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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended September 30, 2010

OR



| ̈ | 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





LOGO

(Exact name of registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 75-2770432                          
|(State or other jurisdiction of
incorporation or organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|4450 Sojourn Drive, Suite 500
Addison, Texas                   |  | 75001                               
|(Address of principal executive offices)                       |  | (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)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90
days.    Yes  x    No   ̈

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule
405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files).    Yes   ̈    No   ̈

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.



|                        |  |                                                  |  |                           |  |  
|----------------------- |  | ------------------------------------------------ |  | ------------------------- |  | -
|Large accelerated filer |  |  ̈                                                |  | Accelerated filer         |  |  ̈
|                        |  |                                                  | 
|Non-accelerated filer   |  |  ̈  (Do not check if a smaller reporting company) |  | Smaller reporting company |  | x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     ̈  Yes    No  x

Indicate the number of shares outstanding of each of the issuers classes of common stock, as of the latest practicable date.

The number of shares outstanding of the registrants common stock, $.01 par value, as of November 15, 2010: 15,408,358









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AFFIRMATIVE INSURANCE HOLDINGS, INC.

NINE MONTHS ENDED SEPTEMBER 30, 2010

INDEX TO FORM 10-Q



|                                                                                                                  |  |  |    | 
|----------------------------------------------------------------------------------------------------------------- |  |  | -- | 
|PART I  FINANCIAL INFORMATION                                                                                    |  |  | 3  | 
|                                                                                                                  | 
|Item 1. Financial Statements                                                                                      |  |  | 3  | 
|Consolidated Balance Sheets  September 30, 2010 and December 31, 2009                                            |  |  | 3  | 
|Consolidated Statements of Loss  Three and Nine Months Ended September 30, 2010 and
2009                         |  |  | 4  | 
|Consolidated Statements of Stockholders Equity  Nine Months Ended September 
30, 2010 and 2009                  |  |  | 5  | 
|Consolidated Statements of Comprehensive Income (Loss)  Three and Nine Months Ended September 
30, 2010 and 2009 |  |  | 5  | 
|Consolidated Statements of Cash Flows  Nine Months Ended September 30, 2010 and
2009                             |  |  | 6  | 
|Notes to Consolidated Financial Statements                                                                        |  |  | 7  | 
|                                                                                                                  | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations                     |  |  | 20 | 
|                                                                                                                  | 
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                                                |  |  | 29 | 
|                                                                                                                  | 
|Item 4. Controls and Procedures                                                                                   |  |  | 31 | 
|                                                                                                                  | 
|PART II  OTHER INFORMATION                                                                                       |  |  | 31 | 
|                                                                                                                  | 
|Item 1. Legal Proceedings                                                                                         |  |  | 31 | 
|                                                                                                                  | 
|Item 1A. Risk Factors                                                                                             |  |  | 31 | 
|                                                                                                                  | 
|Item 6. Exhibits                                                                                                  |  |  | 31 | 
|                                                                                                                  | 
|SIGNATURES                                                                                                        |  |  | 32 | 



2



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PART I  FINANCIAL INFORMATION



|Item 1. | Financial Statements
|------- | --------------------

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)



|                                                                                                                                                                                |  |                   |         |   |                  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                                |  | September 30,2010 |         |   | December 31,2009 |  
|                                                                                                                                                                                |  | (Unaudited)       |         |   |                  |  
|Assets                                                                                                                                                                          |  |                   |         |   |                  |   |         |  
|Investment securities, at fair value                                                                                                                                            |  |                   |         |   |                  |   |         |  
|Trading securities                                                                                                                                                              |  | $                 | 8,843   |   |                  | $ | 37,416  |  
|Available-for-sale securities                                                                                                                                                   |  |                   | 222,591 |   |                  |   | 213,656 |  
|Cash and cash equivalents                                                                                                                                                       |  |                   | 63,352  |   |                  |   | 60,928  |  
|Fiduciary and restricted cash                                                                                                                                                   |  |                   | 6,546   |   |                  |   | 15,004  |  
|Accrued investment income                                                                                                                                                       |  |                   | 2,470   |   |                  |   | 2,823   |  
|Premiums and fees receivable, net                                                                                                                                               |  |                   | 52,128  |   |                  |   | 63,344  |  
|Premium finance receivable, net                                                                                                                                                 |  |                   | 46,777  |   |                  |   | 40,825  |  
|Commissions receivable                                                                                                                                                          |  |                   | 1,859   |   |                  |   | 1,362   |  
|Receivable from reinsurers                                                                                                                                                      |  |                   | 86,843  |   |                  |   | 42,082  |  
|Deferred acquisition costs                                                                                                                                                      |  |                   | 24,246  |   |                  |   | 24,230  |  
|Federal income taxes receivable                                                                                                                                                 |  |                   | 2,036   |   |                  |   | 3,326   |  
|Investment in real property, net                                                                                                                                                |  |                   | 11,375  |   |                  |   | 5,831   |  
|Property and equipment (net of accumulated depreciation of $39,935 for 2010 and $33,581 for 2009)                                                                               |  |                   | 39,917  |   |                  |   | 41,984  |  
|Goodwill                                                                                                                                                                        |  |                   | 163,570 |   |                  |   | 163,570 |  
|Other intangible assets (net of accumulated amortization of $12,988 for 2010 and $12,765 for 2009)                                                                              |  |                   | 16,530  |   |                  |   | 16,752  |  
|Prepaid expenses                                                                                                                                                                |  |                   | 6,148   |   |                  |   | 5,750   |  
|Other assets, (net of allowance for doubtful accounts of $7,213 for 2010 and 2009) (includes other receivables of $2,123 at
September 30, 2010 and $8,830 at December 31, 2009) |  |                   | 4,679   |   |                  |   | 12,397  |  
|                                                                                                                                                                                |  |                   |         |   |                  |   |         |  
|Total assets                                                                                                                                                                    |  | $                 | 759,910 |   |                  | $ | 751,280 |  
|                                                                                                                                                                                |  |                   |         |   |                  |   |         |  
|                                                                                                                                                                                |  |                  
|Liabilities and Stockholders Equity                                                                                                                                            |  |                   |         |   |                  |   |         |  
|Liabilities:                                                                                                                                                                    |  |                   |         |   |                  |   |         |  
|Reserves for losses and loss adjustment expenses                                                                                                                                |  | $                 | 223,346 |   |                  | $ | 193,647 |  
|Unearned premium                                                                                                                                                                |  |                   | 107,970 |   |                  |   | 109,361 |  
|Amounts due to reinsurers                                                                                                                                                       |  |                   | 7,167   |   |                  |   | 4,037   |  
|Deferred revenue                                                                                                                                                                |  |                   | 8,578   |   |                  |   | 10,190  |  
|Capital lease obligation                                                                                                                                                        |  |                   | 26,441  |   |                  |   |        |  
|Senior secured credit facility                                                                                                                                                  |  |                   | 98,029  |   |                  |   | 111,506 |  
|Notes payable                                                                                                                                                                   |  |                   | 76,878  |   |                  |   | 76,891  |  
|Deferred tax liability                                                                                                                                                          |  |                   | 11,776  |   |                  |   | 10,820  |  
|Other liabilities (includes interest rate swaps of $2,201 at September 30, 2010 and $4,108 at December 31,
2009)                                                                |  |                   | 54,962  |   |                  |   | 51,473  |  
|                                                                                                                                                                                |  |                   |         |   |                  |   |         |  
|Total liabilities                                                                                                                                                               |  |                   | 615,147 |   |                  |   | 567,925 |  
|                                                                                                                                                                                |  |                   |         |   |                  |   |         |  
|Stockholders equity:                                                                                                                                                           |  |                   |         |   |                  |   |         |  
|Common stock, $0.01 par value; 75,000,000 shares authorized, 17,768,721 shares issued and 15,415,358 outstanding at
September 30, 2010 and December 31, 2009                    |  |                   | 178     |   |                  |   | 178     |  
|Additional paid-in capital                                                                                                                                                      |  |                   | 165,734 |   |                  |   | 164,752 |  
|Treasury stock, at cost (2,353,363 shares at September 30, 2010 and December 31, 2009)                                                                                          |  |                   | (32,880 | ) |                  |   | (32,880 | )
|Accumulated other comprehensive income                                                                                                                                          |  |                   | 1,980   |   |                  |   | 2,859   |  
|Retained earnings                                                                                                                                                               |  |                   | 9,751   |   |                  |   | 48,446  |  
|                                                                                                                                                                                |  |                   |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                                                      |  |                   | 144,763 |   |                  |   | 183,355 |  
|                                                                                                                                                                                |  |                   |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                                                                      |  | $                 | 759,910 |   |                  | $ | 751,280 |  
|                                                                                                                                                                                |  |                   |         |   |                  |   |         |  

See accompanying Notes to Consolidated Financial Statements



3



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AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(in thousands, except per share data)



|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|--------------------------------------------------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                          |  | Three Months
EndedSeptember 30, |         |   | Nine Months
EndedSeptember 30, |  
|                                                          |  | 2010                            |         |   | 2009                           |   |         | 2010 |  |   | 2009    |  
|                                                          |  | (Unaudited)                     |        
|Revenues                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net premiums earned                                       |  | $                               | 91,075  |   |                                | $ | 88,561  |      |  | $ | 280,212 |   |  | $ | 276,006 |  
|Commission income and fees                                |  |                                 | 18,231  |   |                                |   | 20,024  |      |  |   | 64,091  |   |  |   | 60,474  |  
|Net investment income                                     |  |                                 | 1,160   |   |                                |   | 2,399   |      |  |   | 3,735   |   |  |   | 7,284   |  
|Net realized gains                                        |  |                                 | 1,115   |   |                                |   | 17      |      |  |   | 8,295   |   |  |   | 604     |  
|Other income (loss)                                       |  |                                 | (1,077  | ) |                                |   | 512     |      |  |   | (6,110  | ) |  |   | 1,049   |  
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total revenues                                            |  |                                 | 110,504 |   |                                |   | 111,513 |      |  |   | 350,223 |   |  |   | 345,417 |  
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|                                                          |  |                                 |         |  
|Expenses                                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Losses and loss adjustment expenses                       |  |                                 | 76,345  |   |                                |   | 70,293  |      |  |   | 228,257 |   |  |   | 221,860 |  
|Selling, general and administrative expenses              |  |                                 | 48,689  |   |                                |   | 38,092  |      |  |   | 133,775 |   |  |   | 117,728 |  
|Depreciation and amortization                             |  |                                 | 2,381   |   |                                |   | 2,341   |      |  |   | 7,196   |   |  |   | 7,131   |  
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total expenses                                            |  |                                 | 127,415 |   |                                |   | 110,726 |      |  |   | 369,228 |   |  |   | 346,719 |  
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Operating income (loss)                                   |  |                                 | (16,911 | ) |                                |   | 787     |      |  |   | (19,005 | ) |  |   | (1,302  | )
|                                                          |  |                                 |         |  
|Gain on extinguishment of debt                            |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   | 19,434  |  
|Loss on interest rate swaps                               |  |                                 | 252     |   |                                |   | 926     |      |  |   | 862     |   |  |   | 5,872   |  
|Interest expense                                          |  |                                 | 5,491   |   |                                |   | 6,425   |      |  |   | 17,527  |   |  |   | 17,143  |  
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Loss from continuing operations before income tax expense |  |                                 | (22,654 | ) |                                |   | (6,564  | )    |  |   | (37,394 | ) |  |   | (4,883  | )
|Income tax expense (benefit)                              |  |                                 | 466     |   |                                |   | (3,172  | )    |  |   | 1,301   |   |  |   | (4,634  | )
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Loss from continuing operations                           |  |                                 | (23,120 | ) |                                |   | (3,392  | )    |  |   | (38,695 | ) |  |   | (249    | )
|Discontinued operations                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Loss from operations (including loss on disposal)         |  |                                 |        |   |                                |   | (47     | )    |  |   |        |   |  |   | (1,835  | )
|Income tax benefit                                        |  |                                 |        |   |                                |   | (17     | )    |  |   |        |   |  |   | (479    | )
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Loss from discontinued operations                         |  |                                 |        |   |                                |   | (30     | )    |  |   |        |   |  |   | (1,356  | )
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net Loss                                                  |  | $                               | (23,120 | ) |                                | $ | (3,422  | )    |  | $ | (38,695 | ) |  | $ | (1,605  | )
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|                                                          |  |                                 |         |  
|Basic loss per common share:                              |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Continuing operations                                     |  | $                               | (1.50   | ) |                                | $ | (0.22   | )    |  | $ | (2.51   | ) |  | $ | (0.01   | )
|Discontinued operations                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   | (0.09   | )
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net loss                                                  |  | $                               | (1.50   | ) |                                | $ | (0.22   | )    |  | $ | (2.51   | ) |  | $ | (0.10   | )
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|                                                          |  |                                 |         |  
|Diluted loss per common share:                            |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Continuing operations                                     |  | $                               | (1.50   | ) |                                | $ | (0.22   | )    |  | $ | (2.51   | ) |  | $ | (0.01   | )
|Discontinued operations                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   | (0.09   | )
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net loss                                                  |  | $                               | (1.50   | ) |                                | $ | (0.22   | )    |  | $ | (2.51   | ) |  | $ | (0.10   | )
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|                                                          |  |                                 |         |  
|Weighted average common shares outstanding:               |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Basic                                                     |  |                                 | 15,415  |   |                                |   | 15,415  |      |  |   | 15,415  |   |  |   | 15,415  |  
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Diluted                                                   |  |                                 | 15,415  |   |                                |   | 15,415  |      |  |   | 15,415  |   |  |   | 15,415  |  
|                                                          |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  

See accompanying Notes to Consolidated Financial Statements



4



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##### Table of Contents



AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

(in thousands, except share data)



|                                                                               |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|------------------------------------------------------------------------------ |  | ------------------------------- | ---------- |  | ------- | - | ------- | ------ |  |  | ---------- |  |  | - | ------- | -
|                                                                               |  | Nine Months Ended September 30, |           
|                                                                               |  | 2010                            |            |  | 2009    |  
|                                                                               |  | Shares                          |            |  | Amounts |   |         | Shares |  |  | Amounts    | 
|                                                                               |  | (Unaudited)                     |           
|Common stock                                                                   |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|Balance at beginning of year and end of period                                 |  |                                 | 17,768,721 |  |         | $ | 178     |        |  |  | 17,768,721 |  |  | $ | 178     |  
|                                                                               |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|                                                                               |  |                                 |            | 
|Additional paid-in capital                                                     |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|Balance at beginning of year                                                   |  |                                 |            |  |         |   | 164,752 |        |  |  |            |  |  |   | 163,707 |  
|Stock-based compensation expense                                               |  |                                 |            |  |         |   | 982     |        |  |  |            |  |  |   | 763     |  
|                                                                               |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|Balance at end of period                                                       |  |                                 |            |  |         |   | 165,734 |        |  |  |            |  |  |   | 164,470 |  
|                                                                               |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|                                                                               |  |                                 |            | 
|Retained earnings                                                              |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|Balance at beginning of year                                                   |  |                                 |            |  |         |   | 48,446  |        |  |  |            |  |  |   | 87,327  |  
|Net Loss                                                                       |  |                                 |            |  |         |   | (38,695 | )      |  |  |            |  |  |   | (1,605  | )
|                                                                               |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|Balance at end of period                                                       |  |                                 |            |  |         |   | 9,751   |        |  |  |            |  |  |   | 85,722  |  
|                                                                               |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|                                                                               |  |                                 |            | 
|Treasury stock                                                                 |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|Balance at beginning of year and end of period                                 |  |                                 | 2,353,363  |  |         |   | (32,880 | )      |  |  | 2,353,363  |  |  |   | (32,880 | )
|                                                                               |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|                                                                               |  |                                 |            | 
|Accumulated other comprehensive income (loss)                                  |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|Balance at beginning of year, net of tax                                       |  |                                 |            |  |         |   | 2,859   |        |  |  |            |  |  |   | (1,849  | )
|Unrealized gain (loss) on available-for-sale investment securities, net of tax |  |                                 |            |  |         |   | (879    | )      |  |  |            |  |  |   | 1,334   |  
|Gain on cash flow hedges transferred to earnings, net of tax                   |  |                                 |            |  |         |   |        |        |  |  |            |  |  |   | 3,858   |  
|                                                                               |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|Balance at end of period, net of tax                                           |  |                                 |            |  |         |   | 1,980   |        |  |  |            |  |  |   | 3,343   |  
|                                                                               |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  
|                                                                               |  |                                 |            | 
|Total stockholders equity                                                     |  |                                 |            |  |         | $ | 144,763 |        |  |  |            |  |  | $ | 220,833 |  
|                                                                               |  |                                 |            |  |         |   |         |        |  |  |            |  |  |   |         |  

