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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, 2009

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

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 4, 2009: 15,415,358









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##### Table of Contents

AFFIRMATIVE INSURANCE HOLDINGS, INC.

NINE MONTHS ENDED SEPTEMBER 30, 2009

INDEX TO FORM 10-Q



|                                                                                                                  |  |   
|----------------------------------------------------------------------------------------------------------------- |  | --
|PART I  FINANCIAL INFORMATION                                                                                    |  | 3 
|                                                                                                                  | 
|Item 1. Financial Statements                                                                                      |  | 3 
|Consolidated Balance Sheets  September 30, 2009 and December 31, 2008                                            |  | 3 
|Consolidated Statements of Income (Loss)  Three and Nine Months Ended September 30, 2009 and
2008                |  | 4 
|Consolidated Statements of Stockholders Equity  Nine Months Ended September 
30, 2009 and 2008                  |  | 5 
|Consolidated Statements of Comprehensive Income (Loss)  Three and Nine Months Ended September 
30, 2009 and 2008 |  | 5 
|Consolidated Statements of Cash Flows  Nine Months Ended September 30, 2009 and
2008                             |  | 6 
|Notes to Consolidated Financial Statements                                                                        |  | 7 
|                                                                                                                  | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations                     |  | 21
|                                                                                                                  | 
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                                                |  | 32
|                                                                                                                  | 
|Item 4. Controls and Procedures                                                                                   |  | 34
|                                                                                                                  | 
|PART II  OTHER INFORMATION                                                                                       |  | 35
|                                                                                                                  | 
|Item 1. Legal Proceedings                                                                                         |  | 35
|                                                                                                                  | 
|Item 1A. Risk Factors                                                                                             |  | 35
|                                                                                                                  | 
|Item 6. Exhibits                                                                                                  |  | 35
|                                                                                                                  | 
|SIGNATURES                                                                                                        |  | 36



2



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##### Table of Contents

PART I  FINANCIAL INFORMATION



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

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)



|                                                                                                                                                                    |  |                   |         |   |                  |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                    |  | September 30,2009 |         |   | December 31,2008 |  
|                                                                                                                                                                    |  | (Unaudited)       |         |   |                  |  
|Assets                                                                                                                                                              |  |                   |         |   |                  |   |         |  
|Investment securities, at fair value                                                                                                                                |  |                   |         |   |                  |   |         |  
|Trading securities                                                                                                                                                  |  | $                 | 37,694  |   |                  | $ | 40,155  |  
|Available-for-sale securities                                                                                                                                       |  |                   | 229,447 |   |                  |   | 218,988 |  
|Cash and cash equivalents                                                                                                                                           |  |                   | 53,369  |   |                  |   | 66,513  |  
|Fiduciary and restricted cash                                                                                                                                       |  |                   | 14,022  |   |                  |   | 20,109  |  
|Accrued investment income                                                                                                                                           |  |                   | 3,473   |   |                  |   | 3,106   |  
|Premiums and fees receivable, net                                                                                                                                   |  |                   | 64,124  |   |                  |   | 57,805  |  
|Premium finance receivable, net                                                                                                                                     |  |                   | 47,153  |   |                  |   | 40,987  |  
|Commissions receivable                                                                                                                                              |  |                   | 2,063   |   |                  |   | 1,840   |  
|Receivable from reinsurers                                                                                                                                          |  |                   | 42,064  |   |                  |   | 63,331  |  
|Deferred acquisition costs                                                                                                                                          |  |                   | 24,425  |   |                  |   | 21,993  |  
|Deferred tax assets                                                                                                                                                 |  |                   | 21,173  |   |                  |   | 16,459  |  
|Federal income taxes receivable                                                                                                                                     |  |                   |        |   |                  |   | 1,316   |  
|Investment in real property, net                                                                                                                                    |  |                   | 5,761   |   |                  |   | 5,848   |  
|Property and equipment (net of accumulated depreciation of $31,963 and $25,550 for 2009 and 2008)                                                                   |  |                   | 41,189  |   |                  |   | 42,143  |  
|Goodwill                                                                                                                                                            |  |                   | 163,570 |   |                  |   | 163,650 |  
|Other intangible assets, net                                                                                                                                        |  |                   | 16,863  |   |                  |   | 17,255  |  
|Prepaid expenses                                                                                                                                                    |  |                   | 6,468   |   |                  |   | 8,967   |  
|Other assets (net of allowance for doubtful accounts of $7,213 for 2009 and 2008)                                                                                   |  |                   | 14,231  |   |                  |   | 11,586  |  
|                                                                                                                                                                    |  |                   |         |   |                  |   |         |  
|Total assets                                                                                                                                                        |  | $                 | 787,089 |   |                  | $ | 802,051 |  
|                                                                                                                                                                    |  |                   |         |   |                  |   |         |  
|                                                                                                                                                                    |  |                  
|Liabilities and Stockholders Equity                                                                                                                                |  |                   |         |   |                  |   |         |  
|Liabilities:                                                                                                                                                        |  |                   |         |   |                  |   |         |  
|Reserves for losses, loss adjustment expenses and deposits                                                                                                          |  | $                 | 197,253 |   |                  | $ | 204,637 |  
|Unearned premium                                                                                                                                                    |  |                   | 117,383 |   |                  |   | 109,097 |  
|Amounts due reinsurers                                                                                                                                              |  |                   | 3,207   |   |                  |   | 5,146   |  
|Deferred revenue                                                                                                                                                    |  |                   | 10,301  |   |                  |   | 5,943   |  
|Senior secured credit facility                                                                                                                                      |  |                   | 110,150 |   |                  |   | 136,677 |  
|Notes payable                                                                                                                                                       |  |                   | 76,895  |   |                  |   | 76,909  |  
|Federal income taxes payable                                                                                                                                        |  |                   | 1,237   |   |                  |   |        |  
|Other liabilities                                                                                                                                                   |  |                   | 49,830  |   |                  |   | 47,159  |  
|                                                                                                                                                                    |  |                   |         |   |                  |   |         |  
|Total liabilities                                                                                                                                                   |  |                   | 566,256 |   |                  |   | 585,568 |  
|                                                                                                                                                                    |  |                   |         |   |                  |   |         |  
|Stockholders equity:                                                                                                                                               |  |                   |         |   |                  |   |         |  
|Common stock, $0.01 par value; 75,000,000 shares authorized, 17,768,721 shares issued and 15,415,358 shares outstanding at
September 30, 2009 and December 31, 2008 |  |                   | 178     |   |                  |   | 178     |  
|Additional paid-in capital                                                                                                                                          |  |                   | 164,470 |   |                  |   | 163,707 |  
|Treasury stock, at cost (2,353,363 shares at September 30, 2009 and December 31, 2008)                                                                              |  |                   | (32,880 | ) |                  |   | (32,880 | )
|Accumulated other comprehensive income (loss)                                                                                                                       |  |                   | 3,343   |   |                  |   | (1,849  | )
|Retained earnings                                                                                                                                                   |  |                   | 85,722  |   |                  |   | 87,327  |  
|                                                                                                                                                                    |  |                   |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                                          |  |                   | 220,833 |   |                  |   | 216,483 |  
|                                                                                                                                                                    |  |                   |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                                                          |  | $                 | 787,089 |   |                  | $ | 802,051 |  
|                                                                                                                                                                    |  |                   |         |   |                  |   |         |  

See accompanying Notes to Consolidated Financial Statements



3



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##### Table of Contents

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, |  
|                                                                   |  | 2009                            |         |   | 2008                           |   |         | 2009 |  |   | 2008    |  
|                                                                   |  | (Unaudited)                     |        
|Revenues                                                           |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net premiums earned                                                |  | $                               | 88,561  |   |                                | $ | 87,511  |      |  | $ | 276,006 |   |  | $ | 275,902 |  
|Commission income and fees                                         |  |                                 | 20,024  |   |                                |   | 18,446  |      |  |   | 60,474  |   |  |   | 58,646  |  
|Net investment income                                              |  |                                 | 2,399   |   |                                |   | 2,952   |      |  |   | 7,284   |   |  |   | 10,982  |  
|Net realized gains (losses)                                        |  |                                 | 17      |   |                                |   | (52     | )    |  |   | 604     |   |  |   | 55      |  
|Other income                                                       |  |                                 | 512     |   |                                |   |        |      |  |   | 1,049   |   |  |   |        |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total revenues                                                     |  |                                 | 111,513 |   |                                |   | 108,857 |      |  |   | 345,417 |   |  |   | 345,585 |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|                                                                   |  |                                 |         |  
|Expenses                                                           |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Losses and loss adjustment expenses                                |  |                                 | 70,293  |   |                                |   | 70,576  |      |  |   | 221,860 |   |  |   | 212,154 |  
|Selling, general and administrative expenses                       |  |                                 | 38,092  |   |                                |   | 37,758  |      |  |   | 117,728 |   |  |   | 107,762 |  
|Depreciation and amortization                                      |  |                                 | 2,341   |   |                                |   | 2,836   |      |  |   | 7,131   |   |  |   | 7,556   |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total expenses                                                     |  |                                 | 110,726 |   |                                |   | 111,170 |      |  |   | 346,719 |   |  |   | 327,472 |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Operating income (loss)                                            |  |                                 | 787     |   |                                |   | (2,313  | )    |  |   | (1,302  | ) |  |   | 18,113  |  
|                                                                   |  |                                 |         |  
|Gain on extinguishment of debt                                     |  |                                 |        |   |                                |   |        |      |  |   | 19,434  |   |  |   |        |  
|Loss on interest rate swaps                                        |  |                                 | 926     |   |                                |   |        |      |  |   | 5,872   |   |  |   |        |  
|Interest expense                                                   |  |                                 | 6,425   |   |                                |   | 4,305   |      |  |   | 17,143  |   |  |   | 14,136  |  
|Other intangible assets impairment                                 |  |                                 |        |   |                                |   | 212     |      |  |   |        |   |  |   | 212     |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Income (loss) from continuing operations before income tax expense |  |                                 | (6,564  | ) |                                |   | (6,830  | )    |  |   | (4,883  | ) |  |   | 3,765   |  
|Income tax benefit                                                 |  |                                 | (3,172  | ) |                                |   | (3,380  | )    |  |   | (4,634  | ) |  |   | (681    | )
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Income (loss) from continuing operations                           |  |                                 | (3,392  | ) |                                |   | (3,450  | )    |  |   | (249    | ) |  |   | 4,446   |  
|Discontinued operations (Note 14)                                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Loss from operations (including loss on disposal of $961)          |  |                                 | (47     | ) |                                |   | (678    | )    |  |   | (1,835  | ) |  |   | (1,969  | )
|Other intangible assets impairment                                 |  |                                 |        |   |                                |   | (4,397  | )    |  |   |        |   |  |   | (4,397  | )
|Income tax benefit                                                 |  |                                 | (17     | ) |                                |   | (1,908  | )    |  |   | (479    | ) |  |   | (2,272  | )
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Loss from discontinued operations                                  |  |                                 | (30     | ) |                                |   | (3,167  | )    |  |   | (1,356  | ) |  |   | (4,094  | )
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net income (loss)                                                  |  | $                               | (3,422  | ) |                                | $ | (6,617  | )    |  | $ | (1,605  | ) |  | $ | 352     |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|                                                                   |  |                                 |         |  
|Basic income (loss) per common share:                              |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Continuing operations                                              |  | $                               | (0.22   | ) |                                | $ | (0.22   | )    |  | $ | (0.01   | ) |  | $ | 0.29    |  
|Discontinued operations                                            |  |                                 | (0.00   | ) |                                |   | (0.21   | )    |  |   | (0.09   | ) |  |   | (0.27   | )
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net income (loss)                                                  |  | $                               | (0.22   | ) |                                | $ | (0.43   | )    |  | $ | (0.10   | ) |  | $ | 0.02    |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|                                                                   |  |                                 |         |  
|Diluted income (loss) per common share:                            |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Continuing operations                                              |  | $                               | (0.22   | ) |                                | $ | (0.22   | )    |  | $ | (0.01   | ) |  | $ | 0.29    |  
|Discontinued operations                                            |  |                                 | (0.00   | ) |                                |   | (0.21   | )    |  |   | (0.09   | ) |  |   | (0.27   | )
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Net income (loss)                                                  |  | $                               | (0.22   | ) |                                | $ | (0.43   | )    |  | $ | (0.10   | ) |  | $ | 0.02    |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|                                                                   |  |                                 |         |  
|Weighted average common shares outstanding:                        |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Basic                                                              |  |                                 | 15,415  |   |                                |   | 15,415  |      |  |   | 15,415  |   |  |   | 15,415  |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Diluted                                                            |  |                                 | 15,415  |   |                                |   | 15,415  |      |  |   | 15,415  |   |  |   | 15,415  |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Dividends declared per common share                                |  | $                               |        |   |                                | $ | 0.02    |      |  | $ |        |   |  | $ | 0.06    |  
|                                                                   |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  

