##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from                      to
 Commission file number 000-50795
 AFFIRMATIVE INSURANCE HOLDINGS, INC.
 (Exact name of registrant as specified in its charter)
 Delaware(State of other jurisdiction of 
incorporation or organization)
    
    75-2770432(I.R.S. Employer
Identification No.)4450 Sojourn Drive, Suite 500
Addison, Texas(Address of principal executive offices)
    
    75001(Zip Code)
 (972) 728-6300
 (Registrants telephone number, including area code)
 Not Applicable
 (Former name, former address and former fiscal year, if changed since last report)
 þ o
  o þ o
 o þ




---



##### 



Affirmative Insurance Holdings, Inc.
Index
 Part I  Financial Information
    
    
    3Item 1. Financial Statements
    
    
    3Consolidated Balance Sheets
    
    
    3Consolidated Statements of Operations (Unaudited)
    
    
    4Consolidated Statements of Stockholders Equity and Comprehensive Income (Loss)
(Unaudited)
    
    
    5Consolidated Statements of Cash Flows (Unaudited)
    
    
    6Notes to Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    26Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    45Item 4. Controls and Procedures
    
    
    46PART II  Other Information
    
    
    47Item 1. Legal Proceedings
    
    
    47Item 1A. Risk Factors
    
    
    49Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    49Item 3. Defaults Upon Senior Securities
    
    
    49Item 4. Submission of Matters to a Vote of Security Holders
    
    
    49Item 5. Other Information
    
    
    50Item 6. Exhibits
    
    
    50SIGNATURES
    
    
    51Certification of Kevin R. Callahan, CEO, Pursuant to Section 302Certification of Mark E. Pape, CFO, Pursuant to Section 302Certification of Kevin R. Callahan, CEO, Pursuant to Section 906Certification of Mark E. Pape, CFO, Pursuant to Section 906
  2




---



##### Table of Contents



Part I  Financial Information
 
 Item 1. Financial Statements
 
 Affirmative Insurance Holdings, Inc.
Consolidated Balance Sheets
June 30, 2007 and December 31, 2006
 June 30,
    
    
    December 31,(dollars in thousands, except share data)
    
    2007
    
    
    2006(unaudited)AssetsFixed maturities  available for sale, at fair value (amortized cost 2007: $342,824; 2006: $220,649)
    
    $
    341,134
    
    
    $
    219,960Short-term investments
    
    
    13,468
    
    
    
    1,810Total invested assets
    
    
    354,602
    
    
    
    221,770Cash and cash equivalents
    
    
    81,881
    
    
    
    52,484Fiduciary and restricted cash
    
    
    23,494
    
    
    
    35,582Accrued investment income
    
    
    4,163
    
    
    
    1,837Premiums and fees receivable
    
    
    84,992
    
    
    
    78,307Premium finance receivable, net
    
    
    38,630
    
    
    
    Commissions receivable
    
    
    1,890
    
    
    
    909Receivable from reinsurers
    
    
    78,201
    
    
    
    24,795Deferred acquisition costs
    
    
    30,558
    
    
    
    23,865Deferred tax asset
    
    
    8,163
    
    
    
    8,880Federal income taxes receivable
    
    
    13,772
    
    
    
    7,153Investment in real property, net
    
    
    6,022
    
    
    
    Property and equipment, net
    
    
    19,728
    
    
    
    10,289Goodwill
    
    
    163,635
    
    
    
    65,288Other intangible assets, net
    
    
    25,983
    
    
    
    18,155Other assets, net of allowance for doubtful accounts of: 2007 and 2006: $7,213
    
    
    15,175
    
    
    
    7,953Total assets
    
    $
    950,889
    
    
    $
    557,267Liabilities and Stockholders EquityLiabilitiesReserves for losses and loss adjustment expenses
    
    
    241,324
    
    
    
    162,569Unearned premium
    
    
    148,918
    
    
    
    92,124Amounts due reinsurers
    
    
    
    
    
    
    5,089Deferred revenue
    
    
    11,733
    
    
    
    7,877Senior secured credit facility
    
    
    199,000
    
    
    
    Notes payable
    
    
    76,941
    
    
    
    56,702Capital lease obligation
    
    
    69
    
    
    
    Consideration due for acquisitions
    
    
    1,023
    
    
    
    1,023Other liabilities
    
    
    62,265
    
    
    
    25,490Total liabilities
    
    
    741,273
    
    
    
    350,874Commitments and contingencies (Note 8)Stockholders equityCommon stock, $0.01 par value; 75,000,000 shares authorized, 17,726,811 shares issued
and 15,373,448 shares outstanding at June 30, 2007; 17,707,938 shares issued
and 15,354,575 outstanding at December 31, 2006
    
    
    177
    
    
    
    177Additional paid-in capital
    
    
    161,589
    
    
    
    160,862Treasury stock, at cost; 2,353,363 shares at June 30, 2007 and December 31, 2006
    
    
    (32,880
    )
    
    
    (32,880
    )Accumulated other comprehensive income (loss)Net unrealized depreciation on investment securities
    
    
    (1,098
    )
    
    
    (448
    )Net gain on cash flow hedge
    
    
    395
    
    
    
    Retained earnings
    
    
    81,433
    
    
    
    78,682Total stockholders equity
    
    
    209,616
    
    
    
    206,393Total liabilities and stockholders equity
    
    $
    950,889
    
    
    $
    557,267
 See accompanying Notes to Consolidated Financial Statements
 3




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Consolidated Statements of Operations (Unaudited)
Three and Six Months Ended June 30, 2007 and 2006
 Three months ended
    
    
    Six months endedJune 30,
    
    
    June 30,(dollars in thousands, except per share data)
    
    2007
    
    
    2006
    
    
    2007
    
    
    2006RevenuesNet premiums earned
    
    $
    113,257
    
    
    $
    73,753
    
    
    $
    196,027
    
    
    $
    146,791Commission income and fees
    
    
    23,287
    
    
    
    14,552
    
    
    
    46,670
    
    
    
    32,051Net investment income
    
    
    4,039
    
    
    
    2,154
    
    
    
    8,000
    
    
    
    4,214Net realized gains (losses)
    
    
    (322
    )
    
    
    1
    
    
    
    (491
    )
    
    
    (366
    )Total revenues
    
    
    140,261
    
    
    
    90,460
    
    
    
    250,206
    
    
    
    182,690ExpensesLosses and loss adjustment expenses
    
    
    81,900
    
    
    
    47,081
    
    
    
    139,852
    
    
    
    94,733Selling, general and administrative expenses
    
    
    47,912
    
    
    
    34,194
    
    
    
    86,537
    
    
    
    66,795Depreciation and amortization
    
    
    2,810
    
    
    
    1,059
    
    
    
    6,098
    
    
    
    2,119Interest expense
    
    
    6,284
    
    
    
    1,086
    
    
    
    12,916
    
    
    
    2,171Total expenses
    
    
    138,906
    
    
    
    83,420
    
    
    
    245,403
    
    
    
    165,818Net income before income taxes and minority interest
    
    
    1,355
    
    
    
    7,040
    
    
    
    4,803
    
    
    
    16,872Income tax expense
    
    
    237
    
    
    
    2,156
    
    
    
    1,439
    
    
    
    5,676Minority interest, net of income taxes
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    81Net income
    
    $
    1,118
    
    
    $
    4,884
    
    
    $
    3,364
    
    
    $
    11,115Net income per common share  Basic
    
    $
    0.07
    
    
    $
    0.32
    
    
    $
    0.22
    
    
    $
    0.72Net income per common share  Diluted
    
    $
    0.07
    
    
    $
    0.32
    
    
    $
    0.22
    
    
    $
    0.72Weighted average shares outstandingBasic
    
    
    15,368,173
    
    
    
    15,321,771
    
    
    
    15,363,139
    
    
    
    15,376,858Diluted
    
    
    15,436,110
    
    
    
    15,359,005
    
    
    
    15,451,233
    
    
    
    15,414,733
 See accompanying Notes to Consolidated Financial Statements
 4




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Consolidated Statements of Stockholders Equity and Comprehensive Income (Loss) (Unaudited)
Six Months Ended June 30, 2007 and 2006
 AccumulatedAdditional
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other
    
    
    TotalCommon Stock Issued
    
    
    Paid-in
    
    
    Retained
    
    
    Treasury Stock
    
    
    Comprehensive
    
    
    Stockholders(dollars in thousands, except share data)
    
    Shares
    
    
    Amount
    
    
    Capital
    
    
    Earnings
    
    
    Shares
    
    
    Amount
    
    
    Income (Loss)
    
    
    EquityBalance, December 31, 2005
    
    
    17,483,520
    
    
    $
    175
    
    
    $
    158,904
    
    
    $
    70,158
    
    
    
    2,050,963
    
    
    $
    (28,746
    )
    
    $
    (529
    )
    
    $
    199,962Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,115
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,115Other
comprehensive income (loss)Net unrealized depreciation on
investment securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (268
    )
    
    
    (268
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,847Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    302,400
    
    
    
    (4,134
    )
    
    
    
    
    
    
    (4,134
    )Dividends
declared ($.02 per share per quarter)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (612
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (612
    )Issuance of common stock
    
    
    8,225
    
    
    
    
    
    
    
    100
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100Equity based compensation
    
    
    
    
    
    
    
    
    
    
    314
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    314Balance, June 30, 2006
    
    
    17,491,745
    
    
    $
    175
    
    
    $
    159,318
    
    
    $
    80,661
    
    
    
    2,353,363
    
    
    $
    (32,880
    )
    
    $
    (797
    )
    
    $
    206,477Balance, December 31, 2006
    
    
    17,707,938
    
    
    $
    177
    
    
    $
    160,862
    
    
    $
    78,682
    
    
    
    2,353,363
    
    
    $
    (32,880
    )
    
    $
    (448
    )
    
    $
    206,393Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,364
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,364Other comprehensive income (loss)Net unrealized depreciation on
investment securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (650
    )
    
    
    (650
    )Net gain on cash flow hedge
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    395
    
    
    
    395Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,109Dividends ($.02 per share per quarter)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (613
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (613
    )Issuance of restricted stock
    
    
    7,273
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Issuance of common stock
    
    
    11,600
    
    
    
    
    
    
    
    175
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175Equity based compensation
    
    
    
    
    
    
    
    
    
    
    552
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    552Balance, June 30, 2007
    
    
    17,726,811
    
    
    $
    177
    
    
    $
    161,589
    
    
    $
    81,433
    
    
    
    2,353,363
    
    
    $
    (32,880
    )
    
    $
    (703
    )
    
    $
    209,616
 See accompanying Notes to Consolidated Financial Statements
 5




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Consolidated Statements of Cash Flows (Unaudited)
Six Months Ended June 30, 2007 and 2006
 Six months endedJune 30,(dollars in thousands)
    
    2007
    
    
    2006Cash flows from operating activitiesNet income
    
    $
    3,364
    
    
    $
    11,115Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation and amortization
    
    
    6,098
    
    
    
    2,119Equity based compensation
    
    
    552
    
    
    
    346Amortization of debt acquisition cost
    
    
    420
    
    
    
    Realized loss on sale of assets
    
    
    491
    
    
    
    366Amortization of premiums and discounts on investments
    
    
    1,104
    
    
    
    725Changes in assets and liabilities:Fiduciary and restricted cash
    
    
    12,208
    
    
    
    (3,266
    )Premiums and commissions receivable
    
    
    (7,666
    )
    
    
    (6,920
    )Reserves for loss and loss adjustment expenses
    
    
    7,233
    
    
    
    9,477Net due to/from reinsurers
    
    
    25,050
    
    
    
    (4,531
    )Premium finance contracts
    
    
    (1,360
    )
    
    
    Deferred revenue
    
    
    (4,988
    )
    
    
    19Unearned premiums
    
    
    11,331
    
    
    
