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UNITED STATES SECURITIES AND EXCHANGE COMMISSION  Washington, D.C. 20549
 FORM 10-Q (Mark One) þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended March 31, 2005 OR o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934
 For the transition period from to
 Commission file number 000-50795
 AFFIRMATIVE INSURANCE HOLDINGS, INC. (Exact name of registrant as specified in its charter)
 Delaware
    
    75-2770432(State of 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. þ Yes o
No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of
the Exchange Act):o Yes þ No 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 May 12, 2005
16,852,753




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Affirmative Insurance Holdings, Inc.
Index PagePart I            Financial InformationItem 1. Financial Statements (unaudited)Consolidated Balance Sheets as of March 31, 2005 and December 31, 2004
    
    
    1Consolidated Statements of Operations for the Three Months Ended March 31, 2005 and 2004
    
    
    2Consolidated Statements of Stockholders Equity and Comprehensive Income
for the Three Months Ended March 31, 2005 and 2004
    
    
    3Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2005 and 2004
    
    
    4Notes to Consolidated Financial Statements
    
    
    5Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    12Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    17Item 4. Control Procedures
    
    
    18Part II Other InformationItem 1. Legal Proceedings
    
    
    18Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    18Item 3. Defaults Upon Senior Securities
    
    
    18Item 4. Submission of Matters to a Vote of Security Holders
    
    
    18Item 5. Other Information
    
    
    18Item 6. Exhibits
    
    
    19Signatures
    
    
    19Desription of Non-Employee Director CompensationQuota Share Reinsurance Agreement - A-Affordable Managing General Agency, Inc.Quota Share Reinsurance Agreement - American Agencies General Agency, Inc.Certification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906




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##### Table of Contents



Part I 
 Item 1. Financial Statements
 Affirmative Insurance Holdings, Inc.
 
 Consolidated Balance Sheets
 March 31, 2005 and December 31, 2004
 March 31,
    
    
    December 31,2005
    
    
    2004(dollars in thousands, except share data)
    
    (unaudited)AssetsFixed maturities  available for sale, at fair value (amortized cost 2005: $161,006; 2004: $157,296)
    
    $
    158,866
    
    
    $
    157,666Short-term investments
    
    
    
    
    
    
    1,995158,866
    
    
    
    159,661Cash and cash equivalents
    
    
    30,268
    
    
    
    24,096Fiduciary and restricted cash
    
    
    27,230
    
    
    
    16,267Accrued investment income
    
    
    2,115
    
    
    
    1,979Premiums and fees receivable (includes related parties - 2005: $33,887; 2004: $30,980)
    
    
    131,350
    
    
    
    107,411Commissions receivable (includes related parties - 2005: $3,038; 2004: $5,136)
    
    
    8,678
    
    
    
    11,890Receivable from reinsurers (includes related parties - 2005: $25,099; 2004: $28,873)
    
    
    55,294
    
    
    
    75,403Deferred acquisition costs
    
    
    28,980
    
    
    
    19,118Receivable from affiliates
    
    
    1,043
    
    
    
    310Deferred tax asset
    
    
    7,515
    
    
    
    6,637Property and equipment, net
    
    
    6,560
    
    
    
    6,485Goodwill
    
    
    68,530
    
    
    
    67,430Other intangible assets, net
    
    
    18,180
    
    
    
    18,361Other assets
    
    
    7,616
    
    
    
    5,872Total assets
    
    $
    552,225
    
    
    $
    520,920Liabilities and Stockholders EquityLiabilities
Reserves for losses and loss adjustment expenses (includes related parties - 2005: $23,132; 2004: $23,037)
    
    
    103,808
    
    
    
    93,030Unearned
premium (includes related parties - 2005: $14,636; 2004: $16,921)
    
    
    119,567
    
    
    
    90,695Amounts due
reinsurers (includes related parties - 2005: $12,133; 2004: $9,640)
    
    
    28,673
    
    
    
    43,167Deferred revenue
    
    
    28,076
    
    
    
    24,478Federal income taxes payable
    
    
    6,509
    
    
    
    7,526Notes payable
    
    
    30,928
    
    
    
    30,928Consideration due for acquisitions
    
    
    1,068
    
    
    
    1,098Other liabilities
    
    
    22,032
    
    
    
    24,692Total liabilities
    
    
    340,661
    
    
    
    315,614Commitments and contingencies (Note 5)Stockholders equityCommon stock, $0.01 par value; 75,000,000 shares authorized, 16,852,753 and 16,838,519 shares
issued and outstanding at March 31, 2005 and December 31, 2005, respectively
    
    
    169
    
    
    
    168Additional paid-in capital
    
    
    151,976
    
    
    
    151,752Accumulated other comprehensive (loss) income
    
    
    (1,375
    )
    
    
    251Retained earnings
    
    
    60,794
    
    
    
    53,135Total stockholders equity
    
    
    211,564
    
    
    
    205,306Total liabilities and stockholders equity
    
    $
    552,225
    
    
    $
    520,920
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Affirmative Insurance Holdings, Inc. 
 Consolidated Statements of Operations  (Unaudited)
 Three Months Ended March 31, 2005 and 2004
 Three months endedMarch 31,(dollars in thousands, except per share data)
    
    2005
    
    
    2004RevenuesNet premiums earned
    
    $
    67,936
    
    
    $
    47,210Commission income (includes related parties - 2005: $(189); 2004: $649)
    
    
    3,808
    
    
    
    10,924Fee income
    
    
    13,628
    
    
    
    13,491Claims processing fees
    
    
    466
    
    
    
    346Net investment income
    
    
    1,257
    
    
    
    227Realized gains (losses)
    
    
    3
    
    
    
    (17
    )Total revenues
    
    
    87,098
    
    
    
    72,181ExpensesLosses and loss adjustment expenses
    
    
    44,567
    
    
    
    31,708Policy acquisition expenses
    
    
    14,503
    
    
    
    12,653Employee compensation and benefits
    
    
    9,359
    
    
    
    10,679Depreciation and amortization
    
    
    1,029
    
    
    
    884Operating expenses
    
    
    4,626
    
    
    
    4,283Interest expense
    
    
    579
    
    
    
    217Total expenses
    
    
    74,663
    
    
    
    60,424Net income before income taxes, minority interest
and equity interest in unconsolidated subsidiaries
    
    
    12,435
    
    
    
    11,757Income tax expense
    
    
    4,406
    
    
    
    4,207Minority interest, net of income taxes
    
    
    33
    
    
    
    95Equity interest in unconsolidated subsidiaries, net of income taxes
    
    
    
    
    
    
    173Net income
    
    $
    7,996
    
    
    $
    7,282Net income per common share  Basic
    
    $
    0.47
    
    
    $
    0.63Net income per common share  Diluted
    
    $
    0.47
    
    
    $
    0.62Weighted average shares outstandingBasic
    
    
    16,845,934
    
    
    
    11,582,422Diluted
    
    
    17,119,853
    
    
    
    11,700,663
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Affirmative Insurance Holdings, Inc. 
 Consolidated Statements of Stockholders Equity and Comprehensive Income  (Unaudited)
 Three Months Ended March 31, 2005 and 2004
 AccumulatedAdditional
    
    
    
    
    
    
    Other
    
    
    TotalCommon Stock
    
    
    
    
    
    
    Paid-in
    
    
    Retained
    
    
    Comprehensive
    
    
    StockholdersShares
    
    
    Amount
    
    
    Warrants
    
    
    Capital
    
    
    Earnings
    
    
    Income (Loss)
    
    
    Equity(dollars in thousands, except share data)Balance, December 31, 2003
    
    
    11,557,215
    
    
    $
    116
    
    
    $
    157
    
    
    $
    84,074
    
    
    $
    29,039
    
    
    $
    (9
    )
    
    $
    113,377Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,282
    
    
    
    
    
    
    
    7,282Other comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    272
    
    
    
    272Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,554Issuance of common stock
    
    
    114,668
    
    
    
    1
    
    
    
    (157
    )
    
    
    1,156
    
    
    
    
    
    
    
    
    
    
    
    1,000Balance, March 31, 2004
    
    
    11,671,883
    
    
    $
    117
    
    
    $
    
    
    
    $
    85,230
    
    
    $
    36,321
    
    
    $
    263
    
    
    $
    121,931Balance, December 31, 2004
    
    
    16,838,519
    
    
    $
    168
    
    
    $
    
    
    
    $
    151,752
    
    
    $
    53,135
    
    
    $
    251
    
    
    $
    205,306Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,996
    
    
    
    
    
    
    
    7,996Other comprehensive loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,626
    )
    
    
    (1,626
    )Total comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,370Dividends
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (337
    )
    
    
    
    
    
    
    (337
    )Equity based compensation
    
    
    14,234
    
    
    
    1
    
    
    
    
    
    
    
    224
    
    
    
    
    
    
    
    
    
    
    
    225Balance, March 31, 2005
    
    
    16,852,753
    
    
    $
    169
    
    
    $
    
    
    
    $
    151,976
    
    
    $
    60,794
    
    
    $
    (1,375
    )
    