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, | 
|                                                                               |  | 2009                            |  |         | 2008    |  
|                                                                               |  | 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                                                   |  |                                 |  |         | 163,707 |   |        |            |         |   | 162,603 |  
|Stock-based compensation expense                                               |  |                                 |  |         | 763     |   |        |            |         |   | 789     |  
|                                                                               |  |                                 |  |         |         |   |        |            |         |   |         |  
|Balance at end of period                                                       |  |                                 |  |         | 164,470 |   |        |            |         |   | 163,392 |  
|                                                                               |  |                                 |  |         |         |   |        |            |         |   |         |  
|                                                                               |  |                                 |  |        
|Retained earnings                                                              |  |                                 |  |         |         |   |        |            |         |   |         |  
|Balance at beginning of year                                                   |  |                                 |  |         | 87,327  |   |        |            |         |   | 87,122  |  
|Net income (loss)                                                              |  |                                 |  |         | (1,605  | ) |        |            |         |   | 352     |  
|Dividends declared                                                             |  |                                 |  |         |        |   |        |            |         |   | (925    | )
|                                                                               |  |                                 |  |         |         |   |        |            |         |   |         |  
|Balance at end of period                                                       |  |                                 |  |         | 85,722  |   |        |            |         |   | 86,549  |  
|                                                                               |  |                                 |  |         |         |   |        |            |         |   |         |  
|                                                                               |  |                                 |  |        
|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                                       |  |                                 |  |         | (1,849  | ) |        |            |         |   | 22      |  
|Unrealized gain (loss) on available-for-sale investment securities, net of tax |  |                                 |  |         | 1,334   |   |        |            |         |   | (7,999  | )
|Unrealized gain on cash flow hedges, net of tax                                |  |                                 |  |         | 3,858   |   |        |            |         |   | 126     |  
|                                                                               |  |                                 |  |         |         |   |        |            |         |   |         |  
|Balance at end of period, net of tax                                           |  |                                 |  |         | 3,343   |   |        |            |         |   | (7,851  | )
|                                                                               |  |                                 |  |         |         |   |        |            |         |   |         |  
|                                                                               |  |                                 |  |        
|Total stockholders equity                                                     |  | 15,415,358                      |  | $       | 220,833 |   |        | 15,415,358 |         | $ | 209,388 |  
|                                                                               |  |                                 |  |         |         |   |        |            |         |   |         |  

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)



|                                                                               |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------ |  | ------------------------------- | ------ | - | ------------------------------ | - | ------- | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                               |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                               |  | 2009                            |        |   | 2008                           |   |         | 2009 |  |   | 2008   |  
|                                                                               |  | (Unaudited)                     |       
|Net income (loss)                                                              |  | $                               | (3,422 | ) |                                | $ | (6,617  | )    |  | $ | (1,605 | ) |  | $ | 352    |  
|Other comprehensive income (loss):                                             |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  
|Unrealized gain (loss) on available-for-sale investment securities, net of tax |  |                                 | 656    |   |                                |   | (5,625  | )    |  |   | 1,334  |   |  |   | (7,999 | )
|Unrealized gain (loss) on cash flow hedges, net of tax                         |  |                                 |       |   |                                |   | (329    | )    |  |   | 3,858  |   |  |   | 126    |  
|                                                                               |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  
|Other comprehensive income (loss), net                                         |  |                                 | 656    |   |                                |   | (5,954  | )    |  |   | 5,192  |   |  |   | (7,873 | )
|                                                                               |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  
|Total comprehensive income (loss)                                              |  | $                               | (2,766 | ) |                                | $ | (12,571 | )    |  | $ | 3,587  |   |  | $ | (7,521 | )
|                                                                               |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  

See accompanying Notes to Consolidated Financial Statements



5



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##### Table of Contents

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                            |  |                                |         |   |      |   |         |  
|------------------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                            |  | Nine Months EndedSeptember 30, |        
|                                                                                            |  | 2009                           |         |   | 2008 |  
|                                                                                            |  | (Unaudited)                    |        
|Cash flows from operating activities                                                        |  |                                |         |   |      |   |         |  
|Net income (loss)                                                                           |  | $                              | (1,605  | ) |      | $ | 352     |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                                |         |   |      |   |         |  
|Depreciation and amortization of intangible assets                                          |  |                                | 7,164   |   |      |   | 7,648   |  
|Stock-based compensation expense                                                            |  |                                | 848     |   |      |   | 789     |  
|Amortization of debt issuance and modification costs                                        |  |                                | 577     |   |      |   | 1,006   |  
|Amortization of debt discount                                                               |  |                                | 3,960   |   |      |   |        |  
|Realized gains from sales of available-for-sale securities                                  |  |                                | (230    | ) |      |   | (43     | )
|Realized gain on trading securities                                                         |  |                                | (44     | ) |      |   |        |  
|Other income                                                                                |  |                                | (1,049  | ) |      |   |        |  
|(Gain) loss on disposal of assets (including sale of business)                              |  |                                | 631     |   |      |   | (8      | )
|Amortization of premiums on investments, net                                                |  |                                | 2,501   |   |      |   | 1,894   |  
|Provision for doubtful premiums receivable                                                  |  |                                | 749     |   |      |   | 395     |  
|Other intangible assets impairment                                                          |  |                                |        |   |      |   | 4,609   |  
|Gain on extinguishment of debt                                                              |  |                                | (19,434 | ) |      |   |        |  
|Loss on interest rate swaps                                                                 |  |                                | 5,872   |   |      |   |        |  
|Change in operating assets and liabilities:                                                 |  |                                |         |   |      |   |         |  
|Fiduciary and restricted cash                                                               |  |                                | 6,087   |   |      |   | (5,923  | )
|Premiums, fees and commissions receivable                                                   |  |                                | (7,291  | ) |      |   | 6,932   |  
|Reserves for losses and loss adjustment expenses                                            |  |                                | (7,384  | ) |      |   | (13,510 | )
|Amounts due from reinsurers                                                                 |  |                                | 19,328  |   |      |   | 4,531   |  
|Premium finance receivable, net (related to our insurance premiums)                         |  |                                | (5,255  | ) |      |   | (1,583  | )
|Deferred revenue                                                                            |  |                                | 4,358   |   |      |   | (470    | )
|Unearned premium                                                                            |  |                                | 8,286   |   |      |   | (10,142 | )
|Deferred acquisition costs                                                                  |  |                                | (2,432  | ) |      |   | 1,796   |  
|Deferred tax assets                                                                         |  |                                | (7,510  | ) |      |   | (3,434  | )
|Federal income taxes receivable (payable)                                                   |  |                                | 2,553   |   |      |   | 3,563   |  
|Other                                                                                       |  |                                | (608    | ) |      |   | (2,343  | )
|                                                                                            |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) operating activities                                         |  |                                | 10,072  |   |      |   | (3,941  | )
|                                                                                            |  |                                |         |   |      |   |         |  
|                                                                                            |  |                               
|Cash flows from investing activities                                                        |  |                                |         |   |      |   |         |  
|Proceeds from sales of available-for-sale securities                                        |  |                                | 19,237  |   |      |   | 100,266 |  
|Proceeds from maturities of available-for-sale securities                                   |  |                                | 57,717  |   |      |   | 53,576  |  
|Proceeds from sales of trading securities                                                   |  |                                | 2,505   |   |      |   |        |  
|Purchases of available-for-sale securities                                                  |  |                                | (87,631 | ) |      |   | (64,743 | )
|Premium finance receivable, net (related to third-party insurance premiums)                 |  |                                | (911    | ) |      |   | (5,584  | )
|Purchases of property and equipment                                                         |  |                                | (6,070  | ) |      |   | (16,465 | )
|Proceeds from insurance recoveries                                                          |  |                                | 600     |   |      |   |        |  
|Net cash paid for acquisitions                                                              |  |                                | (60     | ) |      |   | (188    | )
|Proceeds from sale of business                                                              |  |                                | 250     |   |      |   |        |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Net cash provided by (used in) investing activities                                         |  |                                | (14,363 | ) |      |   | 66,862  |  
|                                                                                            |  |                                |         |   |      |   |         |  
|                                                                                            |  |                               
|Cash flows from financing activities                                                        |  |                                |         |   |      |   |         |  
|Principal payments on senior secured credit facility                                        |  |                                | (6,321  | ) |      |   | (59,941 | )
|Debt modification costs paid                                                                |  |                                | (2,532  | ) |      |   |        |  
|Dividends paid                                                                              |  |                                |        |   |      |   | (925    | )
|                                                                                            |  |                                |         |   |      |   |         |  
|Net cash used in financing activities                                                       |  |                                | (8,853  | ) |      |   | (60,866 | )
|                                                                                            |  |                                |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                        |  |                                | (13,144 | ) |      |   | 2,055   |  
|Cash and cash equivalents at beginning of year                                              |  |                                | 66,513  |   |      |   | 44,048  |  
|                                                                                            |  |                                |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                                  |  | $                              | 53,369  |   |      | $ | 46,103  |  
|                                                                                            |  |                                |         |   |      |   |         |  
|                                                                                            |  |                               
|Supplemental disclosure of cash flow information:                                           |  |                                |         |   |      |   |         |  
|Cash paid for interest                                                                      |  | $                              | 12,569  |   |      | $ | 13,825  |  
|Cash paid for income taxes                                                                  |  |                                | 774     |   |      |   | 368     |  

See accompanying Notes to Consolidated Financial Statements



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##### Table of Contents

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)





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

Affirmative
Insurance Holdings, Inc. (Affirmative or the Company) , formerly known as Instant Insurance Holdings, Inc., was incorporated in Delaware in June 1998 and completed an initial public offering of its common stock in July 2004.
In this report, the terms we, us, management, or our, refer to Affirmative Insurance Holdings, Inc. and all entities included in our consolidated financial statements. We are a distributor and producer
of non-standard personal automobile insurance policies and related products and services 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. 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 independent agents or brokers in 11 states (Louisiana, Texas, Illinois, Alabama, California, Michigan, Florida, 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, 2008 included in our
Annual Report on Form 10-K.

The consolidated balance sheet at December 31, 2008 was derived from the audited financial
statements at that date but does not include all of the information and notes required by GAAP.

Certain prior year amounts
have been reclassified to conform to the current presentation and for discontinued operations.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires us 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

Effective July 1, 2009, The Financial Accounting Standards Board (FASB) issued the Accounting Standards Codification (ASC or
Codification), which superseded all existing non-SEC accounting and reporting standards under U.S. GAAP and became the single official source for U.S. authoritative GAAP combined with guidance issued by the U.S. Securities and Exchange Commission
(SEC), and is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The FASB no longer issues new standards in the form of Statements of Financial Accounting Standards (SFAS), FASB Staff
Positions, or Emerging Issues Task Force Abstracts. Instead, amendments to the Codification are made by issuing Accounting Standards Updates. The Codification did not change existing GAAP. Accordingly, the issuance of the
codification did not impact the Companys consolidated results of operations or financial condition.

Two FASB standards
issued in June 2009, SFAS No. 166, Accounting for Transfers of Financial Assets  An Amendment of FASB Statement No. 140(SFAS 166);and SFAS No. 167, Amendments to FASB Interpretation No. 46(R)(SFAS
167) have not been added to the Codification as of September 30, 2009, and are not effective as of that date without the ability to early adopt.

SFAS 167 eliminates Interpretation 46(R)s exceptions to consolidating qualifying special-purpose entities, contains new criteria for determining the
primary beneficiary, and increases the frequency of required reassessments to determine whether a company is the primary beneficiary of a variable interest entity. SFAS 167 also contains a new requirement that any term, transaction, or arrangement
that does not have a substantive effect on an entitys status as a variable interest entity, a companys power over a variable interest entity, or a companys obligation to absorb losses or its right to receive benefits of an entity
must be disregarded in applying Interpretation 46(R)s provisions. The elimination of the qualifying special-purpose entity concept and its consolidation exceptions means more entities will be subject to consolidation assessments and
reassessments. SFAS 167 will be effective for the fiscal year beginning January 1, 2010. The Company is currently assessing the potential impacts, if any, on the consolidated results of operations and financial condition.



7



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SFAS 166 eliminates 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. SFAS 166
will be effective for fiscal years beginning after November 15, 2009. The Company is currently assessing the potential impacts, if any, on the consolidated results of operations and financial condition.

In May 2009, the FASB issued authoritative guidance establishing general standards for the accounting and reporting of subsequent events
that occur between the balance sheet date and issuance of financial statements. It should not result in significant changes in the subsequent events that an entity reports, either through recognition or disclosure in its financial
statements. This guidance requires companies to recognize the effects, if material, of subsequent events in the financial statements if the subsequent event provides additional evidence about conditions that existed as of the balance sheet
date. Beginning in financial reporting periods ending after June 15, 2009, companies must also disclose the date through which subsequent events have been evaluated and the nature of any nonrecognized subsequent events. Nonrecognized
subsequent events include events that provide evidence about conditions that did not exist as of the balance sheet date, but which are of such a nature that they must be disclosed to keep the financial statements from being misleading. This
disclosure should alert all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented. The Company adopted this standard in the second quarter of 2009 and it
had no material impact on the consolidated results of operations or financial condition. Management evaluated subsequent events for recognition or disclosure through November 9, 2009.

On January 1, 2009, the Company adopted authoritative guidance issued by the FASB that amended and expanded the disclosure requirements
to provide users of financial statements with enhanced disclosures about an entitys derivative and hedging activities thereby improving the transparency of financial reporting. This standard requires qualitative disclosure about objectives and
strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit risk related contingent features in derivative agreements. The adoption of this
standard did not have a material impact on the Companys consolidated results of operations or financial condition.

In
April 2009, the FASB issued authoritative guidance that requires fair value disclosures in both interim as well as annual financial statements in order to provide more timely information about the effects of current market conditions on financial
instruments. The Company adopted this guidance in the second quarter of 2009, the impact of which related only to disclosures of the Companys debt and did not have a material impact on the Companys consolidated financial statements.

In the second quarter of 2009, the Company adopted authoritative guidance issued by the FASB that amended the
other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments in the financial statements. This guidance did not amend
existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. Adoption of this guidance did not have a material impact on the Companys consolidated results of operations or financial
condition.

In the second quarter of 2009, the Company adopted authoritative guidance issued by the FASB on estimating fair
value when the volume and level of activity for the asset or liability have significantly decreased and identifying circumstances that may indicate that a transaction is not orderly. Adoption of this guidance did not have a material impact on the
Companys consolidated results of operations or financial condition.

On January 1, 2009, the Company adopted
authoritative guidance issued by the FASB on fair value measurement for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).
Adoption of the new guidance did not have a material impact on the Companys consolidated results of operations or financial condition.

In August, the FASB issued authoritative guidance on measuring the fair value of liabilities and clarifies that the quoted price for an identical liability, when traded as an asset in an active market, is
also a Level 1 measurement, the highest priority in the fair value hierarchy, when no adjustment to the quoted price is required. This guidance is effective for interim and annual periods beginning after August 27, 2009. The Company does not
anticipate any revisions in valuation techniques to be considered necessary as a result of adopting this guidance in the fourth quarter of 2009.