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)



|                                                                         |  |                                  |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|------------------------------------------------------------------------ |  | -------------------------------- | ------- | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                                         |  | Three Months 
EndedSeptember 30, |         |   | Nine Months
EndedSeptember 30, |  
|                                                                         |  | 2010                             |         |   | 2009                           |   |        | 2010 |  |   | 2009    |  
|                                                                         |  | (Unaudited)                      |        
|Net loss                                                                 |  | $                                | (23,120 | ) |                                | $ | (3,422 | )    |  | $ | (38,695 | ) |  | $ | (1,605 | )
|Other comprehensive income (loss):                                       |  |                                  |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Unrealized gain arising during period, net of tax                        |  |                                  | 1,137   |   |                                |   | 681    |      |  |   | 521     |   |  |   | 1,484  |  
|Reclassification adjustment for gains included in net income, net of tax |  |                                  | (43     | ) |                                |   | (25    | )    |  |   | (1,400  | ) |  |   | (150   | )
|Unrealized gain on cash flow hedges, net of tax                          |  |                                  |        |   |                                |   |       |      |  |   |        |   |  |   | 3,858  |  
|                                                                         |  |                                  |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Other comprehensive income (loss), net                                   |  |                                  | 1,094   |   |                                |   | 656    |      |  |   | (879    | ) |  |   | 5,192  |  
|                                                                         |  |                                  |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Total comprehensive income (loss)                                        |  | $                                | (22,026 | ) |                                | $ | (2,766 | )    |  | $ | (39,574 | ) |  | $ | 3,587  |  
|                                                                         |  |                                  |         |   |                                |   |        |      |  |   |         |   |  |   |        |  

See accompanying Notes to Consolidated Financial Statements



5



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AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                          |  |                                |          |   |      |   |         |  
|----------------------------------------------------------------------------------------- |  | ------------------------------ | -------- | - | ---- | - | ------- | -
|                                                                                          |  | Nine Months
EndedSeptember 30, |         
|                                                                                          |  | 2010                           |          |   | 2009 |  
|                                                                                          |  | (Unaudited)                    |         
|Cash flows from operating activities                                                      |  |                                |          |   |      |   |         |  
|Net Loss                                                                                  |  | $                              | (38,695  | ) |      | $ | (1,605  | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                                |          |   |      |   |         |  
|Depreciation and amortization                                                             |  |                                | 7,196    |   |      |   | 7,164   |  
|Stock-based compensation expense                                                          |  |                                | 1,165    |   |      |   | 848     |  
|Amortization of debt issuance and modification costs                                      |  |                                | 359      |   |      |   | 577     |  
|Amortization of debt discount                                                             |  |                                | 4,883    |   |      |   | 3,960   |  
|Net realized gains from sales of available-for-sale securities                            |  |                                | (1,400   | ) |      |   | (230    | )
|Realized gain on trading securities                                                       |  |                                | (6,897   | ) |      |   | (44     | )
|Fair value (gain) loss on settlement rights for auction-rate securities                   |  |                                | 6,707    |   |      |   | (1,049  | )
|Loss on disposal of assets (including sale of business)                                   |  |                                | 2        |   |      |   | 631     |  
|Amortization of premiums on investments, net                                              |  |                                | 2,535    |   |      |   | 2,501   |  
|Provision for doubtful receivables                                                        |  |                                | 342      |   |      |   | 749     |  
|Gain on extinguishment of debt                                                            |  |                                |         |   |      |   | (19,434 | )
|Loss on interest rate swaps                                                               |  |                                | 862      |   |      |   | 5,872   |  
|Change in operating assets and liabilities:                                               |  |                                |          |   |      |   |         |  
|Fiduciary and restricted cash                                                             |  |                                | 8,458    |   |      |   | 6,087   |  
|Premiums, fees and commissions receivable                                                 |  |                                | 10,377   |   |      |   | (7,291  | )
|Reserves for losses and loss adjustment expenses                                          |  |                                | 29,699   |   |      |   | (7,384  | )
|Amounts due from reinsurers                                                               |  |                                | (41,631  | ) |      |   | 19,328  |  
|Premium finance receivable, net (related to our insurance premiums)                       |  |                                | (9,715   | ) |      |   | (5,255  | )
|Deferred revenue                                                                          |  |                                | (1,612   | ) |      |   | 4,358   |  
|Unearned premium                                                                          |  |                                | (1,391   | ) |      |   | 8,286   |  
|Deferred acquisition costs                                                                |  |                                | (16      | ) |      |   | (2,432  | )
|Deferred tax liability                                                                    |  |                                | 956      |   |      |   | (7,510  | )
|Federal income taxes receivable                                                           |  |                                | 1,290    |   |      |   | 2,553   |  
|Other                                                                                     |  |                                | 2,135    |   |      |   | (608    | )
|                                                                                          |  |                                |          |   |      |   |         |  
|Net cash provided by (used in) operating activities                                       |  |                                | (24,391  | ) |      |   | 10,072  |  
|                                                                                          |  |                                |          |   |      |   |         |  
|                                                                                          |  |                               
|Cash flows from investing activities                                                      |  |                                |          |   |      |   |         |  
|Proceeds from sales of available-for-sale securities                                      |  |                                | 102,231  |   |      |   | 19,237  |  
|Proceeds from maturities of available-for-sale securities                                 |  |                                | 48,510   |   |      |   | 57,717  |  
|Proceeds from sales of trading securities                                                 |  |                                | 35,470   |   |      |   | 2,505   |  
|Purchases of available-for-sale securities                                                |  |                                | (160,688 | ) |      |   | (87,631 | )
|Premium finance receivable, net (related to third-party insurance premiums)               |  |                                | 3,763    |   |      |   | (911    | )
|Purchases of property and equipment                                                       |  |                                | (4,922   | ) |      |   | (6,070  | )
|Proceeds from insurance recoveries                                                        |  |                                |         |   |      |   | 600     |  
|Net cash paid for acquisitions                                                            |  |                                |         |   |      |   | (60     | )
|Proceeds from sale of business                                                            |  |                                |         |   |      |   | 250     |  
|Improvements to investment in real property                                               |  |                                | (5,630   | ) |      |   |        |  
|                                                                                          |  |                                |          |   |      |   |         |  
|Net cash provided by (used in) investing activities                                       |  |                                | 18,734   |   |      |   | (14,363 | )
|                                                                                          |  |                                |          |   |      |   |         |  
|                                                                                          |  |                               
|Cash flows from financing activities                                                      |  |                                |          |   |      |   |         |  
|Proceeds from financing under capital lease obligation                                    |  |                                | 28,189   |   |      |   |        |  
|Principal payments under capital lease obligation                                         |  |                                | (1,748   | ) |      |   |        |  
|Principal payments on senior secured credit facility                                      |  |                                | (18,360  | ) |      |   | (6,321  | )
|Debt issuance costs paid                                                                  |  |                                |         |   |      |   | (2,532  | )
|                                                                                          |  |                                |          |   |      |   |         |  
|Net cash provided by (used in) financing activities                                       |  |                                | 8,081    |   |      |   | (8,853  | )
|                                                                                          |  |                                |          |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                      |  |                                | 2,424    |   |      |   | (13,144 | )
|Cash and cash equivalents at beginning of year                                            |  |                                | 60,928   |   |      |   | 66,513  |  
|                                                                                          |  |                                |          |   |      |   |         |  
|Cash and cash equivalents at end of period                                                |  | $                              | 63,352   |   |      | $ | 53,369  |  
|                                                                                          |  |                                |          |   |      |   |         |  
|                                                                                          |  |                               
|Supplemental disclosure of cash flow information:                                         |  |                                |          |   |      |   |         |  
|Cash paid for interest                                                                    |  | $                              | 11,795   |   |      | $ | 12,569  |  
|Cash paid for income taxes                                                                |  |                                | 364      |   |      |   | 774     |  

See accompanying Notes
to Consolidated Financial Statements



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AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)





|1. | General
|-- | -------

Affirmative
Insurance Holdings, Inc., formerly known as Instant Insurance Holdings, Inc., was incorporated in Delaware in June 1998. The Company is a distributor and producer of non-standard personal automobile insurance policies and related products and
services for individual consumers in targeted geographic areas. The Company currently offers insurance directly to individual consumers through retail stores in 9 states (Louisiana, Texas, Illinois, Alabama, Missouri, Indiana, South Carolina, Kansas
and Wisconsin) as well as through 9,300 independent agents or brokers in 10 states (Louisiana, Texas, Illinois, Alabama, California, Michigan, Missouri, Indiana, South Carolina and New Mexico).



|2. | Summary of Significant Accounting Policies
|-- | ------------------------------------------

Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP) for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements of the Company. In the opinion of management, all adjustments necessary
for a fair presentation have been included and are of a normal recurring nature. Interim results are not necessarily indicative of the results that may be expected for the year. The consolidated financial statements should be read in conjunction
with the consolidated financial statements and notes thereto for the year ended December 31, 2009 included in the Companys Annual Report on Form 10-K.

The consolidated balance sheet at December 31, 2009 was derived from the audited financial statements at that date, but does not include all of the information and notes required by GAAP. All
material intercompany transactions and balances have been eliminated in consolidation.

Certain prior year amounts have been
reclassified to conform to the current presentation.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires the Company to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the 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, valuation of assets, and deferred income taxes.

Recently Issued Accounting Standards

ASU 2009-17 amended the standards for determining whether to consolidate a variable interest entity. These new
standards amended the evaluation criteria to identify the primary beneficiary of a variable interest entity and require ongoing reassessment of whether an enterprise is the primary beneficiary of the variable interest entity. The
provisions of the new standards are effective for annual reporting periods beginning after November 15, 2009 and interim periods within those fiscal years. The adoption of this new standard effective January 1, 2010 did not impact the
Companys consolidated financial position, results of operations or cash flows.

ASU 2009-16 eliminated the concept of a
qualifying special-purpose entity, creates more stringent conditions for reporting a transfer of a portion of a financial asset as a sale, clarifies other sale-accounting criteria, and changes the initial measurement of a transferors interest
in transferred financial assets. The provisions of the new standards are effective for fiscal years beginning after November 15, 2009. The adoption of the new standard effective January 1, 2010 did not impact the Companys
consolidated financial position, results of operations or cash flows.

ASU 2010-06 requires additional disclosures about fair
value measurements, including transfers in and out of Levels 1 and 2 and activity in Level 3 on a gross basis, and clarifies certain other existing disclosure requirements including level of disaggregation and disclosures around inputs and valuation
techniques. The provisions of the new standards are effective for interim or annual reporting periods beginning after December 15, 2009, except for the additional Level 3 disclosures which will become effective for fiscal years beginning after
December 15, 2010. These standards are disclosure only in nature and do not change accounting requirements. Accordingly, adoption of the new standard had no impact on the Companys consolidated financial position, results of operations or
cash flows.



ASU 2010-26 modifies the types of costs
incurred by insurance entities that can be capitalized in the acquisition of new and renewal insurance contracts. The Task Force reached a final Consensus that requires costs to be incremental or directly related to the



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##### Table of Contents

successful acquisition of new or renewal contracts to be capitalized as a deferred acquisition cost. This Issue is effective for interim and annual periods beginning after December 15, 2011.
Adoption of the new standard could have a material impact on the Companys consolidated financial position or results of operations. Management is evaluating the impact.



|3. | Trading Investment Securities
|-- | -----------------------------

The Companys trading investment securities consist solely of auction-rate tax-exempt securities, which are carried at fair value with realized gains and losses reported in current period earnings.
The Company had redemptions of $4.4 million and $35.5 million, at par, during the three and nine months ended September 30, 2010.

The amortized cost, net realized losses and estimated fair value of the Companys trading securities portfolio at September 30, 2010 and December 31, 2009, were as follows (in thousands):



|                   |  |               |        |  |                    |   |       |           |  |   |        | 
|------------------ |  | ------------- | ------ |  | ------------------ | - | ----- | --------- |  | - | ------ | 
|                   |  | AmortizedCost |        |  | Net RealizedLosses |   |       | FairValue | 
|September 30, 2010 |  | $             | 10,970 |  |                    | $ | 2,127 |           |  | $ | 8,843  | 
|December 31, 2009  |  | $             | 46,440 |  |                    | $ | 9,024 |           |  | $ | 37,416 | 

In October 2008, the
Companys broker filed a prospectus with the Securities and Exchange Commission (SEC), which published a legally-binding offer to all authorized holders of auction-rate securities to purchase all eligible securities at par (the
settlement). The time frames set by the Companys broker for buybacks have different start dates based upon the individual clients size, which is determined by each clients balance of investments held at the Companys
broker. In November 2008, the Company elected to participate in its brokers offer to purchase the Companys auction-rate securities at par and classified its portfolio of auction-rate securities as trading. The settlement agreement
requires the Companys broker to purchase eligible securities at par, at any time during a two-year period beginning June 30, 2010. All auction-rate securities held at September 30, 2010 are eligible for buyback under the settlement
agreements. At September 30, 2010 and December 31, 2009, the fair value of the settlement was $2.1 million and $8.8 million, respectively, which is recorded in other assets in the consolidated balance sheets with changes in fair value
recorded in other income in the consolidated statement of income (loss).



|4. | Available-for-Sale Investment Securities
|-- | ----------------------------------------

The Companys available-for-sale investment securities are carried at fair value with unrealized gains and losses, net of income taxes, reported in accumulated other comprehensive income, a separate
component of stockholders equity. Gains and losses realized on the disposition of investment securities are determined on the specific-identification basis and credited or charged to income. The Investment Committee periodically reviews
investment portfolio results and evaluates strategies to maximize yields, to match maturity durations with anticipated needs, and to maintain compliance with investment guidelines.

The amortized cost, gross unrealized gains (losses), and estimated fair value of the Companys available-for-sale securities at
September 30, 2010, and December 31, 2009, were as follows (in thousands):



|                                       |  |               |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 
|-------------------------------------- |  | ------------- | ------- |  | -------------------- | - | ----- | --------------------- |  | - | ---------- | - |  | - | ------- | 
|                                       |  | AmortizedCost |         |  | GrossUnrealizedGains |   |       | GrossUnrealizedLosses |  |   | Fair Value |  
|September 30, 2010                     |  |               |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 
|U.S. Treasury and government agencies  |  | $             | 29,451  |  |                      | $ | 215   |                       |  | $ | (31        | ) |  | $ | 29,635  | 
|Residential mortgage-backed securities |  |               | 3,468   |  |                      |   | 318   |                       |  |   |           |   |  |   | 3,786   | 
|States and political subdivisions      |  |               | 23,519  |  |                      |   | 495   |                       |  |   | (28        | ) |  |   | 23,986  | 
|Corporate debt securities              |  |               | 134,699 |  |                      |   | 2,493 |                       |  |   | (45        | ) |  |   | 137,147 | 
|FDIC-insured certificates of deposit   |  |               | 27,935  |  |                      |   | 105   |                       |  |   | (3         | ) |  |   | 28,037  | 
|                                       |  |               |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 
|Total                                  |  | $             | 219,072 |  |                      | $ | 3,626 |                       |  | $ | (107       | ) |  | $ | 222,591 | 
|                                       |  |               |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 
|December 31, 2009                      |  |               |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 
|U.S. Treasury and government agencies  |  | $             | 24,529  |  |                      | $ | 212   |                       |  | $ | (99        | ) |  | $ | 24,642  | 
|Residential mortgage-backed securities |  |               | 4,342   |  |                      |   | 322   |                       |  |   |           |   |  |   | 4,664   | 
|States and political subdivisions      |  |               | 117,659 |  |                      |   | 2,667 |                       |  |   | (21        | ) |  |   | 120,305 | 
|Corporate debt securities              |  |               | 62,728  |  |                      |   | 1,346 |                       |  |   | (29        | ) |  |   | 64,045  | 
|                                       |  |               |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 
|Total                                  |  | $             | 209,258 |  |                      | $ | 4,547 |                       |  | $ | (149       | ) |  | $ | 213,656 | 
|                                       |  |               |         |  |                      |   |       |                       |  |   |            |   |  |   |         | 



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Expected maturities
may differ from contractual maturities because certain borrowers may have the right to call or prepay obligations with or without penalties. The Companys amortized cost and estimated fair values of fixed-income securities at September 30,
2010 by contractual maturity were as follows (in thousands):



|                                       |  |               |         |  |            |   |         | 
|-------------------------------------- |  | ------------- | ------- |  | ---------- | - | ------- | 
|                                       |  | AmortizedCost |         |  | Fair Value |  
|Due in one year or less                |  | $             | 45,289  |  |            | $ | 45,635  | 
|Due after one year through five years  |  |               | 163,560 |  |            |   | 166,414 | 
|Due after five years through ten years |  |               | 6,755   |  |            |   | 6,756   | 
|Residential mortgage-backed securities |  |               | 3,468   |  |            |   | 3,786   | 
|                                       |  |               |         |  |            |   |         | 
|Total                                  |  | $             | 219,072 |  |            | $ | 222,591 | 
|                                       |  |               |         |  |            |   |         | 

Gross realized gains and losses on available-for-sale investments for the nine months ended
September 30 were as follows (in thousands):



|             |  |      |       |   |      |   |     |  
|------------ |  | ---- | ----- | - | ---- | - | --- | -
|             |  | 2010 |       |   | 2009 |  
|Gross gains  |  | $    | 1,455 |   |      | $ | 251 |  
|Gross losses |  |      | (55   | ) |      |   | (21 | )
|             |  |      |       |   |      |   |     |  
|Total        |  | $    | 1,400 |   |      | $ | 230 |  
|             |  |      |       |   |      |   |     |  

