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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549





FORM 10-Q





(Mark One)

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

For the quarterly period ended March 31, 2010

OR



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

For the transition period from              to

Commission file number 000-50795





LOGO

(Exact name of registrant as specified in its charter)







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

(972) 728-6300

(Registrants telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)





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

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

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





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

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

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

The number of shares outstanding of the registrants common stock, $.01 par value, as of May 6, 2010: 15,415,358









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AFFIRMATIVE INSURANCE HOLDINGS, INC.

THREE MONTHS ENDED MARCH 31, 2010

INDEX TO FORM 10-Q



|                                                                                                     |  |   
|---------------------------------------------------------------------------------------------------- |  | --
|PART I  FINANCIAL INFORMATION                                                                       |  | 3 
|                                                                                                     | 
|Item 1. Financial Statements                                                                         |  | 3 
|Consolidated Balance Sheets  March 31, 2010 and December 31, 2009                                   |  | 3 
|Consolidated Statements of Income (Loss)  Three Months Ended March 31, 2010 and
2009                |  | 4 
|Consolidated Statements of Stockholders Equity  March 31, 2010 and 2009                            |  | 5 
|Consolidated Statements of Comprehensive Income (Loss)  Three Months Ended March 
31, 2010 and 2009 |  | 5 
|Consolidated Statements of Cash Flows  Three Months Ended March 31, 2010 and
2009                   |  | 6 
|Notes to Consolidated Financial Statements                                                           |  | 7 
|                                                                                                     | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations        |  | 19
|                                                                                                     | 
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                                   |  | 25
|                                                                                                     | 
|Item 4. Controls and Procedures                                                                      |  | 27
|                                                                                                     | 
|PART II  OTHER INFORMATION                                                                          |  | 27
|                                                                                                     | 
|Item 1. Legal Proceedings                                                                            |  | 27
|                                                                                                     | 
|Item 1A. Risk Factors                                                                                |  | 27
|                                                                                                     | 
|Item 6. Exhibits                                                                                     |  | 27
|                                                                                                     | 
|SIGNATURES                                                                                           |  | 28



2



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##### Table of Contents

PART I  FINANCIAL INFORMATION



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

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)



|                                                                                                                                                                            |  |               |         |   |                  |   |         |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                                                                                                                                                                            |  | March 31,2010 |         |   | December 31,2009 |  
|                                                                                                                                                                            |  | (Unaudited)   |         |   |                  |  
|Assets                                                                                                                                                                      |  |               |         |   |                  |   |         |  
|Investment securities, at fair value                                                                                                                                        |  |               |         |   |                  |   |         |  
|Trading securities                                                                                                                                                          |  | $             | 32,503  |   |                  | $ | 37,416  |  
|Available-for-sale securities                                                                                                                                               |  |               | 159,936 |   |                  |   | 213,656 |  
|Cash and cash equivalents                                                                                                                                                   |  |               | 91,960  |   |                  |   | 60,928  |  
|Fiduciary and restricted cash                                                                                                                                               |  |               | 9,461   |   |                  |   | 15,004  |  
|Accrued investment income                                                                                                                                                   |  |               | 2,080   |   |                  |   | 2,823   |  
|Premiums and fees receivable, net                                                                                                                                           |  |               | 70,169  |   |                  |   | 63,344  |  
|Premium finance receivable, net                                                                                                                                             |  |               | 52,181  |   |                  |   | 40,825  |  
|Commissions receivable                                                                                                                                                      |  |               | 1,536   |   |                  |   | 1,362   |  
|Receivable from reinsurers                                                                                                                                                  |  |               | 43,937  |   |                  |   | 42,082  |  
|Deferred acquisition costs                                                                                                                                                  |  |               | 28,945  |   |                  |   | 24,230  |  
|Federal income taxes receivable                                                                                                                                             |  |               | 3,010   |   |                  |   | 3,326   |  
|Investment in real property, net                                                                                                                                            |  |               | 6,032   |   |                  |   | 5,831   |  
|Property and equipment (net of accumulated depreciation of $35,838 for 2010 and $33,581 for 2009)                                                                           |  |               | 40,895  |   |                  |   | 41,984  |  
|Goodwill                                                                                                                                                                    |  |               | 163,570 |   |                  |   | 163,570 |  
|Other intangible assets (net of accumulated amortization of $12,844 for 2010 and $12,765 for 2009)                                                                          |  |               | 16,673  |   |                  |   | 16,752  |  
|Prepaid expenses                                                                                                                                                            |  |               | 6,131   |   |                  |   | 5,750   |  
|Other assets, (net of allowance for doubtful accounts of $7,213 for 2010 and 2009) (Includes other receivables of $6,491 at
March 31, 2010 and $8,830 at December 31, 2009) |  |               | 28,715  |   |                  |   | 12,397  |  
|                                                                                                                                                                            |  |               |         |   |                  |   |         |  
|Total assets                                                                                                                                                                |  | $             | 757,734 |   |                  | $ | 751,280 |  
|                                                                                                                                                                            |  |               |         |   |                  |   |         |  
|                                                                                                                                                                            |  |              
|Liabilities and Stockholders Equity                                                                                                                                        |  |               |         |   |                  |   |         |  
|Liabilities:                                                                                                                                                                |  |               |         |   |                  |   |         |  
|Reserves for losses and loss adjustment expenses                                                                                                                            |  | $             | 177,088 |   |                  | $ | 193,647 |  
|Unearned premium                                                                                                                                                            |  |               | 133,132 |   |                  |   | 109,361 |  
|Amounts due to reinsurers                                                                                                                                                   |  |               | 5,982   |   |                  |   | 4,037   |  
|Deferred revenue                                                                                                                                                            |  |               | 10,211  |   |                  |   | 10,190  |  
|Senior secured credit facility                                                                                                                                              |  |               | 107,915 |   |                  |   | 111,506 |  
|Notes payable                                                                                                                                                               |  |               | 76,886  |   |                  |   | 76,891  |  
|Deferred tax liability                                                                                                                                                      |  |               | 11,139  |   |                  |   | 10,820  |  
|Other liabilities (Includes swap of $3,592 at March 31, 2010 and $4,108 at December 31, 2009)                                                                               |  |               | 57,044  |   |                  |   | 51,473  |  
|                                                                                                                                                                            |  |               |         |   |                  |   |         |  
|Total liabilities                                                                                                                                                           |  |               | 579,397 |   |                  |   | 567,925 |  
|                                                                                                                                                                            |  |               |         |   |                  |   |         |  
|Stockholders equity:                                                                                                                                                       |  |               |         |   |                  |   |         |  
|Common stock, $0.01 par value; 75,000,000 shares authorized, 17,768,721 shares issued and 15,415,358 shares outstanding at
March 31, 2010 and December 31, 2009             |  |               | 178     |   |                  |   | 178     |  
|Additional paid-in capital                                                                                                                                                  |  |               | 164,944 |   |                  |   | 164,752 |  
|Treasury stock, at cost (2,353,363 shares at March 31, 2010 and December 31, 2009)                                                                                          |  |               | (32,880 | ) |                  |   | (32,880 | )
|Accumulated other comprehensive income                                                                                                                                      |  |               | 1,113   |   |                  |   | 2,859   |  
|Retained earnings                                                                                                                                                           |  |               | 44,982  |   |                  |   | 48,446  |  
|                                                                                                                                                                            |  |               |         |   |                  |   |         |  
|Total stockholders equity                                                                                                                                                  |  |               | 178,337 |   |                  |   | 183,355 |  
|                                                                                                                                                                            |  |               |         |   |                  |   |         |  
|Total liabilities and stockholders equity                                                                                                                                  |  | $             | 757,734 |   |                  | $ | 751,280 |  
|                                                                                                                                                                            |  |               |         |   |                  |   |         |  

See accompanying Notes to Consolidated Financial Statements



3



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AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS)

(in thousands, except per share data)