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|3. | Goodwill and Other Intangible Assets
|-- | ------------------------------------

The Company completed its annual goodwill and indefinite lived intangible asset impairment analyses as of September 30, 2009. 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, 2009. As of September 30, 2008, the Company concluded that the carrying value of other intangible assets related to the Companys Florida operations exceeded their fair value, resulting in an
impairment loss of $4.4 million for indefinite lived other intangible assets and $0.2 million for amortizing other intangible assets.



|4. | Trading Investment Securities
|-- | -----------------------------

The amortized cost, realized losses and estimated fair value of our trading securities were as follows (in thousands):



|                   |  |               |        |                      |   |         |           |  |   |       
|------------------ |  | ------------- | ------ | -------------------- | - | ------- | --------- |  | - | ------
|                   |  | AmortizedCost |        | Total RealizedLosses |   |         | FairValue
|September 30, 2009 |  | $             | 48,790 |                      | $ | (11,096 | )         |  | $ | 37,694
|December 31, 2008  |  |               | 51,295 |                      |   | (11,140 | )         |  |   | 40,155

Our trading investment securities consist solely 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 early 2008 and investment banks stopped committing capital to the auctions. 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 August 2008, our broker announced settlements in principle with each of the Division
of Enforcement of the U.S. Securities and Exchange Commission (SEC), the New York Attorney General and other state agencies to purchase all of its clients auction-rate securities at par and several other items, including fines. 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 in our brokers accounts (the settlement). The time frames that our broker has set 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. For the majority of our auction-rate holdings, the buybacks are expected to occur
between July 2010 and two years thereafter. In November 2008, the Company elected to participate in our brokers offer to purchase our auction-rate securities at par. In November 2008, we classified our portfolio of auction-rate securities as
trading. At September 30, 2009 and December 31, 2008, the fair value of the settlement was $10.7 million and $9.6 million, respectively, which is recorded in other assets with changes in fair value recorded in other income.



|5. | Available-for-Sale Investment Securities
|-- | ----------------------------------------

Our available-for-sale investment portfolio consists of fixed-income securities carried at fair value with unrealized gains and losses reported in our financial statements as a separate component of
stockholders equity on an after-tax basis. 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.



9



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##### Table of Contents

The amortized cost, gross unrealized gains (losses), and estimated fair value of our
investments at September 30, 2009, and December 31, 2008, are as follows (in thousands):



|                                       |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|-------------------------------------- |  | ------------- | ------- | -------------------- | - | --------------------- |  | - | ---------- | - |  | - | -------
|                                       |  | AmortizedCost |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | Fair Value
|September 30, 2009                     |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|U.S. Treasury and government agencies  |  | $             | 14,531  |                      | $ | 308                   |  | $ |           |   |  | $ | 14,839 
|Residential mortgage-backed securities |  |               | 4,601   |                      |   | 380                   |  |   |           |   |  |   | 4,981  
|States and political subdivisions      |  |               | 141,258 |                      |   | 3,148                 |  |   | (38        | ) |  |   | 144,368
|Corporate debt securities              |  |               | 63,913  |                      |   | 1,381                 |  |   | (35        | ) |  |   | 65,259 
|                                       |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|Total                                  |  | $             | 224,303 |                      | $ | 5,217                 |  | $ | (73        | ) |  | $ | 229,447
|                                       |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|December 31, 2008                      |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|U.S. Treasury and government agencies  |  | $             | 28,482  |                      | $ | 416                   |  | $ | (107       | ) |  | $ | 28,791 
|Residential mortgage-backed securities |  |               | 5,829   |                      |   | 337                   |  |   |           |   |  |   | 6,166  
|States and political subdivisions      |  |               | 180,601 |                      |   | 2,712                 |  |   | (237       | ) |  |   | 183,076
|Corporate debt securities              |  |               | 986     |                      |   |                      |  |   | (31        | ) |  |   | 955    
|                                       |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|Total                                  |  | $             | 215,898 |                      | $ | 3,465                 |  | $ | (375       | ) |  | $ | 218,988
|                                       |  |               |         |                      |   |                       |  |   |            |   |  |   |        

Expected maturities may differ from contractual maturities because certain borrowers
may have the right to call or prepay obligations with or without penalties. Our amortized cost and estimated fair value of fixed-income securities at September 30, 2009 by contractual maturity are as follows (in thousands):



|                                       |  |               |         |            |   |        
|-------------------------------------- |  | ------------- | ------- | ---------- | - | -------
|                                       |  | AmortizedCost |         | Fair Value
|Due in one year or less                |  | $             | 83,842  |            | $ | 84,700 
|Due after one year through five years  |  |               | 126,475 |            |   | 130,170
|Due after five years through ten years |  |               | 6,515   |            |   | 6,734  
|Due after ten years                    |  |               | 2,870   |            |   | 2,862  
|Mortgage-backed securities             |  |               | 4,601   |            |   | 4,981  
|                                       |  |               |         |            |   |        
|Total                                  |  | $             | 224,303 |            | $ | 229,447
|                                       |  |               |         |            |   |        

At September 30, 2009, we owned approximately $25.7 million of pre-refunded
municipal bonds. These pre-refunded municipal bonds have contractual maturities in excess of ten years. However, due to pre-refunding, these securities will be called by the issuer generally within three years or less. Pre-refunded
municipal bonds are created when municipalities issue new debt to refinance debt issued when interest rates were higher. Once the refinancing is completed, the issuer uses the proceeds to purchase U.S. Treasury securities and places these securities
in an escrow account. These proceeds are then used to pay interest and principal on the original debt until the bond is called.

Our amortized cost and estimated fair value of pre-refunded municipal bonds at September 30, 2009 by contractual maturity are as follows (in thousands):



|                                       |  |               |        |            |   |       
|-------------------------------------- |  | ------------- | ------ | ---------- | - | ------
|                                       |  | AmortizedCost |        | Fair Value
|Due in one year or less                |  | $             | 10,007 |            | $ | 10,191
|Due after one year through five years  |  |               | 10,197 |            |   | 10,477
|Due after five years through ten years |  |               | 2,073  |            |   | 2,207 
|Due after ten years                    |  |               | 2,870  |            |   | 2,862 
|                                       |  |               |        |            |   |       
|Total                                  |  | $             | 25,147 |            | $ | 25,737
|                                       |  |               |        |            |   |       

Proceeds from sales, maturities, and principal receipts of available-for-sale
investment securities were $77.0 million, of which proceeds from investments sold prior to maturity were $19.3 million, and proceeds from investment maturities were $57.7 million for the nine months ended September 30, 2009.



10



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##### Table of Contents

Gross realized gains and losses on investments for the nine months ended September 30,
2009, are summarized as follows (in thousands):



|             |  |   |     |  
|------------ |  | - | --- | -
|Gross gains  |  | $ | 251 |  
|Gross losses |  |   | (21 | )
|             |  |   |     |  
|Total        |  | $ | 230 |  
|             |  |   |     |  

The following tables show our investments with fair value and gross unrealized
losses, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2009 and December 31, 2008 (in thousands):



|                                  |  |                        |        |                       |                         |     |           |       |                       |       |  |           |     |                       |  |   |        |  |   |     |  
|--------------------------------- |  | ---------------------- | ------ | --------------------- | ----------------------- | --- | --------- | ----- | --------------------- | ----- |  | --------- | --- | --------------------- |  | - | ------ |  | - | --- | -
|                                  |  | September 30, 2009     |       
|                                  |  | Less Than TwelveMonths |        |                       | Twelve Monthsor Greater |     |           | Total |                      
|                                  |  | FairValue              |        | GrossUnrealizedLosses |                         |     | FairValue |       | GrossUnrealizedLosses |       |  | FairValue |     | GrossUnrealizedLosses | 
|States and political subdivisions |  | $                      | 3,950  |                       | $                       | (6  | )         |       | $                     | 1,047 |  | $         | (32 | )                     |  | $ | 4,997  |  | $ | (38 | )
|Corporate debt securities         |  |                        | 7,536  |                       |                         | (35 | )         |       |                       |      |  |           |    |                       |  |   | 7,536  |  |   | (35 | )
|                                  |  |                        |        |                       |                         |     |           |       |                       |       |  |           |     |                       |  |   |        |  |   |     |  
|Total                             |  | $                      | 11,486 |                       | $                       | (41 | )         |       | $                     | 1,047 |  | $         | (32 | )                     |  | $ | 12,533 |  | $ | (73 | )
|                                  |  |                        |        |                       |                         |     |           |       |                       |       |  |           |     |                       |  |   |        |  |   |     |  



|                                      |  |                        |        |                       |                         |      |           |       |                       |     |  |           |     |                       |  |   |        |  |   |      |  
|------------------------------------- |  | ---------------------- | ------ | --------------------- | ----------------------- | ---- | --------- | ----- | --------------------- | --- |  | --------- | --- | --------------------- |  | - | ------ |  | - | ---- | -
|                                      |  | December 31, 2008      |       
|                                      |  | Less Than TwelveMonths |        |                       | Twelve Monthsor Greater |      |           | Total |                      
|                                      |  | FairValue              |        | GrossUnrealizedLosses |                         |      | FairValue |       | GrossUnrealizedLosses |     |  | FairValue |     | GrossUnrealizedLosses | 
|U.S. Treasury and government agencies |  | $                      | 6,861  |                       | $                       | (107 | )         |       | $                     |    |  | $         |    |                       |  | $ | 6,861  |  | $ | (107 | )
|States and political subdivisions     |  |                        | 22,241 |                       |                         | (214 | )         |       |                       | 940 |  |           | (23 | )                     |  |   | 23,181 |  |   | (237 | )
|Corporate debt securities             |  |                        | 954    |                       |                         | (31  | )         |       |                       |    |  |           |    |                       |  |   | 954    |  |   | (31  | )
|                                      |  |                        |        |                       |                         |      |           |       |                       |     |  |           |     |                       |  |   |        |  |   |      |  
|Total                                 |  | $                      | 30,056 |                       | $                       | (352 | )         |       | $                     | 940 |  | $         | (23 | )                     |  | $ | 30,996 |  | $ | (375 | )
|                                      |  |                        |        |                       |                         |      |           |       |                       |     |  |           |     |                       |  |   |        |  |   |      |  

At September 30, 2009, our portfolio contained approximately 21 individual
investment securities that are in an unrealized loss position.

The unrealized losses at September 30, 2009 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, 2009, management performed its quarterly analysis of all
securities with an unrealized loss and concluded no individual securities were other-than-temporarily impaired.



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##### Table of Contents

|6. | Reinsurance
|-- | -----------

In the
ordinary course of business, we place reinsurance with other insurance companies in order to provide greater diversification of our business and limit the potential for losses arising from large risks. In addition, we assume reinsurance from other
insurance companies.

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



|                    |  |                                  |        |   |               |   |        |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |        |  
|------------------- |  | -------------------------------- | ------ | - | ------------- | - | ------ | ------------------------------ |  | - | -------------- | - |  | ------------- | ------- | - | ------------------------------ | - | ------- | - |  | - | ------ | -
|                    |  | Three Months Ended September 30, |       
|                    |  | 2009                             |        |   | 2008          |  
|                    |  | WrittenPremium                   |        |   | EarnedPremium |   |        | Loss andLossAdjustmentExpenses |  |   | WrittenPremium |   |  | EarnedPremium |         |   | Loss andLossAdjustmentExpenses |  
|Direct              |  | $                                | 71,636 |   |               | $ | 71,930 |                                |  | $ | 57,944         |   |  | $             | 75,581  |   |                                | $ | 84,185  |   |  | $ | 63,746 |  
|Reinsurance assumed |  |                                  | 19,789 |   |               |   | 17,311 |                                |  |   | 13,344         |   |  |               | 13,834  |   |                                |   | 14,335  |   |  |   | 11,655 |  
|Reinsurance ceded   |  |                                  | (862   | ) |               |   | (680   | )                              |  |   | (995           | ) |  |               | (10,689 | ) |                                |   | (11,009 | ) |  |   | (4,825 | )
|                    |  |                                  |        |   |               |   |        |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |        |  
|Total               |  | $                                | 90,563 |   |               | $ | 88,561 |                                |  | $ | 70,293         |   |  | $             | 78,726  |   |                                | $ | 87,511  |   |  | $ | 70,576 |  
|                    |  |                                  |        |   |               |   |        |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |        |  



|                    |  |                                 |         |               |      |         |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |         |  
|------------------- |  | ------------------------------- | ------- | ------------- | ---- | ------- | ------------------------------ |  | - | -------------- | - |  | ------------- | ------- | - | ------------------------------ | - | ------- | - |  | - | ------- | -
|                    |  | Nine Months Ended September 30, |        
|                    |  | 2009                            |         |               | 2008 |        
|                    |  | WrittenPremium                  |         | EarnedPremium |      |         | Loss andLossAdjustmentExpenses |  |   | WrittenPremium |   |  | EarnedPremium |         |   | Loss andLossAdjustmentExpenses |  
|Direct              |  | $                               | 224,367 |               | $    | 226,913 |                                |  | $ | 186,732        |   |  | $             | 254,380 |   |                                | $ | 265,677 |   |  | $ | 199,913 |  
|Reinsurance assumed |  |                                 | 61,526  |               |      | 51,084  |                                |  |   | 38,441         |   |  |               | 45,424  |   |                                |   | 44,391  |   |  |   | 36,478  |  
|Reinsurance ceded   |  |                                 | 8,331   |               |      | (1,991  | )                              |  |   | (3,313         | ) |  |               | (34,604 | ) |                                |   | (34,166 | ) |  |   | (24,237 | )
|                    |  |                                 |         |               |      |         |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |         |  
|Total               |  | $                               | 294,224 |               | $    | 276,006 |                                |  | $ | 221,860        |   |  | $             | 265,200 |   |                                | $ | 275,902 |   |  | $ | 212,154 |  
|                    |  |                                 |         |               |      |         |                                |  |   |                |   |  |               |         |   |                                |   |         |   |  |   |         |  

Under certain of our reinsurance transactions, we receive 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. Effective
January 1, 2009, we terminated our 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. In 2008, ceding commissions recognized as a
reduction of selling, general and administrative expense were $2.5 million and $8.1 million for the three months and nine months ended September 30, 2008, respectively.