The following table summarizes the Companys available-for-sale securities in an unrealized loss
position at September 30, 2010, and December 31, 2009, the fair value and amount of gross unrealized losses, aggregated by investment category and length of time those securities have been continuously in an unrealized loss position (in
thousands):



|                                      |  |                        |        |  |                         |   |      |           |  |   |                       |  |  |           |   |  |                       |   |        |  |  |   |      |  
|------------------------------------- |  | ---------------------- | ------ |  | ----------------------- | - | ---- | --------- |  | - | --------------------- |  |  | --------- | - |  | --------------------- | - | ------ |  |  | - | ---- | -
|                                      |  | September 30, 2010     |       
|                                      |  | Less Than TwelveMonths |        |  | Twelve Monthsor Greater |   |      | Total     | 
|                                      |  | FairValue              |        |  | GrossUnrealizedLosses   |   |      | FairValue |  |   | GrossUnrealizedLosses |  |  | FairValue |   |  | GrossUnrealizedLosses |  
|U.S. Treasury and government agencies |  | $                      | 15,351 |  |                         | $ | (31  | )         |  | $ |                      |  |  | $         |  |  |                       | $ | 15,351 |  |  | $ | (31  | )
|States and political subdivisions     |  |                        | 4,940  |  |                         |   | (28  | )         |  |   |                      |  |  |           |  |  |                       |   | 4,940  |  |  |   | (28  | )
|Corporate debt securities             |  |                        | 10,291 |  |                         |   | (45  | )         |  |   |                      |  |  |           |  |  |                       |   | 10,291 |  |  |   | (45  | )
|FDIC-insured certificates of deposit  |  |                        | 3,170  |  |                         |   | (3   | )         |  |   |                      |  |  |           |  |  |                       |   | 3,170  |  |  |   | (3   | )
|                                      |  |                        |        |  |                         |   |      |           |  |   |                       |  |  |           |   |  |                       |   |        |  |  |   |      |  
|Total                                 |  | $                      | 33,752 |  |                         | $ | (107 | )         |  | $ |                      |  |  | $         |  |  |                       | $ | 33,752 |  |  | $ | (107 | )
|                                      |  |                        |        |  |                         |   |      |           |  |   |                       |  |  |           |   |  |                       |   |        |  |  |   |      |  



|                                      |  |                        |        |  |                         |   |      |           |  |   |                       |  |  |           |    |   |                       |   |        |  |  |   |      |  
|------------------------------------- |  | ---------------------- | ------ |  | ----------------------- | - | ---- | --------- |  | - | --------------------- |  |  | --------- | -- | - | --------------------- | - | ------ |  |  | - | ---- | -
|                                      |  | December 31, 2009      |       
|                                      |  | Less Than TwelveMonths |        |  | Twelve Monthsor Greater |   |      | Total     | 
|                                      |  | FairValue              |        |  | GrossUnrealizedLosses   |   |      | FairValue |  |   | GrossUnrealizedLosses |  |  | FairValue |    |   | GrossUnrealizedLosses |  
|U.S. Treasury and government agencies |  | $                      | 10,930 |  |                         | $ | (99  | )         |  | $ |                      |  |  | $         |   |   |                       | $ | 10,930 |  |  | $ | (99  | )
|States and political subdivisions     |  |                        | 2,605  |  |                         |   | (12  | )         |  |   | 745                   |  |  |           | (9 | ) |                       |   | 3,350  |  |  |   | (21  | )
|Corporate debt securities             |  |                        | 5,168  |  |                         |   | (29  | )         |  |   |                      |  |  |           |   |   |                       |   | 5,168  |  |  |   | (29  | )
|                                      |  |                        |        |  |                         |   |      |           |  |   |                       |  |  |           |    |   |                       |   |        |  |  |   |      |  
|Total                                 |  | $                      | 18,703 |  |                         | $ | (140 | )         |  | $ | 745                   |  |  | $         | (9 | ) |                       | $ | 19,448 |  |  | $ | (149 | )
|                                      |  |                        |        |  |                         |   |      |           |  |   |                       |  |  |           |    |   |                       |   |        |  |  |   |      |  

The Companys portfolio contains approximately 47 individual investment securities that are in an
unrealized loss position as of September 30, 2010.

The unrealized losses at September 30, 2010 were attributable to
changes in market interest rates since the securities were purchased. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to
consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers, (3) structure of the security and (4) the Companys intent to sell the
security or whether its more likely than not that the Company would be required to sell the security before its anticipated recovery in market value. At September 30, 2010, management performed its quarterly analysis of all securities with
an unrealized loss and concluded no individual securities were other-than-temporarily impaired.



9



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|5. | Reinsurance
|-- | -----------

In the
ordinary course of business, the Company places reinsurance with other insurance companies in order to provide greater diversification of its business and limit the potential for losses arising from large risks. In addition, the Company assumes
reinsurance from other insurance companies. Effective January 1, 2009, the Company terminated its quota-share reinsurance contract on a cut-off basis and received $10.5 million of returned unearned premiums, net of $2.6 million returned ceding
commissions.

The effect of reinsurance on premiums written and earned was as follows (in thousands):



|                    |  |                                  |         |   |               |   |         |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |         |  
|------------------- |  | -------------------------------- | ------- | - | ------------- | - | ------- | ------------------------------ |  | - | -------------- | - |  | ------------- | ------- | - | ------------------------------ | - | ------- | - |  | - | ------- | -
|                    |  | Three Months Ended September 30, |        
|                    |  | 2010                             |         |   | 2009          |  
|                    |  | WrittenPremium                   |         |   | EarnedPremium |   |         | Loss andLossAdjustmentExpenses |  |   | WrittenPremium |   |  | EarnedPremium |         |   | Loss andLossAdjustmentExpenses |  
|Direct              |  | $                                | 74,963  |   |               | $ | 75,099  |                                |  | $ | 105,455        |   |  | $             | 71,636  |   |                                | $ | 71,930  |   |  | $ | 57,944  |  
|Reinsurance assumed |  |                                  | 18,331  |   |               |   | 19,082  |                                |  |   | 18,221         |   |  |               | 19,789  |   |                                |   | 17,311  |   |  |   | 13,344  |  
|Reinsurance ceded   |  |                                  | (3,140  | ) |               |   | (3,106  | )                              |  |   | (47,331        | ) |  |               | (862    | ) |                                |   | (680    | ) |  |   | (995    | )
|                    |  |                                  |         |   |               |   |         |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |         |  
|Total               |  | $                                | 90,154  |   |               | $ | 91,075  |                                |  | $ | 76,345         |   |  | $             | 90,563  |   |                                | $ | 88,561  |   |  | $ | 70,293  |  
|                    |  |                                  |         |   |               |   |         |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |         |  
|                    | 
|                    |  | Nine Months Ended September 30,  |        
|                    |  | 2010                             |         |   | 2009          |  
|                    |  | WrittenPremium                   |         |   | EarnedPremium |   |         | Loss andLossAdjustmentExpenses |  |   | WrittenPremium |   |  | EarnedPremium |         |   | Loss andLossAdjustmentExpenses |  
|Direct              |  | $                                | 231,365 |   |               | $ | 228,763 |                                |  | $ | 224,502        |   |  | $             | 224,367 |   |                                | $ | 226,913 |   |  | $ | 186,732 |  
|Reinsurance assumed |  |                                  | 51,971  |   |               |   | 57,018  |                                |  |   | 55,502         |   |  |               | 61,526  |   |                                |   | 51,084  |   |  |   | 38,441  |  
|Reinsurance ceded   |  |                                  | (5,588  | ) |               |   | (5,569  | )                              |  |   | (51,747        | ) |  |               | 8,331   |   |                                |   | (1,991  | ) |  |   | (3,313  | )
|                    |  |                                  |         |   |               |   |         |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |         |  
|Total               |  | $                                | 277,748 |   |               | $ | 280,212 |                                |  | $ | 228,257        |   |  | $             | 294,224 |   |                                | $ | 276,006 |   |  | $ | 221,860 |  
|                    |  |                                  |         |   |               |   |         |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |         |  

Under certain of the Companys reinsurance transactions, the Company has received ceding commissions.
The ceding commission rate structure varies based on loss experience. The estimates of loss experience are continually reviewed and adjusted, and the resulting adjustments to ceding commissions are reflected in current operations. Ceding commissions
recognized were reflected as a (reduction) increase of selling, general and administrative expenses, as follows (in thousands):



|                                             |  |                                  |     |   |                                 |   |     |      |  |   |      |   |  |   |       | 
|-------------------------------------------- |  | -------------------------------- | --- | - | ------------------------------- | - | --- | ---- |  | - | ---- | - |  | - | ----- | 
|                                             |  | Three Months 
EndedSeptember 30, |     |   | Nine Months 
EndedSeptember 30, |  
|                                             |  | 2010                             |     |   | 2009                            |   |     | 2010 |  |   | 2009 |  
|Selling, general and administrative expenses |  | $                                | (10 | ) |                                 | $ | 966 |      |  | $ | (20  | ) |  | $ | 3,953 | 
|                                             |  |                                  |     |   |                                 |   |     |      |  |   |      |   |  |   |       | 

The amount of loss reserves and unearned premium the Company would remain liable for in the event its
reinsurers are unable to meet their obligations were as follows (in thousands):



|                                            |  |                   |        |  |                  |   |        | 
|------------------------------------------- |  | ----------------- | ------ |  | ---------------- | - | ------ | 
|                                            |  | September 30,2010 |        |  | December 31,2009 |  
|Losses and loss adjustment expense reserves |  | $                 | 79,175 |  |                  | $ | 32,447 | 
|Unearned premium reserve                    |  |                   | 1,116  |  |                  |   | 1,096  | 
|                                            |  |                   |        |  |                  |   |        | 
|Total                                       |  | $                 | 80,291 |  |                  | $ | 33,543 | 
|                                            |  |                   |        |  |                  |   |        | 

The Michigan Catastrophic Claims Association (MCCA) is the mandatory reinsurance facility that covers
no-fault medical losses above a specific retention amount in Michigan. For policies effective July 1, 2010 to June 30, 2011, the required retention is $0.5 million. As a writer of personal automobile policies in the state of Michigan,
the Company cedes premiums and claims to the MCCA. Funding for MCCA comes from assessments against automobile insurers based upon their proportionate market share of the states automobile liability insurance market. Insurers are allowed
to pass along this cost to Michigan automobile policyholders. The



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Companys ceded premiums written to the MCCA were $1.8 million and $0.7 million for the three months ended September 30, 2010 and 2009, and $4.0 million and $1.5 million for the nine
months ended September 30, 2010 and 2009, respectively. The Companys ceded losses to the MCCA were $46.7 million and $51.0 million for the three months and nine months ended September 30, 2010, respectively. The Companys ceded
losses to the MCCA were $1.2 million and $2.8 million for the three and nine months ended September 30, 2009, respectively.

The Company entered into an excess of loss reinsurance contract effective August 1, 2010 that provides coverage for individual losses in excess of $100,000 up to $1 million. In addition, the
Company entered into a reinsurance agreement effective June 1, 2010 to provide coverage for catastrophic events that may involve multiple insured losses.

At September 30, 2010, the Companys total receivables from reinsurers were $86.8 million, consisting of $67.5 million receivable from the MCCA, $0.7 million from a quota-share reinsurer (rated
A- by A.M. Best) for business reinsured in Louisiana and Alabama, $13.0 million net receivable (net of $2.8 million payable) from subsidiaries of Vesta Insurance Group (VIG), including primarily Vesta Fire Insurance Corporation (VFIC) and $5.6
million receivables from other reinsurers. Under the reinsurance agreement with Vesta Insurance Group (VIG), including primarily Vesta Fire Insurance Corporation (VFIC), the Companys wholly-owned subsidiaries, Affirmative Insurance Company
(AIC) and Insura Property and Casualty Insurance Company (Insura), had the right, under certain circumstances, to require VFIC to provide a letter of credit or establish a trust account to collateralize gross amounts due from VFIC under the
reinsurance agreement. Accordingly, AIC, Insura and VFIC entered into a Security Fund Agreement effective September 2004. In August 2005, AIC received a letter from VFICs President that irrevocably confirmed VFICs duty and
obligation under the Security Fund Agreement to provide security sufficient to satisfy VFICs gross obligations under the reinsurance agreement (the VFIC Trust). At September 30, 2010, the VFIC Trust held $16.9 million (after cumulative
withdrawals of $8.5 million through September 30, 2010), consisting of $12.0 million of a U.S. Treasury money market account and $4.9 million of corporate bonds rated BBB- or higher, to collateralize the $13.0 million net recoverable from VFIC.

The Company assumes reinsurance from a Texas county mutual insurance company (the county mutual) whereby the Company has
assumed 100% of the policies issued by the county mutual for business produced by the Companys owned managing general agents (MGAs). The county mutual does not retain any of this business and there are no loss limits other than the underlying
policy limits. The county mutual reinsurance agreement may be terminated by either party on any annual anniversary upon prior written notice of not less than 90 days. AIC has established a trust to secure the Companys obligation under this
reinsurance contract with a balance of $47.4 million as of September 30, 2010.

At September 30, 2010, $11.4 million
was included in reserves for losses and loss adjustment expenses that represented the amounts owed by 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 $21.6 million in securities (the AIC Trust). The Special Deputy Receiver in Texas had cumulative withdrawals from the AIC Trust of $0.4 million through
September 2010, and the Special Deputy Receiver in Hawaii had cumulative withdrawals from the AIC Trust of $1.7 million through September 2010.



|6. | Premium Finance Receivables, Net
|-- | --------------------------------

Premium finance receivables (related to policies of both the Company and third-party carriers) are secured by unearned premiums from the underlying insurance policies and consisted of the following at
September 30, 2010 and December 31, 2009 (in thousands):



|                            |  |                   |        |   |                  |   |        |  
|--------------------------- |  | ----------------- | ------ | - | ---------------- | - | ------ | -
|                            |  | September 30,2010 |        |   | December 31,2009 |  
|Premium finance contracts   |  | $                 | 49,782 |   |                  | $ | 43,473 |  
|Unearned finance charges    |  |                   | (2,568 | ) |                  |   | (2,216 | )
|Allowance for credit losses |  |                   | (437   | ) |                  |   | (432   | )
|                            |  |                   |        |   |                  |   |        |  
|Total                       |  | $                 | 46,777 |   |                  | $ | 40,825 |  
|                            |  |                   |        |   |                  |   |        |  



11



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|7. | Deferred Policy Acquisition Costs
|-- | ---------------------------------

Policy acquisition costs, consisting of primarily commissions, advertising, premium taxes, underwriting and agency expenses, are deferred and charged against income ratably over the terms of the related
policies. The components of deferred policy acquisition costs and the related amortization expense were as follows (in thousands):



|                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|----------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                  |  | Three Months
EndedSeptember 30, |         |   | Nine Months
EndedSeptember 30, |  
|                  |  | 2010                            |         |   | 2009                           |   |         | 2010 |  |   | 2009    |  
|Beginning balance |  | $                               | 24,276  |   |                                | $ | 24,732  |      |  | $ | 24,230  |   |  | $ | 21,993  |  
|Additions         |  |                                 | 21,158  |   |                                |   | 18,740  |      |  |   | 63,889  |   |  |   | 59,517  |  
|Amortization      |  |                                 | (21,188 | ) |                                |   | (19,047 | )    |  |   | (63,873 | ) |  |   | (57,085 | )
|                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Ending balance    |  | $                               | 24,246  |   |                                | $ | 24,425  |      |  | $ | 24,246  |   |  | $ | 24,425  |  
|                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  



|8. | Goodwill and Other Intangible Assets
|-- | ------------------------------------

The Company completed its annual goodwill and indefinite lived intangible asset impairment analyses as of September 30, 2010. The Company reports under a single reporting segment and, as such, the
goodwill analysis is measured under one reporting unit. Consistent with prior assessments, the fair value of the Companys reporting unit was determined using an internally developed discounted cash flow methodology and other relevant
indicators of value available in the market place such as market transactions and trading values of similar companies. Based upon the results of the assessment, the Company concluded that the carrying values of goodwill and other intangible assets
were not impaired as of September 30, 2010.



|9. | Debt
|-- | ----

The Companys
long-term debt instruments and balances outstanding at September 30, 2010 and December 31, 2009 were as follows (in thousands):



|                               |  |                   |         |  |                  |   |         | 
|------------------------------ |  | ----------------- | ------- |  | ---------------- | - | ------- | 
|                               |  | September 30,2010 |         |  | December 31,2009 |  
|Notes payable due 2035         |  | $                 | 30,928  |  |                  | $ | 30,928  | 
|Notes payable due 2035         |  |                   | 25,774  |  |                  |   | 25,774  | 
|Notes payable due 2035         |  |                   | 20,176  |  |                  |   | 20,189  | 
|                               |  |                   |         |  |                  |   |         | 
|Total notes payable            |  |                   | 76,878  |  |                  |   | 76,891  | 
|Senior secured credit facility |  |                   | 98,029  |  |                  |   | 111,506 | 
|                               |  |                   |         |  |                  |   |         | 
|Total long-term debt           |  | $                 | 174,907 |  |                  | $ | 188,397 | 
|                               |  |                   |         |  |                  |   |         | 

The $30.9 million notes payable bear an initial interest rate of 7.545% until March 15, 2010, at which
time the securities adjust quarterly to the three-month LIBOR rate plus 3.60%. The interest rate as of September 30, 2010 was 3.89%.

The $25.8 million notes payable due 2035 bear an initial interest rate of 7.792% until June 15, 2010, at which time they adjust quarterly to the three-month LIBOR rate plus 3.55%. The interest rate
as of September 30, 2010 was 3.84%.