|                                                                   |  |                              |         |   |      |   |         |  
|------------------------------------------------------------------ |  | ---------------------------- | ------- | - | ---- | - | ------- | -
|                                                                   |  | Three Months EndedMarch 
31, |        
|                                                                   |  | 2010                         |         |   | 2009 |  
|                                                                   |  | (Unaudited)                  |        
|Revenues                                                           |  |                              |         |   |      |   |         |  
|Net premiums earned                                                |  | $                            | 92,722  |   |      | $ | 93,225  |  
|Commission income and fees                                         |  |                              | 23,595  |   |      |   | 20,570  |  
|Net investment income                                              |  |                              | 1,459   |   |      |   | 2,469   |  
|Net realized gains (losses)                                        |  |                              | 3,655   |   |      |   | (2,004  | )
|Other income (loss)                                                |  |                              | (1,813  | ) |      |   | 2,598   |  
|                                                                   |  |                              |         |   |      |   |         |  
|Total revenues                                                     |  |                              | 119,618 |   |      |   | 116,858 |  
|                                                                   |  |                              |         |   |      |   |         |  
|                                                                   |  |                             
|Expenses                                                           |  |                              |         |   |      |   |         |  
|Losses and loss adjustment expenses                                |  |                              | 71,025  |   |      |   | 69,676  |  
|Selling, general and administrative expenses                       |  |                              | 42,539  |   |      |   | 40,123  |  
|Depreciation and amortization                                      |  |                              | 2,432   |   |      |   | 2,392   |  
|                                                                   |  |                              |         |   |      |   |         |  
|Total expenses                                                     |  |                              | 115,996 |   |      |   | 112,191 |  
|                                                                   |  |                              |         |   |      |   |         |  
|Operating income                                                   |  |                              | 3,622   |   |      |   | 4,667   |  
|                                                                   |  |                             
|Gain on extinguishment of debt                                     |  |                              |        |   |      |   | 19,434  |  
|Loss on interest rate swaps                                        |  |                              | (521    | ) |      |   | (4,430  | )
|Interest expense                                                   |  |                              | 6,120   |   |      |   | 4,142   |  
|                                                                   |  |                              |         |   |      |   |         |  
|Income (loss) from continuing operations before income tax expense |  |                              | (3,019  | ) |      |   | 15,529  |  
|Income tax expense                                                 |  |                              | 445     |   |      |   | 4,359   |  
|                                                                   |  |                              |         |   |      |   |         |  
|Income (loss) from continuing operations                           |  |                              | (3,464  | ) |      |   | 11,170  |  
|Discontinued operations                                            |  |                              |         |   |      |   |         |  
|Loss from operations                                               |  |                              |        |   |      |   | (464    | )
|Income tax benefit                                                 |  |                              |        |   |      |   | (118    | )
|                                                                   |  |                              |         |   |      |   |         |  
|Loss from discontinued operations                                  |  |                              |        |   |      |   | (346    | )
|                                                                   |  |                              |         |   |      |   |         |  
|Net income (loss)                                                  |  | $                            | (3,464  | ) |      | $ | 10,824  |  
|                                                                   |  |                              |         |   |      |   |         |  
|                                                                   |  |                             
|Basic income (loss) per common share:                              |  |                              |         |   |      |   |         |  
|Continuing operations                                              |  | $                            | (0.22   | ) |      | $ | 0.72    |  
|Discontinued operations                                            |  |                              |        |   |      |   | (0.02   | )
|                                                                   |  |                              |         |   |      |   |         |  
|Net income (loss)                                                  |  | $                            | (0.22   | ) |      | $ | 0.70    |  
|                                                                   |  |                              |         |   |      |   |         |  
|                                                                   |  |                             
|Diluted income (loss) per common share:                            |  |                              |         |   |      |   |         |  
|Continuing operations                                              |  | $                            | (0.22   | ) |      | $ | 0.72    |  
|Discontinued operations                                            |  |                              |        |   |      |   | (0.02   | )
|                                                                   |  |                              |         |   |      |   |         |  
|Net income (loss)                                                  |  | $                            | (0.22   | ) |      | $ | 0.70    |  
|                                                                   |  |                              |         |   |      |   |         |  
|                                                                   |  |                             
|Weighted average common shares outstanding:                        |  |                              |         |   |      |   |         |  
|Basic                                                              |  |                              | 15,415  |   |      |   | 15,415  |  
|                                                                   |  |                              |         |   |      |   |         |  
|Diluted                                                            |  |                              | 15,415  |   |      |   | 15,415  |  
|                                                                   |  |                              |         |   |      |   |         |  
|Dividends declared per common share                                |  | $                            |        |   |      | $ |        |  
|                                                                   |  |                              |         |   |      |   |         |  

See accompanying Notes to Consolidated Financial Statements



4



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AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITY

(in thousands, except share data)



|                                                                                 |  |                              |  |         |         |   |        |            |         |   |         |  
|-------------------------------------------------------------------------------- |  | ---------------------------- |  | ------- | ------- | - | ------ | ---------- | ------- | - | ------- | -
|                                                                                 |  | Three Months Ended March 31, | 
|                                                                                 |  | 2010                         |  |         | 2009    |  
|                                                                                 |  | Shares                       |  | Amounts |         |   | Shares |            | Amounts |  
|                                                                                 |  | (Unaudited)                  | 
|Common stock                                                                     |  |                              |  |         |         |   |        |            |         |   |         |  
|Balance at beginning of year and end of period                                   |  | 17,768,721                   |  | $       | 178     |   |        | 17,768,721 |         | $ | 178     |  
|                                                                                 |  |                              |  |         |         |   |        |            |         |   |         |  
|                                                                                 |  |                              |  |        
|Additional paid-in capital                                                       |  |                              |  |         |         |   |        |            |         |   |         |  
|Balance at beginning of year                                                     |  |                              |  |         | 164,752 |   |        |            |         |   | 163,707 |  
|Stock-based compensation expense                                                 |  |                              |  |         | 192     |   |        |            |         |   | 256     |  
|                                                                                 |  |                              |  |         |         |   |        |            |         |   |         |  
|Balance at end of period                                                         |  |                              |  |         | 164,944 |   |        |            |         |   | 163,963 |  
|                                                                                 |  |                              |  |         |         |   |        |            |         |   |         |  
|                                                                                 |  |                              |  |        
|Retained earnings                                                                |  |                              |  |         |         |   |        |            |         |   |         |  
|Balance at beginning of year                                                     |  |                              |  |         | 48,446  |   |        |            |         |   | 87,327  |  
|Net income (loss)                                                                |  |                              |  |         | (3,464  | ) |        |            |         |   | 10,824  |  
|                                                                                 |  |                              |  |         |         |   |        |            |         |   |         |  
|Balance at end of period                                                         |  |                              |  |         | 44,982  |   |        |            |         |   | 98,151  |  
|                                                                                 |  |                              |  |         |         |   |        |            |         |   |         |  
|                                                                                 |  |                              |  |        
|Treasury stock                                                                   |  |                              |  |         |         |   |        |            |         |   |         |  
|Balance at beginning of year and end of period                                   |  | 2,353,363                    |  |         | (32,880 | ) |        | 2,353,363  |         |   | (32,880 | )
|                                                                                 |  |                              |  |         |         |   |        |            |         |   |         |  
|                                                                                 |  |                              |  |        
|Accumulated other comprehensive income (loss)                                    |  |                              |  |         |         |   |        |            |         |   |         |  
|Balance at beginning of year, net of tax                                         |  |                              |  |         | 2,859   |   |        |            |         |   | (1,849  | )
|Unrealized gain (loss) on available-for-sale investment securities, net of taxes |  |                              |  |         | (1,746  | ) |        |            |         |   | 523     |  
|Loss on cash flow hedges transferred to earnings, net of taxes of $2,077         |  |                              |  |         |        |   |        |            |         |   | 3,858   |  
|                                                                                 |  |                              |  |         |         |   |        |            |         |   |         |  
|Balance at end of period, net of tax                                             |  |                              |  |         | 1,113   |   |        |            |         |   | 2,532   |  
|                                                                                 |  |                              |  |         |         |   |        |            |         |   |         |  
|                                                                                 |  |                              |  |        
|Total stockholders equity                                                       |  |                              |  | $       | 178,337 |   |        |            |         | $ | 231,944 |  
|                                                                                 |  |                              |  |         |         |   |        |            |         |   |         |  

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands)



|                                                                                 |  |                             |        |   |      |   |       
|-------------------------------------------------------------------------------- |  | --------------------------- | ------ | - | ---- | - | ------
|                                                                                 |  | Three Months EndedMarch
31,
|                                                                                 |  | 2010                        |        |   | 2009
|                                                                                 |  | (Unaudited)                
|Net income (loss)                                                                |  | $                           | (3,464 | ) |      | $ | 10,824
|Other comprehensive income (loss):                                               |  |                             |        |   |      |   |       
|Unrealized gain (loss) on available-for-sale investment securities, net of taxes |  |                             | (1,746 | ) |      |   | 523   
|Loss on cash flow hedges transferred to earnings, net of taxes of $2,077         |  |                             |       |   |      |   | 3,858 
|                                                                                 |  |                             |        |   |      |   |       
|Other comprehensive income (loss), net                                           |  |                             | (1,746 | ) |      |   | 4,381 
|                                                                                 |  |                             |        |   |      |   |       
|Total comprehensive income (loss)                                                |  | $                           | (5,210 | ) |      | $ | 15,205
|                                                                                 |  |                             |        |   |      |   |       