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



|                                            |  |                   |        |                  |   |       
|------------------------------------------- |  | ----------------- | ------ | ---------------- | - | ------
|                                            |  | September 30,2009 |        | December 31,2008
|Losses and loss adjustment expense reserves |  | $                 | 32,444 |                  | $ | 40,667
|Unearned premium reserve                    |  |                   | 715    |                  |   | 11,037
|                                            |  |                   |        |                  |   |       
|Total                                       |  | $                 | 33,159 |                  | $ | 51,704
|                                            |  |                   |        |                  |   |       

Under the reinsurance agreement with Vesta Insurance Group (VIG), including primarily
Vesta Fire Insurance Corporation (VFIC), our 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, 2009, the VFIC Trust held $17.4 million (after cumulative withdrawals of $7.6 million through September 30, 2009), consisting of $12.6 million of a U.S. Treasury money market account and $4.8 million of
corporate bonds rated BBB or higher, to collateralize the $14.3 million gross recoverable from VFIC.

At September 30,
2009, net amounts owed by AIC and Insura under reinsurance agreements with the VIG-affiliated companies, including Hawaiian Insurance and Guaranty Company, Ltd (Hawaiian) were $13.2 million. Affirmative established a trust account to collateralize
this payable, which currently holds $22.4 million (including accrued interest) in securities (the AIC Trust). The Special Deputy Receiver in Texas had cumulative withdrawals from the AIC Trust of $0.4 million through September 2009.



12



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##### Table of Contents

The Michigan Catastrophic Claims Association (MCCA) is a reinsurance facility that covers
no-fault medical losses above a specific retention amount. For policies effective from July 1, 2009 to June 30, 2010, the required retention is $0.5 million. As a writer of personal automobile policies in the state of Michigan, we
cede 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. Our ceded premiums written to the MCCA were $0.7 million and $0.4 million for the three months ended September 30, 2009 and 2008, respectively, and $1.5 million for the nine months ended
September 30, 2009 and 2008.

We have an assumed reinsurance agreement with a Texas county mutual insurance company (the
county mutual), whereby we assume 100% of the policies issued by the county mutual for business produced by our owned 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 upon prior written notice of not less than 90 days. In the event of such termination, the MGA agrees to produce automobile insurance business in the State of Texas solely for
the benefit of the county mutual for a period of ten years. The county mutual reinsurance agreement automatically terminates on January 1, 2014. Assumed written premiums from the county mutual were $19.8 million and $13.8 million for the three
months ended September 30, 2009 and 2008, and $61.5 million and $45.4 million for the nine months ended September 30, 2009 and 2008, respectively.



|7. | Premium Finance Receivables, Net
|-- | --------------------------------

Finance receivables (issued for policies by both the Company and third-party insurance carriers) are secured by unearned premiums from the underlying insurance policies and consisted of the following at September 30, 2009 and
December 31, 2008 (in thousands):



|                            |  |                   |        |   |                  |   |        |  
|--------------------------- |  | ----------------- | ------ | - | ---------------- | - | ------ | -
|                            |  | September 30,2009 |        |   | December 31,2008 |  
|Premium finance contracts   |  | $                 | 50,276 |   |                  | $ | 43,657 |  
|Unearned finance charges    |  |                   | (2,643 | ) |                  |   | (2,265 | )
|Allowance for credit losses |  |                   | (480   | ) |                  |   | (405   | )
|                            |  |                   |        |   |                  |   |        |  
|Total                       |  | $                 | 47,153 |   |                  | $ | 40,987 |  
|                            |  |                   |        |   |                  |   |        |  



|8. | Deferred Policy Acquisition Costs
|-- | ---------------------------------

Policy acquisition costs, consisting of primarily commission, 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 policy acquisition expenses amortized to expense were as follows (in thousands):



|                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|----------------- |  | ------------------------------- | ------- | - | ------------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                  |  | Three Months EndedSeptember 30, |         |   | Nine Months EndedSeptember 30, |  
|                  |  | 2009                            |         |   | 2008                           |   |         | 2009 |  |   | 2008    |  
|Beginning balance |  | $                               | 24,732  |   |                                | $ | 24,691  |      |  | $ | 21,993  |   |  | $ | 24,536  |  
|Additions         |  |                                 | 18,740  |   |                                |   | 18,153  |      |  |   | 59,517  |   |  |   | 54,595  |  
|Amortization      |  |                                 | (19,047 | ) |                                |   | (20,104 | )    |  |   | (57,085 | ) |  |   | (56,391 | )
|                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Ending balance    |  | $                               | 24,425  |   |                                | $ | 22,740  |      |  | $ | 24,425  |   |  | $ | 22,740  |  
|                  |  |                                 |         |   |                                |   |         |      |  |   |         |   |  |   |         |  



13



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##### Table of Contents

|9. | Senior Secured Credit Facility
|-- | ------------------------------

On March 27, 2009, we entered into an amendment to the senior secured credit facility. The amendment included the following changes:



| |  |  | The leverage ratio covenant calculation was changed to include only amounts borrowed under the facility. In addition, the quarterly requirements were
changed for the remaining term of the facility;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The interest coverage ratio covenant calculation was changed to include only interest expense paid in cash. In addition, the quarterly requirements
were changed for the remaining term of the facility;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The combined ratio covenant was replaced with a loss ratio covenant;
| | - |  | --------------------------------------------------------------------



| |  |  | The fixed charge coverage ratio was changed to include only interest expense paid in cash. In addition, the annual requirements were changed for the
remaining term of the facility;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The consolidated net worth covenant calculation was changed to a covenant that excludes goodwill and includes subordinated debt;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | Asset sales are now allowed for transactions with less than 80% of cash proceeds. Financing is limited to $5.0 million per transaction and $10.0
million in the aggregate;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A sale and leaseback transaction of capitalized technology assets is allowed for up to $30.0 million;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | The pricing under the agreement was changed as follows:
| | - |  | -------------------------------------------------------



| |  |  | A LIBOR floor of 3.0% was established; and
| | - |  | ------------------------------------------



| |  |  | Pricing depends on the amount of the 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%;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Common stock dividends are permitted only if the leverage ratio is less than or equal to 1.5;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | The annual excess cash flow payment was changed to 50 percent of non-regulated cash flow and 75 percent of dividends paid from regulated insurance
companies; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The revolving facility was reduced from $20.0 million to $10.0 million.
| | - |  | -----------------------------------------------------------------------

In accordance with ASC 470-50 Debt-Modifications and Extinguishments, the Company 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 will be 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, which is
included in a separate line item in the accompanying consolidated statement of income (loss) for the nine months ended September 30, 2009. 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. As of September 30, 2009, the principal balance of the senior secured credit facility was $130.4 million.



|10. | Income Taxes
|--- | ------------

The
provision for income taxes for the three and nine months ended September 30, 2009 and 2008 consisted of the following (in thousands):



|                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|-------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                 |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                 |  | 2009                            |        |   | 2008                           |   |        | 2009 |  |   | 2008   |  
|Current tax expense (benefit)    |  | $                               | 2,223  |   |                                | $ | (400   | )    |  | $ | 3,312  |   |  | $ | 482    |  
|Deferred tax expense (benefit)   |  |                                 | (5,412 | ) |                                |   | (4,888 | )    |  |   | (8,425 | ) |  |   | (3,435 | )
|                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Net income tax expense (benefit) |  | $                               | (3,189 | ) |                                | $ | (5,288 | )    |  | $ | (5,113 | ) |  | $ | (2,953 | )
|                                 |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |        |  



14



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##### Table of Contents

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, |  
|                                                                             |  | 2009                            |        |   | 2008                           |   |         | 2009 |  |   | 2008   |  
|Income (loss) from continuing operations before income tax expense (benefit) |  | $                               | (6,564 | ) |                                | $ | (6,830  | )    |  | $ | (4,883 | ) |  | $ | 3,765  |  
|Loss from discontinued operations before income tax benefit                  |  |                                 | (47    | ) |                                |   | (5,075  | )    |  |   | (1,835 | ) |  |   | (6,366 | )
|                                                                             |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  
|Loss before income tax benefit                                               |  | $                               | (6,611 | ) |                                | $ | (11,905 | )    |  | $ | (6,718 | ) |  | $ | (2,601 | )
|                                                                             |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  
|Tax provision computed at the federal statutory income tax rate              |  |                                 | (2,314 | ) |                                |   | (4,166  | )    |  |   | (2,351 | ) |  |   | (910   | )
|Increases (reductions) in tax resulting from:                                |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  
|Tax-exempt interest                                                          |  |                                 | (345   | ) |                                |   | (597    | )    |  |   | (1,165 | ) |  |   | (2,138 | )
|State income taxes                                                           |  |                                 | (197   | ) |                                |   | (733    | )    |  |   | (85    | ) |  |   | (69    | )
|Capital loss valuation allowance                                             |  |                                 |       |   |                                |   |        |      |  |   | (1,008 | ) |  |   |       |  
|Other                                                                        |  |                                 | (333   | ) |                                |   | 208     |      |  |   | (504   | ) |  |   | 164    |  
|                                                                             |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  
|                                                                             |  | $                               | (3,189 | ) |                                | $ | (5,288  | )    |  | $ | (5,113 | ) |  | $ | (2,953 | )
|                                                                             |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  
|Effective tax rate                                                           |  |                                 | 48.2   | % |                                |   | 44.4    | %    |  |   | 76.1   | % |  |   | 113.5  | %
|                                                                             |  |                                 |        |   |                                |   |         |      |  |   |        |   |  |   |        |  

The capital loss valuation allowance was reversed in the second quarter of 2009 due
to managements assessment that it is more likely than not that the capital loss carryforwards will be utilized.



|11. | Legal and Regulatory Proceedings
|--- | --------------------------------

We and our subsidiaries are named from time to time as parties in various legal actions arising in the ordinary course of our business and arising out of or related to claims made in connection with our insurance policies and claims
handling. We believe 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. The Company believes that this claim lacks merit and intends to defend itself vigorously.

In November 2008, James Lambie filed an arbitration demand with the American Arbitration Association against Affirmative Insurance Holdings,
Inc. seeking payment of up to $1.2 million pursuant to an Earn-Out Contingency Agreement entered into with Lambie in conjunction with the Companys purchase of Drivers Choice Insurance Services, LLC from Lambie and others. An arbitration
hearing was held on August 20-21, 2009. On October 22, 2009, the arbitrator entered a final, binding award in favor of the Company.

In December 2003, InsureOne Independent Agency, LLC (InsureOne), American Agencies General Agency, Inc. and Affirmative Insurance Holdings, Inc. brought action in the Circuit Court of Cook County,
Illinois to enforce non-compete and non-solicitation agreements entered into with James Hallberg, the former president of InsureOne, a wholly-owned subsidiary, and eight former employees of InsureOne and two of Hallbergs family trusts. On
November 21, 2008, the Court entered a Memorandum Order and Judgment, which was amended on January 20, 2009, entering judgment in favor of InsureOne Independent Agency, LLC, American Agencies General Agency, Inc. and Affirmative Insurance
Holdings, Inc., awarding us $7.7 million, plus reasonable attorneys fees and costs. The Court also entered judgment in favor of James Hallberg on a counterclaim, awarding him $130,168, plus attorneys fees and costs, for which we
established a liability. The parties each filed post-judgment motions, which the Court denied on September 3, 2009. This matter is now on appeal.

From time to time, we and our subsidiaries are subject to random compliance audits from federal and state authorities regarding various operations within our business that involve collecting and remitting
taxes in one form or another. In 2006, two of our 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 we should have collected and remitted approximately $2.9 million in sales tax derived from claims services performed by our underwriting agencies for policies sold by
these underwriting agencies and issued by an affiliated county mutual insurance company through a fronting arrangement. Our insurance companies reinsured 100% of these policies. The assessment included an additional $0.4 million for accrued interest
and penalty for a total assessment of $3.3 million. We believe that these services are not



15



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##### Table of Contents

subject to sales tax and are vigorously contesting the assertions made by the state and exercising all available rights and remedies available to us. In October 2006, we 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 our petition, disputing the validity of positions set forth in our
October 2006 petitions. We are now pursuing discovery from the Comptrollers office and intend 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, 2009.



|12. | Net Income (Loss) Per Common Share
|--- | ----------------------------------

Net income (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 1,601,339 for the three and nine months ended September 30, 2009, and 1,727,531 for the three and nine months ended September 30, 2008, 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 our common stock and thus the inclusion would have been antidilutive.

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, 2009 and 2008 (in thousands, except per share amounts):



|                                                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       
|------------------------------------------------------------------ |  | ------------------------------- | ------ | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------
|                                                                   |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30,
|                                                                   |  | 2009                            |        |   | 2008                           |   |        | 2009 |  |   | 2008  
|Numerator:                                                         |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       
|Income (loss) from continuing operations                           |  | $                               | (3,392 | ) |                                | $ | (3,450 | )    |  | $ | (249   | ) |  | $ | 4,446 
|                                                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       
|Denominator:                                                       |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       
|Weighted average basic shares                                      |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       
|Weighted average common shares outstanding                         |  |                                 | 15,415 |   |                                |   | 15,415 |      |  |   | 15,415 |   |  |   | 15,415
|                                                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       
|Weighted average diluted shares                                    |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       
|Weighted average common shares outstanding                         |  |                                 | 15,415 |   |                                |   | 15,415 |      |  |   | 15,415 |   |  |   | 15,415
|Effect of dilutive stock options                                   |  |                                 |       |   |                                |   |       |      |  |   |       |   |  |   |      
|                                                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       
|Total weighted average diluted shares                              |  |                                 | 15,415 |   |                                |   | 15,415 |      |  |   | 15,415 |   |  |   | 15,415
|                                                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       
|Basic income (loss) per common share from continuing operations:   |  | $                               | (0.22  | ) |                                | $ | (0.22  | )    |  | $ | (0.01  | ) |  | $ | 0.29  
|                                                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       
|Diluted income (loss) per common share from continuing operations: |  | $                               | (0.22  | ) |                                | $ | (0.22  | )    |  | $ | (0.01  | ) |  | $ | 0.29  
|                                                                   |  |                                 |        |   |                                |   |        |      |  |   |        |   |  |   |       



|13. | 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 on going evaluation of methodologies used by independent third-parties and monthly analytical reviews of the prices against current pricing trends and statistics.