    5,422Deferred acquisition costs
    
    
    (6,693
    )
    
    
    (2,491
    )Deferred tax asset
    
    
    8,349
    
    
    
    1,315Federal income taxes receivable/payable
    
    
    (6,644
    )
    
    
    3,051Other
    
    
    8,663
    
    
    
    (5,156
    )Net cash provided by operating activities
    
    
    57,512
    
    
    
    11,591Cash flows from investing activitiesProceeds from the sale and maturities of bonds
    
    
    90,577
    
    
    
    229,661Cost of bonds acquired
    
    
    (126,108
    )
    
    
    (254,158
    )Purchases of property and equipment
    
    
    (7,847
    )
    
    
    (1,533
    )Net cash paid for acquisitions
    
    
    (176,677
    )
    
    
    (4,160
    )Net cash used in investing activities
    
    
    (220,055
    )
    
    
    (30,190
    )Cash flows from financing activitiesPrincipal payments under capital lease obligation
    
    
    (93
    )
    
    
    Proceeds from borrowings
    
    
    200,000
    
    
    
    Principal payments on senior secured credit facility
    
    
    (1,000
    )
    
    
    Principal payments on note payable
    
    
    (11
    )
    
    
    Debt acquisition costs
    
    
    (6,518
    )
    
    
    Acquisition of treasury stock
    
    
    
    
    
    
    (4,134
    )Proceeds from issuance of common stock
    
    
    175
    
    
    
    100Dividends paid
    
    
    (613
    )
    
    
    (309
    )Net cash
provided by (used in) by financing activities
    
    
    191,940
    
    
    
    (4,343
    )Net increase (decrease) in cash and cash equivalents
    
    
    29,397
    
    
    
    (22,942
    )Cash and cash equivalents, beginning of period
    
    
    52,484
    
    
    
    48,037Cash and cash equivalents, end of period
    
    $
    81,881
    
    
    $
    25,095
 See accompanying Notes to Consolidated Financial Statements
 6




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements
 1.
    
    GeneralAffirmative Insurance Holdings, Inc. is an insurance holding company engaged in underwriting,
servicing and distributing non-standard automobile insurance policies and related products and
services to individual consumers in targeted geographic areas. Our subsidiaries include five
insurance companies, four underwriting agencies, six retail agencies with 238 owned retail
locations (22 of which are located in leased space within supermarkets owned by a major
supermarket chain under an agreement signed in late 2005) and 35
operating franchise retail store
locations as of June 30, 2007. Our underwriting agencies utilize approximately 3,500
independent agencies to sell the policies that they administer. In addition, we have
relationships with two unaffiliated underwriting agencies in
California producing new business for our insurance
companies through approximately 4,200 independent agencies. We are currently active in
offering insurance products and services through retail stores in 10 states (Louisiana,
Illinois, Texas, Missouri, Indiana, South Carolina, Florida, Kansas, Wisconsin and Alabama)
and distributing our own insurance policies through independent
agents in 8 states (Illinois,
Texas, Missouri, Indiana, South Carolina, Florida, Michigan and New Mexico). Our
growth has been achieved principally as a result of the acquisition and integration of retail
and/or underwriting agencies and insurance companies. We were formerly known as Instant
Insurance Holdings, Inc. and we incorporated in Delaware on June 25, 1998.On January 31, 2007, we completed the acquisition of USAgencies L.L.C. (USAgencies) in a
fully-financed all cash transaction valued at approximately $199.4 million. USAgencies is a
non-standard automobile insurance distributor and provider headquartered in Baton Rouge,
Louisiana. At the time of acquisition, it had 91 operating retail sales locations in
Louisiana, Illinois and Alabama selling its products directly to consumers through its owned
retail stores, virtual call centers and internet site. The acquisition gives us a leading
market position in Louisiana, the 12th largest non-standard personal automobile
insurance market. The transaction became effective as of January 1, 2007 for accounting
purposes (See Note 5).We completed the initial public offering of our common stock effective July 9, 2004. We
issued 4,420,000 additional shares of our common stock and Vesta Insurance Group, Inc. (VIG)
sold 3,750,000 shares of our common stock that it owned, at an initial public offering price
of $14.00 per share. On July 26, 2004, our underwriters exercised their option to purchase an
additional 663,000 shares from us, and an additional 562,500 shares from VIG. On June 1,
2005, we purchased 2,000,000 of our shares of common stock from VIG at a price of $14.00 per
share. In May and June, 2006, we purchased 302,400 shares of our common stock in open market
purchases at an average price of $13.67 per share.On June 14, 2005, VIG and Vesta Fire Insurance Corporation (VFIC) entered into a stock
purchase agreement with New Affirmative LLC (New Affirmative), J.C. Flowers I LP and
Delaware Street Capital Master Fund for the sale by VIG and VFIC of 5,218,228 shares of our
common stock (Stock Purchase Agreement). New Affirmative was formed for the purpose of
acquiring, holding, voting and disposing of the shares of our common stock acquired in
connection with the Stock Purchase Agreement and any shares of our common stock that New
Affirmative may acquire in the future. At the time of the agreement, New Affirmative was (i)
50% owned by DSC AFFM, LLC (DSC AFFM), an entity controlled by DSC AFFM Manager LLC (DSC
Manager), the sole managing member of DSC AFFM, and Andrew G. Bluhm, the managing member of
DSC Manager, and (ii) 50% owned by Affirmative Investment LLC (Affirmative Investment), an
entity owned, in part, by the Enstar Group, Inc., and controlled by Affirmative Associates LLC
(Affirmative Associates), the sole managing member of Affirmative Investment, and J.
Christopher Flowers, the sole member and manager of Affirmative Associates. Simultaneously
with the closing of the transactions contemplated by the Stock Purchase Agreement: (1) DSC
AFFM contributed 1,459,699 shares of our common stock that were previously acquired in open
market transactions by members of DSC AFFM and subsequently contributed to DSC AFFM, to New
Affirmative and (2) Affirmative Investment contributed 1,183,000 shares of our common stock,
previously acquired by it in open market transactions, to New Affirmative. VIG completed the
sale to New Affirmative on August 30, 2005.On August 31, 2006, DSC AFFM and Affirmative Investment consummated the transactions
contemplated by a purchase agreement dated August 4, 2006, pursuant to which DSC AFFM sold to
Affirmative Investment all
 7




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 of the membership units of New Affirmative owned by DSC AFFM. As a result, Affirmative
Investment now owns 100% of New Affirmative. As of June 30, 2007, New Affirmative owned
7,860,927 shares, or approximately 51.2%, of our outstanding common stock.2.
    
    Summary of Significant Accounting PoliciesBasis of PresentationOur unaudited consolidated financial statements included herein have been prepared in
accordance with U.S. generally accepted accounting principles (GAAP) and include our
accounts and the accounts of our operating subsidiaries. All intercompany accounts and
transactions have been eliminated in consolidation. Certain information and footnote
disclosures normally included in financial statements prepared in accordance with GAAP have
been condensed or omitted pursuant to rules and regulations of the Securities and Exchange
Commission (SEC) for interim financial reporting. These financial statements should be read
in conjunction with the audited financial statements and notes thereto for the year ended
December 31, 2006 included in the reports on the Form 10-K filed with the SEC on March 16,
2007 and the Form 8-K/A filed with the SEC on April 17, 2007.The interim financial data as of June 30, 2007 and 2006 is unaudited; however, in our opinion,
the interim data includes all adjustments, consisting only of normal recurring adjustments,
necessary for a fair statement of the results for the interim periods.Use of Estimates in the Preparation of the Financial StatementsOur preparation of financial statements in conformity with GAAP requires us to make estimates
and assumptions that affect our reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of our financial statements and our reported
amounts of revenues and expenses during the reporting period. Actual results could differ
materially from those estimates. These estimates and assumptions are particularly important
in determining revenue recognition, reserves for losses and loss adjustment expenses, deferred
policy acquisition costs, reinsurance receivables and impairment of assets.Recently Issued Accounting StandardsIn February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial
Instruments  an amendment of FASB Statements No. 133 and 140(SFAS 155), which permits
the fair value remeasurement of any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation under SFAS No. 133, Accounting for
Derivative Instruments and Hedging Activities(SFAS 133); clarifies which interest-only
strips and principal-only strips are not subject to the requirements of SFAS 133; establishes
a requirement to evaluate interests in securitized financial assets to identify interests that
are freestanding derivatives or hybrid financial instruments that contain an embedded
derivative requiring bifurcation and clarifies that concentrations of credit risk in the form
of subordination are not embedded derivatives. All securities acquired on or after January
1, 2007 must be accounted for in accordance with the new guidance. The adoption of SFAS 155
did not have a material impact on our consolidated financial statements.In July 2006, FASB Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes 
An Interpretation of FASB Statement No. 109(FIN 48), was issued. FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprises financial statements
with FASB Statement No. 109, Accounting for Income Taxes. FIN 48 also prescribes a
recognition threshold and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return, as well as
providing guidance on derecognition, classification, interest and penalties, accounting in
interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning
after December 15, 2006 with earlier application permitted as long as the enterprise has not
yet issued financial statements, including interim financial statements, in the period of
adoption. We adopted the provisions of FIN 48 on January 1, 2007. As a result, we recognized
no additional liability or reduction in deferred tax asset for unrecognized tax benefits. We
are no longer subject to U. S. federal, state, local or non-U.S. income tax
 8




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 examinations by tax authorities for years prior to 2003.In September 2006, the FASB issued Statement No. 157, Fair Value Measurements(SFAS 157),
which defines fair value, establishes a framework for measuring fair value in GAAP and expands
disclosures about fair value measurements. This statement applies under other accounting
pronouncements that require or permit fair value measurements, the FASB having previously
concluded in those accounting pronouncements that fair value is the relevant measurement
attribute. Accordingly, this statement does not require any new fair value measurements.
SFAS 157 is effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. Earlier application is
encouraged, provided that the reporting entity has not yet issued financial statements for the
fiscal year, including financial statements for an interim period within that fiscal year. We
have not evaluated the requirements of SFAS 157 and have not yet determined if SFAS 157 will
have a material impact on our future financial statements.In February 2007, the FASB issued Statement No. 159, Establishing the Fair Value Option for
Financial Assets and Liabilities(SFAS 159), which includes an amendment to FASB No. 115,
Accounting for Certain Investments in Debt and Equity Securities(SFAS 115). SFAS 159
permits entities to choose to measure many financial instruments and certain other items at
fair value. The objective is to improve financial reporting by providing entities with the
opportunity to mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting provisions. This
statement is expected to expand the use of fair value measurement, which is consistent with
the FASBs long-term measurement objectives for accounting for financial instruments. This
statement applies to all entities and most of the provisions of this statement apply only to
entities that elect the fair value option. However, the amendment to FAS 115 applies to all
entities with available-for-sale and trading securities. SFAS 159 is effective for fiscal
years beginning after November 15, 2007, with early adoption permitted for an entity that has
also elected to apply the provisions of SFAS 157, Fair Value Measurements. An entity is
prohibited from retrospectively applying SFAS 159, unless it chooses early adoption. SFAS 159
also applies to eligible items existing at November 15, 2007 (or early adoption). We have not
evaluated the requirements of SFAS 159 and have not yet determined if SFAS 159 will have a
material impact on our future financial statements.3.
    