The $20.2 million notes payable due 2035 bear an interest rate of the three-month
LIBOR rate plus 3.95% not exceeding 12.50% through March 2010 with no limit thereafter. The interest rate as of September 30, 2010 was 4.24%.

The pricing under the senior secured credit facility is currently subject to a LIBOR floor of 3.00% plus 6.00%, and is tiered based on the Companys leverage ratio. The interest rate as of
September 30, 2010 was 9.00%.

During the first nine months of 2010, the Company made its scheduled quarterly payments of
$0.9 million and additional payments of $17.4 million on the senior secured credit facility. As of September 30, 2010, the principal balance of the senior secured credit facility was $111.7 million. The revolving portion of the facility expired
in January 2010. As of September 30, 2010, the Company was in compliance with all of its financial and other covenants for the senior secured credit facility.



|10. | Capital Lease Obligation
|--- | ------------------------

In May 2010, the Company entered into a capital lease obligation related to certain computer software, software licenses, and hardware
used in the Companys insurance operations. The Company received cash proceeds from the financing in the amount of $28.2 million. As required by the lease agreements, the Company purchased $28.2 million of FDIC-insured certificates of deposit
held in brokerage accounts and pledged as collateral against all of the Companys obligations under the lease. The dollar amount of



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##### Table of Contents

collateral pledged is set to decline over the term of the lease as the Company makes the scheduled lease payments. The lease term is 60 months with monthly rental payments totaling approximately
$0.6 million. At the end of the initial term, the Company will have the right to purchase the software for a nominal fee, after which all rights, title and interest would transfer to the Company. The Companys capital lease obligation was $26.4
million at September 30, 2010.

Property under capital lease at September 30, 2010 was as follows (in thousands):



|                                                  |  |      |        |  |                         |   |       |     |  |   |        | 
|------------------------------------------------- |  | ---- | ------ |  | ----------------------- | - | ----- | --- |  | - | ------ | 
|                                                  |  | Cost |        |  | AccumulatedDepreciation |   |       | Net | 
|Computer software, software licenses and hardware |  | $    | 28,189 |  |                         | $ | 2,963 |     |  | $ | 25,226 | 
|                                                  |  |      |        |  |                         |   |       |     |  |   |        | 

Estimated future lease payments for the years ending December 31:



|                                       |  |   |        | 
|-------------------------------------- |  | - | ------ | 
|2010                                   |  | $ | 1,684  | 
|2011                                   |  |   | 6,736  | 
|2012                                   |  |   | 6,736  | 
|2013                                   |  |   | 6,736  | 
|2014                                   |  |   | 6,736  | 
|2015                                   |  |   | 2,807  | 
|                                       |  |   |        | 
|Total estimated future lease payments  |  |   | 31,435 | 
|Less: Amount representing interest     |  |   | 4,994  | 
|                                       |  |   |        | 
|Present value of future lease payments |  | $ | 26,441 | 
|                                       |  |   |        | 



|11. | Income Taxes
|--- | ------------

The
provision for income taxes for the three and nine months ended September 30, 2010 and 2009 consisted of the following (in thousands):



|                                 |  |                                  |     |  |                                |   |        |      |  |   |       |  |  |   |        |  
|-------------------------------- |  | -------------------------------- | --- |  | ------------------------------ | - | ------ | ---- |  | - | ----- |  |  | - | ------ | -
|                                 |  | Three Months 
EndedSeptember 30, |     |  | Nine Months
EndedSeptember 30, |  
|                                 |  | 2010                             |     |  | 2009                           |   |        | 2010 |  |   | 2009  | 
|Current tax expense              |  | $                                | 147 |  |                                | $ | 2,223  |      |  | $ | 345   |  |  | $ | 3,312  |  
|Deferred tax expense (benefit)   |  |                                  | 319 |  |                                |   | (5,412 | )    |  |   | 956   |  |  |   | (8,425 | )
|                                 |  |                                  |     |  |                                |   |        |      |  |   |       |  |  |   |        |  
|Net income tax expense (benefit) |  | $                                | 466 |  |                                | $ | (3,189 | )    |  | $ | 1,301 |  |  | $ | (5,113 | )
|                                 |  |                                  |     |  |                                |   |        |      |  |   |       |  |  |   |        |  

The effective tax rate on income differs from the federal statutory tax rate of 35% for the following
reasons (in thousands):



|                                                                |  |                                 |         |    |                                |   |        |      |  |   |         |    |  |   |        |  
|--------------------------------------------------------------- |  | ------------------------------- | ------- | -- | ------------------------------ | - | ------ | ---- |  | - | ------- | -- |  | - | ------ | -
|                                                                |  | Three Months
EndedSeptember 30, |         |    | Nine Months
EndedSeptember 30, |  
|                                                                |  | 2010                            |         |    | 2009                           |   |        | 2010 |  |   | 2009    |   
|Loss before income tax expense (benefit)                        |  | $                               | (22,654 | )  |                                | $ | (6,611 | )    |  | $ | (37,394 | )  |  | $ | (6,718 | )
|Tax provision computed at the federal statutory income tax rate |  |                                 | (7,929  | )  |                                |   | (2,314 | )    |  |   | (13,088 | )  |  |   | (2,351 | )
|Increases (reductions) in tax resulting from:                   |  |                                 |         |    |                                |   |        |      |  |   |         |    |  |   |        |  
|Tax-exempt interest                                             |  |                                 | (48     | )  |                                |   | (345   | )    |  |   | (357    | )  |  |   | (1,165 | )
|State income taxes                                              |  |                                 | 75      |    |                                |   | (197   | )    |  |   | 140     |    |  |   | (85    | )
|Valuation allowance                                             |  |                                 | 8,430   |    |                                |   |       |      |  |   | 14,586  |    |  |   | (1,008 | )
|Other                                                           |  |                                 | (62     | )  |                                |   | (333   | )    |  |   | 20      |    |  |   | (504   | )
|                                                                |  |                                 |         |    |                                |   |        |      |  |   |         |    |  |   |        |  
|Income tax expense (benefit)                                    |  | $                               | 466     |    |                                | $ | (3,189 | )    |  | $ | 1,301   |    |  | $ | (5,113 | )
|                                                                |  |                                 |         |    |                                |   |        |      |  |   |         |    |  |   |        |  
|Effective tax rate                                              |  |                                 | (2.1    | )% |                                |   | 48.2   | %    |  |   | (3.5    | )% |  |   | 76.1   | %
|                                                                |  |                                 |         |    |                                |   |        |      |  |   |         |    |  |   |        |  

Net deferred tax assets prior to recognition of the valuation allowance were $34.8 million and
$20.8 million at September 30, 2010 and December 31, 2009, respectively. In assessing the realizability of its deferred tax assets, the Company considered whether it was more likely than not that its deferred tax assets will be
realized based upon all available evidence, including scheduled reversal of deferred tax liabilities, historical operating results, projected future operating results, tax carry-back availability, and limitations pursuant to Section 382 of the
Internal Revenue Code, among others. Based on this assessment, the Company began recording a valuation allowance against deferred taxes in December 2009. As of September 30, 2010, the valuation allowance was $46.5 million.



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In August 2010, the
Company received a Revenue Agents Report for the 2006 Internal Revenue Service (IRS) audit. The IRS had one proposed adjustment related to the loss reserve deductions for 2006, which the Company has appealed.



|12. | Legal and Regulatory Proceedings
|--- | --------------------------------

The Company and its subsidiaries are named from time to time as parties in various legal actions arising in the ordinary course of the Companys business and arising out of or related to claims made
in connection with the Companys insurance policies and claims handling. The Company believes that the resolution of these legal actions will not have a material adverse effect on the Companys consolidated financial position or results of
operations. However, the ultimate outcome of these matters is uncertain.

In September 2009, plaintiff Toni Hollinger filed a
putative class action in the U.S. District Court for the Eastern District of Texas against several county mutual insurance companies and reinsurance companies, including Affirmative Insurance Company. The complaint alleges that defendants engaged in
unfair discrimination and violated the Texas Insurance Code by charging different policy fees for the same class and hazard of insurance written through county mutual insurance companies. On August 5, 2010, the Court issued an order dismissing
plaintiffs claims for lack of subject matter jurisdiction. Plaintiff filed a notice of appeal of the dismissal on August 25, 2010.

In October 2009, plaintiff Dalton Johnson filed a putative class action in Palm Beach County, Florida against Affirmative Insurance Company. The complaint alleges that Affirmative failed to apply a
statutorily-permitted fee schedule for hospital emergency care and services enacted into law in January 2008, thereby exhausting prematurely the PIP benefits available to Affirmatives insureds. Plaintiff filed an amended complaint in March
2010, which was dismissed with prejudice on May 14, 2010. On June 4, 2010, plaintiff filed a notice of appeal of the dismissal, but subsequently filed a notice of voluntary dismissal of the appeal on September 14, 2010. On
September 17, 2010, the Court entered a final order of dismissal.

In January 2010, the Circuit Court of Cook County,
Illinois granted plaintiff Valerie Thomas leave to amend her complaint to assert a putative class action against Affirmative Insurance Company. The complaint alleges that Affirmative failed to provide a statutory 5% premium discount to insureds who
had anti-theft devices installed as standard equipment on their vehicles even when the insureds did not disclose the existence of such devices to Affirmative. The case has been consolidated with several identical class actions against other
defendant insurance companies. On June 14, 2010, the court dismissed plaintiffs breach of contract count, but denied Affirmatives motion to dismiss as to all remaining counts. On July 19, 2010, Affirmative filed its answer to
the amended complaint. The parties have commenced discovery. The Company believes that this claim lacks merit and intends to defend itself vigorously.

From time to time, the Company and its subsidiaries are subject to random compliance audits from federal and state authorities regarding various operations within its business that involve collecting and
remitting taxes in one form or another. In 2006, two of the Companys wholly-owned underwriting agencies were subject to a sales and use tax audit conducted by the State of Texas. The examiner for the State of Texas completed his audit report
and delivered an audit assessment, for the period from January 2002 to December 2005, asserting that the Company should have collected and remitted approximately $2.9 million in sales tax derived from claims services performed by the Companys
underwriting agencies for policies sold by these underwriting agencies and issued by a county mutual insurance company through a fronting arrangement. The assessment included an additional $0.4 million for accrued interest and penalty for a total
assessment of $3.3 million. The Company believes that these services are not subject to sales tax and is vigorously contesting the assertions made by the state and exercising all available rights and remedies available to the Company. In October
2006, the Company responded to the assessment by filing petitions with the Comptroller of Public Accounts for the State of Texas requesting a re-determination of the tax due. In June 2009, the Comptroller responded to the Companys petition,
disputing the validity of positions set forth in the Companys October 2006 petitions. On July 20, 2010, the Comptroller served the Company with its responses to the Companys discovery requests. The Company is reviewing the
Comptrollers discovery responses and the Company intends to present written and oral evidence and legal arguments to contest the imposition of the asserted taxes. Pending the administrative hearing process, the date for any potential payment
is delayed and the final outcome of this tax assessment will not be known for some time. Due to the uncertainty surrounding the ultimate outcome of this matter, no liability has been recorded as of September 30, 2010.



|13. | Net Loss Per Common Share
|--- | -------------------------

Net loss per common share is based on the weighted average number of shares outstanding. Diluted weighted average shares is calculated by
adjusting basic weighted average shares outstanding by all potentially dilutive stock options and restricted stock. Stock options outstanding of 1,245,900 and 1,601,339 for the three and nine months ended September 30, 2010 and 2009,
respectively, were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price of the common stock and thus the inclusion would have been anti-dilutive.



14



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The following table
sets forth the reconciliation of numerators and denominators for the basic and diluted earnings per share computation for the three and nine months ended September 30, 2010 and 2009 (in thousands, except per share amounts):



|                                                         |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|-------------------------------------------------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------ | -
|                                                         |  | Three Months
EndedSeptember 30, |         |   | Nine Months
EndedSeptember 30, |  
|                                                         |  | 2010                            |         |   | 2009                           |   |        | 2010 |  |   | 2009    |  
|Numerator:                                               |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Loss from continuing operations                          |  | $                               | (23,120 | ) |                                | $ | (3,392 | )    |  | $ | (38,695 | ) |  | $ | (249   | )
|                                                         |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Denominator:                                             |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Weighted average common shares outstanding               |  |                                 | 15,415  |   |                                |   | 15,415 |      |  |   | 15,415  |   |  |   | 15,415 |  
|                                                         |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Weighted average diluted shares                          |  |                                 | 15,415  |   |                                |   | 15,415 |      |  |   | 15,415  |   |  |   | 15,415 |  
|                                                         |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Basic loss per common share from continuing operations   |  | $                               | (1.50   | ) |                                | $ | (0.22  | )    |  | $ | (2.51   | ) |  | $ | (0.01  | )
|                                                         |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |        |  
|Diluted loss per common share from continuing operations |  | $                               | (1.50   | ) |                                | $ | (0.22  | )    |  | $ | (2.51   | ) |  | $ | (0.01  | )
|                                                         |  |                                 |         |   |                                |   |        |      |  |   |         |   |  |   |        |  



|14. | Fair Value of Financial Instruments
|--- | -----------------------------------

The Company utilizes a hierarchy of valuation techniques for the disclosure of fair value estimates based on whether the significant inputs into the valuation are observable. In determining the level of
hierarchy in which the estimate is disclosed, the highest priority is given to unadjusted quoted prices in active markets and the lowest priority to unobservable inputs that reflect the Companys significant market assumptions. The Company
measures certain assets and liabilities at fair value on a recurring basis, including investment securities classified as available-for-sale or trading, cash equivalents, other receivables and interest rate swaps. Following is a brief description of
the type of valuation information that qualifies a financial asset for each level:

Level 1  Unadjusted quoted market
prices for identical assets or liabilities in active markets which are accessible by the Company.

Level 2  Observable
prices in active markets for similar assets or liabilities. Prices for identical or similar assets or liabilities in markets that are not active. Directly observable market inputs for substantially the full term of the asset or liability, e.g.,
interest rates and yield curves at commonly quoted intervals, volatilities, prepayment speeds, default rates, and credit spreads. Market inputs that are not directly observable but are derived from or corroborated by observable market data.

Level 3  Unobservable inputs based on the Companys own judgment as to assumptions a market participant would use,
including inputs derived from extrapolation and interpolation that are not corroborated by observable market data.

The
Company evaluates the various types of financial assets and liabilities to determine the appropriate fair value hierarchy based upon trading activity and the observability of market inputs. The Company employs control processes to validate the
reasonableness of the fair value estimates of its assets and liabilities, including those estimates based on prices and quotes obtained from independent third-party sources. The Companys procedures generally include, but are not limited to,
initial and ongoing evaluation of methodologies used by independent third-parties and monthly analytical reviews of the prices against current pricing trends and statistics.

Where possible, the Company utilizes quoted market prices to measure fair value. For assets and liabilities that have quoted market prices in active markets, the Company uses the quoted market prices as
fair value and includes these prices in the amounts disclosed in Level 1 of the hierarchy. When quoted market prices in active markets are unavailable, the Company determines fair values based on independent external valuation information, which
utilizes various models and valuation techniques based on a range of inputs including pricing models, quoted market prices of publicly traded securities with similar duration and yield, time value, yield curve, prepayment speeds, default rates and
discounted cash flow. In most cases, these estimates are determined based on independent third-party valuation information, and the amounts are disclosed as Level 2 or Level 3 of the fair value hierarchy depending on the level of observable market
inputs.