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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 price 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.

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

The following table provides information as of
September 30, 2009 about the Companys financial assets and liabilities measured at fair value on a recurring basis:



|                                        |  |                   |         |                                       |   |                                           |  |                                        |         |  |   |       
|--------------------------------------- |  | ----------------- | ------- | ------------------------------------- | - | ----------------------------------------- |  | -------------------------------------- | ------- |  | - | ------
|                                        |  | September 30,2009 |         | QuotedPrices inActiveMarkets(Level 1) |   | SignificantOtherObservableInputs(Level 2) |  | SignificantUnobservableInputs(Level 3)
|Assets:                                 |  |                   |         |                                       |   |                                           |  |                                        |         |  |   |       
|U.S. Treasury and government agencies   |  | $                 | 14,839  |                                       | $ | 14,839                                    |  | $                                      |        |  | $ |      
|Residential mortgage-backed securities  |  |                   | 4,981   |                                       |   |                                          |  |                                        | 4,981   |  |   |      
|States and political subdivisions       |  |                   | 144,368 |                                       |   |                                          |  |                                        | 144,368 |  |   |      
|Corporate debt securities               |  |                   | 65,259  |                                       |   | 65,259                                    |  |                                        |        |  |   |      
|Auction-rate tax-exempt securities      |  |                   | 37,694  |                                       |   |                                          |  |                                        |        |  |   | 37,694
|                                        |  |                   |         |                                       |   |                                           |  |                                        |         |  |   |       
|Total investment securities             |  |                   | 267,141 |                                       |   | 80,098                                    |  |                                        | 149,349 |  |   | 37,694
|Cash and cash equivalents               |  |                   | 53,369  |                                       |   | 53,369                                    |  |                                        |        |  |   |      
|Fiduciary and restricted cash           |  |                   | 14,022  |                                       |   | 14,022                                    |  |                                        |        |  |   |      
|Other receivables (other assets)        |  |                   | 10,696  |                                       |   |                                          |  |                                        |        |  |   | 10,696
|                                        |  |                   |         |                                       |   |                                           |  |                                        |         |  |   |       
|Total assets                            |  | $                 | 345,228 |                                       | $ | 147,489                                   |  | $                                      | 149,349 |  | $ | 48,390
|                                        |  |                   |         |                                       |   |                                           |  |                                        |         |  |   |       
|Liabilities:                            |  |                   |         |                                       |   |                                           |  |                                        |         |  |   |       
|Interest rate swaps (other liabilities) |  | $                 | 4,589   |                                       | $ |                                          |  | $                                      |        |  | $ | 4,589 
|                                        |  |                   |         |                                       |   |                                           |  |                                        |         |  |   |       
|Total liabilities                       |  | $                 | 4,589   |                                       | $ |                                          |  | $                                      |        |  | $ | 4,589 
|                                        |  |                   |         |                                       |   |                                           |  |                                        |         |  |   |       

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,
corporate bonds, and cash or cash equivalents. U.S. Government bonds and corporate bonds are traded on a daily basis 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, and certain auction-rate tax-exempt securities that have auctions on a regular basis that do not fail. 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. 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.



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Level 3 Financial assets and liabilities

The Companys Level 3 financial assets include certain illiquid 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 entered
into during November 2008 with our broker to liquidate certain of our auction-rate tax-exempt securities. Under the terms of the agreement, our broker will purchase our eligible auction-rate tax-exempt securities for full par value on or prior to
June 30, 2012. As of September 30, 2009, we held $48.8 million, at amortized cost, and $37.7 million fair value of auction-rate tax-exempt securities that are eligible for such settlement. We have elected to record the settlement as a
financial asset at fair value in accordance with ASC 825-10 Financial Instruments  Overall [SFAS No. 159, Establishing the Fair Value Option for Financial Assets and Liabilities]. The fair value of this agreement was
estimated by third-party valuation sources to be $10.7 million 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, 2009 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, 2009                        |  | $                                                                                                    | 39,253 |   |                                                                                 | $ | 10,184
|Transfers in and/or out of Level 3             |  |                                                                                                      |       |   |                                                                                 |   |      
|Total gains or (losses) (realized/unrealized): |  |                                                                                                      |        |   |                                                                                 |   |       
|Included in earnings                           |  |                                                                                                      | (354   | ) |                                                                                 |   | 512   
|Included in other comprehensive income         |  |                                                                                                      |       |   |                                                                                 |   |      
|Purchases, issuances, and settlements          |  |                                                                                                      | (1,205 | ) |                                                                                 |   |      
|                                               |  |                                                                                                      |        |   |                                                                                 |   |       
|Balance at September 30, 2009                  |  | $                                                                                                    | 37,694 |   |                                                                                 | $ | 10,696
|                                               |  |                                                                                                      |        |   |                                                                                 |   |       

Fair value measurements for liabilities in category Level 3 for the three months
ended September 30, 2009 were as follows (in thousands):



|                                       |  |                                                                                         |       |  
|-------------------------------------- |  | --------------------------------------------------------------------------------------- | ----- | -
|                                       |  | Fair Value MeasurementsUsing SignificantUnobservable Inputs(Level 3)Interest Rate
Swaps |      
|Balance at July 1, 2009                |  | $                                                                                       | 4,555 |  
|Transfers into Level 3                 |  |                                                                                         |      |  
|Total losses (realized/unrealized):    |  |                                                                                         |       |  
|Included in earnings                   |  |                                                                                         | 926   |  
|Included in other comprehensive income |  |                                                                                         |      |  
|Purchases, issuances, and settlements  |  |                                                                                         | (892  | )
|                                       |  |                                                                                         |       |  
|Balance at September 30, 2009          |  | $                                                                                       | 4,589 |  
|                                       |  |                                                                                         |       |  



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Fair value measurements for assets in category Level 3 for the nine months ended
September 30, 2009 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, 2009             |  | $                                                                                                    | 39,130 |   |                                                                                 | $ | 9,647 
|Transfers in and/or out of Level 3     |  |                                                                                                      |       |   |                                                                                 |   |      
|Total gains (realized/unrealized):     |  |                                                                                                      |        |   |                                                                                 |   |       
|Included in earnings                   |  |                                                                                                      | 44     |   |                                                                                 |   | 1,049 
|Included in other comprehensive income |  |                                                                                                      |       |   |                                                                                 |   |      
|Purchases, issuances, and settlements  |  |                                                                                                      | (1,480 | ) |                                                                                 |   |      
|                                       |  |                                                                                                      |        |   |                                                                                 |   |       
|Balance at September 30, 2009          |  | $                                                                                                    | 37,694 |   |                                                                                 | $ | 10,696
|                                       |  |                                                                                                      |        |   |                                                                                 |   |       

Fair value measurements for liabilities in category Level 3 for the nine months ended
September 30, 2009 were as follows (in thousands):



|                                               |  |                                                                                         |        |  
|---------------------------------------------- |  | --------------------------------------------------------------------------------------- | ------ | -
|                                               |  | Fair Value MeasurementsUsing SignificantUnobservable Inputs(Level
3)Interest Rate Swaps |       
|Balance at January 1, 2009                     |  | $                                                                                       | 5,935  |  
|Transfers into Level 3                         |  |                                                                                         |       |  
|Total gains or (losses) (realized/unrealized): |  |                                                                                         |        |  
|Included in earnings                           |  |                                                                                         | 5,872  |  
|Included in other comprehensive income         |  |                                                                                         | (5,935 | )
|Purchases, issuances, and settlements          |  |                                                                                         | (1,283 | )
|                                               |  |                                                                                         |        |  
|Balance at September 30, 2009                  |  | $                                                                                       | 4,589  |  
|                                               |  |                                                                                         |        |  

Derivative financial instruments are reported at fair value on the consolidated
balance sheet. Our current derivative instruments consist of two interest rate swaps entered into in 2007 and 2008, with an aggregate notional amount of $115.0 million outstanding at September 30, 2009, 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.

Historically, our interest rate swaps qualified as cash flow hedges for hedge accounting. Accordingly, we recorded
changes in fair value of the interest rate swaps in accumulated other comprehensive income (loss), net of tax. The credit risk associated with these swap agreements is limited to the uncollected interest payments due from counterparties. As of
September 30, 2009, counterparty credit risk was minimal.

On March 27, 2009, we entered into an amendment to the
senior secured credit facility, which was considered an extinguishment of debt. As a result, the previously hedged interest payments will not occur. Therefore, the amount recorded in accumulated other comprehensive loss through March 27, 2009
was reclassified to earnings as loss on interest rate swaps. Subsequent to March 27, 2009, we record changes in the fair value of the derivative instruments in earnings, as gain or loss on interest rate swaps.



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Gains and losses (realized and unrealized) for Level 3 assets and liabilities included in
earnings for the nine months ended September 30, 2009, are reported in net investment income, other income and loss on interest rate swaps as follows:



|                                              |  |                      |    |             |   |                           |  |   |        |  
|--------------------------------------------- |  | -------------------- | -- | ----------- | - | ------------------------- |  | - | ------ | -
|                                              |  | Net InvestmentIncome |    | OtherIncome |   | Loss onInterest RateSwaps | 
|Assets                                        |  |                      |    |             |   |                           |  |   |        |  
|Total gains (losses) realized in earnings     |  | $                    | 44 |             | $ | 1,049                     |  | $ |       |  
|Liabilities                                   |  |                      |    |             |   |                           |  |   |        |  
|Total gains (losses) realized in earnings     |  |                      |   |             |   |                          |  |   | (5,872 | )
|                                              |  |                      |    |             |   |                           |  |   |        |  
|Total for the period ended September 30, 2009 |  | $                    | 44 |             | $ | 1,049                     |  | $ | (5,872 | )
|                                              |  |                      |    |             |   |                           |  |   |        |  

Fair values represent our 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 value of the notes payable were determined using a third-party valuation source is estimated to be
$24.9 million with a carrying value of $76.9 million at September 30, 2009.

Senior secured credit facility 
The fair value of the senior secured credit facility was determined using a third-party valuation source is estimated to be $98.0 million with a carrying value of $110.2 million at September 30, 2009.

Certain nonfinancial assets and nonfinancial liabilities have not been disclosed at their fair values. Therefore, the aggregate fair value
amounts presented do not purport to represent our underlying value.



|14. | 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. Cash flows related to discontinued operations have been combined with cash flows from continuing operations within each category of cash flows.

The aggregate sales price increased by $0.2 million to $4.2 million in the third quarter upon the failure by the purchaser to make a
scheduled prepayment of $0.2 million. This also increased the secured 10% note to the principal amount of $2.9 million payable over five years. The sales price also included cash at closing of $0.3 million as well as a deferred payment of $1.0
million, subject to certain adjustments, due within 18 months of closing, which may be converted to a secured note at the purchasers option. Due to the uncertainty surrounding the financial viability of the debtor, the note and deferred
payment have been recorded with no estimated net realizable value.

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



|                                         |  |                                 |     |   |                                |   |        |      |  |   |        |   |  |   |        |  
|---------------------------------------- |  | ------------------------------- | --- | - | ------------------------------ | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                         |  | Three Months EndedSeptember 30, |     |   | Nine Months EndedSeptember 30, |  
|                                         |  | 2009                            |     |   | 2008                           |   |        | 2009 |  |   | 2008   |  
|Revenue (including loss on disposal)     |  | $                               | (20 | ) |                                | $ | 644    |      |  | $ | 569    |   |  | $ | 1,954  |  
|Pretax loss from discontinued operations |  |                                 | (47 | ) |                                |   | (678   | )    |  |   | (1,835 | ) |  |   | (1,969 | )
|Other intangible assets impairment       |  |                                 |    |   |                                |   | (4,397 | )    |  |   |       |   |  |   | (4,397 | )
|Income tax (benefit)                     |  |                                 | (17 | ) |                                |   | (1,908 | )    |  |   | (479   | ) |  |   | (2,272 | )
|                                         |  |                                 |     |   |                                |   |        |      |  |   |        |   |  |   |        |  
|Loss from discontinued operations        |  | $                               | (30 | ) |                                | $ | (3,167 | )    |  | $ | (1,356 | ) |  | $ | (4,094 | )
|                                         |  |                                 |     |   |                                |   |        |      |  |   |        |   |  |   |        |  

We assigned store operating leases to the purchaser, but remain contingently liable
on five store leases in the event of default by the assignee. These five stores have future lease related payments totaling approximately $0.4 million through August 2012. We believe the likelihood of a liability being triggered under these leases
is remote, and, therefore, no liability has been accrued for these lease obligations as of September 30, 2009.



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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 and related products and services 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, 2009, our subsidiaries included insurance companies licensed to write policies in 40 states, underwriting agencies, and retail agencies with 203 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 9,200 independent agents or brokers in 11 states (Louisiana, Texas, Illinois, Alabama, California, Michigan, Florida, Missouri, Indiana, South Carolina, and New Mexico).

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 financing 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, 2008.

The Company completed its annual goodwill and indefinite lived intangible asset impairment analyses as of September 30, 2009. 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, 2009. As of September 30, 2008, the Company concluded that the carrying value of other intangible assets related to the Companys
Florida operations exceeded their fair value, resulting in an impairment loss of $4.4 million for indefinite lived other intangible assets and $0.2 million for amortizing other intangible assets.