See accompanying Notes to Consolidated Financial
Statements



5



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AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                            |  |                             |         |   |      |   |         |  
|------------------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                            |  | Three Months EndedMarch
31, |        
|                                                                                            |  | 2010                        |         |   | 2009 |  
|                                                                                            |  | (Unaudited)                 |        
|Cash flows from operating activities                                                        |  |                             |         |   |      |   |         |  
|Net income (loss)                                                                           |  | $                           | (3,464  | ) |      | $ | 10,824  |  
|Adjustments to reconcile net income to net cash provided by (used in) operating activities: |  |                             |         |   |      |   |         |  
|Depreciation and amortization                                                               |  |                             | 2,432   |   |      |   | 2,413   |  
|Stock-based compensation expense                                                            |  |                             | 285     |   |      |   | 281     |  
|Amortization of debt issuance and modification costs                                        |  |                             | 128     |   |      |   | 379     |  
|Amortization of debt discount                                                               |  |                             | 1,744   |   |      |   |        |  
|Net realized gains from sales of available-for-sale securities                              |  |                             | (1,193  | ) |      |   | (191    | )
|Realized (gain) loss on trading securities                                                  |  |                             | (2,462  | ) |      |   | 2,195   |  
|Fair value (gain) loss on settlement rights for auction-rate securities                     |  |                             | 2,339   |   |      |   | (2,598  | )
|Amortization of premiums on investments, net                                                |  |                             | 833     |   |      |   | 819     |  
|Provision for doubtful premiums receivable                                                  |  |                             | 199     |   |      |   | 352     |  
|Gain on extinguishment of debt                                                              |  |                             |        |   |      |   | (19,434 | )
|Loss on interest rate swaps                                                                 |  |                             | 521     |   |      |   | 4,430   |  
|Change in operating assets and liabilities:                                                 |  |                             |         |   |      |   |         |  
|Fiduciary and restricted cash                                                               |  |                             | 5,543   |   |      |   | (644    | )
|Premiums, fees and commissions receivable                                                   |  |                             | (7,198  | ) |      |   | (10,903 | )
|Reserves for losses and loss adjustment expenses                                            |  |                             | (16,559 | ) |      |   | (5,348  | )
|Amounts due from reinsurers                                                                 |  |                             | 90      |   |      |   | 14,411  |  
|Premium finance receivable, net (related to our insurance premiums)                         |  |                             | (10,453 | ) |      |   | (6,989  | )
|Deferred revenue                                                                            |  |                             | 21      |   |      |   | 2,381   |  
|Unearned premium                                                                            |  |                             | 23,771  |   |      |   | 19,309  |  
|Deferred acquisition costs                                                                  |  |                             | (4,715  | ) |      |   | (3,814  | )
|Deferred tax liability                                                                      |  |                             | 319     |   |      |   | 4,763   |  
|Federal income taxes receivable                                                             |  |                             | 316     |   |      |   | (671    | )
|Other                                                                                       |  |                             | 5,470   |   |      |   | 2,613   |  
|                                                                                            |  |                             |         |   |      |   |         |  
|Net cash provided by (used in) operating activities                                         |  |                             | (2,033  | ) |      |   | 14,578  |  
|                                                                                            |  |                             |         |   |      |   |         |  
|                                                                                            |  |                            
|Cash flows from investing activities                                                        |  |                             |         |   |      |   |         |  
|Proceeds from sales of available-for-sale securities                                        |  |                             | 35,111  |   |      |   | 6,609   |  
|Proceeds from maturities of available-for-sale securities                                   |  |                             | 24,140  |   |      |   | 23,829  |  
|Proceeds from sales of trading securities                                                   |  |                             | 7,375   |   |      |   |        |  
|Purchases of available-for-sale securities                                                  |  |                             | (25,814 | ) |      |   | (40,509 | )
|Premium finance receivable, net (related to third-party insurance premiums)                 |  |                             | (903    | ) |      |   | (2,713  | )
|Purchases of property and equipment                                                         |  |                             | (1,279  | ) |      |   | (2,742  | )
|Investment in real property                                                                 |  |                             | (230    | ) |      |   |        |  
|                                                                                            |  |                             |         |   |      |   |         |  
|Net cash provided by (used in) investing activities                                         |  |                             | 38,400  |   |      |   | (15,526 | )
|                                                                                            |  |                             |         |   |      |   |         |  
|                                                                                            |  |                            
|Cash flows from financing activities                                                        |  |                             |         |   |      |   |         |  
|Principal payments on senior secured credit facility                                        |  |                             | (5,335  | ) |      |   | (400    | )
|Debt issuance costs paid                                                                    |  |                             |        |   |      |   | (2,398  | )
|                                                                                            |  |                             |         |   |      |   |         |  
|Net cash used in financing activities                                                       |  |                             | (5,335  | ) |      |   | (2,798  | )
|                                                                                            |  |                             |         |   |      |   |         |  
|Net increase (decrease) in cash and cash equivalents                                        |  |                             | 31,032  |   |      |   | (3,746  | )
|Cash and cash equivalents at beginning of year                                              |  |                             | 60,928  |   |      |   | 66,513  |  
|                                                                                            |  |                             |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                                  |  | $                           | 91,960  |   |      | $ | 62,767  |  
|                                                                                            |  |                             |         |   |      |   |         |  
|                                                                                            |  |                            
|Supplemental disclosure of cash flow information:                                           |  |                             |         |   |      |   |         |  
|Cash paid for interest                                                                      |  | $                           | 4,461   |   |      | $ | 3,659   |  
|Cash paid for income taxes                                                                  |  |                             | 10      |   |      |   | 159     |  

See accompanying Notes
to Consolidated Financial Statements



6



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##### Table of Contents

AFFIRMATIVE INSURANCE HOLDINGS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)





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

Affirmative
Insurance Holdings, Inc., formerly known as Instant Insurance Holdings, Inc., was incorporated in Delaware in June 1998. The Company is a distributor and producer of non-standard personal automobile insurance policies and related products and
services for individual consumers in targeted geographic areas. The Company currently offers insurance directly to individual consumers through retail stores in 9 states (Louisiana, Texas, Illinois, Alabama, Missouri, Indiana, South Carolina, Kansas
and Wisconsin) as well as through 9,200 independent agents or brokers in 11 states (Louisiana, Texas, Illinois, Alabama, California, Michigan, Florida, Missouri, Indiana, South Carolina and New Mexico).



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

Basis of Presentation

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

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

Certain prior year amounts have been reclassified to conform to the current presentation, including discontinued operations for the
Florida retail business sold in June 2009.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires the Company to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ materially from those estimates. These estimates and assumptions are particularly important in determining revenue recognition, reserves for losses and loss adjustment expenses, deferred policy acquisition costs, reinsurance
receivables, valuation of assets, and deferred income taxes.

Recently Issued Accounting Standards

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

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

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



7



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##### Table of Contents

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

The Companys trading investment securities consist solely of auction-rate tax-exempt securities, which are carried at fair value
with realized gains and losses reported in current period earnings. The Investment Committee of the Board of Directors periodically reviews investment portfolio results and evaluates strategies to maximize yields, to match maturity durations with
anticipated needs, and to maintain compliance with investment guidelines.

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



|                  |  |               |        |                    |   |        |           |  |   |       
|----------------- |  | ------------- | ------ | ------------------ | - | ------ | --------- |  | - | ------
|                  |  | AmortizedCost |        | Net RealizedLosses |   |        | FairValue
|March 31, 2010    |  | $             | 39,065 |                    | $ | (6,562 | )         |  | $ | 32,503
|December 31, 2009 |  | $             | 46,440 |                    | $ | (9,024 | )         |  | $ | 37,416

In October 2008, the
Companys broker filed a prospectus with the Securities and Exchange Commission (SEC), which published a legally-binding offer to all authorized holders of auction-rate securities to purchase all eligible securities at par (the
settlement). The time frames set by the Companys broker for buybacks have different start dates based upon the individual clients size, which is determined by each clients balance of investments held at the Companys
broker. In November 2008, the Company elected to participate in its brokers offer to purchase the Companys auction-rate securities at par and classified its portfolio of auction-rate securities as trading. The settlement agreement
requires the Companys broker to purchase eligible securities at par, at any time during a two-year period beginning June 30, 2010. All auction-rate securities held at March 31, 2010 are eligible for buyback under the settlement
agreements. At March 31, 2010 and December 31, 2009, the fair value of the settlement was $6.5 million and $8.8 million, respectively, which is recorded in other assets in the consolidated balance sheets with changes in fair value recorded
in other income in the consolidated statement of income (loss).



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

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

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



|                                       |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|-------------------------------------- |  | ------------- | ------- | -------------------- | - | --------------------- |  | - | ---------- | - |  | - | -------
|                                       |  | AmortizedCost |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | Fair Value
|March 31, 2010                         |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|U.S. Treasury and government agencies  |  | $             | 26,907  |                      | $ | 178                   |  | $ | (46        | ) |  | $ | 27,039 
|Residential mortgage-backed securities |  |               | 4,143   |                      |   | 346                   |  |   |           |   |  |   | 4,489  
|States and political subdivisions      |  |               | 50,773  |                      |   | 813                   |  |   | (18        | ) |  |   | 51,568 
|Corporate debt securities              |  |               | 75,461  |                      |   | 1,485                 |  |   | (106       | ) |  |   | 76,840 
|                                       |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|Total                                  |  | $             | 157,284 |                      | $ | 2,822                 |  | $ | (170       | ) |  | $ | 159,936
|                                       |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|December 31, 2009                      |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|U.S. Treasury and government agencies  |  | $             | 24,529  |                      | $ | 212                   |  | $ | (99        | ) |  | $ | 24,642 
|Residential mortgage-backed securities |  |               | 4,342   |                      |   | 322                   |  |   |           |   |  |   | 4,664  
|States and political subdivisions      |  |               | 117,659 |                      |   | 2,667                 |  |   | (21        | ) |  |   | 120,305
|Corporate debt securities              |  |               | 62,728  |                      |   | 1,346                 |  |   | (29        | ) |  |   | 64,045 
|                                       |  |               |         |                      |   |                       |  |   |            |   |  |   |        
|Total                                  |  | $             | 209,258 |                      | $ | 4,547                 |  | $ | (149       | ) |  | $ | 213,656
|                                       |  |               |         |                      |   |                       |  |   |            |   |  |   |        



8



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##### Table of Contents

Expected maturities may differ from contractual maturities because certain borrowers may
have the right to call or prepay obligations with or without penalties. The Companys amortized cost and estimated fair values of fixed-income securities at March 31, 2010 by contractual maturity were as follows (in thousands):



|                                       |  |               |         |            |   |        
|-------------------------------------- |  | ------------- | ------- | ---------- | - | -------
|                                       |  | AmortizedCost |         | Fair Value
|Due in one year or less                |  | $             | 55,644  |            | $ | 56,116 
|Due after one year through five years  |  |               | 91,618  |            |   | 93,446 
|Due after five years through ten years |  |               | 5,879   |            |   | 5,885  
|Residential mortgage-backed securities |  |               | 4,143   |            |   | 4,489  
|                                       |  |               |         |            |   |        
|Total                                  |  | $             | 157,284 |            | $ | 159,936
|                                       |  |               |         |            |   |        

At March 31, 2010, the Company owned
approximately $4.5 million of pre-refunded municipal bonds. These pre-refunded municipal bonds have contractual maturities in excess of ten years. However, due to pre-refunding, these securities will be called by the issuer generally
within three years or less. Pre-refunded municipal bonds are created when municipalities issue new debt to refinance debt issued when interest rates were higher. Once the refinancing is completed, the issuer uses the proceeds to purchase U.S.
Treasury securities and places these securities in an escrow account. These proceeds are then used to pay interest and principal on the original debt until the bond is called.