    $
    211,564
 3




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Affirmative Insurance Holdings, Inc. 
 Consolidated Statements of Cash Flows  (Unaudited)
 Three Months Ended March 31, 2005 and 2004
 Three months endedMarch 31,2005
    
    
    2004(dollars in thousands)Cash flows from operating activitiesNet income
    
    $
    7,996
    
    
    $
    7,282Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation and amortization
    
    
    1,029
    
    
    
    884Undistributed equity in unconsolidated subsidiaries
    
    
    
    
    
    
    173Equity based compensation
    
    
    23
    
    
    
    Realized (gains) losses
    
    
    (3
    )
    
    
    17Amortization of discount on investment
    
    
    642
    
    
    
    Changes in assets and liabilities:Fiduciary and restricted cash
    
    
    (10,963
    )
    
    
    (2,670
    )Premiums, fees and commissions receivable
    
    
    (20,726
    )
    
    
    (43,935
    )Reserves for loss and loss expenses
    
    
    10,778
    
    
    
    14,983Amounts due reinsurers
    
    
    5,616
    
    
    
    (3,400
    )Receivable from affiliates
    
    
    (733
    )
    
    
    (300
    )Deferred revenue
    
    
    3,598
    
    
    
    4,317Unearned premiums
    
    
    28,872
    
    
    
    23,602Deferred acquisition costs
    
    
    (9,862
    )
    
    
    2,489Other
    
    
    (5,358
    )
    
    
    9,366Net cash provided by operating activities
    
    
    10,909
    
    
    
    12,808Cash flows from investing activitiesProceeds from the sale of bonds
    
    
    2,746
    
    
    
    510Cost of bonds acquired
    
    
    (5,093
    )
    
    
    Purchases of property and equipment
    
    
    (920
    )
    
    
    (862
    )Net cash paid for acquisitions
    
    
    (1,133
    )
    
    
    (1,569
    )Net cash used in investing activities
    
    
    (4,400
    )
    
    
    (1,921
    )Cash flows from financing activitiesPrincipal payments under capital lease obligation
    
    
    
    
    
    
    (53
    )Principal payments on note payable
    
    
    
    
    
    
    (2,824
    )Proceeds from issuance of common stock
    
    
    
    
    
    
    927Dividends paid
    
    
    (337
    )
    
    
    Net cash used in financing activities
    
    
    (337
    )
    
    
    (1,950
    )Net increase in cash and cash equivalents
    
    
    6,172
    
    
    
    8,937Cash and cash equivalents, beginning of period
    
    
    24,096
    
    
    
    14,699Cash and cash equivalents, end of period
    
    $
    30,268
    
    
    $
    23,636
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Affirmative Insurance Holdings, Inc. 
 Notes to Consolidated Financial Statement (Unaudited)
 1. General Affirmative Insurance Holdings, Inc., (we, us, our) is an insurance holding company and
is engaged in underwriting, servicing and distributing non-standard automobile insurance
policies and related products and services to individual consumers in highly targeted
geographic areas. Our subsidiaries include two insurance companies, four underwriting
agencies, five retail agencies with 183 owned and 42 franchise retail store locations as of
March 31, 2005. We offer our products and services in 11 states, including Texas, Illinois,
California and Florida. Our growth has been achieved principally as a result of the
acquisition and integration of six retail and/or underwriting agencies in 2001 and 2002. We
were formerly known as Instant Insurance Holdings, Inc., and we incorporated in Delaware on
June 25, 1998. As a result of a series of transactions commencing on December 21, 2000, Vesta Insurance Group,
Inc. and its subsidiaries (Vesta) owned approximately 98.1% of our issued and outstanding
common stock at June 31, 2004, which were acquired from former stockholders and the purchase of
new common stock directly from us. We completed our initial public offering of our common stock effective July 9, 2004. We issued
4,420,000 additional shares of our common stock and Vesta sold 3,750,000 shares of our common
stock that they owned, at an initial public offering price of $14.00 per share. On July 26,
2004, our underwriters exercised their option to purchase an additional 663,000 shares from us,
and an additional 562,500 shares from Vesta. As of March 31, 2005, Vesta beneficially owned
approximately 42.8% of our issued and outstanding capital stock. 2. Basis of Presentation Our unaudited consolidated financial statements included herein have been prepared in
accordance with accounting principles generally accepted in the United States of America
(GAAP) and include our accounts and the accounts of our operating subsidiaries. All
significant intercompany accounts and transactions have been eliminated in consolidation.
Certain information and footnote disclosures normally included in financial statements prepared
in accordance with GAAP have been condensed or omitted pursuant to rules and regulations of the
Securities and Exchange Commission (SEC) for interim financial reporting. These financial
statements should be read in conjunction with our audited financial statements for the year
ended December 31, 2004 included in our report on Form 10-K filed with the SEC. The interim financial data as of March 31, 2005 and 2004 is unaudited; however, in the opinion
of the Company, the interim data includes all adjustments, consisting only of normal recurring
adjustments, necessary for a fair statement of the results for the interim periods. Reclassification Certain previously reported amounts have been reclassified in order to conform to current year
presentation. Such reclassification had no effects on net income or stockholders equity. Use of Estimates in the Preparation of the Financial Statements Our preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires us to make estimates and assumptions that
affect our reported amounts of assets and liabilities and disclosure of contingent assets and
liabilities at the date of our financial statements and our reported amounts of revenues and
expenses during the reporting period. Actual results could differ materially from those
estimates. These estimates and assumptions are particularly important in determining revenue
recognition, reserves for losses and loss adjustment expenses, deferred policy acquisition
costs, reinsurance receivables and impairment of assets. Stock Based Compensation In December 2002, the FASB issued SFAS No. 148 (SFAS 148), Accounting for Stock-Based
Compensation  Transition and Disclosure.This statement provides alternative methods of
transition for a voluntary change to the fair value based method of accounting for stock-based
employee compensation. It also amends the disclosure requirements of SFAS No. 123 (SFAS
123), Accounting for Stock-Based Compensationto require prominent disclosures in both annual
and interim financial statements about the method of accounting for stock-based employee
compensation and the effect of the method on reported results. We have elected to continue to
apply APB Opinion No. 25 (APB 25) Accounting for Stock Issued to Employeesand related
interpretations in accounting for stock options. 5




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The following table illustrates the effect on our net income and net income per share if we had
applied SFAS 123 to stock-based compensation (in thousands, except per share amounts): Three months endedMarch 31,2005
    
    
    2004Net income, as reported
    
    $
    7,996
    
    
    $
    7,282Deduct: total stock-based compensation expense
determined under fair
value based method for all
awards,
net of related income taxes
    
    
    (197
    )
    
    
    (25
    )Net income, pro forma
    
    $
    7,799
    
    
    $
    7,257Basic earnings per share  as reported
    
    $
    0.47
    
    
    $
    0.63Basic earnings per share  pro forma
    
    $
    0.46
    
    
    $
    0.63Diluted earnings per share  as reported
    
    $
    0.47
    
    
    $
    0.62Diluted earnings per share  pro forma
    
    $
    0.46
    
    
    $
    0.62
 Recently Issued Accounting Standards In March 2004, the Emerging Issues Task Force (EITF) of the FASB reached a consensus on Issue
03-1, The Meaning of Other-Than Temporary Impairment and Its Application to Certain
Investments.EITF 03-1 provides guidance with respect to the meaning of other-than temporary
impairment and its application to investments classified as either available-for-sale or
held-to-maturity under SFAS No. 115, Accounting for Certain Investments in Debt and Equity
Securities,and investments accounted for under the cost method or the equity method. In
September 2004, the FASB issued a Staff Position, FSP EITF 03-1-1, delaying the effective date
for the measurement and recognition guidance included in EITF 03-1, and also issued an exposure
draft, FSP EITF 03-1a, which proposes guidance relating to debt securities that are impaired
because of interest rate and/or sector spread increases. The delay in the effective date for
the measurement and recognition guidance of EITF 03-1 did not suspend existing requirements for
assessing whether investment impairments are other-than-temporary. We do not anticipate that
this will have a material impact on our financials, as our investment portfolio is primarily
comprised of A rated bonds. In December 2004, the FASB issued SFAS No. 123R (SFAS 123R), Share-Based Compensation,which
is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation,and
supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees,and its related
implementation guidance. SFAS 123R focuses primarily on accounting for transactions in which
an entity obtains employee services in share-based payment transactions. This statement
requires a public entity to measure the cost of employee services received in exchange for an
award of equity instruments based on the grant-date fair value of the award (with limited
exceptions). That cost will be recognized over the period during which an employee is required
to provide service in exchange for the award, the requisite service period. No compensation
cost is recognized for equity instruments for which employees do not render the requisite
service. SFAS 123R is effective for public entities that do not file as small business issuers
as of the beginning of the first interim or annual reporting period that begins after December
31, 2005. We anticipate adopting the provisions of SFAS 123R in January 2006. We are
currently evaluating the requirements and the potential impact of SFAS 123R and have not yet
determined if SFAS 123R will have a material impact on our future operations. 3. Reinsurance The effect of reinsurance on premiums written and earned is as follows (dollars in thousands): Three months ended
    