Key inputs in our valuation model are projected cash flows, future inflationary trends, future tax rates, and the risk-adjusted discount
rate. The risk-adjusted discount rate was developed using a capital asset pricing model to estimate our weighted-average cost of capital. 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 15%, and at the same time increasing the discount rate by 100
basis points to 15.4%. The indicated stress value was sufficient to cover the book value of the Company.



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RECENTLY ISSUED ACCOUNTING STANDARDS

Effective July 1, 2009, The Financial Accounting Standards Board (FASB) issued the Accounting Standards Codification (ASC or
Codification), which superseded all existing non-SEC accounting and reporting standards under U.S. GAAP and became the single official source for U.S. authoritative GAAP combined with guidance issued by the U.S. Securities and Exchange Commission
(SEC), and is effective for financial statements issued for interim and annual periods ending after September 15, 2009. The FASB no longer issues new standards in the form of Statements of Financial Accounting Standards (SFAS), FASB Staff
Positions, or Emerging Issues Task Force Abstracts. Instead, amendments to the Codification are made by issuing Accounting Standards Updates. The Codification did not change existing GAAP. Accordingly, the issuance of the
codification did not impact the Companys consolidated results of operations or financial condition.

Two FASB standards
issued in June 2009, SFAS No. 166, Accounting for Transfers of Financial Assets  An Amendment of FASB Statement No. 140(SFAS 166);and SFAS No. 167, Amendments to FASB Interpretation No. 46(R)(SFAS
167) have not been added to the Codification as of September 30, 2009, and are not effective as of that date without the ability to early adopt.

SFAS 167 eliminates Interpretation 46(R)s exceptions to consolidating qualifying special-purpose entities, contains new criteria for determining the primary beneficiary, and increases the frequency
of required reassessments to determine whether a company is the primary beneficiary of a variable interest entity. SFAS 167 also contains a new requirement that any term, transaction, or arrangement that does not have a substantive effect on an
entitys status as a variable interest entity, a companys power over a variable interest entity, or a companys obligation to absorb losses or its right to receive benefits of an entity must be disregarded in applying Interpretation
46(R)s provisions. The elimination of the qualifying special-purpose entity concept and its consolidation exceptions means more entities will be subject to consolidation assessments and reassessments. SFAS 167 will be effective for the fiscal
year beginning January 1, 2010. The Company is currently assessing the potential impacts, if any, on the consolidated results of operations and financial condition.

SFAS 166 eliminates 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. SFAS 166 will be effective for fiscal years beginning after November 15, 2009. The Company is currently assessing the
potential impacts, if any, on the consolidated results of operations and financial condition.

In May 2009, the FASB issued
authoritative guidance establishing general standards for the accounting and reporting of subsequent events that occur between the balance sheet date and issuance of financial statements. It should not result in significant changes in the
subsequent events that an entity reports, either through recognition or disclosure in its financial statements. This guidance requires companies to recognize the effects, if material, of subsequent events in the financial statements if the
subsequent event provides additional evidence about conditions that existed as of the balance sheet date. Beginning in financial reporting periods ending after June 15, 2009, companies must also disclose the date through which subsequent
events have been evaluated and the nature of any nonrecognized subsequent events. Nonrecognized subsequent events include events that provide evidence about conditions that did not exist as of the balance sheet date, but which are of such a
nature that they must be disclosed to keep the financial statements from being misleading. This disclosure should alert all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial
statements being presented. The Company adopted this standard in the second quarter of 2009 and it had no material impact on the consolidated results of operations or financial condition. Management evaluated subsequent events for recognition or
disclosure through November 9, 2009.

On January 1, 2009, the Company adopted authoritative guidance issued by the
FASB that amended and expanded the disclosure requirements to provide users of financial statements with enhanced disclosures about an entitys derivative and hedging activities thereby improving the transparency of financial reporting. This
standard requires qualitative disclosure about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about credit risk related contingent
features in derivative agreements. The adoption of this standard did not have a material impact on the Companys consolidated results of operations or financial condition.

In April 2009, the FASB issued authoritative guidance that requires fair value disclosures in both interim as well as annual financial
statements in order to provide more timely information about the effects of current market conditions on financial instruments. The Company adopted this guidance in the second quarter of 2009, the impact of which related only to disclosures of the
Companys debt and did not have a material impact on the Companys consolidated financial statements.

In the second
quarter of 2009, the Company adopted authoritative guidance issued by the FASB that amended the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of
other-than-temporary impairments in the financial statements. This guidance did not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. Adoption of this guidance did not
have a material impact on the Companys consolidated results of operations or financial condition.



In the second quarter of 2009, the Company adopted authoritative guidance issued by the FASB on estimating fair value when the volume and
level of activity for the asset or liability have significantly decreased and identifying circumstances that may indicate that a transaction is not orderly. Adoption of this guidance did not have a material impact on the Companys consolidated
results of operations or financial condition.

On January 1, 2009, the Company adopted authoritative guidance issued by
the FASB on fair value measurement for nonfinancial assets and liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). Adoption of the new guidance did not
have a material impact on the Companys consolidated results of operations or financial condition.

In August, the FASB
issued authoritative guidance on measuring the fair value of liabilities and clarifies that the quoted price for an identical liability, when traded as an asset in an active market, is also a Level 1 measurement, the highest priority in the fair
value hierarchy, when no adjustment to the quoted price is required. This guidance is effective for interim and annual periods beginning after August 27, 2009. The Company does not anticipate any revisions in valuation techniques to be
considered necessary as a result of adopting this guidance in the fourth quarter of 2009.



22



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##### Table of Contents

MEASUREMENT OF PERFORMANCE

We are an insurance holding company engaged in the underwriting, servicing and distribution 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, 2009 and 2008 (in thousands):



|                                   |  |                                 |        |                                |   |        |  |      |         |  |   |        
|---------------------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------- |  | - | -------
|                                   |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|                                   |  | 2009                            |        | 2008                           |   | 2009   |  | 2008
|Our underwriting agencies:         |  |                                 |        |                                |   |        |  |      |         |  |   |        
|Retail agencies                    |  | $                               | 50,742 |                                | $ | 54,082 |  | $    | 163,445 |  | $ | 180,787
|Independent agencies               |  |                                 | 34,833 |                                |   | 28,905 |  |      | 102,955 |  |   | 95,713 
|                                   |  |                                 |        |                                |   |        |  |      |         |  |   |        
|Subtotal                           |  |                                 | 85,575 |                                |   | 82,987 |  |      | 266,400 |  |   | 276,500
|Unaffiliated underwriting agencies |  |                                 | 5,850  |                                |   | 6,428  |  |      | 19,493  |  |   | 23,304 
|                                   |  |                                 |        |                                |   |        |  |      |         |  |   |        
|Total                              |  | $                               | 91,425 |                                | $ | 89,415 |  | $    | 285,893 |  | $ | 299,804
|                                   |  |                                 |        |                                |   |        |  |      |         |  |   |        

Total gross premiums written for the three months ended September 30, 2009
increased $2.0 million, or 2.2%, compared with the prior year primarily due to the expansion of independent agency relationships. Total gross premiums written for the nine months ended September 30, 2009 decreased $13.9 million, or 4.6%,
compared with the prior year primarily due to macroeconomic factors. 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 and franchised stores. We earn only 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, 2009, decreased $3.3 million and $17.3 million, or 6.2% and 9.6%, respectively, when compared with the prior year. These declines were primarily due to the negative macroeconomic environment.

In our independent agency distribution channel, gross premiums written for the three and nine months ended September 30,
2009 increased $5.9 million and $7.2 million, respectively, or 20.5% and 7.6%, respectively, compared with the prior year. This increase was primarily due to the expansion of independent agency relationships.

Gross premiums written by our unaffiliated underwriting agencies for the three and nine months ended September 30, 2009 decreased $0.6
million and $3.8 million, respectively, or 9.0% and 16.4%, respectively, compared with the prior year. For strategic reasons, we have chosen to reduce our emphasis on growth in the unaffiliated underwriting agencies distribution channel.

In the third quarter of 2009, we began to implement changes in pricing to improve our premium production levels and profitability. The
states of Illinois, Indiana, Michigan and South Carolina are targeted for these changes. We expect it to take about one year before the full benefits from these actions are realized.



23



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The following table displays our gross premiums written and assumed by state for the three
and nine months ended September 30, 2009 and 2008 (in thousands):



|               |  |                                 |        |                                |   |        |  |      |         |  |   |        
|-------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | ---- | ------- |  | - | -------
|               |  | Three Months EndedSeptember 30, |        | Nine Months EndedSeptember 30,
|               |  | 2009                            |        | 2008                           |   | 2009   |  | 2008
|Louisiana      |  | $                               | 36,087 |                                | $ | 33,774 |  | $    | 108,543 |  | $ | 107,583
|Texas          |  |                                 | 20,396 |                                |   | 15,003 |  |      | 64,217  |  |   | 50,212 
|Illinois       |  |                                 | 8,916  |                                |   | 11,903 |  |      | 31,269  |  |   | 41,434 
|Alabama        |  |                                 | 7,324  |                                |   | 6,945  |  |      | 22,729  |  |   | 21,932 
|California     |  |                                 | 5,788  |                                |   | 6,308  |  |      | 19,272  |  |   | 22,905 
|Michigan       |  |                                 | 5,709  |                                |   | 3,850  |  |      | 14,326  |  |   | 13,175 
|Indiana        |  |                                 | 2,136  |                                |   | 2,255  |  |      | 7,295   |  |   | 7,814  
|Missouri       |  |                                 | 2,058  |                                |   | 1,750  |  |      | 7,109   |  |   | 7,884  
|Florida        |  |                                 | 1,136  |                                |   | 4,813  |  |      | 4,934   |  |   | 16,287 
|South Carolina |  |                                 | 1,082  |                                |   | 1,825  |  |      | 3,772   |  |   | 7,322  
|New Mexico     |  |                                 | 728    |                                |   | 869    |  |      | 2,207   |  |   | 2,856  
|Other          |  |                                 | 65     |                                |   | 120    |  |      | 220     |  |   | 400    
|               |  |                                 |        |                                |   |        |  |      |         |  |   |        
|Total          |  | $                               | 91,425 |                                | $ | 89,415 |  | $    | 285,893 |  | $ | 299,804
|               |  |                                 |        |                                |   |        |  |      |         |  |   |        

The following table displays our net premiums written by distribution channel for the
three and nine months ended September 30, 2009 and 2008 (in thousands):



|                                                                 |  |                                 |        |   |                                |   |         |      |  |   |         |   |  |   |         |  
|---------------------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                                                 |  | Three Months EndedSeptember 30, |        |   | Nine Months EndedSeptember 30, |  
|                                                                 |  | 2009                            |        |   | 2008                           |   |         | 2009 |  |   | 2008    |  
|Our underwriting agencies:                                       |  |                                 |        |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Retail agencies  gross premiums written                         |  | $                               | 50,742 |   |                                | $ | 54,082  |      |  | $ | 163,445 |   |  | $ | 180,787 |  
|Ceded reinsurance                                                |  |                                 |       |   |                                |   | (10,179 | )    |  |   | 10,286  |   |  |   | (32,354 | )
|                                                                 |  |                                 |        |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Subtotal retail agencies net premiums written                    |  |                                 | 50,742 |   |                                |   | 43,903  |      |  |   | 173,731 |   |  |   | 148,433 |  
|                                                                 |  |                                 |        |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Independent agencies  gross premiums written                    |  |                                 | 34,833 |   |                                |   | 28,905  |      |  |   | 102,955 |   |  |   | 95,713  |  
|Ceded reinsurance                                                |  |                                 | (651   | ) |                                |   | (402    | )    |  |   | (1,304  | ) |  |   | (1,541  | )
|                                                                 |  |                                 |        |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Subtotal independent agencies net premiums written               |  |                                 | 34,182 |   |                                |   | 28,503  |      |  |   | 101,651 |   |  |   | 94,172  |  
|                                                                 |  |                                 |        |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Unaffiliated underwriting agencies  gross premiums written      |  |                                 | 5,850  |   |                                |   | 6,428   |      |  |   | 19,493  |   |  |   | 23,304  |  
|Ceded reinsurance                                                |  |                                 | (32    | ) |                                |   | (58     | )    |  |   | (121    | ) |  |   | (181    | )
|                                                                 |  |                                 |        |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Subtotal unaffiliated underwriting agencies net premiums written |  |                                 | 5,818  |   |                                |   | 6,370   |      |  |   | 19,372  |   |  |   | 23,123  |  
|                                                                 |  |                                 |        |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Catastrophe and contingent coverages with various reinsurers     |  |                                 | (179   | ) |                                |   | (50     | )    |  |   | (530    | ) |  |   | (528    | )
|                                                                 |  |                                 |        |   |                                |   |         |      |  |   |         |   |  |   |         |  
|Total net premiums written                                       |  | $                               | 90,563 |   |                                | $ | 78,726  |      |  | $ | 294,224 |   |  | $ | 265,200 |  
|                                                                 |  |                                 |        |   |                                |   |         |      |  |   |         |   |  |   |         |  

Total net premiums written for the three months ended September 30, 2009
increased $11.8 million, or 15.0%, compared with the prior year quarter. Total net premiums written for the nine months ended September 30, 2009 increased $29.0 million, or 10.9%, compared with the prior year period. The increase was primarily
due to lower ceded reinsurance for our Louisiana and Alabama businesses. Effective January 1, 2009, we terminated our quota share reinsurance contract on a cut-off basis and $10.5 million of ceded unearned premium was returned.