The Companys amortized cost and estimated fair value of pre-refunded municipal bonds at March 31, 2010 by contractual maturity
were as follows (in thousands):



|                                      |  |               |       |            |   |      
|------------------------------------- |  | ------------- | ----- | ---------- | - | -----
|                                      |  | AmortizedCost |       | Fair Value
|Due in one year or less               |  | $             | 3,260 |            | $ | 3,293
|Due after one year through five years |  |               | 1,203 |            |   | 1,237
|                                      |  |               |       |            |   |      
|Total                                 |  | $             | 4,463 |            | $ | 4,530
|                                      |  |               |       |            |   |      

Gross realized gains and losses on available-for-sale
investments for the three months ended March 31 were as follows (in thousands):



|             |  |      |       |   |      |   |    
|------------ |  | ---- | ----- | - | ---- | - | ---
|             |  | 2010 |       |   | 2009
|Gross gains  |  | $    | 1,205 |   |      | $ | 191
|Gross losses |  |      | (12   | ) |      |   |   
|             |  |      |       |   |      |   |    
|Total        |  | $    | 1,193 |   |      | $ | 191
|             |  |      |       |   |      |   |    

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



|                                      |  |                        |        |                       |                         |      |           |       |                       |     |  |           |    |                       |  |   |        |  |   |      |  
|------------------------------------- |  | ---------------------- | ------ | --------------------- | ----------------------- | ---- | --------- | ----- | --------------------- | --- |  | --------- | -- | --------------------- |  | - | ------ |  | - | ---- | -
|                                      |  | March 31, 2010         |       
|                                      |  | Less Than
TwelveMonths |        |                       | Twelve Monthsor
Greater |      |           | Total |                      
|                                      |  | FairValue              |        | GrossUnrealizedLosses |                         |      | FairValue |       | GrossUnrealizedLosses |     |  | FairValue |    | GrossUnrealizedLosses | 
|U.S. Treasury and government agencies |  | $                      | 11,894 |                       | $                       | (46  | )         |       | $                     |    |  | $         |   |                       |  | $ | 11,894 |  | $ | (46  | )
|States and political subdivisions     |  |                        | 1,251  |                       |                         | (11  | )         |       |                       | 746 |  |           | (7 | )                     |  |   | 1,997  |  |   | (18  | )
|Corporate debt securities             |  |                        | 12,929 |                       |                         | (106 | )         |       |                       |    |  |           |   |                       |  |   | 12,929 |  |   | (106 | )
|                                      |  |                        |        |                       |                         |      |           |       |                       |     |  |           |    |                       |  |   |        |  |   |      |  
|Total                                 |  | $                      | 26,074 |                       | $                       | (163 | )         |       | $                     | 746 |  | $         | (7 | )                     |  | $ | 26,820 |  | $ | (170 | )
|                                      |  |                        |        |                       |                         |      |           |       |                       |     |  |           |    |                       |  |   |        |  |   |      |  



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

The Companys portfolio contains approximately 31 individual investment securities that are in an
unrealized loss position as of March 31, 2010.

The unrealized losses at March 31, 2010 were attributable to changes
in market interest rates since the securities were purchased. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider
various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers, (3) structure of the security and (4) the Companys intent to sell the security or
whether its more likely than not that the Company would be required to sell the security before its anticipated recovery in market value. At March 31, 2010, management performed its quarterly analysis of all securities with an unrealized
loss and concluded no individual securities were other-than-temporarily impaired.

In the first quarter of 2010, the Company
sold approximately $54 million book value of investment securities. As of March 31, 2010, approximately $18.9 million was recorded in Other Assets as sales proceeds receivable pending settlement.



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

In the
ordinary course of business, the Company places reinsurance with other insurance companies in order to provide greater diversification of its business and limit the potential for losses arising from large risks. In addition, the Company assumes
reinsurance from other insurance companies.

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



|                    |  |                              |         |   |               |   |        |                                |  |   |                |   |               |   |         |                                |   |        |   |  |   |        |  
|------------------- |  | ---------------------------- | ------- | - | ------------- | - | ------ | ------------------------------ |  | - | -------------- | - | ------------- | - | ------- | ------------------------------ | - | ------ | - |  | - | ------ | -
|                    |  | Three Months Ended March 31, |        
|                    |  | 2010                         |         |   | 2009          |  
|                    |  | WrittenPremium               |         |   | EarnedPremium |   |        | Loss
andLossAdjustmentExpenses |  |   | WrittenPremium |   | EarnedPremium |   |         | Loss
andLossAdjustmentExpenses |  
|Direct              |  | $                            | 97,741  |   |               | $ | 75,124 |                                |  | $ | 56,940         |   |               | $ | 89,420  |                                | $ | 77,831 |   |  | $ | 58,404 |  
|Reinsurance assumed |  |                              | 19,341  |   |               |   | 18,925 |                                |  |   | 16,472         |   |               |   | 22,741  |                                |   | 16,081 |   |  |   | 12,053 |  
|Reinsurance ceded   |  |                              | (2,210  | ) |               |   | (1,327 | )                              |  |   | (2,387         | ) |               |   | 9,707   |                                |   | (687   | ) |  |   | (781   | )
|                    |  |                              |         |   |               |   |        |                                |  |   |                |   |               |   |         |                                |   |        |   |  |   |        |  
|Total               |  | $                            | 114,872 |   |               | $ | 92,722 |                                |  | $ | 71,025         |   |               | $ | 121,868 |                                | $ | 93,225 |   |  | $ | 69,676 |  
|                    |  |                              |         |   |               |   |        |                                |  |   |                |   |               |   |         |                                |   |        |   |  |   |        |  

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



|                                             |  |                              |    |      |   |        |  
|-------------------------------------------- |  | ---------------------------- | -- | ---- | - | ------ | -
|                                             |  | Three Months EndedMarch 
31, |   
|                                             |  | 2010                         |    | 2009 |  
|Selling, general and administrative expenses |  | $                            | 9  |      | $ | (2,364 | )
|Loss adjustment expenses                     |  |                              | 16 |      |   | 189    |  
|                                             |  |                              |    |      |   |        |  
|Total                                        |  | $                            | 25 |      | $ | (2,175 | )
|                                             |  |                              |    |      |   |        |  



10



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##### Table of Contents

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



|                                            |  |               |        |                  |   |       
|------------------------------------------- |  | ------------- | ------ | ---------------- | - | ------
|                                            |  | March 31,2010 |        | December 31,2009
|Losses and loss adjustment expense reserves |  | $             | 32,699 |                  | $ | 32,447
|Unearned premium reserve                    |  |               | 1,980  |                  |   | 1,096 
|                                            |  |               |        |                  |   |       
|Total                                       |  | $             | 34,679 |                  | $ | 33,543
|                                            |  |               |        |                  |   |       

The Michigan Catastrophic Claims Association (MCCA) is
the mandatory reinsurance facility that covers no-fault medical losses above a specific retention amount in Michigan. For policies effective July 1, 2009 to June 30, 2010, the required retention is $0.5 million. As a writer of
personal automobile policies in the state of Michigan, the Company cedes premiums and claims to the MCCA. Funding for MCCA comes from assessments against automobile insurers based upon their proportionate market share of the states
automobile liability insurance market. Insurers are allowed to pass along this cost to Michigan automobile policyholders. The Companys ceded premiums written to the MCCA were $2.0 million and $0.5 million for the three months ended
March 31, 2010 and 2009, respectively.

At March 31, 2010, the Companys total receivables from reinsurers were
$43.9 million, consisting of $21.3 million receivable from the MCCA, $3.1 million from a quota-share reinsurer (rated A- by A.M. Best) for business reinsured in Louisiana and Alabama, $14.7 million net receivable (net of $2.5 million payable) from
subsidiaries of Vesta Insurance Group (VIG), including primarily Vesta Fire Insurance Corporation (VFIC) and $4.8 million receivables from other reinsurers. Under the reinsurance agreement with Vesta Insurance Group (VIG), including primarily Vesta
Fire Insurance Corporation (VFIC), the Companys wholly-owned subsidiaries, Affirmative Insurance Company (AIC) and Insura Property and Casualty Insurance Company (Insura), had the right, under certain circumstances, to require VFIC to provide
a letter of credit or establish a trust account to collateralize gross amounts due from VFIC under the reinsurance agreement. Accordingly, AIC, Insura and VFIC entered into a Security Fund Agreement effective September 2004. In
August 2005, AIC received a letter from VFICs President that irrevocably confirmed VFICs duty and obligation under the Security Fund Agreement to provide security sufficient to satisfy VFICs gross obligations under the
reinsurance agreement (the VFIC Trust). At March 31, 2010, the VFIC Trust held $17.6 million (after cumulative withdrawals of $7.6 million through March 31, 2010), consisting of $12.7 million of a U.S. Treasury money market account and
$4.9 million of corporate bonds rated BBB or higher, to collateralize the $14.7 million net recoverable from VFIC.

The
Company assumes reinsurance from a Texas county mutual insurance company (the county mutual) whereby the Company has assumed 100% of the policies issued by the county mutual for business produced by the Companys owned managing general agents
(MGAs). The county mutual does not retain any of this business and there are no loss limits other than the underlying policy limits. The county mutual reinsurance agreement may be terminated by either party upon prior written notice of not less than
90 days. In the event of such termination, the MGA agrees that for ten years the MGA shall produce automobile insurance business in the State of Texas solely for the benefit of the county mutual. The county mutual reinsurance agreement automatically
terminates on January 1, 2014. AIC has established a trust to secure the Companys obligation under this reinsurance contract with a balance of $44.2 million as of March 31, 2010.