    ReinsuranceThe effect of reinsurance on premiums written and earned is as follows (dollars in thousands):
 9




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 Three months ended
    
    
    Three months endedJune 30, 2007
    
    
    June 30, 2006Written
    
    
    Earned
    
    
    Written
    
    
    EarnedDirect
    
    $
    87,004
    
    
    $
    74,649
    
    
    $
    45,581
    
    
    $
    45,232Assumed
    
    
    15,149
    
    
    
    17,937
    
    
    
    20,150
    
    
    
    29,174Ceded
    
    
    27,564
    
    
    
    20,671
    
    
    
    2,389
    
    
    
    (653
    )$
    129,717
    
    
    $
    113,257
    
    
    $
    68,120
    
    
    $
    73,753
 Six months ended
    
    
    Six months endedJune 30, 2007
    
    
    June 30, 2006Written
    
    
    Earned
    
    
    Written
    
    
    EarnedDirect
    
    $
    210,043
    
    
    $
    172,797
    
    
    $
    99,369
    
    
    $
    86,832Assumed
    
    
    35,263
    
    
    
    36,364
    
    
    
    55,111
    
    
    
    62,228Ceded
    
    
    (13,477
    )
    
    
    (13,134
    )
    
    
    698
    
    
    
    (2,269
    )$
    231,829
    
    
    $
    196,027
    
    
    $
    155,178
    
    
    $
    146,791
 Through the acquisition of USAgencies, we acquired two additional insurance companies,
USAgencies Casualty Insurance Company (Casualty), a Louisiana-domiciled insurer, and
USAgencies Direct Insurance Company (Direct), a New York-domiciled carrier, issuing policies
in Illinois and Alabama. Casualty and Direct had entered into significant quota share
reinsurance contracts with GMAC Reinsurance (GMAC) and had been dependent upon these
reinsurance contracts in order to continue to write and finance their historical level of
insurance premiums. The quota share reinsurance contracts in existence at the time of
acquisition for Casualtys Louisiana and Directs Illinois business were originally in effect
through 2008. Directs Alabama business was covered under a quota share reinsurance contract
through 2007.In connection with the completion of the acquisition of USAgencies, their reinsurance program
was re-evaluated in light of the capital structure and risk management programs of the larger
combined operations of Affirmative. As a result, terms were re-negotiated with GMAC and a new
quota share reinsurance agreement was made effective April 1, 2007, under which the net
retention increased from 30% to 75% (in Louisiana) and from 25% to 75% (in Alabama) on
policies issued in those two states by Affirmative Insurance Company (AIC), Casualty or
Direct. Concurrently, we exercised our option to terminate the prior GMAC quota share
contracts on a cut-off basis. Further, Casualty has been made a party to the intercompany
reinsurance arrangement by which all premiums on policies written by Casualty since January 1,
2007, that are not specifically ceded to any other reinsurer will be ceded to AIC. As a
result, Casualty will have no net written premium subsequent to January 1, 2007. A new
catastrophe excess of loss reinsurance contract for risks in Alabama and Louisiana was also
negotiated and became effective April 1, 2007.Direct and Casualty have received ceding commissions from GMAC. The quota share ceding
commission rate structure varies based on loss experience. The estimates of loss experience
are continually reviewed and adjusted, and resultant adjustments to ceding commissions are
reflected in current operations.The ceding commissions recognized are reflected as a reduction of the following expenses for
the three and six months ended June 30, 2007 (dollar in thousands):
 10




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 Three months ended
    
    
    Six months endedJune 30,
    
    
    June 30,2007
    
    
    2007Selling, general and administrative expenses
    
    $
    1,239
    
    
    $
    5,790Loss adjustment expenses
    
    
    905
    
    
    
    4,185Total
    
    $
    2,144
    
    
    $
    9,975
 The amount of recoveries pertaining to quota share reinsurance contracts that were
deducted from losses incurred during 2007 were approximately $30.1 million.The amount of unpaid loss and loss adjustment expenses and unearned premium we would remain
liable for in the event our reinsurers are unable to meet their obligations are as follows
(dollars in thousands):
 As of June 30,
    
    
    As of December 31,2007
    
    
    2006Non affiliateLoss and loss adjustment expense
    
    $
    70,499
    
    
    $
    21,590Unearned premiums
    
    
    9,883
    
    
    
    1,221Total
    
    $
    80,382
    
    
    $
    22,811
 On April 1, 2007, as discussed above, we exercised our option to terminate the GMAC quota
share contracts on a cut-off basis. On April 30, 2007, we received $31.0 million to settle
the unearned premiums less return ceding commissions. Taking this recovery into account, our
net exposure for reinsurance provided by GMAC at June 30, 2007 was $50.9 million.For the three and six months ended June 30, 2007, we ceded $15.4 million ($14.4 million is
related to USAgencies) and $37.1 million ($35.4 million is related to USAgencies) of paid
losses and $4.2 million ($1.0 million is related to USAgencies) and $30.1 million ($22.8
million is related to USAgencies) of incurred losses to various reinsurers. For the three and
six months ended June 30, 2006, we ceded $1.9 million and $4.1 million of paid losses and $4.8
million and $5.5 million of incurred losses to various reinsurers, respectively.At June 30, 2007, our total receivables from reinsurers was $78.2 million, consisting of $50.9
million from GMAC (rated A- by A.M. Best) for business reinsured in Louisiana and Alabama,
$14.9 million net receivable (net of $2.5 million payable) from subsidiaries of VIG including
primarily VFIC, $6.6 million receivable from the Michigan Catastrophic Claims Association, the
mandatory reinsurance association in Michigan, $3.8 million from Evergreen National Indemnity
Company (rated A by A.M. Best) and $2.0 million receivables from other reinsurers. In
addition to the net reinsurance receivable of $14.9 million from VIG, we also carry a $6.1
million contingent commission receivable, resulting in a total gross receivables recoverable
from VFIC of $23.5 million. Under the reinsurance agreement with VFIC, AIC had the right,
under certain circumstances, to require VFIC to provide a letter of credit or establish a
trust account to collateralize the gross amount due AIC and Insura Property and Casualty
Insurance Company (Insura) from VFIC under the reinsurance agreement. Accordingly, AIC,
Insura and VFIC entered into a Security Fund Agreement effective September 1, 2004. On August
30, 2005 AIC received a letter from VFICs President that irrevocably confirmed VFICs duty
and obligations under the Security Fund Agreement to provide security sufficient to satisfy
VFICs gross obligations under the reinsurance agreement (the VFIC Trust). Currently, the
VFIC Trust holds $23.6 million to collateralize the $23.5 million gross recoverable from VFIC.
In June 2006, the Texas Department of Insurance placed VFIC, along with several of its
affiliates, into rehabilitation and subsequently into liquidation. Due to VFICs liquidation
status, AIC is working through
 11




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 certain procedures to effect its right to withdraw funds from the VFIC Trust. AIC has
been working with the Special Deputy Receiver (the SDR) and the SDRs staff on this matter
since VFIC was placed into liquidation. To date, the SDR has not taken issue with the
validity of the VFIC Trust. We are currently negotiating with the SDR the manner in which the
funds will be withdrawn from the VFIC Trust, which must then be approved by the Special Master
of the Receivership Court.At June 30, 2007, $16.8 million was included in reserves for losses and loss adjustment
expenses that reflect the amounts owed from AIC and Insura under reinsurance agreements with
the VIG affiliated companies, including Hawaiian Insurance and Guaranty Company, Ltd
(Hawaiian). Affirmative established a trust account to collateralize this payable, which
currently holds $22.9 million in securities (the AFIC Trust). The AFIC Trust has not been
drawn upon by the SDR in Texas or the SDR in Hawaii. It is the expectation that the terms for
withdrawal of funds from the AFIC trust will be similar to those we expect to be agreed to in
regards to the VFIC Trust.AIC, a wholly-owned subsidiary, is a party to a 100% quota share reinsurance agreement with
Hawaiian, which is ultimately a wholly-owned subsidiary of VIG. On November 4, 2004, Hawaiian
was named among a group of four other named defendants and twenty unnamed defendants in a
complaint filed in the Superior Court of the State of California for the County of Los Angeles
alleging causes of action as follows: enforcement of coverage under Hawaiians policy of an
underlying default judgment plaintiff obtained against Hawaiians former insured, who was
denied a defense in the underlying lawsuit due to his failure to timely pay the Hawaiian
policy premium; ratification and waiver of policy lapse and declaratory relief against
Hawaiian; breach of implied covenant of good faith and fair dealing against Hawaiian with the
plaintiff as the assignee of the insured; intentional misconduct as to the defendant SCJ
Insurance Services (SCJ); and professional negligence as to the defendants Prompt Insurance
Services, Paul Ruelas, and Anthony David Medina. SCJ, Prompt Insurance Services, Paul Ruelas,
and Anthony David Medina are not affiliated with Affirmative. The plaintiff sought to enforce
an underlying default judgment obtained against Hawaiians insured on September 24, 2004 in
the amount of $35,000,643 and additional bad faith damages including punitive damages in the
amount of $35,000,000.On August 8, 2005, plaintiff served a copy of its Second Amended Complaint, which added a
cause of action for fraud and deceit against all defendants, and a cause of action for
negligent misrepresentation against Hawaiian and SCJ.On January 31, 2006, Judge Bigelow absolved Hawaiian and SCJ of all counts plaintiff filed
against them in this litigation on the trial court level by virtue of court order on motions
for summary judgment that were submitted by both Hawaiian and SCJ. A partial dismissal
without prejudice was entered as to defendant Paul Ruelas. Plaintiff filed a notice of appeal
on April 18, 2006. On September 22, 2006, Hawaiian moved to stay appellate proceedings
pursuant to an Order of Liquidation entered on August 21, 2006, in the Circuit Court for the
State of Hawaii.On October 2, 2006, The Court of Appeal of the State of California, Second Appellate District,
Division Five, granted the stay order requested by Hawaiian. On December 11, 2006, the court
modified its October 2, 2006 stay order by lifting it as to SCJ, causing the suit to proceed
with SCJ as the sole defendant. Hawaiian filed a status update with the court on March 7,
2007 indicating that the liquidation proceeding for Hawaiian remained pending and in full
force and effect. On March 15, 2007, plaintiff moved the Court of Appeal to lift the stay and
that motion was denied. On March 27, 2007, plaintiff filed a petition with the Supreme Court
of California for review of the Court of Appeals order denying plaintiffs motion to lift the
stay, and on July 13, 2007, the Supreme Court of California denied that petition. Hawaiian
and the other defendants thereto believe plaintiffs allegations in this lawsuit are without
merit and will continue to vigorously contest the claims brought by the plaintiff, and intend
to exercise all available rights and remedies against them; however, the ultimate outcome of
this matter is uncertain.Effective August 1, 2005, we entered into novation agreements with several unaffiliated
reinsurers who participated in a quota share reinsurance agreement in which we also
participated. Pursuant to these agreements, we were substituted in place of these reinsurers
assuming all rights, interests, liabilities and obligations related to the original quota
share reinsurance agreement. As a result of these novation
 12




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 agreements, our participation in the original reinsurance agreement increased from 5% to
100%, effective August 1, 2005. In consideration for our assumption of their liabilities,
these reinsurers agreed to pay us an amount equal to their share of the liabilities under the
original quota share agreement as of July 31, 2005. We received cash in the amount of $14.2
million in relation to this novation. The terms of this reinsurance agreement did not meet
the risk transfer requirements according to FAS 113, therefore, this contract was accounted
for as deposits according to the guidelines of SOP 98-7, Deposit Accounting for Insurance and
Reinsurance Contracts that do not Transfer Insurance Risk. Under deposit accounting, the
deposit liability should be adjusted based on the adjusted amount and timing of the cash
flows. Changes in the carrying amount of the deposit liability should be reported as income
or expense as appropriate. In the second quarter and first half of 2007, we recognized
$112,800 and $220,700, respectively, in income related to this novation. In the second
quarter and first half of 2006, we recognized $174,900 and $392,300, respectively, in income
related to this novation.4.
    