RESULTS OF OPERATIONS

We
had a loss from continuing operations of $3.4 million and $0.2 million for the three and nine months ended September 30, 2009, respectively, compared with a loss from continuing operations of $3.5 million for the three months ended
September 30, 2008 and income from continuing operations of $4.4 million for the nine months ended September 30, 2008. Significant items impacting the current year to date results were:



| |  |  | net pretax gain on extinguishment of debt of $19.4 million in the first quarter of 2009;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | unfavorable development on reserve estimates for prior accident years of $11.0 million in the second quarter of 2009;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | net contingent commission expense related to prior period development of $1.0 million and $3.3 million for the three and nine months ended
September 30, 2009, respectively;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | an accrual of $1.0 million for severance payments to be made to a former executive in the second quarter of 2009; and
| | - |  | ---------------------------------------------------------------------------------------------------------------------



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| |  |  | loss on interest rate swaps of $0.9 million and $5.9 million for the three and nine months ended September 30, 2009, respectively,
associated with the discontinuation of hedge accounting for the interest rate swaps.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Comparison of the Three Months
Ended September 30, 2009 to the Three Months Ended September 30, 2008

Total revenues for the three months ended
September 30, 2009 increased $2.7 million, or 2.4%, compared with the three months ended September 30, 2008. The increase was primarily due to increased commission and fees revenue as well as reduced reinsurance in 2009.

The largest component of revenue is net premiums earned on our insurance policies. Net premiums earned for the current quarter increased
$1.1 million, or 1.2%, 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 $2.2 million, or 2.8%.
This increase is primarily due to the termination of our quota-share reinsurance agreement for Louisiana and Alabama business. Net premiums earned on insurance products sold through the unaffiliated underwriting agencies distribution channel
decreased by $1.2 million, or 15.7%, 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,
|                                   |  | 2009                            |        | 2008
|Our underwriting agencies          |  | $                               | 82,260 |      | $ | 80,039
|Unaffiliated underwriting agencies |  |                                 | 6,301  |      |   | 7,472 
|                                   |  |                                 |        |      |   |       
|Total net premiums earned          |  | $                               | 88,561 |      | $ | 87,511
|                                   |  |                                 |        |      |   |       

Commission Income and Fees. Another measurement of our performance is the
relative level of production of commission income and fees. Commission income and fees consist 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. Policy, installment and agency fees are fees charged to the
customers in connection with their purchase of coverage from our insurance company subsidiaries. Generally, we can increase or decrease agency and installment fees subject to limited regulatory restrictions, but policy fees and interest rates 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 interest and origination fees on premiums that customers choose to finance.

Commissions, premium finance and agency fees are earned on sales of unaffiliated (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, bond cards and tax preparation services offered by unaffiliated companies.



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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, |       
|                                 |  | 2009                            |        | 2008 |  
|Policyholder fees                |  | $                               | 9,604  |      | $ | 10,253 |  
|Premium finance revenue          |  |                                 | 5,597  |      |   | 4,593  |  
|Commissions and fees             |  |                                 | 3,445  |      |   | 2,650  |  
|Agency fees                      |  |                                 | 1,133  |      |   | 1,036  |  
|Other, net                       |  |                                 | 245    |      |   | (86    | )
|                                 |  |                                 |        |      |   |        |  
|Total commission income and fees |  | $                               | 20,024 |      | $ | 18,446 |  
|                                 |  |                                 |        |      |   |        |  

Total commission income and fees increased $1.6 million, or 8.6%, compared with the
prior year quarter. Policyholder fees have decreased due to the lower volume of premiums written in states where we collect policyholder fees. We have experienced a steady increase in premium finance revenue since December 2007 when we began
financing third-party premiums. Commissions and fees increased as a result of a revised rate structure in 2009 and more of our retail customers choosing third-party products due to the soft market conditions.

Net Investment Income and Other Income.Net investment income for the current quarter decreased $0.6 million, or 18.7%,
compared with the prior year quarter. The decrease was primarily due to a reduction in yields and an 8.0% decrease in total average invested assets to $272.2 million during the current quarter from $296.0 million during the prior year quarter. The
average investment yield was 2.5% (3.9% on a taxable equivalent basis) in the current quarter, compared with 3.1% (4.8% on taxable equivalent basis) in the prior year quarter.

As of September 30, 2009, we held $48.8 million, at amortized cost, and $37.7 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 February 2008, investment
banks stopped committing capital to the auctions and there have been widespread auctions failures since that time.

In August
2008, our broker announced settlements in principle with each of the Division Enforcement of the U.S. Securities and Exchange Commission (SEC), the New York Attorney General and other state agencies to purchase all of its clients auction-rate
securities at par and several other items, including fines. 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 in our brokers accounts
(the settlement). The majority of our auction-rate securities qualify under the terms of the settlement. The time frames that our broker has set 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. For the majority of our auction-rate holdings, the buybacks are expected to occur between July 2010 and two years thereafter. In November 2008, the Company elected to
participate in our brokers offer to purchase our auction-rate securities at par. We classify our portfolio of auction-rate securities as trading and as of the quarter ended September 30, 2009, recorded a realized loss of $0.4 million for
the change in fair value since June 30, 2009. As of September 30, 2009, the fair value of the settlement was $10.7 million, which we reported in other assets with the increase in fair value of $0.5 million during the three months ended
September 30, 2009, reported in other income.

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 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. 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. We have a limited history in establishing reserves and 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.



Losses
and loss adjustment expenses for the current quarter decreased $0.3 million, or 0.4 %, compared with the prior year quarter. The percentage of losses and loss adjustment expense to net premiums earned (the loss ratio) was 79.4% in the current
quarter, compared with 80.6% in the prior year quarter. The decline was primarily due to hurricane losses and prior period adverse development in 2008. Excluding these items, the loss ratio for the current quarter increased to 79.4% from 75.5%. The
increase in the loss ratio for the current



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##### Table of Contents

quarter ended September 30, 2009 compared to the prior year quarter, excluding noted items, was due to the increase of the current period loss ratio to 76.4% for the nine months ended
September 30, 2009 from 75.0% for the six months ended June 30, 2009. This increase was primarily due to increased loss frequency from our Florida and Texas businesses.

The Florida losses were primarily the result of our decision to push the full coverage product in Florida in 2007 in response to the
Personal Injury Protection (PIP) sunset in that state on October 1, 2007 and the development recorded in the second quarter primarily was for 2008. Inadequate pricing and product management produced significantly higher losses than anticipated.
We have drastically reduced the production of this product by restricting writings by agent, territory and coverage based on where significant loss ratio swings occurred.

In the third quarter of 2009, we undertook a study to assess how we carry out our claims administration activities. Through this review, we identified specific actions to achieve organizational
efficiencies and reduce our loss and loss adjustment expenses. We have started to implement these steps in the fourth quarter of 2009 and expect these actions to have a significant impact on mitigating our loss and loss adjustment expenses. We
expect it to take about one year before the full benefits from these actions are realized.

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, |  
|                                                       |  | 2009                            |   |  | 2008 |  
|Loss ratio  current quarter                           |  | 79.4                            | % |  | 75.5 | %
|Hurricane losses                                       |  |                                |   |  | 2.2  |  
|Adverse loss ratio development  prior period business |  |                                |   |  | 2.9  |  
|                                                       |  |                                 |   |  |      |  
|Reported loss ratio                                    |  | 79.4                            | % |  | 80.6 | %
|                                                       |  |                                 |   |  |      |  

Selling, General and Administrative Expenses. Another measurement of our
performance that addresses our overall efficiency is the level of selling, general and administrative 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 selling, general and administrative 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 selling, general and administrative expenses is personnel costs,
including payroll, benefits and accrued bonus expenses.

Selling, general and administrative expenses increased $0.3 million,
or 0.9%, compared with the prior year quarter. This increase was primarily related to a reduction in ceding commission of $2.5 million due to the termination of the Louisiana and Alabama quota-share agreement and contingent commissions related to
prior period development of $1.0 million. These increases were offset by cost reduction initiatives implemented by management.

In July 2009, we suspended matching contributions to the 401(k) plan. This action is expected to decrease selling, general and administrative expenses by approximately $1.0 million annually. We are also in the process of implementing the
following organizational changes by the end of 2009 including:



| |  |  | consolidating insurance operations into one location;
| | - |  | -----------------------------------------------------



| |  |  | consolidating agency and claims operations; and
| | - |  | -----------------------------------------------



| |  |  | conducting a general business unit review to identify and implement additional expense savings opportunities.
| | - |  | -------------------------------------------------------------------------------------------------------------

We believe that the cumulative effect of all of the actions outlined above, including the sale of the Florida retail operations and the
suspension of the 401(k) matching contributions, should produce expense savings of at least $10.0 million annually and the elimination of approximately 150 jobs.

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.



27



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##### Table of Contents

The following table sets forth the impact that amortization of deferred acquisition costs
had on selling, general and administrative expenses and the change in deferred acquisition costs (in thousands):



|                                                                                  |  |                                 |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Three Months EndedSeptember 30, |        
|                                                                                  |  | 2009                            |         |   | 2008 |  
|Amortization of deferred acquisition costs                                        |  | $                               | 19,047  |   |      | $ | 20,104  |  
|Other selling, general and administrative expenses                                |  |                                 | 19,045  |   |      |   | 17,654  |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Total selling, general and administrative expenses                                |  | $                               | 38,092  |   |      | $ | 37,758  |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Total as a percentage of net premiums earned                                      |  |                                 | 43.0    | % |      |   | 43.1    | %
|                                                                                  |  |                                 |         |   |      |   |         |  
|Beginning deferred acquisition costs                                              |  | $                               | 24,732  |   |      | $ | 24,691  |  
|Additions                                                                         |  |                                 | 18,740  |   |      |   | 18,153  |  
|Amortization                                                                      |  |                                 | (19,047 | ) |      |   | (20,104 | )
|                                                                                  |  |                                 |         |   |      |   |         |  
|Ending deferred acquisition costs                                                 |  | $                               | 24,425  |   |      | $ | 22,740  |  
|                                                                                  |  |                                 |         |   |      |   |         |  
|Amortization of deferred acquisition costs as a percentage of net premiums earned |  |                                 | 21.5    | % |      |   | 23.0    | %
|                                                                                  |  |                                 |         |   |      |   |         |  

During 2006, we developed a comprehensive implementation plan and supporting business
case to consolidate and transform our primary business applications onto a new strategic platform. This plan encompasses consolidating and migrating our multiple claims, point-of-sale and policy administration systems onto single strategic
platforms, as well as deploying new premium finance, reporting and business analytics capabilities. For all components of this systems transformation plan, we have selected a software package that we will configure and integrate to meet our unique
needs. We believe this systems transformation will position us to realize significant strategic benefits including: systemic pricing advantage in our marketplace via consolidated and streamlined systems and operations; faster product time to market;
additional retail revenue via premium financing; improved claims and underwriting performance via increased automated application of best practice processing rules; a platform to simplify and hasten post-merger and acquisition integration-reducing
integration costs and accelerating synergies realization; and improved customer focus and retention. Through September 30, 2009, we have capitalized $40.7 million of costs related to the transformation. The agency management and premium finance
systems were fully implemented in the first quarter of 2008. The insurance systems began to be implemented in June 2008 with the claims system implemented to support all of our operations except for our Louisiana and Alabama operations in the last
six months of 2008. We are in the process of converting all remaining open claims from the legacy system to the new system (with the exception of Louisiana and Alabama). Through the third quarter of 2009, the new point-of-sale and policy
administration system was implemented in Texas, Illinois, Indiana and South Carolina. For the new policy administration system implementation, we plan to operate the legacy systems through the policies renewal dates when they will be converted
to the new system. This will result in additional operating expense until the legacy systems can be retired.

Depreciation
and Amortization.Depreciation and amortization expenses for the current quarter decreased $0.5 million, or 17.5%, compared with the prior year quarter. Depreciation expense increased by $0.1 million, or 5.6%, primarily due to the
implementation of the insurance systems mentioned above. Amortization expense decreased by $0.6 million, or 82.3%, for the current quarter primarily as a result of lower amortization expense related to the purchase of USAgencies.

Loss on Interest Rate Swaps. Loss on interest rate swaps for the current quarter was $0.9 million. The modification of the senior
credit facility effective March 27, 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
general decline in short term interest rates implied in the current forward yield curve.

Interest Expense.Interest
expense for the current quarter increased $2.1 million, or 49.2%, compared with the prior year quarter. This increase reflects the amortization of loan discount of $1.9 million resulting from the modification of the senior credit facility as well as
the increased interest rate, which was partially offset by a lower loan balance due to principal reductions.

Income
Taxes.Income tax benefit for the current quarter was $3.2 million, or an effective rate of 48.2%, as compared with income tax benefit of $5.3 million, or an effective rate of 44.4%, for the prior year quarter.

Discontinued Operations.In June 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. The sale of these stores is expected to improve pretax income in the range of $1.0
million to $1.5 million annually.

The aggregate sales price increased by $0.2 million to $4.2 million in the third quarter
upon the failure by the purchaser to make a scheduled prepayment of $0.2 million. This also increased the secured 10% note to the principal amount of $2.9 million payable over five years. The sales price also included cash at closing of $0.3 million
as well as a deferred payment of $1.0 million, subject to certain adjustments, due within 18 months of closing, which may be converted to a secured note at the purchasers option. Due to the uncertainty surrounding the financial viability of
the debtor, the note and deferred payment have been recorded with no estimated net realizable value.



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We assigned store operating leases to the purchaser, but remain contingently liable on five
store leases in the event of default by the assignee. These five stores have future lease related payments totaling approximately $0.4 million through August 2012. We believe the likelihood of a liability being triggered under these leases is
remote, and therefore no liability has been accrued for these lease obligations as of September 30, 2009.

Comparison of the Nine
Months Ended September 30, 2009 to the Nine Months Ended September 30, 2008

Total revenues for the nine months
ended September 30, 2009 decreased $0.2 million, or 0.1%, compared with the nine months ended September 30, 2008. The decrease was primarily due to a decrease in net investment income, partially offset by increases in commission income and
fees and other income.