15



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Financial assets and financial
liabilities measured at fair value on a recurring basis

The following table provides information as of September 30,
2010 about the Companys financial assets and liabilities measured at fair value on a recurring basis (in thousands):



|                                        |  |                   |         |  |                                       |   |        |                                           |  |   |                                        |  |  |   |        | 
|--------------------------------------- |  | ----------------- | ------- |  | ------------------------------------- | - | ------ | ----------------------------------------- |  | - | -------------------------------------- |  |  | - | ------ | 
|                                        |  | September 30,2010 |         |  | QuotedPrices inActiveMarkets(Level 1) |   |        | SignificantOtherObservableInputs(Level 2) |  |   | SignificantUnobservableInputs(Level 3) | 
|Assets:                                 |  |                   |         |  |                                       |   |        |                                           |  |   |                                        |  |  |   |        | 
|U.S. Treasury and government agencies   |  | $                 | 29,635  |  |                                       | $ | 29,635 |                                           |  | $ |                                       |  |  | $ |       | 
|Residential mortgage-backed securities  |  |                   | 3,786   |  |                                       |   |       |                                           |  |   | 3,786                                  |  |  |   |       | 
|States and political subdivisions       |  |                   | 23,986  |  |                                       |   |       |                                           |  |   | 23,986                                 |  |  |   |       | 
|Corporate debt securities               |  |                   | 137,147 |  |                                       |   |       |                                           |  |   | 137,147                                |  |  |   |       | 
|FDIC-insured certificates of deposit    |  |                   | 28,037  |  |                                       |   |       |                                           |  |   | 28,037                                 |  |  |   |       | 
|Auction-rate tax-exempt securities      |  |                   | 8,843   |  |                                       |   |       |                                           |  |   |                                       |  |  |   | 8,843  | 
|                                        |  |                   |         |  |                                       |   |        |                                           |  |   |                                        |  |  |   |        | 
|Total investment securities             |  |                   | 231,434 |  |                                       |   | 29,635 |                                           |  |   | 192,956                                |  |  |   | 8,843  | 
|Cash and cash equivalents               |  |                   | 63,352  |  |                                       |   | 63,352 |                                           |  |   |                                       |  |  |   |       | 
|Fiduciary and restricted cash           |  |                   | 6,546   |  |                                       |   | 6,546  |                                           |  |   |                                       |  |  |   |       | 
|Other receivables (other assets)        |  |                   | 2,123   |  |                                       |   |       |                                           |  |   |                                       |  |  |   | 2,123  | 
|                                        |  |                   |         |  |                                       |   |        |                                           |  |   |                                        |  |  |   |        | 
|Total assets                            |  | $                 | 303,455 |  |                                       | $ | 99,533 |                                           |  | $ | 192,956                                |  |  | $ | 10,966 | 
|                                        |  |                   |         |  |                                       |   |        |                                           |  |   |                                        |  |  |   |        | 
|Liabilities:                            |  |                   |         |  |                                       |   |        |                                           |  |   |                                        |  |  |   |        | 
|Interest rate swaps (other liabilities) |  | $                 | 2,201   |  |                                       | $ |       |                                           |  | $ |                                       |  |  | $ | 2,201  | 
|                                        |  |                   |         |  |                                       |   |        |                                           |  |   |                                        |  |  |   |        | 
|Total liabilities                       |  | $                 | 2,201   |  |                                       | $ |       |                                           |  | $ |                                       |  |  | $ | 2,201  | 
|                                        |  |                   |         |  |                                       |   |        |                                           |  |   |                                        |  |  |   |        | 

The following table provides information as of December 31, 2009 about the Companys financial
assets and liabilities measured at fair value on a recurring basis (in thousands):



|                                        |  |                  |         |  |                                       |   |         |                                           |  |   |                                        |  |  |   |        | 
|--------------------------------------- |  | ---------------- | ------- |  | ------------------------------------- | - | ------- | ----------------------------------------- |  | - | -------------------------------------- |  |  | - | ------ | 
|                                        |  | December 31,2009 |         |  | QuotedPrices inActiveMarkets(Level 1) |   |         | SignificantOtherObservableInputs(Level 2) |  |   | SignificantUnobservableInputs(Level 3) | 
|Assets:                                 |  |                  |         |  |                                       |   |         |                                           |  |   |                                        |  |  |   |        | 
|U.S. Treasury and government agencies   |  | $                | 24,642  |  |                                       | $ | 24,642  |                                           |  | $ |                                       |  |  | $ |       | 
|Residential mortgage-backed securities  |  |                  | 4,664   |  |                                       |   |        |                                           |  |   | 4,664                                  |  |  |   |       | 
|States and political subdivisions       |  |                  | 120,305 |  |                                       |   |        |                                           |  |   | 120,305                                |  |  |   |       | 
|Corporate debt securities               |  |                  | 64,045  |  |                                       |   |        |                                           |  |   | 64,045                                 |  |  |   |       | 
|Auction-rate tax-exempt securities      |  |                  | 37,416  |  |                                       |   |        |                                           |  |   |                                       |  |  |   | 37,416 | 
|                                        |  |                  |         |  |                                       |   |         |                                           |  |   |                                        |  |  |   |        | 
|Total investment securities             |  |                  | 251,072 |  |                                       |   | 24,642  |                                           |  |   | 189,014                                |  |  |   | 37,416 | 
|Cash and cash equivalents               |  |                  | 60,928  |  |                                       |   | 60,928  |                                           |  |   |                                       |  |  |   |       | 
|Fiduciary and restricted cash           |  |                  | 15,004  |  |                                       |   | 15,004  |                                           |  |   |                                       |  |  |   |       | 
|Other receivables (other assets)        |  |                  | 8,830   |  |                                       |   |        |                                           |  |   |                                       |  |  |   | 8,830  | 
|                                        |  |                  |         |  |                                       |   |         |                                           |  |   |                                        |  |  |   |        | 
|Total assets                            |  | $                | 335,834 |  |                                       | $ | 100,574 |                                           |  | $ | 189,014                                |  |  | $ | 46,246 | 
|                                        |  |                  |         |  |                                       |   |         |                                           |  |   |                                        |  |  |   |        | 
|Liabilities:                            |  |                  |         |  |                                       |   |         |                                           |  |   |                                        |  |  |   |        | 
|Interest rate swaps (other liabilities) |  | $                | 4,108   |  |                                       | $ |        |                                           |  | $ |                                       |  |  | $ | 4,108  | 
|                                        |  |                  |         |  |                                       |   |         |                                           |  |   |                                        |  |  |   |        | 
|Total liabilities                       |  | $                | 4,108   |  |                                       | $ |        |                                           |  | $ |                                       |  |  | $ | 4,108  | 
|                                        |  |                  |         |  |                                       |   |         |                                           |  |   |                                        |  |  |   |        | 

Level 1 Financial assets

Financial assets classified as Level 1 in the fair value hierarchy include U.S. Government bonds and certain government agencies securities and cash or cash equivalents. These securities are actively
traded and the Company estimates the fair value of these securities using unadjusted quoted market prices. Cash and cash equivalents primarily consist of highly liquid money market funds, which are reflected within Level 1 of the fair value
hierarchy.

Level 2 Financial assets

Financial assets classified as Level 2 in the fair value hierarchy include mortgage-backed securities, tax-exempt securities, corporate bonds and FDIC-insured certificates of deposit. The fair value of
these securities is determined based on observable market inputs provided by independent third-party pricing services and the Company discloses the fair values of these investments in Level 2 of the fair value hierarchy. The Company determined that
its corporate debt securities are more appropriately classified as Level 2 in the fair value hierarchy. Prior year amounts have been reclassified to conform to the current year presentation. To date, the Company has not experienced a circumstance
where it has determined that an adjustment is required to a quote or price received from independent third-party pricing sources. To the extent the Company determines that a price or quote is inconsistent with actual trading activity observed in
that investment or similar investments, the Company would determine a fair value using this observable market information and disclose the occurrence of this circumstance. All of the fair values of securities disclosed in Level 2 are estimated based
on independent third-party pricing services.



16



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Level 3 Financial assets and
liabilities

The Companys Level 3 financial assets include auction-rate tax-exempt securities. Observable market inputs
for certain auction-rate tax-exempt securities that have experienced failed auctions as a result of liquidity issues in the global credit and capital market are not readily available. The fair value of these securities is estimated using third-party
valuation sources.

The Companys Level 3 financial assets also include other receivables related to a settlement
agreement with the Companys broker to liquidate certain of the Companys auction-rate tax-exempt securities. The settlement agreement requires the Companys broker to purchase eligible securities at par, at any time during a two-year
period beginning June 30, 2010. As of September 30, 2010, the Company held $11.0 million, at amortized cost, and $8.8 million fair value of auction-rate tax-exempt securities that are eligible for such settlement. The Company elected to
record the settlement as a financial asset at fair value in accordance with ASC 825-10 Financial Instruments  Overall. The fair value of this agreement was estimated by third-party valuation sources to be $2.1 million as of
September 30, 2010, and is included in other assets in Level 3 of the fair value hierarchy.

The Companys Level 3
financial liabilities are interest rate swaps. The fair value of these swaps are determined by quotes from brokers that are not considered binding.

Fair value measurements for assets in category Level 3 for the three months ended September 30, 2010 were as follows (in thousands):



|                                               |  |                                                                                                        |        |   |                                                                                   |   |        |  
|---------------------------------------------- |  | ------------------------------------------------------------------------------------------------------ | ------ | - | --------------------------------------------------------------------------------- | - | ------ | -
|                                               |  | Fair
ValueMeasurements 
UsingSignificantUnobservable 
Inputs(Level
3)Auction-RateTax-Exempt Securities |        |   | Fair
ValueMeasurements 
UsingSignificantUnobservable 
Inputs(Level 3)Other Assets |  
|Balance at July 1, 2010                        |  | $                                                                                                      | 12,166 |   |                                                                                   | $ | 3,199  |  
|Transfers in and/or out of Level 3             |  |                                                                                                        |       |   |                                                                                   |   |       |  
|Total gains or (losses) (realized/unrealized): |  |                                                                                                        |        |   |                                                                                   |   |        |  
|Included in earnings                           |  |                                                                                                        | 1,072  |   |                                                                                   |   | (1,076 | )
|Included in other comprehensive income         |  |                                                                                                        |       |   |                                                                                   |   |       |  
|Settlements                                    |  |                                                                                                        | (4,395 | ) |                                                                                   |   |       |  
|                                               |  |                                                                                                        |        |   |                                                                                   |   |        |  
|Balance at September 30, 2010                  |  | $                                                                                                      | 8,843  |   |                                                                                   | $ | 2,123  |  
|                                               |  |                                                                                                        |        |   |                                                                                   |   |        |  

Fair value measurements for liabilities in category Level 3 for the three months ended September 30,
2010 were as follows (in thousands):



|                                  |  |                                                                                         |       |  
|--------------------------------- |  | --------------------------------------------------------------------------------------- | ----- | -
|                                  |  | Fair Value MeasurementsUsing
SignificantUnobservable Inputs(Level
3)Interest Rate Swaps |      
|Balance at July 1, 2010           |  | $                                                                                       | 2,800 |  
|Transfers into Level 3            |  |                                                                                         |      |  
|Total losses included in earnings |  |                                                                                         | 252   |  
|Settlements                       |  |                                                                                         | (851  | )
|                                  |  |                                                                                         |       |  
|Balance at September 30, 2010     |  | $                                                                                       | 2,201 |  
|                                  |  |                                                                                         |       |  

The Company did not have any significant transfers between Levels 1 and 2 during the period ended
September 30, 2010.



17



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Fair value
measurements for assets in category Level 3 for the nine months ended September 30, 2010 were as follows (in thousands):



|                                               |  |                                                                                                       |         |   |                                                                                  |   |        |  
|---------------------------------------------- |  | ----------------------------------------------------------------------------------------------------- | ------- | - | -------------------------------------------------------------------------------- | - | ------ | -
|                                               |  | Fair
ValueMeasurements 
UsingSignificantUnobservable Inputs(Level
3)Auction-RateTax-Exempt Securities |         |   | Fair
ValueMeasurements 
UsingSignificantUnobservable Inputs(Level
3)Other Assets |  
|Balance at January 1, 2010                     |  | $                                                                                                     | 37,416  |   |                                                                                  | $ | 8,830  |  
|Transfers in and/or out of Level 3             |  |                                                                                                       |        |   |                                                                                  |   |       |  
|Total gains or (losses) (realized/unrealized): |  |                                                                                                       |         |   |                                                                                  |   |        |  
|Included in earnings                           |  |                                                                                                       | 6,897   |   |                                                                                  |   | (6,707 | )
|Included in other comprehensive income         |  |                                                                                                       |        |   |                                                                                  |   |       |  
|Settlements                                    |  |                                                                                                       | (35,470 | ) |                                                                                  |   |       |  
|                                               |  |                                                                                                       |         |   |                                                                                  |   |        |  
|Balance at September 30, 2010                  |  | $                                                                                                     | 8,843   |   |                                                                                  | $ | 2,123  |  
|                                               |  |                                                                                                       |         |   |                                                                                  |   |        |  

Fair value measurements for liabilities in category Level 3 for the nine months ended September 30,
2010 were as follows (in thousands):



|                                  |  |                                                                                         |        |  
|--------------------------------- |  | --------------------------------------------------------------------------------------- | ------ | -
|                                  |  | Fair Value MeasurementsUsing
SignificantUnobservable Inputs(Level
3)Interest Rate Swaps |       
|Balance at January 1, 2010        |  | $                                                                                       | 4,108  |  
|Transfers into Level 3            |  |                                                                                         |       |  
|Total losses included in earnings |  |                                                                                         | 862    |  
|Settlements                       |  |                                                                                         | (2,769 | )
|                                  |  |                                                                                         |        |  
|Balance at September 30, 2010     |  | $                                                                                       | 2,201  |  
|                                  |  |                                                                                         |        |  

Derivative financial instruments are reported at fair value on the consolidated balance sheet. The
Companys current derivative instruments consist of two interest rate swaps with an aggregate notional amount of $90 million outstanding at September 30, 2010, previously designated as hedges against the variability of cash flows
associated with that portion of the senior secured credit facility. The interest rate swap liability is recorded in other liabilities on the consolidated balance sheet. The credit risk associated with these swap agreements is limited to the
uncollected interest payments due from counterparties. As of September 30, 2010, counterparty credit risk was minimal.

Gains and losses (realized and unrealized) for Level 3 assets and liabilities included in earnings for the nine months ended
September 30, 2010, are reported in net investment income, other income and loss on interest rate swaps as follows (in thousands):



|                                              |  |                       |       |  |                   |   |        |                           |  |   |      |  
|--------------------------------------------- |  | --------------------- | ----- |  | ----------------- | - | ------ | ------------------------- |  | - | ---- | -
|                                              |  | Net 
InvestmentIncome |       |  | OtherIncome(Loss) |   |        | Loss
onInterest RateSwaps | 
|Assets                                        |  |                       |       |  |                   |   |        |                           |  |   |      |  
|Total gains (losses) realized in earnings     |  | $                     | 6,897 |  |                   | $ | (6,707 | )                         |  | $ |     |  
|Liabilities                                   |  |                       |       |  |                   |   |        |                           |  |   |      |  
|Total gains (losses) realized in earnings     |  |                       |      |  |                   |   |       |                           |  |   | (862 | )
|                                              |  |                       |       |  |                   |   |        |                           |  |   |      |  
|Total for the period ended September 30, 2010 |  | $                     | 6,897 |  |                   | $ | (6,707 | )                         |  | $ | (862 | )
|                                              |  |                       |       |  |                   |   |        |                           |  |   |      |  

Fair values represent the Companys best estimates and may not be substantiated by comparisons to
independent markets and, in many cases, could not be realized in immediate settlement of the instruments. The following financial liabilities are not required to be recorded at fair value, but their fair value is being disclosed.

Notes payable  The fair values of the notes payable were determined using a third-party valuation source and were estimated
to be $21.3 million in the aggregate with a total carrying value of $76.9 million at September 30, 2010.

Senior
secured credit facility  The fair value of the senior secured credit facility was determined using a third-party valuation source and was estimated to be $88.1 million with a carrying value of $98.0 million at September 30, 2010.



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##### Table of Contents



|15. | Discontinued Operations
|--- | -----------------------

On June 24, 2009, the Company sold all of its retail stores and its franchise business in Florida effective May 31,
2009. The results of operations of the sold business have been classified as discontinued operations in the consolidated statements of income (loss). Cash flows related to discontinued operations have been combined with cash flows from
continuing operations within each category of cash flows.

The summarized statements of loss from discontinued operations were
as follows (in thousands):



|                                         |  |                                  |   |  |                                 |   |     |      |  |   |      |  |  |   |        |  
|---------------------------------------- |  | -------------------------------- | - |  | ------------------------------- | - | --- | ---- |  | - | ---- |  |  | - | ------ | -
|                                         |  | Three Months 
EndedSeptember 30, |   |  | Nine Months 
EndedSeptember 30, |  
|                                         |  | 2010                             |   |  | 2009                            |   |     | 2010 |  |   | 2009 | 
|Revenue (including loss on disposal)     |  | $                                |  |  |                                 | $ | (20 | )    |  | $ |     |  |  | $ | 569    |  
|Pretax loss from discontinued operations |  |                                  |  |  |                                 |   | (47 | )    |  |   |     |  |  |   | (1,835 | )
|Income tax benefit                       |  |                                  |  |  |                                 |   | (17 | )    |  |   |     |  |  |   | (479   | )
|                                         |  |                                  |   |  |                                 |   |     |      |  |   |      |  |  |   |        |  
|Loss from discontinued operations        |  | $                                |  |  |                                 | $ | (30 | )    |  | $ |     |  |  | $ | (1,356 | )
|                                         |  |                                  |   |  |                                 |   |     |      |  |   |      |  |  |   |        |  



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##### Table of Contents



|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

OVERVIEW

We are a distributor and producer of non-standard personal
automobile insurance policies for individual consumers in targeted geographic markets. Non-standard personal automobile insurance policies provide coverage to drivers who find it difficult to obtain insurance from standard automobile insurance
companies due to their lack of prior insurance, age, driving record, limited financial resources or other factors. Non-standard personal automobile insurance policies generally require higher premiums than standard automobile insurance policies for
comparable coverage.

As of September 30, 2010, our subsidiaries included insurance companies licensed to write insurance
policies in 40 states, underwriting agencies, and retail agencies with 201 owned stores and relationships with two unaffiliated underwriting agencies. We are currently active in offering insurance directly to individual consumers through retail
stores in 9 states (Louisiana, Texas, Illinois, Alabama, Missouri, Indiana, South Carolina, Kansas, and Wisconsin) and distributing our own insurance policies through 9,300 independent agents or brokers in 10 states (Louisiana, Texas, Illinois,
Alabama, California, Michigan, Missouri, Indiana, South Carolina, and New Mexico). In February 2010, we notified the Florida Insurance Commissioner of our intent to discontinue writing new and renewal policies in the state of Florida. We began
issuing notices of non-renewal to insureds in May 2010.