    Premium Finance ReceivablesFinance receivables, which are secured by unearned premiums from the underlying insurance
policies, consisted of the following at June 30, 2007 (dollar in thousands):
 June 30,2007Premium finance contracts
    
    $
    42,727Unearned finance charges
    
    
    (3,547
    )Allowance for credit losses
    
    
    (550
    )Premium finance receivable, net
    
    $
    38,630
 The original term of a substantial portion of a premium finance contract is five months,
although premium finance contracts are generally no longer than twelve months. Our experience
is that a substantial portion of the insurance coverage and related finance receivables will
cancel before contractual maturity dates.5.
    
    AcquisitionsOn January 31, 2007, we completed the acquisition of USAgencies in a fully-financed all cash
transaction valued at approximately $199.4 million. USAgencies is a non-standard personal
automobile insurance provider headquartered in Baton Rouge, Louisiana. At the time of
acquisition, it had 91 operating retail sales locations in Louisiana, Illinois and Alabama
selling its products directly to consumers through its owned retail stores, virtual call
centers and internet site. In 2006, USAgencies had gross written premiums of approximately
$177.1 million, an increase of 12.6% from 2005 gross written premiums of $157.3 million. The
purchase of USAgencies was financed through $200.0 million in borrowings under a $220.0
million senior secured credit facility that was entered into concurrently with the completion
of the acquisition. The acquisition gives us a leading market position in Louisiana, the
12th largest non-standard automobile insurance market. For accounting purposes,
the transaction was effective as of January 1, 2007, so our reported results for the first
quarter of 2007 include USAgencies first quarter 2007 operating results, as adjusted to
reflect purchase accounting treatment. The transaction was reported on our Form 8-K filed on
February 6, 2007 and our Form 8-K/A filed on April 17, 2007.The total estimated cost of the acquisition of USAgencies was as follows (dollars in
thousands):
 Purchase price paid to sellers
    
    $
    176,305Purchase price paid to escrow account
    
    
    20,000Transaction costs paid to third parties on behalf of sellers
    
    
    2,820Acquisition costs paid directly to third parties
    
    
    1,724Total estimated purchase price, before imputed interest
    
    
    200,849Less: adjustment to reduce cost of acquisition for interest imputed
from the acquisition date to the closing date
    
    
    (1,470
    )Estimated cost of acquisition
    
    $
    199,379
 13




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 The estimated fair values and useful lives of assets acquired and liabilities assumed are
based on preliminary management estimates and are subject to final valuation adjustments which
may cause the amount ultimately recorded as goodwill and other intangible assets to be
different from that shown on the accompanying Consolidated Balance Sheets. The Company is
undertaking a valuation study to determine the allocation of the total purchase price to the
various assets acquired and liabilities assumed. The final purchase price allocations may
result in different allocations for tangible and intangible assets than presented in these
accompanying Consolidated Balance Sheets, and those differences could be material.The following table summarizes the preliminary purchase price adjustments based on
managements preliminary assessment of fair values of the assets acquired and the liabilities
assumed at the date of acquisition (dollars in thousands):
 Net tangible assets acquired
    
    $
    88,124Amortizable intangible assets acquired, at preliminary estimates of fair value:Non-compete agreement (2 year straight-line amortization)
    
    
    1,000Customer relationships (approximate 3 year amortization period)
    
    
    4,700Trademark and trade name (3 year straight-line amortization)
    
    
    3,900Leases (approximate half year amortization period)
    
    
    200Non-amortizable intangible asset acquired, at preliminary estimates of fair value:State licenses
    
    
    1,700Adjustment to deferred taxes for preliminary purchase
allocation adjustments
    
    
    1,775Goodwill
    
    
    97,980Estimated net assets acquired
    
    $
    199,379
 Included in the preliminary purchase price allocation are intangible assets subject to
amortization totaling $9.8 million. As of June 30, 2007, such intangible assets had a
carrying value of $6.7 million, less accumulated amortization of $3.1 million. Estimated
amortization expenses related to the USAgencies acquisition for 2007 and future years is as
follows (dollars in thousands):
 2007
    
    $
    5,0952008
    
    
    2,8902009
    
    
    1,7002010
    
    
    115Total
    
    $
    9,800
 In conjunction with the acquisition of USAgencies, cash and cash equivalents were used in the
acquisition as follows (dollars in thousands):
 14




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 Fair value of tangible assets
excluding cash and cash equivalents
    
    $
    222,186Fair value of intangible assets acquired
    
    
    109,480Capitalized direct expenses
    
    
    1,512Liabilities assumed
    
    
    (156,548
    )Cash and cash equivalents used
    
    $
    176,630
 On March 14, 2006, we completed the acquisition of the 27% minority ownership interest of
Space Coast Holdings, Inc (Space Coast). We paid approximately $3.2 million to the minority
owners and recorded $3.2 million in goodwill. Consequently, our current ownership interest in
Space Coast is 100%.For the first half of 2007, we incurred $367,000 in contingent purchase price adjustments related
to prior acquisitions. For the first half of 2006, we paid $721,000 in contingent purchase
price adjustments related to prior acquisitions and $225,000 for the purchase of two retail
stores. We do not anticipate making any material future payments of contingent purchase price
adjustments related to acquisitions completed prior to the date of this report.6.
    
    Notes PayableOn December 31, 2004, our newly formed trust entity, Affirmative Insurance Holdings Statutory
Trust I (Trust Entity I), completed a private placement of $30.0 million of 30 year floating
rate trust preferred securities. Simultaneously, we borrowed $30.9 million from Trust Entity
I and contributed $29.0 million to AICs policyholders surplus. The trust preferred
securities, which can be redeemed in whole or in part by the issuer after five years, bear an
initial interest rate of 7.545% until December 15, 2009, at which time the securities will
adjust quarterly to the 90-day LIBOR rate plus 3.60 percentage points. As of June 30, 2007,
the note balance was $30.9 million.On June 1, 2005, our newly formed trust entity, Affirmative Insurance Holdings Statutory Trust
II (Trust Entity II), completed a private placement of $25.0 million of 30 year floating
rate trust preferred securities. Simultaneously, we borrowed $25.0 million from Trust Entity
II and the net proceeds from this borrowing, along with cash from operations, were used to
purchase the 2.0 million shares of our common stock as discussed in Notes 1 and 9. The trust
preferred securities, which can be redeemed in whole or in part by the issuer after five
years, bear an initial interest rate of 7.792% until June 15, 2010, at which time they will
adjust quarterly to the 90-day LIBOR rate plus 3.60 percentage points. As of June 30, 2007,
the note balance was $25.8 million.On March 29, 2005, USAgencies issued $20.0 million of floating rate subordinated notes with a
stated maturity of March 15, 2035. We are required to make interest-only payments on a
quarterly basis at the rate of the three-month LIBOR plus 3.95 percentage points (9.305% as of
June 30, 2007). The variable interest rate will not exceed 12.50% through March 2010, with no
limit thereafter. The notes are redeemable in whole or in part anytime after March 15, 2010.
Prior to March 15, 2010, the notes may only be redeemed in whole or in part subject to certain
specific restrictions and prepayment penalties pursuant to the indenture agreement.
As of June 30, 2007, the note balance was $20.2 million.7.
    
    Senior Credit FacilityOn January 31, 2007, we entered into a $220.0 million senior secured credit facility (the
Facility) provided by a syndicate of lenders, including Credit Suisse, Cayman Islands
Branch, as Administrative Agent and Collateral Agent that provides for a $200.0 million senior
term loan facility and a revolving facility of up to $20.0 million, depending on our borrowing
capacity. On March 8, 2007, we added The Frost National Bank, N.A. to the Facility when we
received approval of the First Amendment to the Facility and executed a joinder agreement
whereby Frost became the provider of an initial revolving credit commitment of $15.0 million.
 15




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 The revolving portion of the Facility includes an option to increase the $20.0 million
principal amount of revolving loans available thereunder by up to an additional $20.0 million
and a $2.0 million sublimit for letters of credit. Our obligations under the Facility are
guaranteed by our material operating subsidiaries (other than our insurance companies) and are
secured by a first lien security interest on all of our assets and the assets of our material
operating subsidiaries (other than our insurance companies), including a pledge of 100% of the
stock of AIC. The facility contains certain financial covenants, which include capital
expenditure limitations, minimum interest coverage requirements, maximum leverage ratio
requirements, minimum risk-based capital requirements, maximum combined ratio limitations,
minimum fixed charge coverage ratios and a minimum consolidated net worth requirement, as well
as other restrictive covenants. At June 30, 2007, we were in compliance with all of our
financial and other restrictive covenants.In connection with entering into the Facility, we recognized $6.5 million in deferred debt
acquisition costs that is being amortized over the seven year term of the Facility.Concurrently with entering into the Facility, the Company borrowed $200.0 million (the
Borrowing) under the term loan portion of the Facility to finance our acquisition of
USAgencies and to pay related costs and expenses. The principal amount of the Borrowing is
payable in quarterly installments of $500,000, with the remaining balance due on the seventh
anniversary of the closing of the Facility. Beginning in 2008, we are also required to make
additional annual principal payments that are to be calculated based upon our financial
performance during the preceding fiscal year. In addition, certain events, such as the sale
of material assets or the issuance of significant new equity, necessitate additional required
principal repayments.The interest rate shall be determined at the beginning of each interest period based on the
Alternative Base Rate (ABR) or the Adjusted LIBOR Rate as defined in the credit agreement.
The ABR is the greater of (a) the prime rate plus 2.50% or (b) the federal funds rate plus
3.00%. The Adjusted LIBOR Rate is the 1, 2, 3 or 6 month LIBOR plus a margin of 3.50%. For
the initial 60 day interest period ending March 30, 2007, interest was determined by the
credit agreement at the ABR of 10.75% (8.25% prime rate plus 2.50%). At the beginning of each
subsequent interest period, the rate is the ABR unless the Company elects to use the Adjusted
LIBOR Rate by notifying the lender prior to the effective interest period. The Company will
choose the lower interest rate for each subsequent interest period. Based on June 30, 2007
interest rates, the Adjusted LIBOR Rate is 8.82%, as determined by using the 1 month LIBOR
rate plus a margin of 3.5%. The Company notified the lender prior to the June 30, 2007
interest period of its election to use the Adjusted LIBOR Rate for the current interest
period.Effective April 30, 2007, we entered into an interest rate swap with a notional amount of
$50.0 million that has been designated as a hedge of variable cash flows associated with that
portion of the senior secured credit facility. This derivative instrument requires quarterly
settlements whereby we pay a fixed rate of 4.993% and receive a three-month LIBOR rate, reset
every three months. The derivative expires on April 30, 2011. The Company utilizes the hypothetical
derivative methodology for the measurement of ineffectiveness. Derivative gains and losses not effective in
hedging the expected cash flows will be recognized
immediately in earnings. The Company does not expect the ineffectiveness related to its hedging activity to be
material to the Companys financial results in the future. There were no components of the derivative instrument that was excluded from the assessment of hedge effectiveness.We have designated this derivative instrument as a cash flow hedge in accordance with
Statement of Financial Accounting Standards No. 133 (SFAS 133), Accounting for Derivative
Instruments and Hedging Activities, as subsequently amended by SFAS 138, Accounting for
Certain Derivative Instruments and Certain Hedging Activities an amendment of SFAS 133.
The credit risk associated with this contract is limited to the uncollected interest payments
and the fair market value of the derivative to the extent it has become favorable to us.As of June 30, 2007, we have no borrowings under the revolving portion of the Facility.In connection with our closing on the Facility on January 31, 2007, we terminated our then
existing credit agreement with The Frost National Bank dated July 30, 2004, as amended (the
Prior Credit Agreement). At the time of the termination of the Prior Credit Agreement,
there were no borrowings or other amounts outstanding under the Prior Credit Agreement. As of
December 31, 2006, there were no outstanding loan amounts due under the Prior Credit
Agreement, and we were in compliance with all of our financial and other restrictive
covenants.
 16




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 8.
    