At March 31, 2010, $11.1 million was included in reserves for losses and loss adjustment expenses that represented the amounts owed
by AIC and Insura under reinsurance agreements with the VIG affiliated companies, including Hawaiian Insurance and Guaranty Company, Ltd (Hawaiian). Affirmative established a trust account to collateralize this payable, which currently holds $20.7
million in securities (the AIC Trust). The Special Deputy Receiver in Texas had cumulative withdrawals from the AIC Trust of $0.4 million through March 2010, and the Special Deputy Receiver in Hawaii had cumulative withdrawals from the AIC Trust of
$1.7 million through March 2010.



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

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



|                            |  |               |        |   |                  |   |        |  
|--------------------------- |  | ------------- | ------ | - | ---------------- | - | ------ | -
|                            |  | March 31,2010 |        |   | December 31,2009 |  
|Premium finance contracts   |  | $             | 55,539 |   |                  | $ | 43,473 |  
|Unearned finance charges    |  |               | (2,859 | ) |                  |   | (2,216 | )
|Allowance for credit losses |  |               | (499   | ) |                  |   | (432   | )
|                            |  |               |        |   |                  |   |        |  
|Total                       |  | $             | 52,181 |   |                  | $ | 40,825 |  
|                            |  |               |        |   |                  |   |        |  



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##### Table of Contents

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

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



|                  |  |               |         |   |               |   |         |  
|----------------- |  | ------------- | ------- | - | ------------- | - | ------- | -
|                  |  | March 31,2010 |         |   | March 31,2009 |  
|Beginning balance |  | $             | 24,230  |   |               | $ | 21,993  |  
|Additions         |  |               | 24,994  |   |               |   | 21,925  |  
|Amortization      |  |               | (20,279 | ) |               |   | (18,111 | )
|                  |  |               |         |   |               |   |         |  
|Ending balance    |  | $             | 28,945  |   |               | $ | 25,807  |  
|                  |  |               |         |   |               |   |         |  



|8. | Debt
|-- | ----

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



|                               |  |      |         |      |   |        
|------------------------------ |  | ---- | ------- | ---- | - | -------
|                               |  | 2010 |         | 2009
|Notes payable due 2035         |  | $    | 30,928  |      | $ | 30,928 
|Notes payable due 2035         |  |      | 25,774  |      |   | 25,774 
|Notes payable due 2035         |  |      | 20,184  |      |   | 20,189 
|                               |  |      |         |      |   |        
|Total notes payable            |  |      | 76,886  |      |   | 76,891 
|Senior secured credit facility |  |      | 107,915 |      |   | 111,506
|                               |  |      |         |      |   |        
|Total long-term debt           |  | $    | 184,801 |      | $ | 188,397
|                               |  |      |         |      |   |        

The $30.9 million notes payable bear an initial
interest rate of 7.545% until March 15, 2010, at which time the securities adjust quarterly to the three-month LIBOR rate plus 3.60%. The interest rate as of March 31, 2010 was 3.86%.

The $25.8 million notes payable due 2035 bear an initial interest rate of 7.792% until June 15, 2010, at which time they will adjust
quarterly to the three-month LIBOR rate plus 3.55%. The interest rate as of March 31, 2010 was 7.79%.

The $20.2 million
notes payable due 2035 bear an interest rate of the three-month LIBOR rate plus 3.95% not exceeding 12.50% through March 2010 with no limit thereafter. The interest rate as of March 31, 2010 was 4.21%.

The pricing under the senior secured credit facility is currently subject to a LIBOR floor of 3.00% plus 6.25%, and is tiered based on
the Companys leverage ratio. The interest rate as of March 31, 2010 was 9.25%.

During the first quarter of 2010,
the Company made its scheduled quarterly payment of $0.3 million and a voluntary prepayment of $5.0 million on the senior secured credit facility. As of March 31, 2010, the principal balance of the senior secured credit facility was $124.7
million. The revolving portion of the facility expired in January 2010. As of March 31, 2010, the Company was in compliance with all of its financial and other covenants for the senior secured credit facility.



|9. | Income Taxes
|-- | ------------

The
provision for income taxes for the three months ended March 31, 2010 and 2009 consisted of the following (in thousands):



|                              |  |                             |     |      |   |       |  
|----------------------------- |  | --------------------------- | --- | ---- | - | ----- | -
|                              |  | Three Months EndedMarch
31, |    
|                              |  | 2010                        |     | 2009 |  
|Current tax expense (benefit) |  | $                           | 121 |      | $ | (522  | )
|Deferred tax expense          |  |                             | 324 |      |   | 4,763 |  
|                              |  |                             |     |      |   |       |  
|Net income tax expense        |  | $                           | 445 |      | $ | 4,241 |  
|                              |  |                             |     |      |   |       |  



12



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##### Table of Contents

The Companys effective tax rate differed from the statutory rate of 35% for the three
months ended March 31 as follows (in thousands):



|                                                                |  |                             |        |    |      |   |        |  
|--------------------------------------------------------------- |  | --------------------------- | ------ | -- | ---- | - | ------ | -
|                                                                |  | Three Months EndedMarch
31, |       
|                                                                |  | 2010                        |        |    | 2009 |  
|Income (loss) before income taxes                               |  | $                           | (3,019 | )  |      | $ | 15,065 |  
|Tax provision computed at the federal statutory income tax rate |  |                             | (1,056 | )  |      |   | 5,273  |  
|Increases (reductions) in tax resulting from:                   |  |                             |        |    |      |   |        |  
|Tax-exempt interest                                             |  |                             | (216   | )  |      |   | (428   | )
|State income taxes                                              |  |                             | (16    | )  |      |   | 88     |  
|Valuation allowance                                             |  |                             | 1,689  |    |      |   |       |  
|Other                                                           |  |                             | 44     |    |      |   | (692   | )
|                                                                |  |                             |        |    |      |   |        |  
|Income tax expense                                              |  | $                           | 445    |    |      | $ | 4,241  |  
|                                                                |  |                             |        |    |      |   |        |  
|Effective tax rate                                              |  |                             | (14.7  | )% |      |   | 28.2   | %
|                                                                |  |                             |        |    |      |   |        |  

Net deferred tax assets prior to recognition of the valuation allowance were $22.9 million and
$20.8 million at March 31, 2010 and December 31, 2009, respectively. In assessing the realizability of our deferred tax assets, we considered whether it was more likely than not that our deferred tax assets will be realized based upon
all available evidence, including scheduled reversal of deferred tax liabilities, historical operating results, projected future operating results, tax carry-back availability, and limitations pursuant to Section 382 of the Internal Revenue
Code, among others. Based on this assessment, the Company began recording a valuation allowance against deferred taxes in December 2009.

The Internal Revenue Service is currently auditing the Companys 2006 federal income tax return.



|10. | Legal and Regulatory Proceedings
|--- | --------------------------------

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

In August 2009, plaintiff Sunrise Business Resources, Inc. (Sunrise) filed suit against Affirmative Insurance Company in the Superior
Court for the State of California, County of Los Angeles. Sunrise alleges that it is due approximately $722,000 in deferred compensation arising out of a Claims Administration Agreement between itself and Hawaiian Insurance & Guaranty
Company (HIG). AIC, along with other third-party reinsurance companies, were parties to Quota Share Reinsurance Contracts with HIG during 2004 through June 30, 2006. Sunrise claims that it is a third-party beneficiary of the Quota Share
Reinsurance Contract, thus rendering AIC liable for the deferred compensation owed under the HIG Claims Administration Agreement. Sunrise also seeks recovery under theories of quantum meruit, negligent misrepresentation and intentional
misrepresentation. The Company has removed the action to the U.S. District Court for the Central District of California. In February 2010, the court denied the companys request for a stay of the proceedings pending resolution of the HIG
liquidation proceedings pending in Hawaii. Both parties have been served with discovery and are preparing their responses. The Company believes that this claim lacks merit and intends to defend itself vigorously.

In October 2009, plaintiff Dalton Johnson filed a putative class action in Palm Beach County, Florida against Affirmative Insurance
Company. The complaint alleges that Affirmative failed to apply a statutorily-permitted fee schedule for hospital emergency care and services enacted into law in January 2008, thereby exhausting prematurely the PIP benefits available to
Affirmatives insureds. In February 2010, the case was dismissed. Plaintiff filed an amended complaint in March 2010. Affirmative has filed a second motion to dismiss. The Company believes that this claim lacks merit and intends to defend
itself vigorously.



|11. | Net Income (Loss) per Common Share
|--- | ----------------------------------

Net income (loss) per common share is based on the weighted average number of shares outstanding. Diluted weighted average shares is
calculated by adjusting basic weighted average shares outstanding by all potentially dilutive stock options and restricted stock. Stock options outstanding of 1,262,100 and 1,724,531 for the three months ended March 31, 2010 and 2009,
respectively, were not included in the computation of diluted earnings per share because the exercise price of the options was greater than the average market price of the common stock and thus the inclusion would have been anti-dilutive.