We believe that the delivery of non-standard personal automobile
insurance policies to individual consumers requires the interaction of four basic operations, each with a specialized function:



| |  |  | Insurance companies, which possess the regulatory authority and capital necessary to issue insurance policies;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | Underwriting agencies, which supply centralized infrastructure and personnel required to design and service insurance policies that are
distributed through retail agencies;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Retail agencies,which provide multiple points of sale under established local brands with personnel licensed and trained to sell insurance
policies and ancillary products to individual consumers; and
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Premium finance companies, which provide payment alternatives to individual customers of our retail agencies.
| | - |  | -------------------------------------------------------------------------------------------------------------

Our four operating components often function as a vertically integrated unit, capturing the premium and associated risk and commission
income and fees generated from the sale of an insurance policy. There are other instances, however, when each of our operations functions with unaffiliated entities on an unbundled basis, either independently or with one or two of the other
operations. For example, our retail stores earn commission income and fees from sales of non-standard automobile insurance policies issued by third-party insurance carriers.

We believe that our ability to enter into a variety of business relationships with third parties allows us to maximize sales penetration and profitability through industry cycles better than if we
employed a single, vertically integrated operating structure.

CRITICAL ACCOUNTING POLICIES

There have been no changes of critical accounting policies since December 31, 2009.

The Company completed its annual goodwill and indefinite lived intangible asset impairment analyses as of September 30, 2010. The
Company reports under a single reporting segment and, as such, the goodwill analysis is measured under one reporting unit. Consistent with prior assessments, the fair value of the Companys reporting unit was determined using an internally
developed discounted cash flow methodology and other relevant indicators of value available in the market place such as market transactions and trading values of similar companies. Based upon the results of the assessment, the Company concluded that
the carrying values of goodwill and other intangible assets were not impaired as of September 30, 2010.

Key inputs in
our valuation model are projected cash flows, future inflationary trends, future tax rates, and the risk-adjusted discount rates. The risk-adjusted discount rates were developed using a capital asset pricing model to estimate our weighted-average
cost of capital and ranged between 12.5% and 14.0%. The relative mix of capital between debt and equity was estimated at approximately 34 percent based on observed industry averages.

Based on the valuation model results, management concluded that goodwill was not impaired as the fair value of the Company exceeded its
carrying value. Further, the fair value obtained from the discounted cash flow model was subject to a stress test by decreasing forecasted cash flows by 10%. The indicated stress value was sufficient to cover the book value of the Company.

RECENTLY ISSUED ACCOUNTING STANDARDS

Refer to Note 2 to the unaudited Consolidated Financial Statements for a discussion of certain accounting standards that have been adopted during 2010 and certain accounting standards which we have not
yet been required to adopt and may be applicable to the Companys future Consolidated Financial Statements.



20



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##### Table of Contents



MEASUREMENT OF PERFORMANCE

We are an insurance holding company engaged in the underwriting, servicing and distributing of non-standard personal
automobile insurance policies and related products and services. We distribute our products through three distinct distribution channels: our retail stores, independent agents and unaffiliated underwriting agencies. We generate earned premiums and
fees from policyholders through the sale of our insurance products. In addition, through our retail stores, we sell insurance policies of third-party insurers and other products or services of unaffiliated third-party providers and thereby earn
commission income from those third-party providers and insurers and fees from the customers.

As part of our corporate
strategy, we treat our retail stores as independent agents, encouraging them to sell to their individual customers whatever products are most appropriate for and affordable to those customers. We believe that this offers our retail customers the
best combination of service and value, developing stronger customer loyalty and improving customer retention. In practice, this means that in our retail stores, the relative proportion of the sales of our own insurance products as compared to the
sales of the third-party policies will vary depending upon the competitiveness of our insurance products in the marketplace during the period. This reflects our intention of maintaining the margins in our insurance company subsidiaries, even at the
cost of business lost to third-party carriers.

In the independent agency distribution channel and the unaffiliated
underwriting agency distribution channel, the effect of competitive conditions is the same as in our retail store distribution channel. As in our retail stores, independent agents (either working directly with us or through unaffiliated underwriting
agencies) not only offer our products but also offer their customers a selection of products by third-party carriers. Therefore, our insurance products must be competitive in pricing, features, commission rates and ease of sale or the independent
agents will sell the products of those third parties instead of our products. We believe that we are generally competitive in the markets we serve, and we constantly evaluate our products relative to those of other carriers.

Premiums.One measurement of our performance is the level of gross premiums written and a second measurement is the relative
proportion of premiums written through our three distribution channels. The following table displays our gross premiums written and assumed by distribution channel for the three and nine months ended September 30, 2010 and 2009 (in thousands):



|                                   |  |                                 |        |  |                                |   |        |      |  |   |         |  |  |   |         | 
|---------------------------------- |  | ------------------------------- | ------ |  | ------------------------------ | - | ------ | ---- |  | - | ------- |  |  | - | ------- | 
|                                   |  | Three Months EndedSeptember
30, |        |  | Nine Months EndedSeptember
30, |  
|                                   |  | 2010                            |        |  | 2009                           |   |        | 2010 |  |   | 2009    | 
|Our underwriting agencies:         |  |                                 |        |  |                                |   |        |      |  |   |         |  |  |   |         | 
|Retail agencies                    |  | $                               | 47,104 |  |                                | $ | 50,742 |      |  | $ | 144,213 |  |  | $ | 163,445 | 
|Independent agencies               |  |                                 | 41,394 |  |                                |   | 34,833 |      |  |   | 123,124 |  |  |   | 102,955 | 
|                                   |  |                                 |        |  |                                |   |        |      |  |   |         |  |  |   |         | 
|Subtotal                           |  |                                 | 88,498 |  |                                |   | 85,575 |      |  |   | 267,337 |  |  |   | 266,400 | 
|Unaffiliated underwriting agencies |  |                                 | 4,796  |  |                                |   | 5,850  |      |  |   | 15,999  |  |  |   | 19,493  | 
|                                   |  |                                 |        |  |                                |   |        |      |  |   |         |  |  |   |         | 
|Total                              |  | $                               | 93,294 |  |                                | $ | 91,425 |      |  | $ | 283,336 |  |  | $ | 285,893 | 
|                                   |  |                                 |        |  |                                |   |        |      |  |   |         |  |  |   |         | 

Total gross premiums written for the three months ended September 30, 2010 increased $1.9 million, or
2.0%, compared with the prior year primarily due to an increase in production from our independent agent distribution channel. Total gross premiums written for the nine months ended September 30, 2010 decreased $2.6 million, or 0.9%, compared
with the prior year primarily due to a decline in production from our retail distribution channel. In our retail distribution channel, gross premiums written consist of premiums written for our affiliated insurance carriers products only and
do not include premiums written for third-party insurance carriers in our retail stores. We earn commission income and fees in our retail distribution channel for sales of third-party insurance policies. Gross premiums written in our retail
distribution channel for the three and nine months ended September 30, 2010, decreased $3.6 million and $19.2 million, or 7.2% and 11.8%, respectively, when compared with the prior year. This decrease was due to more of our retail customers
choosing third-party products due to soft market conditions.

In our independent agency distribution channel, gross premiums
written for the three months ended September 30, 2010 increased $6.6 million, or 18.8%, compared with the prior year period, and gross premiums written for the nine months ended September 30, 2010 increased $20.2 million, or 19.6%,
compared with the prior year period. The increase was due to an initiative to target the expansion of certain independent agent relationships.



21



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Gross premiums written
by our unaffiliated underwriting agencies for the three and nine months ended September 30, 2010 decreased $1.1 million and $3.5 million, respectively, or 18.0% and 17.9%, respectively, compared with the prior year. The following table displays
our gross premiums written and assumed by state for the three and nine months ended September 30, 2010 and 2009 (in thousands):



|               |  |                                 |        |  |                                |   |        |      |  |   |         |  |  |   |         | 
|-------------- |  | ------------------------------- | ------ |  | ------------------------------ | - | ------ | ---- |  | - | ------- |  |  | - | ------- | 
|               |  | Three Months
EndedSeptember 30, |        |  | Nine Months
EndedSeptember 30, |  
|               |  | 2010                            |        |  | 2009                           |   |        | 2010 |  |   | 2009    | 
|Louisiana      |  | $                               | 35,876 |  |                                | $ | 36,087 |      |  | $ | 109,923 |  |  | $ | 108,543 | 
|Texas          |  |                                 | 18,684 |  |                                |   | 20,396 |      |  |   | 53,271  |  |  |   | 64,217  | 
|Illinois       |  |                                 | 10,565 |  |                                |   | 8,916  |      |  |   | 31,812  |  |  |   | 31,269  | 
|Michigan       |  |                                 | 10,325 |  |                                |   | 5,709  |      |  |   | 30,123  |  |  |   | 14,326  | 
|Alabama        |  |                                 | 7,392  |  |                                |   | 7,324  |      |  |   | 23,086  |  |  |   | 22,729  | 
|California     |  |                                 | 4,763  |  |                                |   | 5,788  |      |  |   | 15,873  |  |  |   | 19,272  | 
|Indiana        |  |                                 | 2,662  |  |                                |   | 2,136  |      |  |   | 7,946   |  |  |   | 7,295   | 
|South Carolina |  |                                 | 1,381  |  |                                |   | 1,082  |      |  |   | 4,295   |  |  |   | 3,772   | 
|Missouri       |  |                                 | 1,130  |  |                                |   | 2,058  |      |  |   | 4,010   |  |  |   | 7,109   | 
|New Mexico     |  |                                 | 452    |  |                                |   | 728    |      |  |   | 1,507   |  |  |   | 2,207   | 
|Florida        |  |                                 | 32     |  |                                |   | 1,136  |      |  |   | 1,365   |  |  |   | 4,934   | 
|Other          |  |                                 | 32     |  |                                |   | 65     |      |  |   | 125     |  |  |   | 220     | 
|               |  |                                 |        |  |                                |   |        |      |  |   |         |  |  |   |         | 
|Total          |  | $                               | 93,294 |  |                                | $ | 91,425 |      |  | $ | 283,336 |  |  | $ | 285,893 | 
|               |  |                                 |        |  |                                |   |        |      |  |   |         |  |  |   |         | 

In order to improve profitability, we have implemented and plan to continue to implement a number of pricing
and underwriting actions. It is anticipated that these actions will result in a decline in premium production.

The following
table displays our net premiums written by distribution channel for the three and nine months ended September 30, 2010 and 2009 (in thousands):



|                                                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                 |  | Three Months EndedSeptember
30, |        |   | Nine Months EndedSeptember
30, |  
|                                                                 |  | 2010                            |        |   | 2009                           |   |        | 2010 |  |   | 2009    |  
|Our underwriting agencies:                                       |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Retail agencies  gross premiums written                         |  | $                               | 47,104 |   |                                | $ | 50,742 |      |  | $ | 144,213 |   |  | $ | 163,445 |  
|Ceded reinsurance                                                |  |                                 |       |   |                                |   |       |      |  |   |        |   |  |   | 10,286  |  
|                                                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Subtotal retail agencies net premiums written                    |  |                                 | 47,104 |   |                                |   | 50,742 |      |  |   | 144,213 |   |  |   | 173,731 |  
|                                                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Independent agencies  gross premiums written                    |  |                                 | 41,394 |   |                                |   | 34,833 |      |  |   | 123,124 |   |  |   | 102,955 |  
|Ceded reinsurance                                                |  |                                 | (1,839 | ) |                                |   | (651   | )    |  |   | (3,997  | ) |  |   | (1,304  | )
|                                                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Subtotal independent agencies net premiums written               |  |                                 | 39,555 |   |                                |   | 34,182 |      |  |   | 119,127 |   |  |   | 101,651 |  
|                                                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Unaffiliated underwriting agencies  gross premiums written      |  |                                 | 4,796  |   |                                |   | 5,850  |      |  |   | 15,999  |   |  |   | 19,493  |  
|Ceded reinsurance                                                |  |                                 | (19    | ) |                                |   | (32    | )    |  |   | (73     | ) |  |   | (121    | )
|                                                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Subtotal unaffiliated underwriting agencies net premiums written |  |                                 | 4,777  |   |                                |   | 5,818  |      |  |   | 15,926  |   |  |   | 19,372  |  
|                                                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Catastrophe and excess of loss reinsurance                       |  |                                 | (1,282 | ) |                                |   | (179   | )    |  |   | (1,518  | ) |  |   | (530    | )
|                                                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  
|Total net premiums written                                       |  | $                               | 90,154 |   |                                | $ | 90,563 |      |  | $ | 277,748 |   |  | $ | 294,224 |  
|                                                                 |  |                                 |        |   |                                |   |        |      |  |   |         |   |  |   |         |  

Total net premiums written for the three months ended September 30, 2010 decreased $0.4 million, or
0.5%, compared with the prior year quarter. Total net premiums written for the nine months ended September 30, 2010 decreased $16.5 million, or 5.6%, compared with the prior year period. The decrease for the nine-month period was primarily due
to the termination of our quota share reinsurance contract for our Louisiana and Alabama business on a cut-off basis effective January 1, 2009 and the resulting return of $10.5 million of ceded unearned premium.

RESULTS OF OPERATIONS

We had a net loss from continuing operations of $23.1 million and $3.4 million for the three months ended September 30, 2010, and
2009, respectively. We had a net loss from continuing operations of $38.7 million and $0.2 million for the nine months ended September 30, 2010, and 2009, respectively. Significant items impacting the nine months ended September 30, 2009
results were a net pretax gain on extinguishment of debt of $19.4 million, which was partially offset by unfavorable prior year loss development of $11.0 million and loss on interest rate swaps of $4.9 million associated with the discontinuation of
hedge accounting. Significant items impacting the nine months ended September 30, 2010 results were unfavorable loss development of $10.0 million.



22



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##### Table of Contents



Comparison of the Three Months
Ended September 30, 2010 to the Three Months Ended September 30, 2009

Total revenues for the three months ended
September 30, 2010 decreased $1.0 million, or 0.9%, compared with the three months ended September 30, 2009. The decrease was primarily due to an increase in losses and loss adjustment expenses and decreases in commission income and fees,
net investment income and other income (loss), partially offset by increases in net premiums earned and net realized gains.

The largest component of revenue is net premiums earned on insurance policies. Net premiums earned for the current quarter increased $2.5
million, or 2.8%, compared with the prior year quarter. Since insurance premiums are earned over the service period of the policies, the revenue in the current quarter includes premiums earned on insurance products written through our three
distribution channels in both current and previous periods. Net premiums earned during the current quarter on policies sold through our affiliated underwriting agencies (including retail and independent agencies) increased by $3.4 million, or 4.1%.
This increase is primarily due to continued expansion of the independent agent distribution channel, which was partially offset by the macroeconomic environment and soft market conditions. Net premiums earned on insurance products sold through the
unaffiliated underwriting agencies distribution channel decreased by $0.9 million, or 13.8%, compared with the prior year quarter.

The following table sets forth net premiums earned by distribution channel for the current quarter and the prior year quarter (in thousands):



|                                   |  |                                  |        |  |      |   |        | 
|---------------------------------- |  | -------------------------------- | ------ |  | ---- | - | ------ | 
|                                   |  | Three Months 
EndedSeptember 30, |       
|                                   |  | 2010                             |        |  | 2009 |  
|Our underwriting agencies          |  | $                                | 85,642 |  |      | $ | 82,260 | 
|Unaffiliated underwriting agencies |  |                                  | 5,433  |  |      |   | 6,301  | 
|                                   |  |                                  |        |  |      |   |        | 
|Total net premiums earned          |  | $                                | 91,075 |  |      | $ | 88,561 | 
|                                   |  |                                  |        |  |      |   |        | 

Commission Income and Fees. Another measurement of our performance is the relative level of
production of commission income and fees. Commission income and fees consists of (a) policy, installment, premium finance and agency fees earned for business written or assumed by our insurance companies both through independent agents and our
retail agencies and (b) the commission, premium finance and agency fee income earned on sales of unaffiliated, third-party companies insurance policies or other products sold by our retail agencies. These various types of commission
income and fees are impacted in different ways by the decisions we make in pursuing our corporate strategy.

Policy,
installment, premium finance and agency fees are earned for business written or assumed by our insurance companies both through independent agents and our retail agencies. Generally, we can increase or decrease agency fees, installment fees, and
interest rates subject to limited regulatory restrictions, but policy fees must be approved by the applicable states department of insurance. Premium finance fees are financing fees earned by our premium finance subsidiaries, and consist of
origination and servicing fees as well as interest on premiums that customers choose to finance.

Commissions, premium finance
and agency fees are earned on sales of third-party companies products sold by our retail agencies. As described above, in our owned stores, there can be a shift in the relative proportion of the sales of third-party insurance products as
compared to sales of our own carriers products due to the relative competitiveness of our insurance products that could result in an increase in our commission income and fees from non-affiliated third-party insurers. We negotiate commission
rates with the various third-party carriers whose products we agree to sell in our retail stores. As a result, the level of third-party commission income will also vary depending upon the mix by carrier of third-party products that are sold. In
addition, we earn fees from the sales of other products and services such as auto club memberships and bond cards offered by unaffiliated companies.