    Commitments and Contingent LiabilitiesWe and our subsidiaries are named from time to time as defendants in various legal actions
arising in the ordinary course of our business and arising out of or related to claims made in
connection with our insurance policies, claims handling and employment related disputes. The
plaintiffs in some of these lawsuits have alleged bad faith or extra-contractual damages and
some have claimed punitive damages. We believe that the resolution of these legal actions will
not have a material adverse effect on our financial position or results of operations. For
detailed information concerning legal actions, please refer to Legal Proceedings contained
elsewhere in this report.In December 2003, InsureOne Independent Agency, LLC (InsureOne), American Agencies General
Agency, Inc. and Affirmative Insurance Holdings, Inc. brought action in the Circuit Court of
Cook County, Illinois to enforce non-compete and non-solicitation agreements entered into with
James Hallberg, the former president of InsureOne, a wholly-owned subsidiary, and eight former
employees of InsureOne and two of Hallbergs family trusts. The court entered interim orders
prohibiting all defendants, including Hallberg, from hiring any employees of InsureOne or of
plaintiffs other underwriting agencies. On November 9, 2005 upon the close of plaintiffs
side of the case, the court ruled that the following counts from plaintiffs 5th
Amended Verified Complaint would remain in the case to be considered until the close of trial:
1) breach of contract by James P. Hallberg; 2) breach of contract by James P. Hallberg Gift
Trust and Patricia L. Hallberg Gift Trust; and 3) breach of contract by William Hallberg.
James Hallbergs currently pending counterclaims include breach of contract, fraud, and breach
of fiduciary duty. The Hallberg family gift trusts have also asserted a single counterclaim
that alleges fraud and breach of fiduciary duty in relation to the purchase of that same 20%
minority interest in InsureOne in 2003. We are vigorously contesting the counterclaims and
are exercising all available rights and remedies. We are seeking between $15 and 23 million
in damages for lost profits and diminution in value. James Hallberg and the Hallberg family
gift trust are seeking combined damages of $4,530,482. The bench trial of this matter has
concluded, and the parties are currently waiting for the court to render judgment.Affirmative Insurance Holdings, Inc. and Affirmative Property Holdings, Inc. brought action
against Business Risk Technology, Inc. and Steven M. Repetti (BRT) in the Circuit Court of
the 17th Judicial Circuit, Broward County, Florida on January 6, 2006 for
fraudulent inducement, breach of contract, breach of the covenant of good faith and fair
dealing, and for declaratory and supplemental relief arising from the defendants wrongful
conduct and contractual breaches. The details of such allegations are set forth in the
petition. This action involves our enforcement of certain rights under a software license
agreement we entered with BRT wherein BRT agreed to develop and provide us with a complete,
turnkey software system for use by our various affiliates. Among the requested relief, we are
seeking declaratory relief, a return of confidential and proprietary information, monetary
damages, attorneys fees, reasonable pre-judgment and post-judgment interest, and any other
relief the Court deems just. On April 27, 2006, BRT counterclaimed for breach of contract,
unjust enrichment, fraud, unfair and deceptive trade practices and libel. Subsequently, the
court dismissed the unfair and deceptive trade practices and libel claims without prejudice
and provided BRT with leave to amend its complaint in ten (10) days; however, BRT did not
amend. The parties unsuccessfully participated in court-ordered mediation in June 2007. In
July 2007, the court granted summary judgment in favor of BRT on the Companys breach of
contract claim. The Company is moving for reconsideration of that ruling. The parties have
been ordered to be ready for trial in October 2007. We are vigorously prosecuting the claims
against the defendants and are exercising all available rights and remedies against them.Affirmative Insurance Holdings, Inc. and Affirmative Insurance Company (referred to herein
collectively as Affirmative) brought action against Hopson B. Nance, E. Murray Meadows, Paul
H. Saeger, Jr., Fred H. Wright, and Does 1-10 in the United States District Court of the
Northern District of Alabama, Southern Division, on December 28, 2006 for negligent
misrepresentation, fraud, tortious interference with contractual relations, breach of
fiduciary duty, negligence and conversion. The details of such allegations are set forth in
the petition. The case involves an action by Affirmative to recover $7.2 million of
Affirmatives funds used improperly by Defendants to satisfy a debt of one of VIGs
subsidiaries. Among the requested relief, Affirmative seeks judgment against the Defendants
for $7.2 million, plus prejudgment interest and punitive
damages. On February 15, 2007, by consent of the parties, the Court referred the action to
the United States Bankruptcy Court for the Northern District of Alabama, where bankruptcy
proceedings are pending with
 17




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 respect to VIG. The Vesta Plan Trustee moved to enjoin Affirmative from pursuing its
action against the Defendants. On February 28, 2007, the Bankruptcy Court entered an order,
upon consent of the parties, temporarily staying the action. The order has been subsequently
extended until August 30, 2007.On December 21, 2005, Donna Villegas brought suit against Affirmative Insurance Holdings, Inc.
in the United States District Court for the Northern District of Texas, Dallas Division, under
the Family and Medical Leave Act (FMLA) for retaliation. Specifically, plaintiff claims that
Affirmative retaliated against her in violation of 29 U.S.C. § 2615(a) for requesting and
taking intermittent FMLA leave by allegedly demoting her and ultimately terminating her
employment. A bench trial took place the week of April 2, 2007, at which time plaintiff
quantified her damages of approximately $270,000 in back and front pay, in addition to seeking
liquidated damages under FMLA, attorneys fees and interest. Judgment is expected to be
rendered by the court within the third quarter of 2007. We believe plaintiffs allegations in
this lawsuit are without merit and will continue to vigorously contest the claims brought by
plaintiff, and intend to exercise all available rights and remedies.On October 18, 2002, the named plaintiff Nickey Marsh filed suit in the Fourth Judicial
District Court of Louisiana against USAgencies alleging that certain adjustments to the actual
cash value of his total loss automobile claim were improper. An amending petition, filed on
October 24, 2003, made class action allegations, and sought class-wide compensatory damages,
attorneys fees and punitive damages of $5,000 per claimant. The parties conducted class
certification discovery, and statistics prepared from discovery estimates indicate that
approximately 2,700 to 4,000 such claims may exist. The contested adjustments to actual cash
value were approximately $50 to $100 per claim. After a class certification hearing in
February of 2006, a judgment was rendered on August 7, 2006 certifying the class. The
Louisiana Second Circuit Court of Appeal subsequently affirmed the trial courts certification
of the class on May 16, 2007. USAgencies continues to contest the class certification and has
filed a writ application with the Supreme Court of Louisiana to pursue an appeal of the lower
court decisions. Pursuant to the terms of the Acquisition Agreement between the Company and
USAgencies, the selling parties are bound to indemnify the Company from any and all losses
attendant to claims arising out of the Marsh litigation out of a sum placed into escrow
specifically for such purpose (the Marsh Litigation Reserve). The Acquisition Agreement
provides that the Marsh Litigation Reserve shall not exceed the amount placed into escrow, and
that upon the final resolution of the Marsh litigation by (i) a court order that is final and
nonappealable or (ii) a binding settlement agreement, and the determination of all amounts to
be paid with respect to Marsh litigation (the Marsh Payments), the amount constituting the
Marsh Payments shall be paid out of the Marsh Litigation Reserve to the Company either (a) in
accordance with a joint written instruction by the Company and the Seller or (b) pursuant to a
court order or judgment that is final and nonappealable sent to the escrow agent by the
Company or the Seller, and any portion of the Marsh Litigation Reserve not so required to be
paid to the Company shall be promptly paid by the escrow agent to the Seller. We believe
plaintiffs allegations in this lawsuit are without merit and will continue to vigorously
contest the claims brought by the plaintiffs, and intend to exercise all available rights and
remedies against them; however, the ultimate outcome of this matter is uncertain, and,
although we believe it is unlikely, it is nevertheless possible that the aggregate amount
payable at the conclusion of the Marsh litigation may exceed the Marsh Litigation Reserve, and
the Seller may not have the financial ability to indemnify the Company for any losses in
excess of said reserve.On December 8, 2006, Michael V. Clegg, APLC, brought suit for damages for alleged breach of
contract against USAgencies Insurance Company [sic] (USAgencies), a subsidiary of the
Registrant, in the Nineteenth Judicial District Court of Louisiana. Plaintiff alleges that
USAgencies breached a contract with Mr. Cleggs law firm purportedly granting the firm
exclusive rights to serve as counsel for USAgencies in the State of Louisiana for a period of
two (2) years commencing on December 15, 2005 and ending December 15, 2007. On May 31, 2007,
final judgment was entered in favor of USAgencies and against plaintiff. Plaintiff
subsequently filed a petition for appeal of the judgment. We believe plaintiffs allegations
in this lawsuit are without merit and will continue to vigorously contest the claims brought
by plaintiff, and intend to exercise all available rights and remedies against him; however,
the ultimate outcome of this matter is uncertain.Recently, two of our owned underwriting agencies were subject to a routine sales and use tax
audit conducted by the State of Texas. The examiner for the State of Texas has now completed
his audit report and delivered an audit assessment to us. The examiners report asserts that,
for the period from January 2002 to December
 18




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 2005, we should have collected and remitted approximately $2.9 million in sales tax
derived from claims services performed by our underwriting agencies for policies sold by these
underwriting agencies and issued by Old American County Mutual Insurance Company, an
unaffiliated insurance company, through a fronting arrangement. The assessment includes an
additional $412,000 for accrued interest and penalty for a total assessment of $3.3 million.
We believe that these services are not subject to sales tax, are vigorously contesting the
assertions made by the state, and are exercising all available rights and remedies available
to us. On October 19, 2006, we responded to the assessment by filing petitions with the
Comptroller of Public Accounts for the State of Texas requesting a redetermination of the tax
due and a hearing to present written and oral evidence and legal arguments to contest the
imposition of the asserted taxes. As a result of the timely filing of these petitions, an
administrative appeal process has commenced and the date for payment is delayed until the
completion of the appeal process. Such appeals routinely take up to three years and much
longer for complex cases. As such, the outcome of this tax assessment will not be known for a
commensurate amount of
time. At this time, we
are uncertain of the probability of the outcome of our appeal. Additionally, we cannot
reasonably estimate the ultimate liability at this time. We have not made an accrual for this
as of June 30, 2007 as we do not believe this meets the requirements of FAS 5, Accounting for
Contingencies.9.
    
    Stockholders EquityIn May 2006, we issued 2,925 shares of our common stock upon the exercise of options.On May 9, 2006, the board of directors approved a share repurchase program for up to $15.0
million of our common stock over the subsequent 12 months. In May and June 2006, we
repurchased a total of 302,400 shares of our common stock at an average cost of $13.67 per
share. We funded the purchases through internally available funds.In June 2006, we issued 5,300 shares of our common stock upon the exercise of options.In August 2006, we issued 2,104 shares of our common stock upon the exercise of options.In October 2006, we issued 70,000 shares of restricted stock to Kevin R. Callahan, Chief
Executive Officer that vest ratably over five years. Total compensation recorded for the
three and six months ended June 30, 2007 was approximately $52,000 and $104,000, respectively.In October 2006, we issued 37,285 shares of our common stock upon the exercise of options.In November 2006, we issued 20,000 shares of restricted stock to Joseph G. Fisher, Senior Vice
President and General Counsel that vest ratably over five years. Total compensation recorded
for the three and six months ended June 30, 2007 was approximately $17,000 and $34,000,
respectively.In November 2006, we issued 25,000 shares of restricted stock to Robert A. Bondi, Executive
Vice President and Chief Operating Officer that vest ratably over five years. Total
compensation recorded for the three and six months ended June 30, 2007 was approximately
$20,000 and $40,000, respectively.In November 2006, we issued 61,804 shares of our common stock upon the exercise of options.In February 2007, we issued 7,273 shares of restricted stock to Robert A. Bondi, Executive
Vice President and Chief Operating Officer that vest ratably over five years. Total
compensation expense recorded for this issuance for the three and six months ended June 30,
2007 was approximately $6,000 and $8,000 respectively.In April 2007, we issued 5,550 shares of our common stock upon the exercise of options.In May 2007, we issued 6,050 shares of our common stock upon the exercise of options.
 19




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 10.
    