    
    Three months endedMarch 31, 2005
    
    
    March 31, 2004Written
    
    
    Earned
    
    
    Written
    
    
    EarnedDirect
    
    $
    55,168
    
    
    $
    45,011
    
    
    $
    51,612
    
    
    $
    32,739Assumed  affiliate
    
    
    11,317
    
    
    
    13,603
    
    
    
    22,392
    
    
    
    22,021Assumed  non affiliate
    
    
    38,617
    
    
    
    17,195
    
    
    
    5,752
    
    
    
    1,393Ceded  affiliate
    
    
    
    
    
    
    (309
    )
    
    
    (259
    )
    
    
    (1,170
    )Ceded  non affiliate
    
    
    (992
    )
    
    
    (7,564
    )
    
    
    (33,216
    )
    
    
    (7,773
    )$
    104,110
    
    
    $
    67,936
    
    
    $
    46,281
    
    
    $
    47,210
 6




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The amount of unpaid loss and loss adjustment expenses and unearned premium we would remain
liable for in the event our reinsurers are unable to meet their obligations are as follows
(dollars in thousands): As of March 31,
    
    
    As of December 31,2005
    
    
    2004AffiliateLoss and loss
adjustment expense
    
    $
    21,385
    
    
    $
    23,815Unearned premiums
    
    
    401
    
    
    
    656Total
    
    $
    21,786
    
    
    $
    24,471Non affiliateLoss and loss
adjustment expense
    
    $
    16,713
    
    
    $
    18,087Unearned premiums
    
    
    3,114
    
    
    
    13,530Total
    
    $
    19,827
    
    
    $
    31,617
 As of and for the three months ended, March 31, 2005, we have ceded $6.8 million of paid
losses and $3.5 million of incurred losses to various reinsurers. Effective December 31, 2004, we terminated two ceded quota share reinsurance agreements with
unaffiliated reinsurers on a run-off basis for business written through our underwriting
agencies in the states of Illinois, Indiana, Missouri, New Mexico and South Carolina.
Effective December 31, 2004, we terminated two quota share reinsurance agreements with Old
American County Mutual Fire Insurance Company on a run-off basis, where we had assumed
business written through our underwriting agencies in the state of Texas. Effective January 1, 2005, we entered into two quota share reinsurance agreements with Old
American County Mutual Fire Insurance Company, where we will assume 100% of the business
written through our underwriting agencies in the state of Texas. Effective May 1, 2004, we entered into a quota share reinsurance agreement with an
unaffiliated reinsurer to cede 25% of the business written through our Florida underwriting
agency. This contract continues in force until terminated by us or our reinsurer at any April
30 with not less than 90 days prior notice. Effective May 1, 2005, we have amended this
agreement and will continue ceding 25% of the business written through our Florida
underwriting agency to the unaffiliated reinsurer at substantially the same terms and
conditions. The reinsurance under this agreement is provided by Folksamerica, which reinsures
100% of the premium we cede. Folksamerica is rated A by A.M. Best. All of our quota share reinsurance agreements contain provisions for sliding scale
commissions, under which the commission paid to us varies with the loss ratio results under
each contract. The effect of this feature in the quota share reinsurance agreements is to
limit the reinsurers aggregate exposure to loss and thereby reduce the ultimate cost to us as
the ceding company. These features also have the effect of reducing the amount of protection
relative to the quota share amount of premiums ceded by us. Before entering into these
reinsurance agreements, and based on our prior operating history, we concluded that each
agreement met the risk transfer test of SFAS No. 113 (SFAS 113) Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contractsas the reinsurers assume significant
risk and have a reasonable possibility of significant loss. On November 4, 2004, The Hawaiian Insurance & Guaranty Company, Ltd. (Hawaiian) was named
among a group of four other named defendants and twenty unnamed defendants in a complaint
filed in the Superior Court of the State of California for the County of Los Angeles alleging
causes of action as follows: enforcement of coverage under Hawaiians policy of an underlying
default judgment plaintiff obtained against Hawaiians former insured, who was denied a
defense in the underlying lawsuit due to his failure to pay the Hawaiian policy premium;
ratification and waiver of policy lapse and declaratory relief against Hawaiian; breach of
implied covenant of good faith and fair dealing against Hawaiian with the plaintiff as the
assignee of the insured; intentional misconduct as to the defendant SCJ Insurance Services;
and professional negligence as to the defendants Prompt Insurance Services, Paul Ruelas, and
Anthony David Medina. The plaintiff is seeking to enforce an underlying default judgment
obtained against Hawaiians insured on September 24, 2004 in the amount of $35,000,643 and
additional bad faith damages including punitive damages in the amount of $35,000,000. Affirmative Insurance Company, a wholly-owned subsidiary of Affirmative Insurance Holdings,
Inc. (Affirmative), is a party to a 100% quota share reinsurance agreement with Hawaiian and
is sharing in the defense of this matter. Hawaiian is ultimately a wholly-owned subsidiary of
Vesta Insurance Group, Inc. which is a 42.9% stockholder of Affirmative. The other named
defendants, SCJ Insurance Services, Prompt Insurance Services, Paul Ruelas, and Anthony David
Medina, are unaffiliated persons to Affirmative. This matter is currently proceeding through pre-trial discovery and depositions of pertinent
witnesses in preparation for a September 6, 2005 trial date. Hawaiian and the other
defendants thereto believe these allegations are without merit and are vigorously contesting
the claims brought by the plaintiffs and exercising all available rights and remedies against
them; however, the ultimate outcome of this matter is uncertain. 7




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##### Table of Contents



4. Related Party Transactions We provide various services for Vesta and its subsidiaries, including underwriting, premium
processing, and claims processing. For the three months ended March 31, the accompanying
unaudited consolidated statements of operations reflect these services as follows (dollars in
thousands): Three months endedMarch 31,2005
    
    
    2004Commission income
    
    $
    (189
    )
    
    $
    649
 In addition, we have presented, in the accompanying consolidated balance sheets, the following
amounts related to contracts with Vesta and its subsidiaries (dollars in thousands): March 31,
    
    
    December 31,2005
    
    
    2004AssetsPremiums and fees receivable
    
    $
    33,887
    
    
    $
    30,980Commissions receivable
    
    
    3,038
    
    
    
    5,136Receivable from reinsurer
    
    
    25,099
    
    
    
    28,873Receivable from affiliates
    
    
    1,043
    
    
    
    310$
    63,067
    
    
    $
    65,299LiabilitiesLoss and loss adjustment expense
    
    $
    23,132
    
    
    $
    23,037Unearned premium
    
    
    14,636
    
    
    
    16,921Amounts due reinsurers
    
    
    12,133
    
    
    
    9,640$
    49,901
    
    
    $
    49,598
 As part of the terms of the acquisition of Affirmative Insurance Company and Insura Property
and Casualty Insurance Company from Vesta, Vesta 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 March 31, 2005, all such unaffiliated reinsurers
had A.M. Best ratings of A- or better. 5. Commitments and Contingencies We and our subsidiaries are named from time to time as defendants in various legal actions
arising in the ordinary course of our business and arising out of or related to claims made in
connection with our insurance policies, claims handling and employment related disputes. The
plaintiffs in some of these lawsuits have alleged bad faith or extra-contractual damages and
some have claimed punitive damages. We believe that the resolution of these legal actions will
not have a material adverse effect on our financial position or results of operations. InsureOnes former president, James Hallberg, is a defendant, along with eight former
employees of InsureOne and two of Hallbergs family trusts, in actions we brought in the
Circuit Court of Cook County, Illinois in December 2003 and in the United States District
Court for the Eastern District of Missouri in February 2004 to enforce non-compete and
non-solicitation agreements entered into with those employees. Both courts entered interim
orders prohibiting all defendants, including Hallberg, from hiring any employees of InsureOne
or one of AIHIs other underwriting agencies. The order expired in the Missouri action in
November of 2004, but is still in effect in the Illinois action until the conclusion of the
trial of the Illinois action, which is currently scheduled to begin in August of 2005. On May
17, 2004, the former president of InsureOne filed a counterclaim in the Illinois case seeking
unspecified compensatory damages, specific performance, attorneys fees and court costs based
on causes of action for breach of contract, fraud, negligent misrepresentation and breach of
fiduciary duty in connection with Vestas original acquisition of the InsureOne business in
2002, the claimants employment with InsureOne and our purchase of the 20% minority interest
in InsureOne in 2003. We filed a motion to dismiss these counterclaims, which was granted in
part and denied in part. Hallberg subsequently filed amended counterclaims based on causes of
action for breach of contract, fraud, and breach of fiduciary duty. We have answered those
counterclaims, and believe the counterclaims are without merit. We are vigorously contesting
the counterclaims and are exercising all rights and remedies available to us. In the Missouri
action, the parties filed a joint motion for voluntary dismissal which was granted by the
Court without prejudice and provided for the right of each party to re-file. 8