23



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##### Table of Contents



The following sets
forth the components of consolidated commission income and fees earned for the current quarter and the prior year quarter (in thousands):



|                                 |  |                                  |        |  |      |   |        | 
|-------------------------------- |  | -------------------------------- | ------ |  | ---- | - | ------ | 
|                                 |  | Three Months 
EndedSeptember 30, |       
|                                 |  | 2010                             |        |  | 2009 |  
|Policyholder fees                |  | $                                | 7,491  |  |      | $ | 9,604  | 
|Premium finance revenue          |  |                                  | 5,731  |  |      |   | 5,597  | 
|Commissions and fees             |  |                                  | 3,778  |  |      |   | 3,690  | 
|Agency fees                      |  |                                  | 1,230  |  |      |   | 1,133  | 
|Other, net                       |  |                                  | 1      |  |      |   |       | 
|                                 |  |                                  |        |  |      |   |        | 
|Total commission income and fees |  | $                                | 18,231 |  |      | $ | 20,024 | 
|                                 |  |                                  |        |  |      |   |        | 

Commission income and fees decreased $1.8 million, or 9.0%, compared with the prior year quarter.

Net Investment Income and Other Income (Loss).Net investment income for the current quarter decreased $1.2 million,
or 51.6%, compared with the prior year quarter. The decrease was primarily due to a reduction in yields and a 15.7% decrease in total average invested assets to $229.4 million during the current quarter from $272.1 million during the prior year
quarter. The average investment yield was 2.2% (2.3% on a taxable equivalent basis) in the current quarter, compared with 3.0% (3.9% on taxable equivalent basis) in the prior year quarter. In addition, investment income for our investment in real
estate declined $0.5 million for the three months ended September 30, 2010, compared with the prior year quarter. This decrease is due to improvements we are making to the property for a new long-term lease, which is expected to commence in the
fourth quarter of 2010.

In the first quarter of 2010, we began to reposition our investment portfolio by decreasing our
tax-exempt investments. The purpose of the repositioning is to monetize the tax-exempt portion of the investments and to decrease our municipal credit exposure. The repositioning was completed in the second quarter of 2010. We sold $25.2 million of
available-for-sale securities during the three-month period ended September 30, 2010, for a net realized gain of $0.1 million.

As of September 30, 2010, we held $11.0 million, at amortized cost, and $8.8 million fair value of auction-rate tax-exempt securities. Generally, the interest rates for these securities are
determined by bidding every 7, 28 or 35 days. When there are more sellers than buyers, an auction fails and bondholders that want to sell are unable to sell the securities. Auctions for these securities began to fail in late January 2008. Issuers
remain obligated to pay interest and principal when due when an auction fails. Rates at failed auctions are set at a level established in the terms of the debt.

In October 2008, our broker filed a prospectus with the SEC, which published a legally-binding offer to all authorized holders of auction-rate securities to purchase all eligible securities at par
(the settlement). The time frames set by our broker for buybacks have different start dates based upon the individual clients size, which is determined by each clients balance of investments held at our broker. In November
2008, we elected to participate in our brokers offer to purchase our auction-rate securities at par and classified our portfolio of auction-rate securities as trading. The settlement agreement requires our broker to purchase eligible
securities at par, at any time during a two-year period beginning June 30, 2010. All auction-rate securities held at September 30, 2010 are eligible for buyback under the settlement agreements. At September 30, 2010 and
December 31, 2009, the fair value of the settlement was $2.1 million and $8.8 million, respectively, which is recorded in other assets in the consolidated balance sheets with changes in fair value recorded in other income (loss) in the
consolidated statements of income (loss). The Company had redemptions of auction rate securities, at par, of $4.4 million and realized gains of $1.1 million during the third quarter of 2010 offset by a corresponding reduction in fair value of the
settlement recorded in other income (loss).

Losses and Loss Adjustment Expenses.Since the largest expenses of an
insurance company are the losses and loss adjustment expenses, another measurement of our insurance carriers performance is the level of such expenses, specifically as a ratio to earned premiums. Our losses and loss adjustment expenses are a
blend of the specific estimated and actual costs of providing the coverage contracted by the purchasers of our insurance policies. We maintain reserves to cover our estimated ultimate liability for losses and related loss adjustment expenses for
both reported and unreported claims on the insurance policies issued by our insurance companies. The establishment of appropriate reserves is an inherently uncertain process, involving actuarial and statistical projections of what we expect to be
the cost of the ultimate settlement and administration of claims based on historical claims information, estimates of future trends in claims severity, changes in the mix of business/limits and other variable factors such as inflation. Due to the
inherent uncertainty of estimating reserves, reserve estimates can be expected to vary from period to period. The claim initiatives that we started in the second half of 2009 shortened the claims payment cycle and have reduced the number of claims
outstanding. The acceleration of payment patterns has necessitated increased use of judgment by management to account for the deviation in trends. To the extent that our reserves prove to be inadequate in the future, we would be required to increase
our reserves for losses and loss adjustment expenses and incur a charge to earnings in the period during which such reserves are increased. The historic development of our reserves for losses and loss adjustment expenses is not necessarily
indicative of future trends in the development of these amounts.



24



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Losses and loss
adjustment expenses for the current quarter increased $6.1 million, or 8.6%, compared with the prior year quarter. The current quarter included a reallocation of expenses to selling, general and administrative expenses to more accurately reflect
claim handling costs. If the new allocation methodology was in place in the third quarter of 2009, losses and loss adjustment expenses would have been lower by $1.9 million. The percentage of losses and loss adjustment expense to net premiums earned
(the loss ratio) was 83.8% in the current quarter, compared with 79.4% in the prior year quarter. The increase in the current quarter loss ratio was primarily due to Texas and Michigan. Price increases have been made for both of those states to
increase profitability. For the three months ended September 30, 2010, the adverse loss development of $1.0 million for the prior period was primarily due to continued unfavorable development from our 2009 business.

The following table displays the impact of loss development related to prior periods business on our loss ratio for the current
quarter and the prior year quarter:



|                                                       |  |                                 |      |   |      |  |      |  
|------------------------------------------------------ |  | ------------------------------- | ---- | - | ---- |  | ---- | -
|                                                       |  | Three Months EndedSeptember
30, |     
|                                                       |  | 2010                            |      |   | 2009 | 
|Loss ratio  current quarter                           |  |                                 | 82.7 | % |      |  | 79.4 | %
|Adverse loss ratio development  prior period business |  |                                 | 1.1  |   |      |  |     |  
|                                                       |  |                                 |      |   |      |  |      |  
|Reported loss ratio                                    |  |                                 | 83.8 | % |      |  | 79.4 | %
|                                                       |  |                                 |      |   |      |  |      |  

Selling, General and Administrative Expenses. Another measurement of our performance that addresses
our overall efficiency is the level of selling, general and administrative (SG&A) expenses. We recognize that our customers are primarily motivated by low prices. As a result, we strive to keep our costs as low as possible to be able to keep our
prices affordable and thus to maximize our sales while still maintaining profitability. Our SG&A expenses include not only the cost of acquiring the insurance policies through our insurance carriers (the amortization of the deferred acquisition
costs) and managing our insurance carriers and the retail stores, but also the costs of the holding company. The largest component of SG&A expenses is personnel costs, including payroll, benefits and accrued bonus expenses. SG&A expenses
increased $10.6 million, or 27.8%, compared with the prior year quarter primarily related to a $6.3 million increase in employee compensation and benefits, including $3.1 million in executive severance, a $1.1 million increase in amortization of
policy acquisition costs due to increased independent agent sales volumes, and a reallocation of expenses from loss adjustment expense to more accurately reflect claim handling costs. If the new allocation methodology was in place in the third
quarter of 2009, SG&A expenses would have been higher by $1.9 million.

Deferred policy acquisition costs represent the
deferral of expenses that we incur in acquiring new business or renewing existing business. Policy acquisition costs, consisting of primarily commission, advertising, premium taxes, underwriting and retail agency expenses, are initially deferred and
then charged against income ratably over the terms of the related policies through amortization of the deferred policy acquisition costs. Thus, the amortization of deferred acquisition costs is correlated with earned premium and the ratio of
amortization of deferred acquisition costs to earned premium in an accounting period is another measurement of performance.

Amortization of deferred policy acquisition costs is a major component of SG&A expenses. The following table sets forth the impact
that amortization of deferred acquisition costs had on SG&A expenses and the change in deferred acquisition costs (in thousands):



|                                                                                  |  |                                 |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Three Months EndedSeptember 30, |        
|                                                                                  |  | 2010                            |         |   | 2009 |  
|Amortization of deferred acquisition costs                                        |  | $                               | 21,188  |   |      | $ | 19,047  |  
|Other selling, general and administrative expenses                                |  |                                 | 27,501  |   |      |   | 19,045  |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Total selling, general and administrative expenses                                |  | $                               | 48,689  |   |      | $ | 38,092  |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Total as a percentage of net premiums earned                                      |  |                                 | 53.5    | % |      |   | 43.0    | %
|                                                                                  |  |                                 |         |   |      |   |         |  
|Beginning deferred acquisition costs                                              |  | $                               | 24,276  |   |      | $ | 24,732  |  
|Additions                                                                         |  |                                 | 21,158  |   |      |   | 18,740  |  
|Amortization                                                                      |  |                                 | (21,188 | ) |      |   | (19,047 | )
|                                                                                  |  |                                 |         |   |      |   |         |  
|Ending deferred acquisition costs                                                 |  | $                               | 24,246  |   |      | $ | 24,425  |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Amortization of deferred acquisition costs as a percentage of net premiums earned |  |                                 | 23.3    | % |      |   | 21.5    | %
|                                                                                  |  |                                 |         |   |      |   |         |  

Depreciation and Amortization.Depreciation and amortization expenses for the current quarter were
consistent with the prior year quarter.



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Loss on Interest
Rate Swaps. Loss on interest rate swaps for the three months ended September 30, 2010 decreased $0.7 million, or 72.8%, compared with the same period in the prior year. The amendment of the senior credit facility in March 2009 resulted in
the interest rate swaps becoming ineffective as cash flow hedges and are therefore carried at fair value. The loss relates to the impact on the determination of fair value associated with the decline in short-term interest rates implied in the
forward yield curve.

Interest Expense.Interest expense for the current quarter decreased $0.9 million, or 14.5%,
compared with the prior quarter. This decrease was due to a decrease in the average debt outstanding and lower weighted average interest rate, partially offset by the amortization of debt discount of $1.4 million in the current quarter.

Income Taxes.Income tax expense for the current quarter was $0.5 million as compared with an income tax benefit of $3.2 million
for the same period in the prior year. The income tax expense for the three months ended September 30, 2010 was primarily due to an increase in the deferred tax liability related to goodwill and state tax expense.

Our net deferred tax assets prior to recognition of valuation allowance were $34.8 million and $20.8 million at
September 30, 2010 and December 31, 2009, respectively. In assessing the realizability of our deferred tax assets, we considered whether it was more likely than not that our deferred tax assets will be realized based upon all available
evidence, including scheduled reversal of deferred tax liabilities, historical operating results, projected future operating results, tax carry-back availability, and limitations pursuant to Section 382 of the Internal Revenue Code, among
others. Based on this assessment, we began recording a valuation allowance against deferred taxes in December 2009. As of September 30, 2010, the valuation allowance was $46.5 million.

Comparison of the Nine Months Ended September 30, 2010 to the Nine Months Ended September 30, 2009

Total revenues for the nine months ended September 30, 2010 increased $4.8 million, or 1.4%, compared with the nine months ended September 30, 2009. The increase was primarily due to increases
in net premiums earned, commission income and fees and net realized gains, partially offset by decreases in net investment income and other income (loss).

The largest component of revenue is net premiums earned on insurance policies. Net premiums earned for the current period increased $4.2 million, or 1.5%, compared with the prior year period. Since
insurance premiums are earned over the service period of the policies, the revenue in the current period includes premiums earned on insurance products written through our three distribution channels in both current and previous periods. Net
premiums earned during the current period on policies sold through our affiliated underwriting agencies (including retail and independent agencies) increased by $6.4 million, or 2.5%. Net premiums earned on insurance products sold through the
unaffiliated underwriting agencies distribution channel decreased by $2.2 million, or 11.3%, compared with the prior year period.

The following table sets forth net premiums earned by distribution channel for the current period and the prior year period (in thousands):



|                                   |  |                                 |         |  |      |   |         | 
|---------------------------------- |  | ------------------------------- | ------- |  | ---- | - | ------- | 
|                                   |  | Nine Months 
EndedSeptember 30, |        
|                                   |  | 2010                            |         |  | 2009 |  
|Our underwriting agencies          |  | $                               | 263,114 |  |      | $ | 256,733 | 
|Unaffiliated underwriting agencies |  |                                 | 17,098  |  |      |   | 19,273  | 
|                                   |  |                                 |         |  |      |   |         | 
|Total net premiums earned          |  | $                               | 280,212 |  |      | $ | 276,006 | 
|                                   |  |                                 |         |  |      |   |         | 

Commission Income and Fees.

The following sets forth the components of consolidated commission income and fees earned for the current period and the prior year period (in thousands):



|                                 |  |                                 |        |  |      |   |        | 
|-------------------------------- |  | ------------------------------- | ------ |  | ---- | - | ------ | 
|                                 |  | Nine Months 
EndedSeptember 30, |       
|                                 |  | 2010                            |        |  | 2009 |  
|Policyholder fees                |  | $                               | 30,907 |  |      | $ | 29,251 | 
|Premium finance revenue          |  |                                 | 17,427 |  |      |   | 16,627 | 
|Commissions and fees             |  |                                 | 11,994 |  |      |   | 10,830 | 
|Agency fees                      |  |                                 | 3,763  |  |      |   | 3,753  | 
|Other, net                       |  |                                 |       |  |      |   | 13     | 
|                                 |  |                                 |        |  |      |   |        | 
|Total commission income and fees |  | $                               | 64,091 |  |      | $ | 60,474 | 
|                                 |  |                                 |        |  |      |   |        | 



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Commission income and
fees increased $3.6 million, or 6.0%, compared with the prior year period. Policyholder fees have increased due to an increase in managing general agents fee income due to a change in the mix of business. Commissions and fees increased as a
result of more of our retail customers choosing third-party products due to the soft market conditions.

Net Investment
Income and Other Income (Loss).Net investment income for the current period decreased $3.5 million, or 48.7%, compared with the prior year period. The decrease was primarily due to a reduction in yields and a 12.7% decrease in total average
invested assets to $234.3 million during the current period from $268.4 million during the prior year period. The average investment yield was 2.3% (2.7% on a taxable equivalent basis) in the current period, compared with 3.1% (4.1% on taxable
equivalent basis) in the prior year period. In addition, investment income for our investment in real estate declined $1.7 million for the nine months ended September 30, 2010, compared with the prior year period. This decrease is due to
improvements we are making to the property for a new long-term lease, which is expected to commence in the fourth quarter of 2010.

In the first quarter of 2010, we began to reposition our investment portfolio by decreasing our tax-exempt investments. The purpose of the repositioning is to monetize the tax-exempt portion of the
investments and to decrease our municipal credit exposure. The repositioning was completed in the second quarter of 2010. As a result of the repositioning, we sold $102.2 million of available-for-sale securities during the nine months ended
September 30, 2010, for a net realized gain of $1.4 million offset by a corresponding reduction in fair value of the settlement recorded in other income (loss).

For the nine-month period ended September 30, 2010, other income includes $0.6 million related to a settlement received from legal proceedings.

Losses and Loss Adjustment Expenses.Losses and loss adjustment expenses for the current period increased $6.4 million, or 2.9%,
compared with the prior year period. The current period included a reallocation of expenses to selling, general and administrative expenses to more accurately reflect claim handling costs. If the new allocation methodology was in place in the first
nine months of 2009, losses and loss adjustment expenses would have been lower by $5.4 million. The percentage of losses and loss adjustment expense to net premiums earned (the loss ratio) was 81.5% in the current period, compared with 80.4% in the
prior year period. The increase in the current period loss ratio was primarily due to a change in mix due to growth in Texas and Michigan which have higher loss ratios than our average. For the nine months ended September 30, 2010, the adverse
loss development of $10.0 million for the prior period accident year was primarily due to unfavorable development from our 2009 Texas and Michigan businesses. In the first nine months ended September 30, 2009, we recorded adverse loss
development of $11.0 million primarily related to our Florida, Michigan and Louisiana businesses.

The following table
displays the impact of loss development related to prior periods business on our loss ratio for the current period and the prior year period:



|                                                       |  |                                |      |   |      |  |      |  
|------------------------------------------------------ |  | ------------------------------ | ---- | - | ---- |  | ---- | -
|                                                       |  | Nine Months EndedSeptember
30, |     
|                                                       |  | 2010                           |      |   | 2009 | 
|Loss ratio  current period                            |  |                                | 77.9 | % |      |  | 76.4 | %
|Adverse loss ratio development  prior period business |  |                                | 3.6  |   |      |  | 4.0  |  
|                                                       |  |                                |      |   |      |  |      |  
|Reported loss ratio                                    |  |                                | 81.5 | % |      |  | 80.4 | %
|                                                       |  |                                |      |   |      |  |      |  

Selling, General and Administrative Expenses. The largest component of SG&A expenses is personnel
costs, including payroll, benefits and accrued bonus expenses. SG&A increased $16.0 million, or 13.6%, compared with the prior year period. This increase was primarily related to a $5.5 million increase in amortization of policy acquisition
costs due to higher independent agent sales volumes, an increase in employee compensation and benefits, including $3.1 million in executive severance, and a reallocation of expenses from loss adjustment expense to more accurately reflect claim
handling costs. If the new allocation methodology was in place in the first nine months of 2009, SG&A expenses would have been higher by $5.4 million.