    Earnings per ShareThe provisions of FASB Statement No. 128 (SFAS 128), Earnings per Sharerequire presentation
of both basic and diluted earnings per share. A reconciliation of the numerators and
denominators of the basic and diluted earnings per share computations as required by SFAS 128
is presented below:
 Income
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount(dollars in thousands, except number ofshares and per share amounts)Three months ended June 30, 2007Basic Earnings per ShareNet Income
    
    $
    1,118
    
    
    
    15,368,173
    
    
    $
    0.07Diluted Earnings per ShareNet Income
    
    $
    1,118
    
    
    
    15,368,173
    
    
    $
    0.07Effect of Dilutive Securities
    
    
    
    
    
    
    67,937
    
    
    
    $
    1,118
    
    
    
    15,436,110
    
    
    $
    0.07Three months ended June 30, 2006Basic Earnings per ShareNet Income
    
    $
    4,884
    
    
    
    15,321,771
    
    
    $
    0.32Diluted Earnings per ShareNet Income
    
    $
    4,884
    
    
    
    15,321,771
    
    
    $
    0.32Effect of Dilutive Securities
    
    
    
    
    
    
    37,234
    
    
    
    $
    4,884
    
    
    
    15,359,005
    
    
    $
    0.32Six months ended June 30, 2007Basic Earnings per ShareNet Income
    
    $
    3,364
    
    
    
    15,363,139
    
    
    $
    0.22Diluted Earnings per ShareNet Income
    
    $
    3,364
    
    
    
    15,363,139
    
    
    $
    0.22Effect of Dilutive Securities
    
    
    
    
    
    
    88,094
    
    
    
    $
    3,364
    
    
    
    15,451,233
    
    
    $
    0.22Six months ended June 30, 2006Basic Earnings per ShareNet Income
    
    $
    11,115
    
    
    
    15,376,858
    
    
    $
    0.72Diluted Earnings per ShareNet Income
    
    $
    11,115
    
    
    
    15,376,858
    
    
    $
    0.72Effect of Dilutive Securities
    
    
    
    
    
    
    37,875
    
    
    
    $
    11,115
    
    
    
    15,414,733
    
    
    $
    0.72
 11.
    
    Stock-Based CompensationEffective January 1, 2006, we account for our stock-based compensation in accordance with FASB
Statement No. 123R (SFAS 123R), Share-Based Payment.For the three and six months ended June 30, 2007, we
have recognized $218,000 before income
taxes ($142,000 after income taxes) and $366,000 before income taxes
($238,000 after income
taxes), respectively, in stock-based compensation expense under the requirements of SFAS 123R resulting in a
negligible impact on
earnings per share. In comparison, for the three and six months ended June 30, 2006, we
recognized $150,500 before income taxes ($97,000 after income taxes) and $313,500 before
income taxes ($201,000 after income
 20




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 taxes), respectively, in stock-based compensation expense
under the requirements of SFAS 123R resulting in a negligible impact on earnings per share.As permitted by SFAS 123R, we used the modified Black-Scholes model to estimate the value of
employee stock options on the date of grant that used the assumptions noted below. The
risk-free rate for periods within the contractual life of the options is based on the U.S.
Treasury yield curve in effect at the time of grant. The expected term of each option is
based on our estimate that all individuals granted stock options would have an average holding
period of two years after the vesting before any of the vested options are exercised. We
expect all grantees to exercise their options within two years after each individual tranches
vesting date within the single option grant. Expected volatilities are based on historical
volatilities of our common stock. The dividend yield was based on expected dividends at the
time of grant.
 Six months endedJune 30,2007
    
    2006Weighted average risk-free interest rate: 1998 Plan
    
    
    N/A
    
    
    
    N/AWeighted average risk-free interest rate: 2004 Plan
    
    
    4.5
    %
    
    
    4.5
    %Expected term of option (in years): 1998 Plan
    
    
    5.0
    
    
    
    5.0Expected term of option (in years): 2004 Plan
    
    
    5.0
    
    
    
    3.0Volatility
    
    
    25
    %
    
    
    25
    %Dividend yield
    
    
    0.5
    %
    
    
    0.6
    %
 A summary of activity under the 1998 and 2004 Plans for the three and six months ended
June 30, 2007 and 2006 is as follows:
 21




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 For the three months ended June 30, 2007WeightedWeighted
    
    
    Average
    
    
    AggregateAverage
    
    
    Remaining
    
    
    IntrinsicExercise
    
    
    Contractual
    
    
    ValueOptions
    
    
    Price
    
    
    Term (years)
    
    
    (000s)1998 PlanOutstanding, beginning of period
    
    
    58,461
    
    
    $
    7.59Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Outstanding, end of period
    
    
    58,461
    
    
    $
    7.59
    
    
    
    0.47
    
    
    $
    448Exercisable, end of period
    
    
    58,461
    
    
    $
    7.59
    
    
    
    0.47
    
    
    $
    4482004 PlanOutstanding, beginning of period
    
    
    1,831,080
    
    
    $
    18.95Granted
    
    
    114,500
    
    
    
    18.79Exercised
    
    
    (11,600
    )
    
    
    14.67Forfeited
    
    
    (26,920
    )
    
    
    14.69Outstanding, end of period
    
    
    1,907,060
    
    
    $
    19.02
    
    
    
    8.72
    
    
    $
    323Exercisable, end of period
    
    
    443,504
    
    
    $
    15.93
    
    
    
    8.14
    
    
    $
    150
 For the six months ended June 30, 2007WeightedWeighted
    
    
    Average
    
    
    AggregateAverage
    
    
    Remaining
    
    
    IntrinsicExercise
    
    
    Contractual
    
    
    ValueOptions
    
    
    Price
    
    
    Term (years)
    
    
    (000s)1998 PlanOutstanding, beginning of period
    
    
    58,461
    
    
    $
    7.59Granted
    
    
    
    
    
    
    Exercised
    
    
    
    
    
    
    Forfeited
    
    
    
    
    
    
    Outstanding, end of period
    
    
    58,461
    
    
    $
    7.59
    
    
    
    0.47
    
    
    $
    448Exercisable, end of period
    
    
    58,461
    
    
    $
    7.59
    
    
    
    0.47
    
    
    $
    4482004 PlanOutstanding, beginning of period
    
    
    1,936,080
    
    
    $
    19.01Granted
    
    
    114,500
    
    
    
    18.79Exercised
    
    
    (11,600
    )
    
    
    14.67Forfeited
    
    
    (131,920
    )
    
    
    18.94Outstanding, end of period
    
    
    1,907,060
    
    
    $
    19.02
    
    
    
    8.72
    
    
    $
    323Exercisable, end of period
    
    
    443,504
    
    
    $
    15.93
    
    
    
    8.14
    
    
    $
    150
 22




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 For the three months ended June 30, 2006WeightedWeighted
    
    
    Average
    
    
    AggregateAverage
    
    
    Remaining
    
    
    IntrinsicExercise
    
    
    Contractual
    
    
    ValueOptions
    
    
    Price
    
    
    Term (years)
    
    
    (000s)1998 PlanOutstanding, beginning of period
    
    
    94,675
    
    
    $
    7.59Granted
    
    
    
    
    
    
    Exercised
    
    
    (2,925
    )
    
    
    7.59Forfeited
    
    
    
    
    
    
    Outstanding, end of period
    
    
    91,750
    
    
    $
    7.59
    
    
    
    1.48
    
    
    $
    744Exercisable, end of period
    
    
    91,750
    
    
    $
    7.59
    
    
    
    1.48
    
    
    $
    7442004 PlanOutstanding, beginning of period
    
    
    1,449,180
    
    
    $
    16.91Granted
    
    
    
    
    
    
    Exercised
    
    
    (5,300
    )
    
    
    14.64Forfeited
    
    
    (82,820
    )
    
    
    15.36Outstanding, end of period
    
    
    1,361,060
    
    
    $
    17.01
    
    
    
    9.02
    
    
    $
    959Exercisable, end of period
    
    
    333,616
    
    
    $
    14.90
    
    
    
    9.01
    
    
    $
    274
 For the six months ended June 30, 2006WeightedWeighted
    
    
    Average
    
    
    AggregateAverage
    
    
    Remaining
    
    
    IntrinsicExercise
    
    
    Contractual
    
    
    ValueOptions
    
    
    Price
    
    
    Term (years)
    
    
    (000s)1998 PlanOutstanding, beginning of period
    
    
    94,675
    
    
    $
    7.59Granted
    
    
    
    
    
    
    Exercised
    
    
    (2,925
    )
    
    
    7.59Forfeited
    
    
    
    
    
    
    Outstanding, end of period
    
    
    91,750
    
    
    $
    7.59
    
    
    
    1.48
    
    
    $
    744Exercisable, end of period
    
    
    91,750
    
    
    $
    7.59
    
    
    
    1.48
    
    
    $
    7442004 PlanOutstanding, beginning of period
    
    
    1,493,670
    
    
    $
    16.84Granted
    
    
    15,000
    
    
    
    14.22Exercised
    
    
    (5,300
    )
    
    
    14.64Forfeited
    
    
    (142,310
    )
    
    
    14.96Outstanding, end of period
    
    
    1,361,060
    
    
    $
    17.01
    
    
    
    9.02
    
    
    $
    959Exercisable, end of period
    
    
    333,616
    
    
    $
    14.90
    
    
    
    9.01
    
    
    $
    274
  23




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
  For the three months ended June 30,2007
    
    
    2006Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    AverageRestricted
    
    
    Grant-Date
    
    
    Restricted
    
    
    Grant-DateStock
    
    
    Fair Value
    
    
    Stock
    
    
    Fair ValueNonvested, beginning of period
    
    
    122,273
    
    
    $
    15.50
    
    
    
    4,000
    
    
    $
    12.73Granted
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Vested
    
    
    
    
    
    
    
    
    
    
    (4,000
    )
    
    
    12.73Canceled or expired
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Nonvested, end of period
    
    
    122,273
    
    
    $
    15.50
    
    
    
    
    
    
    $
    
 For the six months ended June 30,2007
    
    
    2006Weighted
    
    
    
    
    
    
    WeightedAverage
    
    
    
    
    
    
    AverageRestricted
    
    
    Grant-Date
    
    
    Restricted
    
    
    Grant-DateStock
    
    
    Fair Value
    
    
    Stock
    
    
    Fair ValueNonvested, beginning of period
    
    
    115,000
    
    
    $
    15.44
    
    
    
    8,000
    
    
    $
    14.05Granted
    
    
    7,273
    
    
    
    16.50
    
    
    
    
    
    
    
    Vested
    
    
    
    
    
    
    
    
    
    
    (8,000
    )
    
    
    14.05Canceled or expired
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Nonvested, end of period
    
    
    122,273
    
    
    $
    15.50
    
    
    
    
    
    
    $
    
  12. Policy Acquisition Costs
   Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Beginning deferred acquisition costs (DAC)
    
    $
    30,039
    
    
    $
    28,069
    
    
    $
    23,865
    
    
    $
    24,453Additions
    
    
    30,528
    
    
    
    17,536
    
    
    
    55,939
    
    
    
    40,048Amortization of DAC
    
    
    (30,009
    )
    
    
    (18,661
    )
    
    
    (49,246
    )
    
    
    (37,557
    )Ending deferred acquisition costs
    
    $
    30,558
    
    
    $
    26,944
    
    
    $
    30,558
    
    
    $
    26,944
 24




---



##### Table of Contents



Affirmative Insurance Holdings, Inc.
Notes to Consolidated Financial Statements  Continued
 13. Supplemental Information
  Six months endedJune 30,(dollars in thousands)
    