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##### Table of Contents



On May 6, 2004, the former minority owners of our InsureOne retail agency, including
InsureOnes former president, in his capacity as trustee of one of his family trusts, filed a
complaint in the United States District Court for the Northern District of Illinois alleging
causes of action against us and three of our executive officers under Section 10(b) of the
Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, as well as causes of
action for fraudulent misrepresentation, negligent misrepresentation and breach of fiduciary
duty in connection with our purchase of the plaintiffs 20% minority interest in this retail
agency in 2003. The plaintiffs sought damages equal to the difference between the amount paid
for the 20% interest and the courts determination of the value of this interest, plus
attorneys fees and court costs. Defendants filed a motion to dismiss this case, which was
granted by the Court on March 8, 2005. The Courts March 8, 2005 Order dismissed all claims
without prejudice and granted plaintiffs 20 days from the date of the order to attempt to
replead their claims. On May 2, 2005, plaintiffs filed a motion to voluntarily dismiss this
matter without prejudice, which was granted by the Court. Plaintiffs may still bring these
claims in federal court at a later date, or alternatively, the plaintiffs may file the state
law claims in state court. We believe these claims are without merit, and should the
plaintiffs choose to refile them, we will vigorously contest the claims and exercise all
rights and remedies available to us. On November 4, 2004, The Hawaiian Insurance & Guaranty Company, Ltd. (Hawaiian) was named
among a group of four other named defendants and twenty unnamed defendants in a complaint filed
in the Superior Court of the State of California for the County of Los Angeles alleging causes
of action as follows: enforcement of coverage under Hawaiians policy of an underlying default
judgment plaintiff obtained against Hawaiians former insured, who was denied a defense in the
underlying lawsuit due to his failure to timely pay the Hawaiian policy premium; ratification
and waiver of policy lapse and declaratory relief against Hawaiian; breach of implied covenant
of good faith and fair dealing against Hawaiian with the plaintiff as the assignee of the
insured; intentional misconduct as to the defendant SCJ Insurance Services; and professional
negligence as to the defendants Prompt Insurance Services, Paul Ruelas, and Anthony David
Medina. The plaintiff is seeking to enforce an underlying default judgment obtained against
Hawaiians insured on September 24, 2004 in the amount of $35,000,643, and additional bad faith
damages including punitive damages in the amount of $35,000,000. Affirmative Insurance Company, our wholly owned subsidiary is a party to a 100% quota share
reinsurance agreement with Hawaiian and is sharing in the defense of this matter. Hawaiian is
ultimately a wholly-owned subsidiary of Vesta, which owns 42.9% of our common stock. The other
named defendants SCJ Insurance Services, Prompt Insurance Services, Paul Ruelas, and Anthony
David Medina are unaffiliated persons to Affirmative. This matter is currently proceeding through pretrial discovery and depositions of pertinent
witnesses in preparation for a September 6, 2005 trial date. Hawaiian and the other defendants
thereto believe these allegations are without merit and are vigorously contesting the claims
brought by the plaintiffs and exercising all available rights and remedies against them;
however, the ultimate outcome of this matter is uncertain. 6. Credit Facility On August 6, 2004, we entered into a senior secured credit facility with The Frost National
Bank. Under this credit facility, the maximum amount available to us from time to time is $15.0
million, which may include up to $15.0 million under a two-year revolving line of credit, up to
$10.0 million in five-year term loans and up to $10.0 million in five-year stand-by letters of
credit. The borrowings under our credit facility will initially accrue interest at an annual
rate of LIBOR plus 1.50% and we will pay letter of credit fees based on an initial annual rate
of 0.75%. Our obligations under the facility are guaranteed by our material operating
subsidiaries (other than our insurance companies) and are secured by a first lien security
interest on all of our assets and the assets of our material operating subsidiaries (other than
our insurance companies), including a pledge of 100% of the stock of Affirmative Insurance
Company. The facility contains certain financial covenants, which
include combined ratio, risk-based capital requirement, fixed charge coverage ratio,
consolidated net worth and consolidated net income requirements and other restrictive covenants
governing distributions and management changes. The proceeds are available to issue letters of
credit securing our obligations under reinsurance agreements, to fund general working capital
for our agency operations, capital surplus for our insurance companies and to finance
acquisition activities. During the three months ended March 31, 2005, we executed letters of
credit under this credit facility of approximately $2.3 million to collateralize a loss
corridor position with certain of our reinsurers. Total fees were approximately $13,000. As
of March 31, 2005, there were no outstanding loan amounts due under our credit facility, and we
are in compliance with all of our financial and other restrictive covenants. 7. Stockholders Equity In January 2005, we issued 6,734 shares of common stock to certain of our Board of Directors,
in lieu of cash as their annual retainer. In February 2005, we issued 7,500 shares of common
stock to certain of our Board of Directors for compensation related to services performed. We
recorded prepaid expense for these grants of approximately $225,000 at the date of the grant
and are amortizing the amount to compensation expense over the service period. Total
compensation expense recorded for the three months ended March 31, 2005 was approximately
$23,000. 9




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##### Table of Contents



8.
    Earnings per ShareThe provisions of SFAS No. 128 (SFAS 128) Earnings per Sharerequire presentation of both
basic and diluted earnings per share. A reconciliation of the numerators and denominators of
the basic and diluted earnings per share computations as required by SFAS 128 is presented
below: Income
    
    
    Shares
    
    
    Per Share(Numerator)
    
    
    (Denominator)
    
    
    Amount(dollars in thousands, except number ofshares and per share amounts)Three months ended March 31, 2005Basic Earnings per ShareNet Income
    
    $
    7,996
    
    
    
    16,845,934
    
    
    $
    0.47Diluted Earnings per ShareNet Income
    
    $
    7,996
    
    
    
    16,845,934
    
    
    $
    0.47Effect of Dilutive Securities
    
    
    
    
    
    
    273,919
    
    
    
    $
    7,996
    
    
    
    17,119,853
    
    
    $
    0.47Three months ended March 31, 2004Basic Earnings per ShareNet Income
    
    $
    7,282
    
    
    
    11,582,422
    
    
    $
    0.63Diluted Earnings per ShareNet Income
    
    $
    7,282
    
    
    
    11,582,422
    
    
    $
    0.63Effect of Dilutive Securities
    
    
    
    
    
    
    118,241
    
    
    
    (0.01
    )$
    7,282
    
    
    
    11,700,663
    
    
    $
    0.62
  9.
    Segment InformationIn June 1997, the FASB issued SFAS No. 131 (SFAS 131) Disclosures about Segments of an
Enterprise and Related Information. SFAS 131 defines an operating segment as a component of an
enterprise if it meets the following criteria: (1) it engages in business activities from which
it may earn revenue and incur expenses; (2) whose operating results are regularly reviewed by
the enterprises chief operating decision maker; and (3) for which discrete financial
information is available.We have reflected the requirements of SFAS 131 for the three months ended March 31, 2005 and
2004 in the following tables for our three operating segments: agency segment, insurance
segment, and corporate segment.Our agency segment is comprised of our underwriting agencies and our retail agencies. Our
underwriting agencies primarily design, distribute and service policies issued or reinsured by
our insurance companies or another unaffiliated insurance company. In our insurance segment,
we issue non-standard personal automobile insurance policies through our two
Illinois-domiciled insurance company subsidiaries. Our insurance companies possess the
certificates of authority and capital necessary to transact insurance business and issue
policies, but they rely on both affiliated and unaffiliated underwriting agencies to design,
distribute and service those policies. 10




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##### Table of Contents



Agency
    
    
    Insurance
    
    
    Corporate
    
    
    
    
    
    
    AffirmativeThree months ended March 31, 2005
    
    Segment
    
    
    Segment
    
    
    Segment
    
    
    Eliminations
    
    
    Consolidated(dollars in thousands)Revenues:Net premiums earned
    
    $
    
    
    
    $
    67,936
    
    
    $
    
    
    
    $
    
    
    
    $
    67,936Commission income
    
    
    29,298
    
    
    
    
    
    
    
    
    
    
    
    (25,490
    )
    
    
    3,808Fee income
    
    
    10,847
    
    
    
    6,926
    
    
    
    
    
    
    
    (4,145
    )
    
    
    13,628Claims processing fees
    
    
    7,519
    
    
    
    
    
    
    
    
    
    
    
    (7,053
    )
    
    
    466Investment income
    
    
    46
    
    
    
    1,211
    
    
    
    
    
    
    
    
    
    
    
    1,257Realized gains
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3Total revenues
    
    
    47,713
    
    
    
    76,073
    
    
    
    
    
    
    
    (36,688
    )
    
    
    87,098Expenses:Losses and loss adjustment expenses incurred
    
    
    
    
    
    
    44,567
    
    
    
    
    
    
    
    
    
    
    
    44,567Policy acquisition expenses
    
    
    7,540
    
    
    
    25,158
    
    
    
    
    
    
    
    (18,195
    )
    
    
    14,503Employee compensation and benefits
    
    
    16,612
    
    
    
    147
    
    
    
    
    
    
    
    (7,400
    )
    