13



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##### Table of Contents

The following table sets forth the reconciliation of numerators and denominators for the
basic and diluted earnings per share computation for the three months ended March 31, 2010 and 2009 (in thousands, except per share amounts):



|                                                                   |  |                             |        |   |      |   |       
|------------------------------------------------------------------ |  | --------------------------- | ------ | - | ---- | - | ------
|                                                                   |  | Three Months EndedMarch
31,
|                                                                   |  | 2010                        |        |   | 2009
|Numerator:                                                         |  |                             |        |   |      |   |       
|Income (loss) from continuing operations                           |  | $                           | (3,464 | ) |      | $ | 11,170
|                                                                   |  |                             |        |   |      |   |       
|Denominator:                                                       |  |                             |        |   |      |   |       
|Weighted average common shares outstanding                         |  |                             | 15,415 |   |      |   | 15,415
|                                                                   |  |                             |        |   |      |   |       
|Weighted average diluted shares outstanding                        |  |                             | 15,415 |   |      |   | 15,415
|                                                                   |  |                             |        |   |      |   |       
|Basic income (loss) per common share from continuing operations:   |  | $                           | (0.22  | ) |      | $ | 0.72  
|                                                                   |  |                             |        |   |      |   |       
|Diluted income (loss) per common share from continuing operations: |  | $                           | (0.22  | ) |      | $ | 0.72  
|                                                                   |  |                             |        |   |      |   |       



|12. | Fair Value of Financial Instruments
|--- | -----------------------------------

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

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

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

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

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

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



14



---

##### Table of Contents

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

The following table provides information as of March 31, 2010 about the Companys financial assets and liabilities measured at
fair value on a recurring basis:



|                                        |  |                |         |                                        |   |                                           |  |                                         |        |  |   |       
|--------------------------------------- |  | -------------- | ------- | -------------------------------------- | - | ----------------------------------------- |  | --------------------------------------- | ------ |  | - | ------
|                                        |  | March 
31,2010 |         | QuotedPrices 
inActiveMarkets(Level 1) |   | SignificantOtherObservableInputs(Level 2) |  | SignificantUnobservable
Inputs(Level 3)
|Assets:                                 |  |                |         |                                        |   |                                           |  |                                         |        |  |   |       
|U.S. Treasury and government agencies   |  | $              | 27,039  |                                        | $ | 27,039                                    |  | $                                       |       |  | $ |      
|Residential mortgage-backed securities  |  |                | 4,489   |                                        |   |                                          |  |                                         | 4,489  |  |   |      
|States and political subdivisions       |  |                | 51,568  |                                        |   |                                          |  |                                         | 51,568 |  |   |      
|Corporate debt securities               |  |                | 76,840  |                                        |   | 76,840                                    |  |                                         |       |  |   |      
|Auction-rate tax-exempt securities      |  |                | 32,503  |                                        |   |                                          |  |                                         |       |  |   | 32,503
|                                        |  |                |         |                                        |   |                                           |  |                                         |        |  |   |       
|Total investment securities             |  |                | 192,439 |                                        |   | 103,879                                   |  |                                         | 56,057 |  |   | 32,503
|Cash and cash equivalents               |  |                | 91,960  |                                        |   | 91,960                                    |  |                                         |       |  |   |      
|Fiduciary and restricted cash           |  |                | 9,461   |                                        |   | 9,461                                     |  |                                         |       |  |   |      
|Other receivables (other assets)        |  |                | 6,491   |                                        |   |                                          |  |                                         |       |  |   | 6,491 
|                                        |  |                |         |                                        |   |                                           |  |                                         |        |  |   |       
|Total assets                            |  | $              | 300,351 |                                        | $ | 205,300                                   |  | $                                       | 56,057 |  | $ | 38,994
|                                        |  |                |         |                                        |   |                                           |  |                                         |        |  |   |       
|Liabilities:                            |  |                |         |                                        |   |                                           |  |                                         |        |  |   |       
|Interest rate swaps (other liabilities) |  | $              | 3,592   |                                        | $ |                                          |  | $                                       |       |  | $ | 3,592 
|                                        |  |                |         |                                        |   |                                           |  |                                         |        |  |   |       
|Total liabilities                       |  | $              | 3,592   |                                        | $ |                                          |  | $                                       |       |  | $ | 3,592 
|                                        |  |                |         |                                        |   |                                           |  |                                         |        |  |   |       

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



|                                        |  |                   |         |                                        |   |                                           |  |                                         |         |  |   |       
|--------------------------------------- |  | ----------------- | ------- | -------------------------------------- | - | ----------------------------------------- |  | --------------------------------------- | ------- |  | - | ------
|                                        |  | December 
31,2009 |         | QuotedPrices 
inActiveMarkets(Level 1) |   | SignificantOtherObservableInputs(Level 2) |  | SignificantUnobservable
Inputs(Level 3)
|Assets:                                 |  |                   |         |                                        |   |                                           |  |                                         |         |  |   |       
|U.S. Treasury and government agencies   |  | $                 | 24,642  |                                        | $ | 24,642                                    |  | $                                       |        |  | $ |      
|Residential mortgage-backed securities  |  |                   | 4,664   |                                        |   |                                          |  |                                         | 4,664   |  |   |      
|States and political subdivisions       |  |                   | 120,305 |                                        |   |                                          |  |                                         | 120,305 |  |   |      
|Corporate debt securities               |  |                   | 64,045  |                                        |   | 64,045                                    |  |                                         |        |  |   |      
|Auction-rate tax-exempt securities      |  |                   | 37,416  |                                        |   |                                          |  |                                         |        |  |   | 37,416
|                                        |  |                   |         |                                        |   |                                           |  |                                         |         |  |   |       
|Total investment securities             |  |                   | 251,072 |                                        |   | 88,687                                    |  |                                         | 124,969 |  |   | 37,416
|Cash and cash equivalents               |  |                   | 60,928  |                                        |   | 60,928                                    |  |                                         |        |  |   |      
|Fiduciary and restricted cash           |  |                   | 15,004  |                                        |   | 15,004                                    |  |                                         |        |  |   |      
|Other receivables (other assets)        |  |                   | 8,830   |                                        |   |                                          |  |                                         |        |  |   | 8,830 
|                                        |  |                   |         |                                        |   |                                           |  |                                         |         |  |   |       
|Total assets                            |  | $                 | 335,834 |                                        | $ | 164,619                                   |  | $                                       | 124,969 |  | $ | 46,246
|                                        |  |                   |         |                                        |   |                                           |  |                                         |         |  |   |       
|Liabilities:                            |  |                   |         |                                        |   |                                           |  |                                         |         |  |   |       
|Interest rate swaps (other liabilities) |  | $                 | 4,108   |                                        | $ |                                          |  | $                                       |        |  | $ | 4,108 
|                                        |  |                   |         |                                        |   |                                           |  |                                         |         |  |   |       
|Total liabilities                       |  | $                 | 4,108   |                                        | $ |                                          |  | $                                       |        |  | $ | 4,108 
|                                        |  |                   |         |                                        |   |                                           |  |                                         |         |  |   |       

Level 1 Financial assets

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



15



---

##### Table of Contents

Level 2 Financial assets

Financial assets classified as Level 2 in the fair value hierarchy include mortgage-backed securities, tax-exempt securities, and certain
auction-rate tax-exempt securities that have auctions on a regular basis that do not fail. The fair value of these securities is determined based on observable market inputs provided by independent third-party pricing services and the Company
discloses the fair values of these investments in Level 2 of the fair value hierarchy. To date, the Company has not experienced a circumstance where it has determined that an adjustment is required to a quote or price received from independent
third-party pricing sources. To the extent the Company determines that a price or quote is inconsistent with actual trading activity observed in that investment or similar investments, the Company would determine a fair value using this observable
market information and disclose the occurrence of this circumstance. All of the fair values of securities disclosed in Level 2 are estimated based on independent third-party pricing services.

Level 3 Financial assets and liabilities

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

The Companys Level 3 financial assets also include other receivables related to a settlement
agreement entered into during November 2008 with the Companys broker to liquidate certain of the Companys auction-rate tax-exempt securities. The settlement agreement requires the Companys broker to purchase eligible securities at
par, at any time during a two-year period beginning June 30, 2010. As of March 31, 2010, the Company held $39.1 million, at amortized cost, and $32.5 million fair value of auction-rate tax-exempt securities that are eligible for such
settlement. The Company has elected to record the settlement as a financial asset at fair value in accordance with ASC 825-10 Financial Instruments  Overall. The fair value of this agreement was estimated by third-party valuation
sources to be $6.5 million and is included in other assets in Level 3 of the fair value hierarchy.

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

Fair value measurements for assets in category Level 3 for the period ended March 31, 2010 were as follows (in thousands):



|                                               |  |                                                                                                        |        |   |                                                                                   |   |        |  
|---------------------------------------------- |  | ------------------------------------------------------------------------------------------------------ | ------ | - | --------------------------------------------------------------------------------- | - | ------ | -
|                                               |  | Fair
ValueMeasurements 
UsingSignificantUnobservable 
Inputs(Level
3)Auction-RateTax-Exempt Securities |        |   | Fair
ValueMeasurements 
UsingSignificantUnobservable 
Inputs(Level 3)Other Assets |  
|Balance at January 1, 2010                     |  | $                                                                                                      | 37,416 |   |                                                                                   | $ | 8,830  |  
|Transfers in and/or out of Level 3             |  |                                                                                                        |       |   |                                                                                   |   |       |  
|Total gains or (losses) (realized/unrealized): |  |                                                                                                        |        |   |                                                                                   |   |        |  
|Included in earnings                           |  |                                                                                                        | 2,462  |   |                                                                                   |   | (2,339 | )
|Included in other comprehensive income         |  |                                                                                                        |       |   |                                                                                   |   |       |  
|Settlements                                    |  |                                                                                                        | (7,375 | ) |                                                                                   |   |       |  
|                                               |  |                                                                                                        |        |   |                                                                                   |   |        |  
|Balance at March 31, 2010                      |  | $                                                                                                      | 32,503 |   |                                                                                   | $ | 6,491  |  
|                                               |  |                                                                                                        |        |   |                                                                                   |   |        |  

Fair value measurements for liabilities in category Level 3 for the period ended March 31, 2010 were as
follows (in thousands):



|                                  |  |                                                                                          |        |  
|--------------------------------- |  | ---------------------------------------------------------------------------------------- | ------ | -
|                                  |  | Fair Value 
MeasurementsUsing SignificantUnobservable
Inputs(Level 3)Interest Rate Swaps |       
|Balance at January 1, 2010        |  | $                                                                                        | 4,108  |  
|Transfers into Level 3            |  |                                                                                          |       |  
|Total losses included in earnings |  |                                                                                          | 521    |  
|Settlements                       |  |                                                                                          | (1,037 | )
|                                  |  |                                                                                          |        |  
|Balance at March 31, 2010         |  | $                                                                                        | 3,592  |  
|                                  |  |                                                                                          |        |  

The Company did not have any significant transfers between Levels 1 and 2 during the quarter ended
March 31, 2010.



