    U.S. Agencies
    
    
    Municipal Bonds
    
    
    (60
    )Taxable Municipal Bonds
    
    
    Corporate Bonds
    
    
    (700
    )High Yield Bonds
    
    
    MBS Passthroughs
    
    
    (23
    )CMOs
    
    
    (1,339
    )Asset Backed Securities
    
    
    (631
    )Commercial MBS
    
    
    (1,011
    )Convertible Securities
    
    
    High Yield Convertible Fund
    
    
    Structured Finance Fund
    
    
    Preferred Stocks
    
    
    (193
    )Common Stocks
    
    
    $
    (3,957
    )
   % 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
    
    
    19.0
    %
    
    $
    7,615
    
    
    $
    1,859
    
    
    
    24.4
    %
    
    
    98.7
    %Investment Grade
    
    
    81.0
    
    
    
    32,477
    
    
    
    2,098
    
    
    
    6.5
    
    
    
    88.5Total
    
    
    100.0
    %
    
    $
    40,092
    
    
    $
    3,957
    
    
    
    9.9
    %
    
    
    93.3
    %
   44




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##### Table of Contents



Deferred Policy Acquisition Costs
  Reinsurance
  Nine Months EndedSeptember 30,2009
    
    
    2008(Dollars in thousands)Direct written premiums
    
    $
    228,619
    
    
    $
    224,720Ceded written premiums
    
    
    92,615
    
    
    
    77,828Net written premiums
    
    $
    136,004
    
    
    $
    146,892Ceded written premiums as percentage of
direct written premiums
    
    
    40.5
    %
    
    
    34.6
    %
  Nine Months EndedSeptember 30,2009
    
    
    2008(Dollars in thousands)Ceded written premiums
    
    $
    92,615
    
    
    $
    77,828Ceded premiums earned
    
    
    81,752
    
    
    
    82,063Losses and loss adjustment expenses ceded
    
    
    59,604
    
    
    
    46,536Ceding commissions
    
    
    21,897
    
    
    
    27,470
 45




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##### Table of Contents



Recent Accounting Pronouncements
 Generally Accepted Accounting Principles Accounting Standards Codification
    46




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##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk
  
 Item 4. Controls and Procedures
  47




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##### Table of Contents



PART II.  OTHER INFORMATION
 
 Item 1. Legal Proceedings
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
   Maximum Number (orTotal Number of
    
    Approximate DollarShares (or Units)
    
    Value) of SharesPurchased as Part
    
    (or Units) that MayTotal Number of
    
    Average Price as
    
    of Publicly
    
    Yet Be PurchasedShares (or Units)
    
    Paid per Share (or
    
    Announced Plans or
    
    Under the Plan orMonth
    
    Purchased
    
    Unit)
    
    Programs
    
    ProgramsJuly
    
    
    118,740
    
    
    $
    13.86
    
    
    
    118,740
    
    
    
    294,925August
    
    
    294,925
    
    
    
    12.74
    
    
    
    294,925
    
    
    
    September
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    413,665
    
    
    $
    13.06
    
    
    
    413,665
    
    
    
    =
 
 Item 6. Exhibits
  48




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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 Officer  49




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##### Table of Contents



INDEX OF EXHIBITS
 ExhibitNumber
    
    Note
    
    Description10.34*
    
    
    (1
    )
    
    Employment Letter from First
Mercury Financial Corporation to Terrance A. Fleckenstein dated June
27, 200831 (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*
    
     Management contract or compensation plan or arrangement. 50