    2007
    
    2006Income taxes paid (recovered)
    
    $
    (2,853
    )
    
    $
    884Interest paid
    
    
    12,147
    
    
    
    2,106
 25




---



##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations.
    Overview
     26




---



##### Table of Contents



Measurement of Performance
 The Sales Process
     27




---



##### Table of Contents



Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Gross Premiums Written By:Our underwriting agencies:Our retail agencies
    
    $
    55,852
    
    
    $
    18,699
    
    
    $
    135,669
    
    
    $
    51,785Independent agencies
    
    
    36,976
    
    
    
    36,903
    
    
    
    88,922
    
    
    
    80,405Subtotal
    
    
    92,828
    
    
    
    55,602
    
    
    
    224,591
    
    
    
    132,190Unaffiliated underwriting agencies
    
    
    9,324
    
    
    
    10,111
    
    
    
    20,716
    
    
    
    22,261Other
    
    
    1
    
    
    
    18
    
    
    
    (1
    )
    
    
    29Total
    
    $
    102,153
    
    
    $
    65,731
    
    
    $
    245,306
    
    
    $
    154,480
      28




---



##### Table of Contents



Three Months Ended June 30,
    
    
    Six Months Ended June 30,2007
    
    
    2006
    
    
    $ Change
    
    
    2007
    
    
    2006
    
    
    $ ChangeLouisiana *
    
    $
    33,165
    
    
    $
    
    
    
    $
    33,165
    
    
    $
    77,450
    
    
    $
    
    
    
    $
    77,450Illinois*
    
    
    15,791
    
    
    
    15,377
    
    
    
    414
    
    
    
    37,846
    
    
    
    38,622
    
    
    
    (776
    )Texas
    
    
    16,867
    
    
    
    19,273
    
    
    
    (2,406
    )
    
    
    38,744
    
    
    
    43,700
    
    
    
    (4,956
    )California
    
    
    8,975
    
    
    
    9,834
    
    
    
    (859
    )
    
    
    19,821
    
    
    
    21,717
    
    
    
    (1,896
    )Michigan
    
    
    4,164
    
    
    
    3,295
    
    
    
    869
    
    
    
    13,594
    
    
    
    7,854
    
    
    
    5,740Florida
    
    
    7,810
    
    
    
    3,630
    
    
    
    4,180
    
    
    
    16,731
    
    
    
    9,648
    
    
    
    7,083Alabama*
    
    
    4,785
    
    
    
    
    
    
    
    4,785
    
    
    
    11,570
    
    
    
    
    
    
    
    11,570Missouri
    
    
    2,859
    
    
    
    2,731
    
    
    
    128
    
    
    
    9,548
    
    
    
    5,178
    
    
    
    4,370Indiana
    
    
    3,006
    
    
    
    4,114
    
    
    
    (1,108
    )
    
    
    8,179
    
    
    
    10,726
    
    
    
    (2,547
    )South Carolina
    
    
    3,453
    
    
    
    4,802
    
    
    
    (1,349
    )
    
    
    8,070
    
    
    
    10,667
    
    
    
    (2,597
    )New Mexico
    
    
    927
    
    
    
    2,380
    
    
    
    (1,453
    )
    
    
    2,858
    
    
    
    5,795
    
    
    
    (2,937
    )Arizona
    
    
    229
    
    
    
    79
    
    
    
    150
    
    
    
    552
    
    
    
    184
    
    
    
    368Georgia
    
    
    96
    
    
    
    142
    
    
    
    (46
    )
    
    
    213
    
    
    
    320
    
    
    
    (107
    )Utah
    
    
    24
    
    
    
    55
    
    
    
    (31
    )
    
    
    130
    
    
    
    42
    
    
    
    88Other
    
    
    2
    
    
    
    19
    
    
    
    (17
    )
    
    
    
    
    
    
    27
    
    
    
    (27
    )Total
    
    $
    102,153
    
    
    $
    65,731
    
    
    $
    36,422
    
    
    $
    245,306
    
    
    $
    154,480
    
    
    $
    90,826
 
 *
    
    States in which USAgencies operated retail locations.  Three Months Ended
    
    
    Six Months EndedJune 30,
    
    
    June 30,2007
    
    
    2006
    
    
    2007
    
    
    2006Net Premiums Written By:Our underwriting agencies:Our retail agencies  gross written
    
    $
    55,852
    
    
    $
    18,699
    
    
    $
    135,669
    
    
    $
    51,785Ceded GMAC
QS January 2007 through March 2007
    
    
    
    
    
    
    
    
    
    
    (39,090
    )
    
    
    Ceded GMAC QS termination (1)
    
    
    39,734
    
    
    
    
    
    
    
    39,734
    
    
    
    Ceded GMAC
25% QS subsequent to April 1, 2007
    
    
    (11,457
    )
    
    
    
    
    
    
    (11,457
    )
    
    
    Subtotal  retail agencies net written
    
    
    84,129
    
    
    
    18,699
    
    
    
    124,856
    
    
    
    51,785Independent agencies  gross written
    
    
    36,976
    
    
    
    36,903
    
    
    
    88,922
    
    
    
    80,405Ceded Michigan (2)
    
    
    (617
    )
    
    
    
    
    
    
    (2,451
    )
    
    
    Ceded FolksAmerica (3)
    
    
    
    
    
    
    (300
    )
    
    
    
    
    
    
    (1,802
    )Ceded FolksAmerica QS termination (4)
    
    
    
    
    
    
    2,850
    
    
    
    
    
    
    
    2,850Subtotal  independent agencies net written
    
    
    36,359
    
    
    
    39,453
    
    
    
    86,471
    
    
    
    81,453Unaffiliated
underwriting agencies  gross written (5)
    
    
    9,324
    
    
    
    10,111
    
    
    
    20,716
    
    
    
    22,261Ceded USAUTO
Ins. Co. (6)
    
    
    (96
    )
    
    
    (161
    )
    
    
    (213
    )
    
    
    (350
    )Subtotal
 unaffiliated underwriting agencies net written
    
    
    9,228
    
    
    
    9,950
    
    
    
    20,503
    
    
    
    21,911Other
    
    
    1
    
    
    
    18
    
    
    
    (1
    )
    
    
    29Total
    
    $
    129,717
    
    
    $
    68,120
    
    
    $
    231,829
    
    
    $
    155,178
 
 (1)
    
    We terminated the existing GMAC quota share agreements on a cut-off basis effective
April 1, 2007.(2)
    
    In Michigan, we are required to cede premiums to the Michigan Catastrophic Claims Association
(MCCA).(3)
    
    In Florida, we ceded 25% of premiums to FolksAmerica through April 30, 2006.(4)
    
    Effective May 1, 2006, we terminated our quota share agreement with FolksAmerica in Florida
on a cut-off basis.(5)
    
    Predominantly premiums written in California through two
unaffiliated underwriting agencies. Includes less than $500,000 per
quarter written in Arizona, Utah and Georgia through programs with
unaffiliated underwriting agencies that are now in run-off.(6)
    
    In Georgia, we cede 100% of the premiums written to USAUTO Ins. Co. 29




---



##### Table of Contents



Commission Income and Fees
 Commission income and fees earned by our underwriting agencies on business that is not written or
retained by us.
 Policy,
installment, premium finance, franchise, royalty and agency fees are earned for business written or assumed by
our insurance companies both through independent agents and our retail agencies.
 The commissions earned on sales of unaffiliated (third-party) companies products sold by our
retail agencies.
 30




---



##### Table of Contents



Losses and Loss Adjustment Expenses
      31




---



##### Table of Contents



Selling, General and Administrative Expenses.
  Consolidation Process.
 Results of Operations
  32




---



##### Table of Contents



Three months ended June 30,
    
    
    Six months ended June 30,2007
    
    
    2006
    
    
    % Change
    
    
    2007
    
    
    2006
    
    
    % ChangeRevenuesNet premiums earned
    
    $
    113,257
    
    
    $
    73,753
    
    
    
    53.6
    %
    
    $
    196,027
    
    
    $
    146,791
    
    
    
    33.5
    %Commission income and fees
    
    
    23,287
    
    
    
    14,552
    
    
    
    60.0
    %
    
    
    46,670
    
    
    
    32,051
    
    
    
    45.6
    %Net investment income
    
    
    4,039
    
    
    
    2,154
    
    
    
    87.5
    %
    
    
    8,000
    
    
    
    4,214
    
    
    
    89.8
    %Net realized gains (losses)
    
    
    (322
    )
    
    
    1
    
    
    NM
    
    
    
    (491
    )
    
    
    (366
    )
    
    
    34.2
    %Total revenues
    
    
    140,261
    
    
    
    90,460
    
    
    
    55.1
    %
    
    
    250,206
    
    
    
    182,690
    
    
    
    37.1
    %ExpensesLosses and loss adjustment expenses
    
    
    81,900
    
    
    
    47,081
    
    
    
    74.0
    %
    
    
    139,852
    
    
    
    94,733
    
    
    
    47.6
    %Selling, general and administrative expenses
    
    
    47,912
    
    
    
    34,194
    
    
    
    40.1
    %
    
    
    86,537
    
    
    
    66,795
    
    
    
    29.6
    %Depreciation and amortization
    
    
    2,810
    
    
    
    1,059
    
    
    
    165.3
    %
    
    
    6,098
    
    
    
    2,119
    
    
    
    187.8
    %Interest expense
    
    
    6,284
    
    
    
    1,086
    
    
    
    478.6
    %
    
    
    12,916
    
    
    
    2,171
    
    
    
    494.9
    %Total expenses
    
    
    138,906
    
    
    
    83,420
    
    
    
    66.5
    %
    
    
    245,403
    
    
    
    165,818
    
    
    
    48.0
    %Net income before income taxes and minority interest
    
    
    1,355
    
    
    
    7,040
    
    
    
    -80.8
    %
    
    
    4,803
    
    
    
    16,872
    
    
    
    -71.5
    %Income tax expense
    
    
    237
    
    
    
    2,156
    
    
    
    -89.0
    %
    
    
    1,439
    
    
    
    5,676
    
    
    
    -74.6
    %Minority interest, net of income taxes
    
    
    
    
    
    
    
    
    
    NM
    
    
    
    
    
    
    
    81
    
    
    NMNet income
    
    $
    1,118
    
    
    $
    4,884
    
    
    
    -77.1
    %
    
    $
    3,364
    
    
    $
    11,115
    
    
    
    -69.7
    %Net income per common share  Basic
    
    $
    0.07
    
    
    $
    0.32
    
    
    
    -78.1
    %
    
    $
    0.22
    
    
    $
    0.72
    
    
    
    -69.4
    %Net income per common share  Diluted
    
    $
    0.07
    
    
    $
    0.32
    
    
    
    -78.1
    %
    
    $
    0.22
    
    
    $
    0.72
    
    
    
    -69.4
    %Weighted average shares outstanding  Basic
    
    
    15,368,173
    
    
    
    15,321,771
    
    
    
    0.3
    %
    
    
    15,363,139
    
    
    
    15,376,858
    
    
    
    -0.1
    %Weighted average shares outstanding  Diluted
    
    
    15,436,110
    
    
    
    15,359,005
    
    
    
    0.5
    %
    
    
    15,451,233
    
    
    
    15,414,733
    
    
    
    0.2
    %Operational InformationGross premiums written
    
    $
    102,153
    
    
    $
    65,731
    
    
    
    55.4
    %
    
    $
    245,306
    
    
    $
    154,480
    
    
    
    58.8
    %Net premiums written
    
    $
    129,717
    (1)
    
    $
    68,120
    
    
    
    90.4
    %
    
    $
    231,829
    (1)
    