16



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##### Table of Contents

Fair value measurements for assets in category Level 3 for the year ended December 31,
2009 were as follows (in thousands):



|                                               |  |                                                                                                      |        |   |                                                                                 |   |       |  
|---------------------------------------------- |  | ---------------------------------------------------------------------------------------------------- | ------ | - | ------------------------------------------------------------------------------- | - | ----- | -
|                                               |  | Fair ValueMeasurements UsingSignificantUnobservable Inputs(Level
3)Auction-RateTax-Exempt Securities |        |   | Fair ValueMeasurements UsingSignificantUnobservable Inputs(Level 3)Other
Assets |  
|Balance at January 1, 2009                     |  | $                                                                                                    | 39,130 |   |                                                                                 | $ | 9,647 |  
|Transfers in and/or out of Level 3             |  |                                                                                                      |       |   |                                                                                 |   |      |  
|Total gains or (losses) (realized/unrealized): |  |                                                                                                      |        |   |                                                                                 |   |       |  
|Included in earnings                           |  |                                                                                                      | 2,116  |   |                                                                                 |   | (817  | )
|Included in other comprehensive income         |  |                                                                                                      |       |   |                                                                                 |   |      |  
|Settlements                                    |  |                                                                                                      | (3,830 | ) |                                                                                 |   |      |  
|                                               |  |                                                                                                      |        |   |                                                                                 |   |       |  
|Balance at December 31, 2009                   |  | $                                                                                                    | 37,416 |   |                                                                                 | $ | 8,830 |  
|                                               |  |                                                                                                      |        |   |                                                                                 |   |       |  

Fair value measurements for liabilities in category Level 3 for the year ended December 31, 2009 were
as follows (in thousands):



|                                                           |  |                                                                                         |        |  
|---------------------------------------------------------- |  | --------------------------------------------------------------------------------------- | ------ | -
|                                                           |  | Fair Value MeasurementsUsing SignificantUnobservable Inputs(Level
3)Interest Rate Swaps |       
|Balance at January 1, 2009                                 |  | $                                                                                       | 5,935  |  
|Transfers into Level 3                                     |  |                                                                                         |       |  
|Total losses included in earnings                          |  |                                                                                         | 6,412  |  
|Write off accumulated other comprehensive loss to earnings |  |                                                                                         | (5,935 | )
|Settlements                                                |  |                                                                                         | (2,304 | )
|                                                           |  |                                                                                         |        |  
|Balance at December 31, 2009                               |  | $                                                                                       | 4,108  |  
|                                                           |  |                                                                                         |        |  

Derivative financial instruments are reported at fair value on the consolidated balance sheet. The
Companys current derivative instruments consist of two interest rate swaps entered into in 2007 and 2008, with an aggregate notional amount of $90 million outstanding at March 31, 2010, previously designated as hedges against the
variability of cash flows associated with that portion of the senior secured credit facility. The interest rate swap liability is recorded in other liabilities on the consolidated balance sheet. The credit risk associated with these swap agreements
is limited to the uncollected interest payments due from counterparties. As of March 31, 2010, counterparty credit risk was minimal.

Gains and losses (realized and unrealized) for Level 3 assets and liabilities included in earnings for the period ended March 31,
2010, are reported in net investment income, other income and loss on interest rate swaps as follows:



|                                          |  |                      |       |                   |   |        |                           |  |   |      |  
|----------------------------------------- |  | -------------------- | ----- | ----------------- | - | ------ | ------------------------- |  | - | ---- | -
|                                          |  | Net InvestmentIncome |       | OtherIncome(Loss) |   |        | Loss onInterest RateSwaps | 
|Assets                                    |  |                      |       |                   |   |        |                           |  |   |      |  
|Total gains (losses) realized in earnings |  | $                    | 2,462 |                   | $ | (2,339 | )                         |  | $ |     |  
|Liabilities                               |  |                      |       |                   |   |        |                           |  |   |      |  
|Total gains (losses) realized in earnings |  |                      |      |                   |   |       |                           |  |   | (521 | )
|                                          |  |                      |       |                   |   |        |                           |  |   |      |  
|Total for the period ended March 31, 2010 |  | $                    | 2,462 |                   | $ | (2,339 | )                         |  | $ | (521 | )
|                                          |  |                      |       |                   |   |        |                           |  |   |      |  

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

Notes payable  The fair values of the notes payable were determined using a third-party valuation source and were estimated
to be $25.3 million in the aggregate with a total carrying value of $76.9 million at March 31, 2010.

Senior secured
credit facility  The fair value of the senior secured credit facility was determined using a third-party valuation source and was estimated to be $95.6 million with a carrying value of $107.9 million at March 31, 2010.



17



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##### Table of Contents

|13. | Discontinued Operations
|--- | -----------------------

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

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



|                                         |  |                              |   |      |   |       |  
|---------------------------------------- |  | ---------------------------- | - | ---- | - | ----- | -
|                                         |  | Three Months EndedMarch 
31, |  
|                                         |  | 2010                         |   | 2009 |  
|Revenue (including loss on disposal)     |  | $                            |  |      | $ | 1,050 |  
|Pretax loss from discontinued operations |  |                              |  |      |   | (464  | )
|Income tax benefit                       |  |                              |  |      |   | (118  | )
|                                         |  |                              |   |      |   |       |  
|Loss from discontinued operations        |  | $                            |  |      | $ | (346  | )
|                                         |  |                              |   |      |   |       |  

The Company assigned store operating leases to the purchaser, but remain contingently liable on store leases
in the event of default by the assignee. These stores have future lease related payments totaling approximately $0.3 million through August 2012. The Company believes the likelihood of a liability being triggered under these leases is remote, and,
therefore, no liability has been accrued for these lease obligations as of March 31, 2010.



18



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##### Table of Contents

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

OVERVIEW

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

As of March 31, 2010, our subsidiaries included
insurance companies licensed to write insurance policies in 40 states, underwriting agencies, and retail agencies with 206 owned stores and relationships with two unaffiliated underwriting agencies. We are currently active in offering insurance
directly to individual consumers through retail stores in 9 states (Louisiana, Texas, Illinois, Alabama, Missouri, Indiana, South Carolina, Kansas, and Wisconsin) and distributing our own insurance policies through 9,200 independent agents or
brokers in 11 states (Louisiana, Texas, Illinois, Alabama, California, Michigan, Florida, Missouri, Indiana, South Carolina, and New Mexico). In February 2010, we notified the Florida Insurance Commissioner of our intent to discontinue writing new
and renewal policies in the state of Florida. We plan to begin issuing notices of non-renewal to insureds beginning on May 17, 2010.

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



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



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



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



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

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

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

CRITICAL
ACCOUNTING POLICIES

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

RECENTLY ISSUED ACCOUNTING STANDARDS

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

MEASUREMENT OF PERFORMANCE

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

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



19



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##### Table of Contents

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

Premiums.One measurement of our performance is the level of gross premiums written and a second measurement is the relative
proportion of premiums written through our three distribution channels. The following table displays our gross premiums written by distribution channel for the three months ended March 31, 2010 and 2009 (in thousands):



|                                   |  |                             |         |      |   |        
|---------------------------------- |  | --------------------------- | ------- | ---- | - | -------
|                                   |  | Three Months EndedMarch
31,
|                                   |  | 2010                        |         | 2009
|Our underwriting agencies:         |  |                             |         |      |   |        
|Retail agencies                    |  | $                           | 57,953  |      | $ | 66,383 
|Independent agencies               |  |                             | 53,007  |      |   | 38,295 
|                                   |  |                             |         |      |   |        
|Subtotal                           |  |                             | 110,960 |      |   | 104,678
|Unaffiliated underwriting agencies |  |                             | 6,122   |      |   | 7,483  
|                                   |  |                             |         |      |   |        
|Total                              |  | $                           | 117,082 |      | $ | 112,161
|                                   |  |                             |         |      |   |        

Total gross premiums written for the three months
ended March 31, 2010 increased $4.9 million, or 4.4%, compared with the prior year quarter primarily due to the overall increase in new and renewal policies written. In our retail distribution channel, gross premiums written consist of premiums
written for our affiliated insurance carriers products only and do not include premiums written for third-party insurance carriers in our retail stores. We earn commission income and fees in our retail distribution channel for sales of
third-party insurance policies. Gross premiums written in our retail distribution channel decreased $8.4 million, or 12.7%, compared with the same period in the prior year. This decrease was due to more of our retail customers choosing third-party
products due to the soft market conditions.

In our independent agency distribution channel, gross premiums written for the
three months ended March 31, 2010 increased $14.7 million, or 38.4%, compared with the same period in the prior year. We have targeted the expansion of some of our independent agent relationships. This was the cause of the increase.