    
    9,359Depreciation and amortization
    
    
    1,029
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,029Operating expenses
    
    
    14,342
    
    
    
    1,013
    
    
    
    364
    
    
    
    (11,093
    )
    
    
    4,626Interest expense
    
    
    
    
    
    
    
    
    
    
    579
    
    
    
    
    
    
    
    579Total expenses
    
    
    39,523
    
    
    
    70,885
    
    
    
    943
    
    
    
    (36,688
    )
    
    
    74,663Net income (loss) before income taxes,
minority interest and equity interest
    
    
    8,190
    
    
    
    5,188
    
    
    
    (943
    )
    
    
    
    
    
    
    12,435Income tax expense (benefit)
    
    
    2,902
    
    
    
    1,839
    
    
    
    (335
    )
    
    
    
    
    
    
    4,406Minority interest, net of tax
    
    
    33
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    33Equity interest in unconsolidated subsidiaries, net of tax
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    $
    5,255
    
    
    $
    3,349
    
    
    $
    (608
    )
    
    $
    
    
    
    $
    7,996Total assets
    
    $
    127,853
    
    
    $
    418,222
    
    
    $
    6,150
    
    
    $
    
    
    
    $
    552,225
 Agency
    
    
    Insurance
    
    
    Corporate
    
    
    
    
    
    
    AffirmativeThree months ended March 31, 2004
    
    Segment
    
    
    Segment
    
    
    Segment
    
    
    Eliminations
    
    
    Consolidated(dollars in thousands)Revenues:Net premiums earned
    
    $
    
    
    
    $
    47,210
    
    
    $
    
    
    
    $
    
    
    
    $
    47,210Commission income
    
    
    25,400
    
    
    
    
    
    
    
    
    
    
    
    (14,476
    )
    
    
    10,924Fee income
    
    
    10,914
    
    
    
    7,103
    
    
    
    
    
    
    
    (4,526
    )
    
    
    13,491Claims processing fees
    
    
    6,225
    
    
    
    
    
    
    
    
    
    
    
    (5,879
    )
    
    
    346Investment income
    
    
    18
    
    
    
    209
    
    
    
    
    
    
    
    
    
    
    
    227Realized gains (losses)
    
    
    1
    
    
    
    (18
    )
    
    
    
    
    
    
    
    
    
    
    (17
    )Total revenues
    
    
    42,558
    
    
    
    54,504
    
    
    
    
    
    
    
    (24,881
    )
    
    
    72,181Expenses:Losses and loss adjustment expenses incurred
    
    
    
    
    
    
    31,708
    
    
    
    
    
    
    
    
    
    
    
    31,708Policy acquisition expenses
    
    
    8,035
    
    
    
    18,026
    
    
    
    
    
    
    
    (13,408
    )
    
    
    12,653Employee compensation and benefits
    
    
    14,667
    
    
    
    
    
    
    
    
    
    
    
    (3,988
    )
    
    
    10,679Depreciation and amortization
    
    
    884
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    884Operating expenses
    
    
    10,881
    
    
    
    887
    
    
    
    
    
    
    
    (7,485
    )
    
    
    4,283Interest expense
    
    
    
    
    
    
    
    
    
    
    217
    
    
    
    
    
    
    
    217Total expenses
    
    
    34,467
    
    
    
    50,621
    
    
    
    217
    
    
    
    (24,881
    )
    
    
    60,424Net income (loss) before income taxes,
minority interest and equity interest
    
    
    8,091
    
    
    
    3,883
    
    
    
    (217
    )
    
    
    
    
    
    
    11,757Income tax expense (benefit)
    
    
    2,895
    
    
    
    1,390
    
    
    
    (78
    )
    
    
    
    
    
    
    4,207Minority interest, net of tax
    
    
    95
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    95Equity interest in unconsolidated subsidiaries, net of tax
    
    
    
    
    
    
    
    
    
    
    173
    
    
    
    
    
    
    
    173Net income (loss)
    
    $
    5,101
    
    
    $
    2,493
    
    
    $
    (312
    )
    
    $
    
    
    
    $
    7,282Total assets
    
    $
    156,304
    
    
    $
    250,529
    
    
    $
    1,259
    
    
    $
    
    
    
    $
    408,092
 11




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##### Table of Contents



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should
be read in conjunction with our unaudited consolidated financial statements and related notes
thereto presented in this Form 10-Q and our annual report on Form 10-K for the year ended December
31, 2004. This discussion contains certain statements of a forward-looking nature that involve
risks and uncertainties. As a result of many factors, our actual results may differ materially from
those anticipated by such forward-looking statements. Overview We are an insurance holding company engaged in underwriting, servicing and distributing
non-standard automobile insurance policies and related products and services to individual
consumers in highly targeted geographic areas. Our subsidiaries include two insurance companies,
four underwriting agencies and five retail agencies with 183 owned and 42 franchise retail store
locations. We offer our products and services in 11 states, including Texas, Illinois, California
and Florida. Our insurance companies, underwriting agencies and retail agencies often function as a vertically
integrated unit, capturing the premium (and associated risk) and commission and fee revenue
generated from the sale of each insurance policy. However, each of these operations also works with
unaffiliated entities on an unbundled basis, either functioning independently or with one or both
of the other two operations. 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. We measure the total gross premiums written from which we derive commissions by our underwriting
agencies or premiums by our insurance companies as our Total Controlled Premium. We report
consolidated financial information in three business segments: our agency segment, our insurance
company segment and our corporate segment. The following table displays our Total Controlled Premium by distribution channel for the three
months ended March 31, 2005 and 2004: Three months endedMarch 31,2005
    
    
    2004(Unaudited in thousands)Our underwriting agencies:Our retail stores
    
    $
    41,014
    
    
    $
    37,586Independent agencies
    
    
    47,066
    
    
    
    53,936Unaffiliated underwriting agencies
    
    
    25,088
    
    
    
    27,278Total
    
    $
    113,168
    
    
    $
    118,800
 Total Controlled Premium for the three months ended March 31, 2005 was $113.2 million, a decrease
of $5.6 million, or 4.7%, as compared to $118.8 million for the same period in 2004. The decrease
in Total Controlled Premium is principally due to a decrease in production by our Florida
underwriting agency and the continued run-off of a cancelled unaffiliated underwriting agency
program in California, partially offset by increases in our retail distribution channel from growth
due to acquisitions and store openings in the state of Texas. 12




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##### Table of Contents



Results of Operations The following table summarizes our historical results of operations by reporting segment. For more
detailed information concerning the components of revenues and expenses by segment, please refer to
Note 9 to our consolidated financial statements included in this report. Three months endedMarch 31,2005
    
    
    2004(Unaudited in thousands)Total Revenues:Agency segment
    
    $
    47,713
    
    
    $
    42,558Insurance segment
    
    
    76,073
    
    
    
    54,504Corporate
    
    
    
    
    
    
    Eliminations
    
    
    (36,688
    )
    
    
    (24,881
    )Total
    
    $
    87,098
    
    
    $
    72,181Total Expenses:Agency segment
    
    $
    39,523
    
    
    $
    34,467Insurance segment
    
    
    70,885
    
    
    
    50,621Corporate
    
    
    943
    
    
    
    217Eliminations
    
    
    (36,688
    )
    
    
    (24,881
    )Total
    
    $
    74,663
    
    
    $
    60,424Pretax Income:Agency segment
    
    $
    8,190
    
    
    $
    8,091Insurance segment
    
    
    5,188
    
    
    
    3,883Corporate
    
    
    (943
    )
    
    
    (217
    )Total
    
    $
    12,435
    
    
    $
    11,757
 Comparison of the Three Months Ended March 31, 2005 to March 31, 2004 Consolidated.Total revenues for the three months ended March 31, 2005 were $87.1 million, an
increase of $14.9 million, or 20.7%, as compared to total revenues of $72.2 million for the same
period in 2004. Total expenses for the three months ended March 31, 2005 were $74.7 million, an increase of $14.2
million, or 23.6%, as compared to total expenses of $60.4 million for the same period in 2004. Pretax net income increased approximately $678,000, or 5.8%, to $12.4 million for the three months
ended March 31, 2005 from $11.8 million for the same period in 2004. This increase is due to our
increase in revenues of $14.9 million or 20.7% for the three months ended March 31, 2005, offset by
an increase in expenses of $14.2 million, or 23.6%. The increase in revenues is due to an increase
in the retention of gross premiums written, partially offset by a decrease in commissions due to
consolidation. The increase in expenses was, primarily, due to an increase in our loss and loss
adjustment and policy and acquisition expenses due to the increased retention of gross premiums and
new general and administrative expenses due to our initial public offering and increased litigation
costs. Income tax expense for the three months ended March 31, 2005 was $4.4 million, or an effective rate
of 35.4%, as compared to income tax expense of $4.2 million, or an effective rate of 35.8% for the
same period in 2004. The decrease in our effective rate is primarily related to an increased
amount of tax-exempt interest from our insurance companies investment portfolios. We invested a
large portion of the proceeds from our initial public offering and the cash generated by our
insurance companies in tax-exempt securities to reduce our effective tax rate. For the three months ended March 31, 2005, minority interest, net of income taxes, was $33,000 as
compared to $95,000 for the same period in 2004, as a result of a decrease in net income in our
Florida underwriting agency. 13