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The following table
sets forth the impact that amortization of deferred acquisition costs had on SG&A expenses and the change in deferred acquisition costs (in thousands):



|                                                                                  |  |                                |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Nine Months EndedSeptember
30, |        
|                                                                                  |  | 2010                           |         |   | 2009 |  
|Amortization of deferred acquisition costs                                        |  | $                              | 63,873  |   |      | $ | 57,085  |  
|Other selling, general and administrative expenses                                |  |                                | 69,902  |   |      |   | 60,643  |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Total selling, general and administrative expenses                                |  | $                              | 133,775 |   |      | $ | 117,728 |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Total as a percentage of net premiums earned                                      |  |                                | 47.7    | % |      |   | 42.7    | %
|                                                                                  |  |                                |         |   |      |   |         |  
|Beginning deferred acquisition costs                                              |  | $                              | 24,230  |   |      | $ | 21,993  |  
|Additions                                                                         |  |                                | 63,889  |   |      |   | 59,517  |  
|Amortization                                                                      |  |                                | (63,873 | ) |      |   | (57,085 | )
|                                                                                  |  |                                |         |   |      |   |         |  
|Ending deferred acquisition costs                                                 |  | $                              | 24,246  |   |      | $ | 24,425  |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Amortization of deferred acquisition costs as a percentage of net premiums earned |  |                                | 22.8    | % |      |   | 20.7    | %
|                                                                                  |  |                                |         |   |      |   |         |  

Depreciation and Amortization.Depreciation and amortization expenses for the current period were
consistent with the prior year period.

Gain on Extinguishment of Debt.In March 2009, we entered into an amendment of
our senior secured credit facility. We evaluated the present value of the cash flows under the terms of the amended credit agreement to determine if they were at least 10 percent different from the present value of the remaining cash flows under the
terms of the original credit agreement. It was determined that the terms were substantially different and therefore should be accounted for as a debt extinguishment. The amended debt agreement was recorded at fair value, which was determined to be
$112.5 million, with the discount to be amortized as interest expense over the remaining life of the note using the effective interest method. In addition, $1.8 million of new debt issuance costs were incurred, which were capitalized and are being
amortized to interest expense over the term of the amended credit agreement.

We recorded a $19.4 million pretax, non-cash
gain on extinguishment of debt as a result of this transaction. The $19.4 million debt extinguishment gain resulted from a $24.2 million discount representing the difference between the carrying value of the original credit agreement and the fair
value of the new modified credit agreement, net of $0.7 million of term lender consent fees and the write-off of $4.1 million of deferred debt issuance costs relating to the original credit agreement.

Loss on Interest Rate Swaps. Loss on interest rate swaps for the current period decreased $5.0 million, or 85.3%, compared with
the prior year period. The amendment of the senior credit facility in March 2009 resulted in the interest rate swaps becoming ineffective as cash flow hedges and are therefore carried at fair value. The loss relates to the impact on the
determination of fair value associated with the decline in short-term interest rates implied in the forward yield curve.

Interest Expense.Interest expense for the current period increased $0.4 million, or 2.2%, compared with the prior period. This
increase was due to higher interest rates on the senior secured credit facility and the amortization of debt discount of $4.9 million in the current period, partially offset by a decrease in the average debt outstanding.

Income Taxes.Income tax expense for the current period was $1.3 million, as compared with an income tax benefit of $5.1 million,
for the prior year period. The income tax expense for the current period was primarily due to an increase in the deferred tax liability related to goodwill and state tax expense.

Our net deferred tax assets prior to recognition of valuation allowance were $34.8 million and $20.8 million at
September 30, 2010 and December 31, 2009, respectively. In assessing the realizability of our deferred tax assets, we considered whether it was more likely than not that our deferred tax assets will be realized based upon all available
evidence, including scheduled reversal of deferred tax liabilities, historical operating results, projected future operating results, tax carry-back availability, and limitations pursuant to Section 382 of the Internal Revenue Code, among
others. Based on this assessment, we began recording a valuation allowance against deferred taxes in December 2009. As of September 30, 2010, the valuation allowance was $46.5 million.

Discontinued Operations. On June 24, 2009, the Company sold all of its retail stores and its franchise business in Florida
effective May 31, 2009. The results of operations of the sold business have been classified as discontinued operations in the consolidated statements of income.

LIQUIDITY AND CAPITAL RESOURCES

Sources and uses of funds.We are a
holding company with no business operations of our own. Consequently, our ability to pay dividends to stockholders, meet our debt payment obligations and pay our taxes and administrative expenses is largely dependent on dividends or other
distributions from our subsidiaries.

There are no restrictions on the payment of dividends by our non-insurance company
subsidiaries other than state corporate laws regarding solvency. As a result, our non-insurance company subsidiaries generate revenues, profits and net cash flows that are generally unrestricted as to their availability for the payment of dividends
and we have and expect to continue to use those revenues to service our corporate financial obligations, such as debt service and stockholder dividends. As of September 30, 2010, we had $1.8 million of cash and cash equivalents at the holding
company level and $19.0 million of cash and cash equivalents at our non-insurance company subsidiaries.

State insurance laws
restrict the ability of our insurance company subsidiaries to declare stockholder dividends. These subsidiaries may not make an extraordinary dividend until 30 days after the applicable commissioner of insurance has received notice of
the intended dividend and has not objected in such time or until the commissioner has approved the payment of the



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extraordinary dividend within the 30-day period. In most states, an extraordinary dividend is defined as any dividend or distribution of cash or other property whose fair market value, together
with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10.0% of the insurance companys surplus as of the preceding year-end or the insurance companys net income for the preceding year,
in each case determined in accordance with statutory accounting practices. In addition, dividends may only be paid from unassigned earnings and an insurance companys remaining surplus must be both reasonable in relation to its outstanding
liabilities and adequate to its financial needs. As of September 30, 2010, our insurance companies could not pay ordinary dividends to us without prior regulatory approval due to a negative unassigned surplus position. However, as mentioned
previously, our nonregulated entities provide adequate cash flow to fund their own operations. In February 2009, we obtained approval from the New York Department of Insurance for one of our insurance subsidiaries to retire one million shares of its
stock for $2.9 million and approved payment of an extraordinary dividend for $0.1 million.

The National Association of
Insurance Commissioners model law for risk-based capital provides formulas to determine the amount of capital that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired. At
September 30, 2010, each of our insurance subsidiaries maintained a risk-based capital level that was in excess of an amount that would require any corrective actions on our part.

Our operating subsidiaries primary sources of funds are premiums received, commission and fee income, investment income and the
proceeds from the sale and maturity of investments. Funds are used to pay claims and operating expenses, to purchase investments and to pay dividends to our holding company.

In May 2010, the Company entered into a capital lease obligation related to certain computer software, software licenses, and hardware currently used by and on the books of Affirmative Insurance Company
and received cash from the financing in the amount of $28.2 million. As required by the lease agreements, the Company purchased $28.2 million of FDIC-insured certificates of deposit with the lease financing proceeds. These investments are pledged as
collateral against the Companys lease obligation and are scheduled to decrease as the Company makes the scheduled lease payments. The lease term is 60 months with monthly rental payments totaling approximately $0.6 million.

We believe that existing cash and investment balances, as well as cash flows generated from operations, will be adequate to meet our
liquidity needs, planned capital expenditures and the debt service requirements of the senior secured credit facility and notes payable, during the 12-month period following the date of this report at both the holding company and insurance company
levels. We do not currently know of any events that could cause a material increase or decrease in our long-term liquidity needs.

Senior secured credit facility. At September 30, 2010, we were in compliance with all of our financial and other covenants.



|Item 3. | Quantitative and Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------

We are principally exposed to two types of market risk: interest rate risk and credit risk.

Interest rate risk.Our investment portfolio consists of investment-grade, fixed-income securities classified as available-for-sale investment securities and auction-rate tax-exempt
securities classified as trading. Accordingly, the primary market risk exposure to our debt securities is interest rate risk. In general, the fair market value of a portfolio of fixed-income securities increases or decreases inversely with changes
in market interest rates, while net investment income realized from future investments in fixed-income securities increases or decreases along with interest rates. In addition, some of our fixed-income securities have call or prepayment options.
This could subject us to reinvestment risk should interest rates fall and issuers call their securities and we reinvest at lower interest rates. We attempt to mitigate this interest rate risk by investing in securities with varied maturity dates and
by managing the duration of our investment portfolio to a defined range of less than three years. The fair value of our fixed-income securities as of September 30, 2010 was $231.4 million. The effective average duration of the portfolio as of
September 30, 2010 was 2.0 years. If market interest rates increase 1.0%, our fixed-income investment portfolio would be expected to decline in market value by 2.0%, or $4.6 million, representing the effective average duration multiplied by the
change in market interest rates. Conversely, a 1.0% decline in interest rates would result in a 2.0%, or $4.6 million, increase in the market value of our fixed-income investment portfolio.

Our senior secured credit facility is also subject to interest rate risk. During the first quarter of 2009, we entered into an amendment
that changed the pricing to be tiered based on the leverage ratio and includes a LIBOR floor of 3.0%. The interest rate is floating based on LIBOR plus increments tied to the Companys leverage ratio. If the leverage ratio is greater than 2.0,
the pricing is LIBOR plus 6.25%. If the leverage ratio is greater than 1.5 and less than or equal to 2.0, the pricing is LIBOR plus 6.00%. If the leverage ratio is less than or equal to 1.5, the pricing is LIBOR plus 5.75%.

Derivative financial instruments are reported at fair value on the consolidated balance sheet. Our current derivative instruments consist
of two interest rate swaps with an aggregate notional amount of $90.0 million outstanding at September 30, 2010. One swap instrument has a notional amount outstanding of $50.0 million that requires quarterly settlements whereby we pay a fixed
rate of 4.993% and receive a three-month LIBOR rate. The second interest rate swap has a notional amount of $40.0 million outstanding, for which we pay a fixed rate of 3.031% and receive a three-month LIBOR rate. The interest rate swaps were
previously designated as hedges against the variability of cash flows associated with that portion of the senior secured credit facility.



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Our notes payable are
also subject to interest rate risk. The $30.9 million notes adjust quarterly to the three-month LIBOR rate plus 3.60%. The interest rate as of September 30, 2010 was 3.89%. The $25.8 million notes adjust quarterly to the three-month LIBOR rate
plus 3.55%. The interest rate as of September 30, 2010 was 3.84%. The $20.2 million notes payable bear an interest rate of the three-month LIBOR rate plus 3.95%. The interest rate as of September 30, 2010 was 4.24%.

Credit risk.An additional exposure to our fixed-income securities portfolio is credit risk. We attempt to manage our
credit risk by investing only in investment-grade securities and limiting our exposure to a single issuer. At September 30, 2010, our fixed-income investments were invested in the following: U.S. Treasury and government agencies securities
12.8%, corporate debt securities 59.3%, residential mortgage-backed securities 1.6%, states and political subdivisions securities 14.2% and FDIC-insured certificates of deposit 12.1%.

We invest our insurance portfolio funds in highly-rated, fixed-income securities. Information about our investment portfolio is as
follows ($ in thousands):



|                          |  |                   |         |   |                  |   |         |  
|------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                          |  | September 30,2010 |         |   | December 31,2009 |  
|Total invested assets     |  | $                 | 231,434 |   |                  | $ | 251,072 |  
|Tax-equivalent book yield |  |                   | 2.70    | % |                  |   | 4.00    | %
|Average duration in years |  |                   | 2.00    |   |                  |   | 1.50    |  
|Average S&P rating        |  |                   | A+      |   |                  |   | AA-     |  

We are subject to
credit risks with respect to our reinsurers. Although a reinsurer is liable for losses to the extent of the coverage which it assumes, our reinsurance contracts do not discharge our insurance companies from primary liability to each policyholder for
the full amount of the applicable policy, and consequently our insurance companies remain obligated to pay claims in accordance with the terms of the policies regardless of whether a reinsurer fulfills or defaults on its obligations under the
related reinsurance agreement. In order to mitigate credit risk to reinsurance companies, we attempt to select financially strong reinsurers with an A.M. Best rating of A- or better and continue to evaluate their financial condition.

The table below presents the total amount of receivables due from reinsurance as of September 30, 2010 and
December 31, 2009, respectively (in thousands):



|                                                         |  |                   |        |  |                  |   |        | 
|-------------------------------------------------------- |  | ----------------- | ------ |  | ---------------- | - | ------ | 
|                                                         |  | September 30,2010 |        |  | December 31,2009 |  
|Michigan Catastrophic Claims Association                 |  | $                 | 67,535 |  |                  | $ | 18,452 | 
|Vesta Insurance Group                                    |  |                   | 13,054 |  |                  |   | 14,691 | 
|Quota-share reinsurer for Louisiana and Alabama business |  |                   | 692    |  |                  |   | 3,955  | 
|Other                                                    |  |                   | 5,562  |  |                  |   | 4,984  | 
|                                                         |  |                   |        |  |                  |   |        | 
|Total reinsurance receivable                             |  | $                 | 86,843 |  |                  | $ | 42,082 | 
|                                                         |  |                   |        |  |                  |   |        | 

Our receivables from the Michigan Catastrophic Claims Association increased significantly in the three
months ended September 30, 2010 as we reevaluated the reserves associated with these claims. The change to our net exposure to these claims was immaterial.

The Michigan Catastrophic Claims Association (MCCA) is the mandatory reinsurance facility that covers no-fault medical losses above a specific retention amount in Michigan. For policies effective
July 1, 2010 to June 30, 2011, the required retention is $0.5 million. As a writer of personal automobile policies in the state of Michigan, the Company cedes premiums and claims to the MCCA. Funding for MCCA comes from assessments
against automobile insurers based upon their proportionate market share of the states automobile liability insurance market. Insurers are allowed to pass along this cost to Michigan automobile policyholders.

Under the reinsurance agreement with Vesta Insurance Group (VIG), including primarily Vesta Fire Insurance Corporation (VFIC),
Affirmative Insurance Company (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
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 obligation under the Security Fund Agreement to provide security sufficient to satisfy VFICs gross obligations under the reinsurance agreement (the VFIC Trust). At September 30, 2010, the VFIC Trust held
$16.9 million (after cumulative withdrawals of $8.5 million through September 30, 2010), consisting of $12.0 million of a U.S. Treasury money market account and $4.9 million of corporate bonds rated BBB or higher, to collateralize the $13.0
million net recoverable from VFIC.

At September 30, 2010, $11.4 million was included in reserves for losses and loss
adjustment expenses that represented the amounts owed by AIC and Insura under reinsurance agreements with the VIG affiliated companies, including Hawaiian Insurance and



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Guaranty Company, Ltd (Hawaiian). Affirmative established a trust account to collateralize this payable, which currently holds $21.6 million in securities (the AIC Trust). The Special Deputy
Receiver (SDR) in Texas or the SDR in Hawaii drew down the AIC Trust $0.4 million through September 2010, and the Special Deputy Receiver in Hawaii had cumulative withdrawals from the AIC Trust of $1.7 million through September 2010.

As part of the terms of the acquisition of AIC and Insura, VIG has indemnified us for any losses due to uncollectible reinsurance related
to reinsurance agreements entered into with unaffiliated reinsurers prior to December 31, 2003. As of September 30, 2010, all such unaffiliated reinsurers had A.M. Best ratings of A or better.



|Item 4. | Controls and Procedures
|------- | -----------------------

The Companys management performed an evaluation under the supervision and with the participation of the Companys principal
executive officer and the principal financial officer, and completed an evaluation of the effectiveness of the design and operation of the Companys disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e)),
as adopted by the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934, as amended (the Exchange Act) as of September 30, 2010. Disclosure controls and procedures are the controls and other procedures that are
designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms. Disclosure
controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to
management, including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures.

Based on that evaluation, the Companys principal executive officer and principal financial officer concluded that the Companys disclosure controls and procedures were effective.

As previously reported in our Form 10-K for the year ended December 31, 2009, management concluded that our disclosure controls and
procedures were not effective because of a material weakness with respect to the preparation and review of the income tax provision.

Subsequently, during the first quarter of 2010, we implemented enhancements to our internal controls over financial reporting to ensure proper presentation and review of the income tax provision. We
believe the controls have been effective during the three and nine months ended September 30, 2010.

There were no other
changes in internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect our internal
control over financial reporting.

PART II  OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

See
Note 12 of Notes to Consolidated Financial Statements, Legal and Regulatory Proceedings.



|Item 1A. | Risk Factors
|-------- | ------------

There are
no material changes to those risk factors previously disclosed in Item 1A to Part I of our Form 10-K for the fiscal year ended December 31, 2009.



|Item 6. | Exhibits
|------- | --------

31.1    Certification of Gary Y. Kusumi, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002

31.2    Certification of Michael J. McClure, Chief Financial Officer, pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002

32.1    Certification of Gary Y. Kusumi, Chief
Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2    Certification of
Michael J. McClure, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002



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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



|                        |  |  |  |     |  |                                                     
|----------------------- |  |  |  | --- |  | ----------------------------------------------------
|                        |  |  |  |     |  | Affirmative Insurance Holdings, Inc.                
|Date: November 15, 2010 |  |  |  |     |  |                                                     
|                        |  |  |  |     |  | /s/ Michael J. McClure                              
|                        |  |  |  | By: |  | Michael J. McClure                                  
|                        |  |  |  |     |  | Executive Vice President and Chief Financial Officer
|                        |  |  |  |     |  | (and in his capacity as Principal Financial Officer)



32