    $
    155,178
    
    
    
    49.4
    %Percentage retained
    
    
    127.0
    %(1)
    
    
    103.6
    %
    
    
    
    
    
    
    94.5
    %(1)
    
    
    100.5
    %Loss Ratio
    
    
    72.3
    %
    
    
    63.8
    %
    
    
    
    
    
    
    71.3
    %
    
    
    64.5
    %Expense Ratio
    
    
    24.2
    %
    
    
    28.1
    %
    
    
    
    
    
    
    23.4
    %
    
    
    25.1
    %Combined Ratio
    
    
    96.5
    %
    
    
    91.9
    %
    
    
    
    
    
    
    94.8
    %
    
    
    89.6
    %
 
 (1)
    
    Reflects the inclusion of $39.7 million from cancellation of the USAgencies quota share
reinsurance contracts with GMAC on a cut-off basis effective April 1, 2007, as more fully
described in Note 3 to the consolidated financial statements. 33




---



##### Table of Contents



Comparison of the Three Month Periods Ended June 30, 2007 and June 30, 2006
   Three Months EndedJune 30,2007
    
    
    2006
    
    
    % ChangeOur underwriting agencies
    
    $
    103,045
    
    
    $
    63,643
    
    
    
    61.9
    %Unaffiliated underwriting
agencies
    
    
    10,212
    
    
    
    10,110
    
    
    
    1.0
    %Total net premiums earned
    
    $
    113,257
    
    
    $
    73,753
    
    
    
    53.6
    %
  34




---



##### Table of Contents



Three Months EndedJune 30,2007
    
    
    2006
    
    
    Variance
    
    
    Variance($)
    
    
    (%)Income on non-retained business MGA commissions
    
    $
    171
    
    
    $
    340
    
    
    
    (169
    )
    
    
    -49.7
    % Claims service fee income
    
    
    379
    
    
    
    650
    
    
    
    (271
    )
    
    
    -41.7
    %Affiliated Policyholder fee income
    
    
    10,522
    
    
    
    9,459
    
    
    
    1,063
    
    
    
    11.2
    % Premium finance fees and interest
    
    
    5,594
    
    
    
    
    
    
    
    5,594
    
    
    NM Agency fees
    
    
    384
    
    
    
    406
    
    
    
    (22
    )
    
    
    -5.4
    %Non-affiliated income  third party Commissions and fees
    
    
    5,668
    
    
    
    3,589
    
    
    
    2,079
    
    
    
    57.9
    % Agency fees
    
    
    569
    
    
    
    108
    
    
    
    461
    
    
    
    426.9
    %Total commission income and fees
    
    $
    23,287
    
    
    $
    14,552
    
    
    
    8,735
    
    
    
    60.0
    %
      35




---



##### Table of Contents



Three Months EndedJune 30,2007
    
    2006Loss and loss adjustment expense ratio   current period
    
    
    73.7
    %
    
    
    68.2
    %Favorable loss ratio development  prior period business
    
    
    -1.4
    %
    
    
    -4.4
    %Reported loss and loss adjustment expense ratio
    
    
    72.3
    %
    
    
    63.8
    %
   Three Months EndedJune 30,2007
    
    
    2006(dollars in thousands)Beginning deferred acquisition costs (DAC)
    
    $
    30,039
    
    
    $
    28,069Additions
    
    
    30,528
    
    
    
    17,536Amortization of DAC
    
    
    (30,009
    )
    
    
    (18,661
    )Ending deferred acquisition costs
    
    $
    30,558
    
    
    $
    26,944Amortization of DAC as % of Earned Premium
    
    
    26.5
    %
    
    
    25.3
    %Total policy acquisition costs (amortization of DAC)
    
    $
    30,009
    
    
    $
    18,661Other selling, general and administrative expenses
    
    
    17,903
    
    
    
    15,533Total selling, general and administrative expenses
    
    $
    47,912
    
    
    $
    34,194Total SG&A expenses as % of Earned Premium
    
    
    42.3
    %
    
    
    46.4
    %
 36




---



##### Table of Contents



Three Months EndedJune 30,2007
    
    
    2006Selling, general and administrative expenses
    
    $
    47,912
    
    
    $
    34,194Depreciation and amortization
    
    
    2,810
    
    
    
    1,059Less: commission income and fees
    
    
    (23,287
    )
    
    
    (14,552
    )Total expenses, net of commission income and fees (dividend)
    
    $
    27,435
    
    
    $
    20,701Net premiums earned (divisor)
    
    $
    113,257
    
    
    $
    73,753Expense ratio
    
    
    24.2
    %
    
    
    28.1
    %
  37




---



##### Table of Contents



Comparison of the Six Month Periods Ended June 30, 2007 and June 30, 2006
   Six Months EndedJune 30,2007
    
    
    2006
    
    
    % ChangeOur underwriting agencies
    
    $
    175,756
    
    
    $
    126,038
    
    
    
    39.4
    %Unaffiliated underwriting
agencies
    
    
    20,271
    
    
    
    20,753
    
    
    
    -2.3
    %Total net premiums earned
    
    $
    196,027
    
    
    $
    146,791
    
    
    
    33.5
    %
  38




---



##### Table of Contents



Six Months EndedJune 30,2007
    
    
    2006
    
    
    Variance
    
    
    Variance($)
    
    (%)Income on non-retained business MGA commissions
    
    $
    580
    
    
    $
    1,253
    
    
    
    (673
    )
    
    
    -53.7
    % Claims service fee income
    
    
    890
    
    
    
    1,542
    
    
    
    (652
    )
    
    
    -42.3
    %Affiliated Policyholder fee income
    
    
    20,314
    
    
    
    20,016
    
    
    
    298
    
    
    
    1.5
    % Premium finance fees and interest
    
    
    11,392
    
    
    
    
    
    
    
    11,392
    
    
    NM Agency fees
    
    
    793
    
    
    
    1,551
    
    
    
    (758
    )
    
    
    -48.9
    %Non-affiliated income  third party Commissions and fees
    
    
    11,645
    
    
    
    7,262
    
    
    
    4,383
    
    
    
    60.4
    % Agency fees
    
    
    1,056
    
    
    
    427
    
    
    
    629
    
    
    
    147.3
    %Total commission income and fees
    
    $
    46,670
    
    
    $
    32,051
    
    
    
    14,619
    
    
    
    45.6
    %
     39




---



##### Table of Contents



Six Months EndedJune 30,2007
    
    2006Loss and loss adjustment expense ratio   current period
    
    
    72.9
    %
    
    
    68.4
    %Favorable loss ratio development  prior period business
    
    
    -1.6
    %
    
    
    -3.9
    %Reported loss and loss adjustment expense ratio
    
    
    71.3
    %
    
    
    64.5
    %
   Six Months EndedJune 30,2007
    
    
    2006(dollars in thousands)Beginning deferred acquisition costs (DAC)
    
    $
    23,865
    
    
    $
    24,453Additions
    
    
    55,939
    
    
    
    40,048Amortization of DAC
    
    
    (49,246
    )
    
    
    (37,557
    )Ending deferred acquisition costs
    
    $
    30,558
    
    
    $
    26,944Amortization of DAC as % of Earned Premium
    
    
    25.1
    %
    
    
    25.6
    %Total policy acquisition costs (amortization of DAC)
    
    $
    49,246
    
    
    $
    37,557Other selling, general and administrative expenses
    
    
    37,291
    
    
    
    29,238Total selling, general and administrative expenses
    
    $
    86,537
    
    
    $
    66,795Total SG&A expenses as % of Earned Premium
    
    
    44.1
    %
    
    
    45.5
    %
  40




---



##### Table of Contents



Six Months EndedJune 30,2007
    
    
    2006Selling, general and administrative expenses
    
    $
    86,537
    
    
    $
    66,795Depreciation and amortization
    
    
    6,098
    
    
    
    2,119Less: commission income and fees
    
    
    (46,670
    )
    
    
    (32,051
    )Total expenses, net of commission income and fees (dividend)
    
    $
    45,965
    
    
    $
    36,863Net premiums earned (divisor)
    
    $
    196,027
    
    
    $
    146,791Expense ratio
    
    
    23.4
    %
    
    
    25.1
    %
   41




---



##### Table of Contents



Liquidity and Capital Resources
 Sources and uses of funds.
     42




---



##### Table of Contents



Senior secured credit facility.
 43




---



##### Table of Contents



Accounting for Derivative Instruments and
Hedging Activities Accounting for Certain Derivative
Instruments and Certain Hedging Activities an amendment of SFAS 133
  Special Note Regarding Forward-Looking Statements
  44




---



##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risk.
  Interest rate risk.
 Credit risk.
  As of
    
    As ofJune 30,
    
    December 31,2007
    
    2006Total invested assets ($ in thousands)
    
    $
    354,602
    
    
    $
    221,770Tax equivalent book yield
    
    
    4.76
    %
    
    
    5.33
    %Average duration in years
    
    
    1.5
    
    
    
    1.0Average S&P rating
    
    AA+
    
    AA+
  45




---



##### Table of Contents



Effects of inflation.
 
 Item 4. Controls and Procedures.
 Evaluation of Disclosure Controls and Procedures
  46




---



##### Table of Contents



Changes in Internal Control over Financial Reporting
   
 PART II  Other Information
 
 Item 1. Legal Proceedings.
  th
 th
 47




---



##### Table of Contents



48




---



##### Table of Contents



Item 1A. Risk Factors.
  
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
  
 Item 3. Defaults Upon Senior Securities.
  
 Item 4. Submission of Matters to a Vote of Security Holders.
   Description of Matter
    
    For
    
    Against
    
    Withheld
    
    Abstentions
    
    Broker Non-Votes1. Election of Directors:Kevin R. Callahan
    
    
    13,274,983
    
    
    
    n/a
    
    
    
    1,632,450
    
    
    
    n/a
    
    
    
    n/aThomas C. Davis
    
    
    13,469,084
    
    
    
    n/a
    
    
    
    1,438,349
    
    
    
    n/a
    
    
    
    n/aNimrod T. Frazer
    
    
    13,391,467
    
    
    
    n/a
    
    
    
    1,515,966
    
    
    
    n/a
    
    
    
    n/aAvshalom Y. Kalichstein
    
    
    11.393,379
    
    
    
    n/a
    
    
    
    3,514,054
    
    
    
    n/a
    
    
    
    n/aSuzanne T. Porter
    
    
    13,479,948
    
    
    
    n/a
    
    
    
    1,427,485
    
    
    
    n/a
    
    
    
    n/aDavid I. Schamis
    
    
    11,503,052
    
    
    
    n/a
    
    
    
    3,404,381
    
    
    
    n/a
    
    
    
    n/aPaul J. Zucconi
    
    
    13,383,805
    
    
    
    n/a
    
    
    
    1,523,628
    
    
    
    n/a
    
    
    
    n/a2. Approval of the
Affirmative Insurance
Holdings, Inc.
Performance-Based Annual
Incentive Plan
    
    
    12,986,642
    
    
    
    1,917,191
    
    
    
    n/a
    
    
    
    3,600
    
    
    
    n/a
 49




---



##### Table of Contents



Item 5. Other Information.
  
 Item 6. Exhibits.
 Exhibit No.
    
    Description31.1*
    
    Certification of Kevin R. Callahan, Chief Executive Officer,
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2*
    
    Certification of Mark E. Pape, Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.32.1*
    
    Certification of Kevin R. Callahan, Chief Executive Officer,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2*
    
    Certification of Mark E. Pape, Chief Financial Officer, pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
 
 *
    
    Filed herewith 50




---



##### Table of Contents



SIGNATURES
  Affirmative Insurance Holdings, Inc.Date: August 9, 2007/s/ Mark E. PapeBy: Mark E. PapeExecutive Vice President and Chief Financial Officer
(and in his capacity as Principal Financial Officer) 51