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##### Table of Contents



Agency segment.Total revenues for the three months ended March 31, 2005 were $47.7 million, an
increase of $5.2 million, or 12.1%, as compared to total revenues of $42.6 million for the same
period in 2004. Revenues for the three months ended March 31, 2005 and 2004 were generated
primarily through commissions, policy fees and claims processing fees, as follows: Three months endedMarch 31,2005
    
    
    2004(Unaudited in millions)Commissions
    
    $
    29.3
    
    
    $
    25.4Policy and other fees
    
    
    10.9
    
    
    
    10.9Claims processing fees
    
    
    7.5
    
    
    
    6.2Total
    
    $
    47.7
    
    
    $
    42.5
 Commissions for the three months ended March 31, 2005 were $29.3 million, an increase of $3.8
million, or 15.1%, as compared to commissions of $25.4 million for the same period in 2004. We
earned commissions in both our underwriting agencies and retail agencies. Commissions for our
underwriting agencies, which include both provisional and profit-sharing commissions, for the three
months ended March 31, 2005 were $26.6 million, an increase of $3.0 million, or 12.5%, as compared
to $23.6 million for the same period in 2004. Provisional commissions for our underwriting agencies for the three months ended March 31, 2005
were $23.8 million, an increase of $2.1 million, or 9.9%, as compared to $21.6 million for the same
period in 2004. The increase in provisional commissions was principally due to an increase in the
average commission rate, which increased to 27.0% in the first quarter of 2005 from 23.6% in the
same period of the prior year, partially offset by a decrease in Total Controlled Premium produced
by our underwriting agencies. Profit sharing commissions for our underwriting agencies for the three months ended March 31, 2005
were $2.8 million, an increase of $809,000, or 40.7%, as compared to $2.0 million for the same
period in 2004. The increase in profit sharing commissions was principally a result of favorable
loss ratio development for business produced by our underwriting agencies as compared to loss
ratios recorded as of the beginning of the period. Commissions related to our retail agencies sales of unaffiliated insurance companies products
were $2.7 million for the three months ended March 31, 2005, an increase of $943,000, or 52.9%, as
compared to $1.8 million for the same period in 2004, primarily due to the acquisition of Fed USA
in December 2004. The Fed USA acquisition added 24 owned and 42 franchise retail store locations
which service the Florida market. Policy and other fees for the three months ended March 31, 2005 were $10.9 million, a decrease of
$67,000 as compared to $10.9 million for the same period in 2004. The comparability between periods
was principally due to an increase in our retention rate, which resulted in an increase in the
deferral, as well as our decreased premium volume in our Florida underwriting agency. Claims processing fees for the three months ended March 31, 2005 were $7.5 million, an increase of
$1.3 million, or 20.8%, as compared to $6.2 million for the same period of 2004. The increase in
claims fees was principally due to the increase in the average rate paid to us and recognized for
claims fees to 10.6% in the first quarter of 2005, as compared to 8.8% in the first quarter of
2004. The increase in the average rate for claims fees is primarily due to contractual changes
where our payment of allocated loss adjustment expenses is included in all our claims
administration contracts starting in 2004, where previously our payment of allocated loss
adjustment expenses was only in some of our contracts. Total expenses for the three months ended March 31, 2005 were $39.5 million, an increase of $5.1
million, or 14.7%, as compared to total expenses of $34.5 million for the same period in 2004.  
    Policy acquisition expenses, comprised solely of commission expenses
in our agency segment, for the three months ended March 31, 2005 were
$7.5 million, a decrease of $495,000, or 6.2%, as compared to $8.0
million for the same period in 2004, principally due to the decrease
in premiums written and partially offset by an increase in average
commission rate to 15.9% from 14.9% during the prior year. The
increase in average commission rate was primarily caused by a higher
proportion of our premiums written in markets where we pay higher
commission rates.
    Employee compensation and benefit expenses for the three months ended
March 31, 2005 were $16.6 million, an increase of $1.9 million, or
13.3%, as compared to $14.7 million for the same period in 2004. The
increase in employee compensation and benefit expenses was principally
due to increased headcount to 1,222 for the three months ended March
31, 2005 as compared to 1,103 for the same period in 2004, principally
related to the Fed USA acquisition, which added 97 employees.
    Depreciation and amortization expenses for the three months ended
March 31, 2005 were $1.0 million, an increase of $145,000, or 16.4%,
as compared to $884,000 for the same period in 2004. The increases in
depreciation and amortization expenses were principally due to
increases in software and hardware purchases as well as the
acceleration of amortization and depreciation of certain software
assets to match their estimated remaining lives, in anticipation of
replacing these systems with a new operating system in the second half
of 2005. 14




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
    Operating expenses for the three months ended March 31, 2005 were
$14.3 million, an increase of $3.5 million, or 31.8%, as compared to
$10.9 million for the same period of 2004. The increase in operating
expenses was principally due to increased payments of allocated loss
adjustment expenses of $1.4 million as well as increases in front fees
and premium taxes of $500,000. The increase in allocated loss
adjustment expense payments is a result of changes in contractual
terms where our payment of allocated loss adjustment expenses in
included in all of our claims administration contracts starting in
2004, where previously our payment of allocated loss adjustment
expenses was only included in some of our contracts. In addition,
advertising expenditures increased $1.0 million over the prior period
principally due to continued expansion of our retail branding and
professional fees increases $400,000 over the prior periods due to
increased audit fees. Pretax income for the three months ended March 31, 2005 was $8.2 million, an increase of $99,000,
or 1.2%, as compared to pretax income of $8.1 million for the same period in 2004. The pretax
margin for the three months ended March 31, 2005 was 17.2%, a decrease from the 19.0% pre-tax
margin recorded in the same period in 2004. Insurance company segment.Total revenues for the three months ended March 31, 2005 were $76.1
million, an increase of $21.6 million, or 39.6%, as compared to total revenues of $54.5 million for
the same period in 2004. The increase in total revenues was principally due to our continued
increased retention of gross premiums written by our insurance companies. Following our initial
public offering in July 2004 and the issuance of trust preferred securities in December 2004, we
were able to increase retention amounts at July 2004 and, again, at January 2005. We retained
approximately 92.0% of our Total Controlled Premium for the three months ended March 31, 2005, as
compared to 39.0% in the same period in 2004. Net investment income for the three months ended March 31, 2005 was $1.2 million, an increase of
$1.0 million from net investment income of $209,000 for the same period in 2004. The increase is
primarily due to the increase in the size of our investment portfolio due to the capital
contributions into our insurance subsidiaries after our initial public offering and the issuance of
trust preferred securities, as well as increased cash flow resulting from the increased retention
of gross premiums written. Net realized capital gains for the three months ended March 31, 2005
were zero compared to net realized capital losses of $18,000 for the same period in 2004. Loss and loss adjustment expenses for the three months ended March 31, 2005, were $44.6 million
compared to $31.7 million for the same period in 2004. Our loss and loss adjustment expense ratio
for the three months ended March 31, 2005 was 59.5%, as compared to 58.4% in the same period in
2004. The increase in loss and loss adjustment expenses was due to our increased retention of
gross premiums written as previously discussed. Policy acquisition and operating expenses for the three months ended March 31, 2005 were $26.3
million, and increase of $7.4 million, or 39.2% compared to $18.9 million for the same period in
2004. The increase in policy acquisition and operating expenses was due to our increased retention
of gross premiums written as previously discussed. Our expense ratio for the three months ended
March 31, 2005 was 35.2%, as compared to 34.8% for the same period in 2004. Pretax income for the three months ended March 31, 2005 was $5.2 million, an increase of $1.3
million, or 33.6%, as compared to $3.9 million for the same period in 2004. The increase in pretax
income was principally a result of the increased retention of the business being retained starting
January 1, 2004 and increasing at July 2004 and January 2005 as previously discussed. Our combined
ratio for the three months ended March 31, 2005 was 94.7%, as compared to 93.2% for the same period
in 2004. Corporate and other segment.Operating expense for the three months ended March 31, 2005 was
$364,000 as compared to zero for the same period in 2004. Operating expenses include investor
relations costs, directors and officers insurance as well as directors fees and travel expenses.
Prior to our initial public offering in July of 2004, we did not incur these expenses. Interest
expense for the three months ended March 31, 2005 was $579,000, as compared to interest expense of
$217,000 for the same period in 2004. The interest expense is primarily related to our $30.9
million note payable, which was issued in December 2004 following our private placement of $30.0
million of trust preferred securities. 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, including our insurance company subsidiaries. There are no restrictions on the payment of dividends by our non-insurance company subsidiaries
other than state corporate laws regarding solvency. As a result, our non-insurance company
subsidiaries generate revenues, profits and net cash flows that are generally unrestricted as to
their availability for the payment of dividends, and we expect to use those revenues to service our
corporate financial obligations, such as debt service and stockholder dividends. As of March 31,
2005, we had $1.5 million of cash and invested assets at the holding company level and $4.9 million
of cash and invested assets 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. 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 December 31 or the insurance companys net
income for the 12-month period ending the preceding December 31, in each case determined in
accordance with statutory accounting practices. In addition, an insurance companys remaining
surplus after payment of a dividend or other distribution to stockholder affiliates must be both
reasonable in relation to its outstanding liabilities and adequate to its financial needs. In 2005,
our insurance companies may pay up to $13.6 million in ordinary dividends without prior regulatory
approval, although we do not anticipate that our insurance company subsidiaries will pay dividends
in the foreseeable future because we intend to reduce our reinsurance purchases and seek stronger
financial strength ratings for our insurance company subsidiaries, both of which will require that
the statutory surplus of our insurance company subsidiaries be increased. 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 March 31, 2005, the capital
ratios of both of our insurance companies substantially exceeded the risk-based capital
requirements. As of March 31, 2005, the capital ratios of both of our insurance companies exceeded
the highest level for regulatory action under the risk-based capital guidelines. 15