The largest component of revenue is net premiums earned on insurance policies issued by our five
affiliated insurance carriers. Net premiums earned for the current period increased $0.1 million, or 0.04%, 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 $5.7 million, or 2.3%. This increase is primarily due to the increase in retention on the Louisiana and Alabama business with the termination of our quota-share reinsurance agreement, 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 $5.6 million, or 22.6%, 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,
|                                   |  | 2009                           |         | 2008
|Our underwriting agencies          |  | $                              | 256,733 |      | $ | 250,990
|Unaffiliated underwriting agencies |  |                                | 19,273  |      |   | 24,912 
|                                   |  |                                |         |      |   |        
|Total net premiums earned          |  | $                              | 276,006 |      | $ | 275,902
|                                   |  |                                |         |      |   |        

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,
|                                 |  | 2009                           |        | 2008
|Policyholder fees                |  | $                              | 29,251 |      | $ | 32,690
|Premium finance revenue          |  |                                | 16,627 |      |   | 14,311
|Commissions and fees             |  |                                | 10,155 |      |   | 7,864 
|Agency fees                      |  |                                | 3,753  |      |   | 3,496 
|Other, net                       |  |                                | 688    |      |   | 285   
|                                 |  |                                |        |      |   |       
|Total commission income and fees |  | $                              | 60,474 |      | $ | 58,646
|                                 |  |                                |        |      |   |       

Commission income and fees increased $1.8 million, or 3.1%, compared with the prior
year period. Policyholder fees have decreased due to the lower volume of premiums written in states where we collect policyholder fees. We have experienced a steady increase in premium finance revenue since December 2007 when we began financing
third-party premiums. Commissions and fees increased as a result of a revised rate structure in 2009 and more of our retail customers choosing third-party products due to the soft market conditions. Agency fees increased due to additional fees that
we began collecting in April 2008.

Net Investment Income and Other Income.Net investment income for the
current period decreased $3.7 million, or 33.7%, compared with the prior year period. The decrease was primarily due to a reduction in yields and a 12.0% decrease in total average invested assets to $270.1 million during the current period from
$306.8 million during the prior year period. The average investment yield was 2.6% (4.0% on a taxable equivalent basis) in the current period, compared with 3.7% (5.7% on taxable equivalent basis) in the prior year period.



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Losses and Loss Adjustment Expenses. Losses and loss adjustment expenses for the
current period increased $9.7 million, or 4.6%, compared with the prior year period. The percentage of losses and loss adjustment expense to net premiums earned (the loss ratio) was 80.4% in the current period, compared with 76.9% in the prior year
period. The increase in the loss ratio for the nine months ended September 30, 2009 compared to the prior year period was due to increased losses from unfavorable development on reserve estimates for prior accident years of $11.1 million
primarily due to $5.6 million for our Florida business, $3.7 million for our Michigan business, and $1.8 million for our Louisiana business.

The Michigan losses were the result of prior accident year development exceeding original estimates. The Florida losses were the result of our decision to push the full coverage product in Florida in 2007
in response to the Personal Injury Protection (PIP) sunset in that state on October 1, 2007 and the development recorded in the second quarter primarily was for 2008. Inadequate pricing and product management produced significantly higher
losses than anticipated. We have drastically reduced the production of this product by restricting writings by agent, territory and coverage based on where significant loss ratio swings occurred. Excluding Florida in the current period, the loss
ratio was 74.3%.

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, |  
|                                                       |  | 2009                           |   |  | 2008 |  
|Loss ratio  current period                            |  | 76.4                           | % |  | 74.7 | %
|Hurricane losses                                       |  |                               |   |  | 0.7  |  
|Adverse loss ratio development  prior period business |  | 4.0                            |   |  | 1.5  |  
|                                                       |  |                                |   |  |      |  
|Reported loss ratio                                    |  | 80.4                           | % |  | 76.9 | %
|                                                       |  |                                |   |  |      |  

Selling, General and Administrative Expenses. The largest component of
selling, general and administrative expenses is personnel costs, including payroll, benefits and accrued bonus expenses. Selling, general and administrative expenses increased $10.0 million, or 9.2%, compared with the prior year period. This
increase was primarily related to no longer receiving ceding commissions and a return of ceding commission of $2.6 million due to the termination of the Louisiana and Alabama quota share agreement in 2009; contingent commissions related to prior
period development of $3.3 million; and a severance charge of $1.3 million. These increases were partially offset by cost reduction initiatives implemented by management.

The following table sets forth the impact that amortization of deferred acquisition costs had on selling, general and administrative expenses and the change in deferred acquisition costs (in thousands):



|                                                                                  |  |                                |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | ------------------------------ | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Nine Months EndedSeptember 30, |        
|                                                                                  |  | 2009                           |         |   | 2008 |  
|Amortization of deferred acquisition costs                                        |  | $                              | 57,085  |   |      | $ | 56,391  |  
|Other selling, general and administrative expenses                                |  |                                | 60,643  |   |      |   | 51,371  |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Total selling, general and administrative expenses                                |  | $                              | 117,728 |   |      | $ | 107,762 |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Total as a percentage of net premiums earned                                      |  |                                | 42.7    | % |      |   | 39.1    | %
|                                                                                  |  |                                |         |   |      |   |         |  
|Beginning deferred acquisition costs                                              |  | $                              | 21,993  |   |      | $ | 24,536  |  
|Additions                                                                         |  |                                | 59,517  |   |      |   | 54,595  |  
|Amortization                                                                      |  |                                | (57,085 | ) |      |   | (56,391 | )
|                                                                                  |  |                                |         |   |      |   |         |  
|Ending deferred acquisition costs                                                 |  | $                              | 24,425  |   |      | $ | 22,740  |  
|                                                                                  |  |                                |         |   |      |   |         |  
|Amortization of deferred acquisition costs as a percentage of net premiums earned |  |                                | 20.7    | % |      |   | 20.4    | %
|                                                                                  |  |                                |         |   |      |   |         |  

Depreciation and Amortization.Depreciation and amortization expenses
for the current period decreased $0.4 million, or 5.6%, compared with the prior year period. Depreciation expense increased by $1.5 million, or 29.2%, primarily due to the implementation of the insurance systems mentioned above and amortization
expense decreased by $1.9 million, or 81.1%, for the current period primarily as a result of decreasing amortization related to the purchase of USAgencies.

Gain on Extinguishment of Debt.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



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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, which is included in a separate line item in the accompanying consolidated statement of income for the nine months ended September 30, 2009. 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 was $5.9 million. The modification of the senior credit facility effective March 27, 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 general decline in short term interest rates implied in the current forward yield curve.

On March 27, 2009, we entered into an amendment to the senior secured credit facility, which was considered an extinguishment of
debt under ASC 470-50. As a result, the previously hedged interest payments will not occur. Therefore, the amount recorded in accumulated other comprehensive loss through March 27, 2009 was reclassified to earnings as loss on interest rate
swaps. Subsequent to March 27, 2009, we record changes in the fair value of the derivative instruments in earnings, as gain or loss on interest rate swaps.

Interest Expense.Interest expense for the current period increased $3.0 million, or 21.3%, compared with the prior period. This increase reflects the amortization of loan discount of $4.0 million
resulting from the modification of the senior credit facility as well as the increased interest rate, which was partially offset by a lower loan balance due to principal reductions.

Income Taxes.Income tax benefit for the current period was $5.1 million, or an effective rate of 76.1%, as compared with
income tax benefit of $3.0 million, or an effective rate of 113.5%, for the prior year period. The lower effective tax rate for the current period was primarily due to the higher level of tax-exempt income in 2008 partially offset by the reversal of
a $1.0 million valuation allowance in 2009 resulting from managements assessment that it is more likely than not that capital loss carryforwards will be utilized.

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.

The payment of dividends by our non-insurance company subsidiaries are restricted under the terms of the amendment to the senior secured
credit facility. As a result, our non-insurance company subsidiaries generate revenues, profits and net cash flows that are generally used to service our corporate financial obligations, such as debt service under the terms of the amendment to the
senior secured credit facility. As of September 30, 2009, we had $9.8 million of cash and equivalents at the holding company level and $14.8 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
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, 2009, 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, 2009, each of our insurance subsidiaries maintained a risk-based capital level that was in excess of the amount that would require any corrective actions.



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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.

We believe that existing cash and investment balances, as well as new cash flows generated from operations and available borrowings under
our other credit facilities, will be adequate to meet our capital and liquidity needs 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 other than the debt service requirements of the senior secured credit facility.

Senior secured credit facility. On March 27, 2009, we entered into an amendment to the facility. The amendment included the following changes:



| |  |  | The leverage ratio covenant calculation was changed to include only amounts borrowed under the facility. In addition, the quarterly requirements were
changed for the remaining term of the facility;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The interest coverage ratio covenant calculation was changed to include only interest expense paid in cash. In addition, the quarterly requirements
were changed for the remaining term of the facility;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The combined ratio covenant was replaced with a loss ratio covenant;
| | - |  | --------------------------------------------------------------------



| |  |  | The fixed charge coverage ratio was changed to include only interest expense paid in cash. In addition, the annual requirements were changed for the
remaining term of the facility;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The consolidated net worth covenant calculation was changed to a covenant that excludes goodwill and includes subordinated debt;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------



| |  |  | Asset sales are now allowed for transactions with less than 80% of cash proceeds. Financing is limited to $5.0 million per transaction and $10.0
million in the aggregate;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | A sale and leaseback transaction of capitalized technology assets is allowed for up to $30.0 million;
| | - |  | -----------------------------------------------------------------------------------------------------



| |  |  | The pricing under the agreement was changed as follows:
| | - |  | -------------------------------------------------------



| |  |  | A LIBOR floor of 3.0% was established.
| | - |  | --------------------------------------



| |  |  | Pricing depends on the amount of the 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%;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Common stock dividends are permitted only if the leverage ratio is less than or equal to 1.5;
| | - |  | ---------------------------------------------------------------------------------------------



| |  |  | The annual excess cash flow payment was changed to 50 percent of non-regulated cash flow and 75 percent of dividends paid from regulated insurance
companies; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The revolving facility was reduced from $20.0 million to $10.0 million.
| | - |  | -----------------------------------------------------------------------



|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, 2009 was $267.1 million. The effective average duration of the portfolio as of
September 30, 2009 was 1.48 years. If market interest rates increase 1.0%, our fixed-income investment portfolio would be expected to decline in market value by 1.48%, or $4.0 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 1.48%, or $4.0 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%.



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Derivative financial instruments are reported at fair value on the consolidated balance
sheet. Our current derivative instruments consist of two interest rate swaps entered into in 2007 and 2008, with an aggregate notional amount of $115.0 million outstanding at September 30, 2009. 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 $65.0 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.

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, 2009, our fixed-income investments were invested in the following: U.S. Treasury and government agencies securities 5.5%,
corporate debt securities 24.4%, resident mortgaged-backed securities 1.9% and states and political subdivisions securities 68.2%. At September 30, 2009, all of our fixed-income securities were rated A or better by nationally
recognized statistical rating organizations. The average quality of our portfolio was AA at September 30, 2009.

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



|                          |  |                   |         |   |                  |   |         |  
|------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                          |  | September 30,2009 |         |   | December 31,2008 |  
|Total invested assets     |  | $                 | 267,141 |   |                  | $ | 259,143 |  
|Tax-equivalent book yield |  |                   | 4.42    | % |                  |   | 4.75    | %
|Average duration in years |  |                   | 1.48    |   |                  |   | 1.58    |  
|Average S&P rating        |  |                   | AA      |   |                  |   | 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, 2009 and December 31, 2008,
respectively (in thousands):



|                                                         |  |                   |        |                  |   |       
|-------------------------------------------------------- |  | ----------------- | ------ | ---------------- | - | ------
|                                                         |  | September 30,2009 |        | December 31,2008
|Michigan Catastrophic Claims Association                 |  | $                 | 17,492 |                  | $ | 15,989
|Vesta Insurance Group                                    |  |                   | 14,302 |                  |   | 14,223
|Quota-share reinsurer for Louisiana and Alabama business |  |                   | 6,363  |                  |   | 28,951
|Other                                                    |  |                   | 3,907  |                  |   | 4,168 
|                                                         |  |                   |        |                  |   |       
|Total reinsurance recoverable                            |  | $                 | 42,064 |                  | $ | 63,331
|                                                         |  |                   |        |                  |   |       

Under the reinsurance agreement with Vesta Insurance Group (VIG), including primarily
Vesta Fire Insurance Corporation (VFIC), our 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, 2009, the VFIC Trust held $17.4 million consisting of $12.6 million of a U.S. Treasury money market account and $4.8 million of corporate bonds rated BBB or higher (after cumulative withdrawals of $7.6 million
through September 30, 2009), to collateralize the $14.3 million gross recoverable from VFIC.

At September 30, 2009,
net amounts owed by AIC and Insura under reinsurance agreements with the VIG-affiliated companies, including Hawaiian Insurance and Guaranty Company, Ltd (Hawaiian) were $13.2 million. Affirmative established a trust account to collateralize this
payable, which currently holds $22.4 million (including accrued interest) in securities (the AIC Trust). The Special Deputy Receiver in Texas had cumulative withdrawals from the AIC Trust of $0.4 million through September 2009.

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, 2009, all such unaffiliated reinsurers had A.M. Best ratings of A- or better.



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

Evaluation of
Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 (Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the United States
Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions
regarding required disclosure.

As of the end of the period covered by this report, we carried out an evaluation, under the
supervision and with the participation of our Disclosure Committee and management, including the principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures
pursuant to Exchange Act Rules 13a-15(b) and 15d-15(b). Based upon this evaluation, the principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of September 30, 2009.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the quarter ended September 30, 2009 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.



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PART II  OTHER INFORMATION



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

See
Note 11 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, 2008.



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



| | 31.1 | Certification of Kevin R. Callahan, 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 Kevin R. Callahan, 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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##### Table of Contents

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 9, 2009 |  |     |  |                                                     
|                       |  |     |  | /s/ Michael J. McClure                              
|                       |  | By: |  | Michael J. McClure                                  
|                       |  |     |  | Executive Vice President and Chief Financial Officer
|                       |  |     |  | (and in his capacity as Principal Financial Officer)



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