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On July 12, 2004, A.M. Best Co. upgraded the financial strength ratings of our insurance
subsidiaries, Affirmative Insurance Company and Insura, to B+ (Very Good) from B (Fair). The
ratings of our insurance companies were removed from review and assigned a stable outlook. Our
rating of B+ (Very Good) is the sixth highest of 15 rating levels. 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. Net cash provided by operating activities was $10.9 million for the three months ended March 31,
2005, as compared to net cash provided by operating activities of $12.8 million for the same period
in 2004. The change in the operating cash flow is principally due to the increased cash flow as a
result of our increased retention of written premiums. This increase was offset by the decrease in
cash flow as a result of the increased fiduciary and restricted cash balance due to the timing of
the settlements on these accounts. Net cash used in investing activities was $4.4 million for the three months ended March 31, 2005,
as compared to net cash used in investing activities of $1.9 million for the same period in 2004.
The increase in cash used in investing activities was primarily due to increases in bonds acquired
by our insurance companies due to increased cash flow. We invest our insurance portfolio funds in highly rated fixed income securities. Our portfolio is
managed by an outside investment advisor on an active basis in compliance with investment policies
provided by us. Information about our investment portfolio is as follows: As ofMarch 31,
    
    
    December 31,($ in thousands)
    
    2005
    
    
    2004Invested assets
    
    $
    158,866
    
    
    $
    159,661Tax equivalent book yield
    
    
    4.15
    %
    
    
    4.03
    %Average duration in years
    
    
    3.7
    
    
    
    3.8Average S&P rating
    
    
    AA+
    
    
    AA+
 Net cash used in financing activities was $0.3 million for the three months ended March 31, 2005,
as compared to net cash used in financing activities of $2.0 million for the same period in 2004.
The decrease in cash used in financing activities was primarily related to payments made during the
first quarter of 2004 on our note payable that we did not make in the first quarter of 2005. We believe that existing cash and investment balances, as well as new cash flows generated from
operations and available borrowings under our credit facility, 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. If such events materialize,
we will identify the source and develop and disclose our plan of action to remedy any deficiency. Initial public offering.We completed our initial public offering of our common stock effective
July 9, 2004. We issued 4,420,000 additional shares of our common stock and Vesta sold 3,750,000
shares of our common stock that they owned, at an initial public offering price of $14 per share.
On July 26, 2004, our underwriters exercised their option to purchase an additional 663,000 shares
from us, and an additional 562,500 shares from Vesta. Our net proceeds from the offering were
$65.3 million, after deducting our offering expenses. We contributed $64.3 million of the net
proceeds to our insurance companies in order to increase their policyholders surplus. Credit facility.On August 6, 2004, we entered into a senior secured credit facility with The
Frost National Bank. Under this credit facility, the maximum amount available to us from time to
time is $15.0 million, which may include up to $15.0 million under a two-year revolving line of
credit, up to $10.0 million in five-year term loans and up to $10.0 million in five-year stand-by
letters of credit. The borrowings under our credit facility will initially accrue interest at an
annual rate of LIBOR plus 1.50% and we will pay letter of credit fees based on an initial annual
rate of 0.75%. Our obligations under the facility are guaranteed by our material operating
subsidiaries (other than our insurance companies) and are secured by a first lien security interest
on all of our assets and the assets of our material operating subsidiaries (other than our
insurance companies), including a pledge of 100% of the stock of Affirmative Insurance Company. The
facility contains certain financial covenants, which include combined ratio, risk-based capital
requirement, fixed charge coverage ratio, consolidated net worth and consolidated net income
requirements, and other restrictive covenants governing distributions and management changes. The
proceeds are available to issue letters of credit securing our obligations under reinsurance
agreements, to fund general working capital for our agency operations, capital surplus for our
insurance companies and to finance acquisitions activities. During the three months ended March
31, 2005, we executed letters of credit under this credit facility of approximately $2.3 million to
collateralize a loss corridor position with certain of our reinsurers. Total fees were
approximately $13,000. As of March 31, 2005, there were no outstanding loan amounts due under our
credit facility, and we are in compliance with all of our financial and other restrictive
covenants. Trust Preferred Securities.On December 21, 2004, our newly formed trust subsidiary completed a
private placement of $30.0 million on 30 year floating rate trust preferred securities.
Simultaneously, we borrowed $30.9 million from the trust subsidiary and contributed $29.0 million
to our insurance companies in order to increase their policyholders surplus. The note bears an
initial interest rate of 7.545% until December 15, 2009, at which time the securities will adjust
quarterly to the 90-day LIBOR rate plus 3.6 percentage points. As of March 31, 2005, the note
balance was $30.9 million. 16




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New Accounting Pronouncements In March 2004, the Emerging Issues Task Force (EITF) of the FASB reached a consensus on Issue
03-1, The Meaning of Other-Than Temporary Impairment and Its Application to Certain Investments.
EITF 03-1 provides guidance with respect to the meaning of other-than temporary impairment and its
application to investments classified as either available-for-sale or held-to-maturity under SFAS
No. 115, Accounting for Certain Investments in Debt and Equity Securities,and investments
accounted for under the cost method or the equity method. In September 2004, the FASB issued a
Staff Position, FSP EITF 03-1-1, delaying the effective date for the measurement and recognition
guidance included in EITF 03-1, and also issued an exposure draft, FSP EITF 03-1a, which proposes
guidance relating to debt securities that are impaired because of interest rate and/or sector
spread increases. The delay in the effective date for the measurement and recognition guidance of
EITF 03-1 did not suspend existing requirements for assessing whether investment impairments are
other-than-temporary. We currently perform an analysis for impairment of investments on a
quarterly basis. We do not anticipate that this will have a material impact on our financials, as
our investment portfolio is primarily comprised of A rated bonds. In December 2004, the FASB issued SFAS No. 123R (SFAS 123R), Share-Based Compensation,which is a
revision of FASB Statement No. 123, Accounting for Stock-Based Compensation,and supersedes APB
Opinion No. 25, Accounting for Stock Issued to Employees,and its related implementation guidance.
SFAS 123R focuses primarily on accounting for transactions in which an entity obtains employee
services in share-based payment transactions. This statement requires a public entity to measure
the cost of employee services received in exchange for an award of equity instruments based on the
grant-date fair value of the award (with limited exceptions). That cost will be recognized over
the period during which an employee is required to provide service in exchange for the award, the
requisite service period. No compensation cost is recognized for equity instruments for which
employees do not render the requisite service. SFAS 123R is effective for public entities that do
not file as small business issuers as of the beginning of the first interim or annual reporting
period that begins after December 31, 2005. We anticipate adopting the provisions of SFAS 123R in
January 2006. We are currently evaluating the requirements and the potential impact of SFAS 123R
and have not yet determined if SFAS 123R will have a material impact on our future operations. Special Note Regarding Forward-Looking Statements Any statement contained in this report which is not a historical fact, or which might otherwise be
considered an opinion or projection concerning the Company or its business, whether express or
implied, is meant as and should be considered a forward-looking statement as that term is defined
in the Private Securities Litigation Reform Act of 1996. Forward-looking statements are based on
assumptions and opinions concerning a variety of known and unknown risks, including but not
necessarily limited to changes in market conditions, natural disasters and other catastrophic
events, increased competition, changes in availability and cost of reinsurance, changes in
governmental regulations, and general economic conditions, as well as other risks more completely
described in our filings with the Securities and Exchange Commission. If any of these assumptions
or opinions prove incorrect, any forward-looking statements made on the basis of such assumptions
or opinions may also prove materially incorrect in one or more respects. 
 Item 3. Quantitative and Qualitative Disclosures About Market Risk We believe that interest rate risk and credit risk are the two types of market risk to which we are
principally exposed. Interest rate risk.Our investment portfolio consists principally of investment-grade, fixed
income securities, all of which are classified as available for sale. 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 three to four years.
The fair value of our fixed income securities as of March 31, 2005 was $158.9 million. The
effective duration of the portfolio as of March 31, 2005 was 3.7 years. Should the market interest
rates increase 1.0%, our fixed income investment portfolio would be expected to decline in market
value by 3.7%, or $5.8 million, representing the effective duration multiplied by the change in
market interest rates. Conversely, a 1.0% decline in interest rates would result in a 3.7%, or
$5.87 million, increase in the market value of our fixed income investment portfolio. 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. As of March 31, 2005, our fixed income investments were invested in
the following: U.S. Treasury securities  3.3%, mortgage-backed securities  10.2%, corporate
securities  15.0%, and tax-exempt securities  71.4%. As of March 31, 2005, all of our fixed
income securities were rated investment grade by nationally recognized statistical rating
organizations. 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. At March 31, 2005, we had a total of $55.3 million of receivables from reinsurers, including $7.0
million net recoverable from Vesta Fire. Our reinsurance agreement with Vesta Fire allows us and
Vesta Fire to offset amounts due to one another under the agreement. Vesta Fire is currently rated
B (Fair) by A.M. Best. According to our reinsurance agreement, if Vesta Fires A.M. Best
financial strength rating remained below B+ we have the right to require Vesta Fire to provide a
letter of credit or establish a trust account to collateralize the net amount due to us from Vesta
Fire under the reinsurance agreement. On July 27, 2004, we notified Vesta to establish a trust
account collateralizing the net amount due to us, due to the fact that Vesta Fires A.M. Best
rating was below a B+. We have $10.3 million currently in a trust account and have notified
Vesta to decrease the collateral held in this account to $7.0 million, which will fully
collateralize the net amount due to us as of March 31, 2005. As part of the terms of the acquisition of Affirmative Insurance Company and Insura, Vesta 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 March 31, 2005, all
such unaffiliated reinsurers had A.M. Best ratings of A- or better. 17




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Effects of inflation.We do not believe that inflation has a material effect on our results of
operations, except for the effect that inflation may have on interest rates and claims costs. The
effects of inflation are considered in pricing and estimating reserves for unpaid claims and claim
expenses. The actual effects of inflation on our results are not known until claims are ultimately
settled. In addition to general price inflation, we are exposed to a persisting long-term upward
trend in the cost of judicial awards for damages. We attempt to mitigate the effects of inflation
in our pricing and establishing of loss and loss adjustment expense reserves. 
 Item 4. Controls and Procedures We carried out an evaluation, under the supervision and with the participation of our principal
executive officer and principal financial officer, of the effectiveness of the design and operation
of our disclosure controls and procedures as of March 31, 2005 pursuant to Rule 13a-15 of the
Securities and Exchange Act of 1934, as amended. Based on this evaluation, our principal executive
officer and principal financial officer concluded that as of March 31, 2005 our disclosure controls
and procedures are effective. Disclosure controls and procedures are controls and procedures designed to ensure that
information required to be disclosed in our reports filed or submitted under the Securities
Exchange Act of 1934 is recorded, processed, summarized and reported within the time period
specified in the SECs rules and forms and include controls and procedures designed to ensure that
information we are required to disclose in such reports is accumulated and communicated to
management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to
allow timely decisions regarding required disclosure. There have been no changes in our internal controls over financial reporting that occurred during
our last fiscal quarter that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. 
 PART II 
 Item 1. Legal Proceedings
 We and our subsidiaries are named from time to time as defendants in various legal actions arising
in the ordinary course of our business and arising out of or related to claims made in connection
with our insurance policies, claims handling and employment related disputes. The plaintiffs in
some of these lawsuits have alleged bad faith or extra-contractual damages and some have claimed
punitive damages. We believe that the resolution of these legal actions will not have a material
adverse effect on our financial position or results of operations. InsureOnes former president, James Hallberg, is a defendant, along with eight former employees of
InsureOne and two of Hallbergs family trusts, in actions we brought in the Circuit Court of Cook
County, Illinois in December 2003 and in the United States District Court for the Eastern District
of Missouri in February 2004 to enforce non-compete and non-solicitation agreements entered into
with those employees. Both courts entered interim orders prohibiting the defendants from hiring any
employees of InsureOne or one of AIHIs other underwriting agencies. The order expired in the
Missouri action in November of 2004, but is still in effect in the Illinois action and prohibits
all defendants, including Hallberg, from hiring any employees of InsureOne et al. until the
conclusion of the trial of the Illinois action. The trial in the Illinois action is currently
scheduled to begin in August of 2005. On May 17, 2004, the former president of InsureOne filed a
counterclaim in the Illinois case seeking unspecified compensatory damages, specific performance,
attorneys fees and court costs based on causes of action for breach of contract, fraud, negligent
misrepresentation and breach of fiduciary duty in connection with Vestas original acquisition of
the InsureOne business in 2002, the claimants employment with InsureOne and our purchase of the
20% minority interest in InsureOne in 2003. InsureOne et al. filed a motion to dismiss these
counterclaims, which was granted in part and denied in part. Hallberg subsequently filed amended
counterclaims based on causes of action for breach of contract, fraud, and breach of fiduciary
duty. InsureOne et al. have answered those counterclaims, and believe the counterclaims are
without merit. We are vigorously contesting the counterclaims and are exercising all rights and
remedies available to us. In the Missouri action, the parties filed a joint motion for voluntary
dismissal which was granted by the Court without prejudice and provided for the right of each party
to re-file. On May 6, 2004, the former minority owners of our InsureOne retail agency, including InsureOnes
former president, in his capacity as trustee of one of his family trusts, filed a complaint in the
United States District Court for the Northern District of Illinois alleging causes of action
against us and three of our executive officers under Section 10(b) of the Securities Exchange Act
of 1934 and Rule 10b-5 promulgated thereunder, as well as causes of action for fraudulent
misrepresentation, negligent misrepresentation and breach of fiduciary duty in connection with our
purchase of the plaintiffs 20% minority interest in this retail agency in 2003. The plaintiffs
sought damages equal to the difference between the amount paid for the 20% interest and the courts
determination of the value of this interest, plus attorneys fees and court costs. Defendants
filed a motion to dismiss this case, which was granted by the Court on March 8, 2005. The Courts
March 8, 2005 Order dismissed all claims without prejudice and granted plaintiffs 20 days from the
date of the order to attempt to replead their claims. On May 2, 2005, plaintiffs filed a motion to
voluntarily dismiss this matter without prejudice, which was granted by the Court. Plaintiffs
may still bring these claims in federal court at a later date, or alternatively, the plaintiffs may
file the state law claims in state court. We believe these claims are without merit, and should the
plaintiffs choose to refile them, we will vigorously contest the claims and exercise all rights and
remedies available to us. 
 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds None. 
 Item 3. Defaults Upon Senior Securities None. 
 Item 4. Submission of Matters to a Vote of Security Holders None. 
 Item 5. Other information None. 18




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Item 6. Exhibits  a)
    EXHIBITS 3.1
    
    Amended and Restated Certificate of Incorporation of Affirmative Insurance Holdings, Inc.
(incorporated by reference to Exhibit 3.1 to our Registration Statement on Form S-1 filed with
the SEC on March 22, 2004, File No. 333-113793).3.2
    
    Amended and Restated Bylaws of Affirmative Insurance Holdings, Inc. (incorporated by
reference to Exhibit 3.2 to our Registration Statement on Form S-1 filed with the SEC on March
22, 2004, File No. 333-113793).4.1
    
    Form of Common Stock Certificate (incorporated by reference to Exhibit 4.1 to Amendment No. 3
to our Registration Statement on Form S-1 filed with the SEC on June 14, 2004, File No.
333-113793).4.2
    
    Form of Registration Rights Agreement between Affirmative Insurance Holdings, Inc. and Vesta
Insurance Group, Inc. (incorporated by reference to Exhibit 4.2 to Amendment No. 2 to our
Registration Statement on Form S-1 filed with the SEC on May 27, 2004, File No. 333-113793).10.1
    
    Form of Stock Option Agreement (incorporated by reference to Exhibit 10.1 to our Current
Report on Form 8-K filed with the SEC on March 1, 2005, File No. 000-50795).10.2
    
    Form of Restricted Stock Agreement (incorporated by reference to Exhibit 10.2 to our Current
Report on Form 8-K filed with the SEC on March 1, 2005, File No. 000-50795).*10.3
    
    Description of Non-Employee Director Compensation*10.4
    
    Quota Share Reinsurance Agreement between Old American County Mutual Fire Insurance Company and Affirmative Insurance
Company dated as of January 1, 2005, for the business written through A-Affordable Managing General Agency, Inc.*10.5
    
    Quota Share Reinsurance Agreement between Old American County Mutual Fire Insurance Company and Affirmative Insurance
Company dated as of January 1, 2005, for the business written through American Agencies General Agency, Inc*31.1
    
    Certification of the Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*31.2
    
    Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.*32.1
    
    Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.*32.2
    
    Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
   *
    
    Filed herewith 
 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: May 16, 2005/s/ Timothy A. BienekBy: Timothy A. BienekExecutive Vice President and Chief Financial Officer(and in his capacity as Principal Financial Officer)
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