Gross premiums written by our unaffiliated underwriting agencies for the three months ended March 31, 2010 decreased $1.4 million,
or 18.2%, compared with the same period in the prior year. The following table displays our gross premiums written and assumed by state for the three months ended March 31, 2010 and 2009 (in thousands):



|               |  |                              |         |      |   |        
|-------------- |  | ---------------------------- | ------- | ---- | - | -------
|               |  | Three Months EndedMarch 
31,
|               |  | 2010                         |         | 2009
|Louisiana      |  | $                            | 44,557  |      | $ | 41,430 
|Texas          |  |                              | 19,894  |      |   | 24,064 
|Michigan       |  |                              | 16,934  |      |   | 5,497  
|Illinois       |  |                              | 11,868  |      |   | 13,648 
|Alabama        |  |                              | 9,928   |      |   | 9,416  
|California     |  |                              | 6,067   |      |   | 7,394  
|Indiana        |  |                              | 3,062   |      |   | 3,461  
|Missouri       |  |                              | 1,868   |      |   | 3,090  
|South Carolina |  |                              | 1,551   |      |   | 1,277  
|Florida        |  |                              | 721     |      |   | 1,939  
|New Mexico     |  |                              | 577     |      |   | 856    
|Georgia        |  |                              | 32      |      |   | 49     
|Arizona        |  |                              | 23      |      |   | 40     
|               |  |                              |         |      |   |        
|Total          |  | $                            | 117,082 |      | $ | 112,161
|               |  |                              |         |      |   |        

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



20



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##### Table of Contents

The following table displays our net premiums written by distribution channel for the three
months ended March 31, 2010 and 2009 (in thousands):



|                                                                |  |                             |         |   |      |   |         |  
|--------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                |  | Three Months EndedMarch 31, |        
|                                                                |  | 2010                        |         |   | 2009 |  
|Our underwriting agencies:                                      |  |                             |         |   |      |   |         |  
|Retail agencies  gross premiums written                        |  | $                           | 57,953  |   |      | $ | 66,383  |  
|Ceded reinsurance                                               |  |                             |        |   |      |   | 10,285  |  
|                                                                |  |                             |         |   |      |   |         |  
|Subtotal retail agencies net premiums written                   |  |                             | 57,953  |   |      |   | 76,668  |  
|                                                                |  |                             |         |   |      |   |         |  
|Independent agencies  gross premiums written                   |  |                             | 53,007  |   |      |   | 38,295  |  
|Ceded reinsurance                                               |  |                             | (2,003  | ) |      |   | (350    | )
|                                                                |  |                             |         |   |      |   |         |  
|Subtotal independent agencies net premiums written              |  |                             | 51,004  |   |      |   | 37,945  |  
|                                                                |  |                             |         |   |      |   |         |  
|Unaffiliated underwriting agencies  gross premiums written     |  |                             | 6,122   |   |      |   | 7,483   |  
|Ceded reinsurance                                               |  |                             | (32     | ) |      |   | (48     | )
|                                                                |  |                             |         |   |      |   |         |  
|Subtotal unaffiliated underwriting agencies net premium written |  |                             | 6,090   |   |      |   | 7,435   |  
|                                                                |  |                             |         |   |      |   |         |  
|Catastrophe and contingent coverages with various reinsurers    |  |                             | (175    | ) |      |   | (180    | )
|                                                                |  |                             |         |   |      |   |         |  
|Total net premiums written                                      |  | $                           | 114,872 |   |      | $ | 121,868 |  
|                                                                |  |                             |         |   |      |   |         |  

Total net premiums written for the three months ended March 31, 2010 decreased $7.0 million, or 5.7%,
compared with the same period in the prior year primarily due to the termination of our quota share reinsurance contract for our Louisiana and Alabama business on a cut-off basis effective January 1, 2009 and the resulting return of $10.5
million of ceded unearned premium.

RESULTS OF OPERATIONS

We had a net loss from continuing operations of $3.5 million for the three months ended March 31, 2010, compared with net income from
continuing operations of $11.2 million for the comparable period in 2009. Significant items impacting the three months ended March 31, 2009 results were a net pretax gain on extinguishment of debt of $19.4 million, which was partially offset by
a loss on interest rate swaps of $4.4 million associated with the discontinuation of hedge accounting.

Comparison of the Three Months
Ended March 31, 2010 to the Three Months Ended March 31, 2009

Total revenues for the three months ended
March 31, 2010 increased $2.8 million, or 2.4%, compared with the three months ended March 31, 2009. The increase was primarily due to increases in net realized gains and commission income and fees, partially offset by decreases in other
income and net investment income.

The largest component of revenue is net premiums earned on insurance policies. Net premiums
earned for the current quarter decreased $0.5 million, or 0.5%, compared with the prior year quarter. Since insurance premiums are earned over the service period of the policies, the revenue in the current quarter includes premiums earned on
insurance products written through our three distribution channels in both current and previous periods.

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



|                                   |  |                             |        |      |   |       
|---------------------------------- |  | --------------------------- | ------ | ---- | - | ------
|                                   |  | Three Months EndedMarch 31,
|                                   |  | 2010                        |        | 2009
|Our underwriting agencies          |  | $                           | 86,807 |      | $ | 86,713
|Unaffiliated underwriting agencies |  |                             | 5,915  |      |   | 6,512 
|                                   |  |                             |        |      |   |       
|Total net premiums earned          |  | $                           | 92,722 |      | $ | 93,225
|                                   |  |                             |        |      |   |       

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

Policy, installment, premium finance and agency fees are earned for business written or assumed by our insurance companies both through
independent agents and our retail agencies. Policy, installment and agency fees are fees charged to the customers in



21



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##### Table of Contents

connection with their purchase of coverage from our insurance company subsidiaries. Generally, we can increase or decrease agency fees, installment fees, and interest rates subject to limited
regulatory restrictions, but policy fees must be approved by the applicable states department of insurance. Premium finance fees are financing fees earned by our premium finance subsidiaries, and consist of origination and servicing fees as
well as interest on premiums that customers choose to finance.

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

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



|                                 |  |                             |        |      |   |       
|-------------------------------- |  | --------------------------- | ------ | ---- | - | ------
|                                 |  | Three Months EndedMarch 31,
|                                 |  | 2010                        |        | 2009
|Policyholder fees                |  | $                           | 12,152 |      | $ | 9,705 
|Premium finance revenue          |  |                             | 5,771  |      |   | 5,567 
|Commissions and fees             |  |                             | 4,289  |      |   | 3,515 
|Agency fees                      |  |                             | 1,382  |      |   | 1,519 
|Other, net                       |  |                             | 1      |      |   | 264   
|                                 |  |                             |        |      |   |       
|Total commission income and fees |  | $                           | 23,595 |      | $ | 20,570
|                                 |  |                             |        |      |   |       

Commission income and fees increased $3.0 million, or
14.7%, compared with the same period in the prior year. Policyholder fees have increased due to the higher overall volume of premiums written and a change in mix in states. We experienced a steady increase in premium finance revenue since December
2007 when we began financing third-party premiums. Commissions and fees increased as more of our retail customers chose third-party products due to the soft market conditions and an expansion of our ancillary product sales.

Net Investment Income and Other Income.Net investment income for the three months ended March 31, 2010 decreased $1.0
million, or 40.9%, compared with the same period in the prior year. The decrease was primarily due to a reduction in yields and a 12.8% decrease in total average invested assets to $230.6 million during the current quarter from $264.3 million in the
prior year. The average investment yield was 2.7% (3.4% on a taxable equivalent basis) in the current quarter, compared with 3.1% (4.3% on a taxable equivalent basis) in the prior year.

As of March 31, 2010, we held $39.1 million, at amortized cost, and $32.5 million fair value of auction-rate tax-exempt securities.
Generally, the interest rates for these securities are determined by bidding every 7, 28 or 35 days. When there are more sellers than buyers, an auction fails and bondholders that want to sell are unable to sell the securities. Auctions for these
securities began to fail in late January 2008. Issuers remain obligated to pay interest and principal when due when an auction fails. Rates at failed auctions are set at a level established in the terms of the debt. In February 2008, investment
banks stopped committing capital to the auctions and there have been widespread auctions failures since that time.

In October
2008, the Companys broker filed a prospectus with the SEC, which published a legally-binding offer to all authorized holders of auction-rate securities to purchase all eligible securities at par (the settlement). The time frames
set by the Companys broker for buybacks have different start dates based upon the individual clients size, which is determined by each clients balance of investments held at the Companys broker. In November 2008, the Company
elected to participate in its brokers offer to purchase the Companys auction-rate securities at par and classified its portfolio of auction-rate securities as trading. The settlement agreement requires our broker to purchase eligible
securities at par, at any time during a two-year period beginning June 30, 2010. All auction-rate securities held at March 31, 2010 are eligible for buyback under the settlement agreements. At March 31, 2010 and December 31,
2009, the fair value of the settlement was $6.5 million and $8.8 million, respectively, which is recorded in other assets in the consolidated balance sheets with changes in fair value recorded in other income (loss) in the consolidated statements of
income (loss).

In the first quarter of 2010, we began to reposition our investment portfolio by decreasing our tax-exempt
investments. The purpose of the repositioning is to monetize the tax-exempt portion of the investments and to decrease our municipal credit exposure. We expect the repositioning to be completed in the second quarter of 2010. As a result of the
repositioning, we sold $54.0 million of available-for-sale securities during the three-month period ended March 31, 2010, for a net realized gain of $1.2 million.



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For the three-month period ended March 31, 2010, other income includes $0.5 million
related to a settlement received from legal proceedings.

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

Losses and loss adjustment expenses for the current quarter increased $1.3 million, or
1.9 %, compared with the prior year quarter. The percentage of losses and loss adjustment expense to net premiums earned (the loss ratio) was 76.6% in the current quarter, compared with 74.7% in the prior year quarter. The increase in the
accident quarter loss ratio was primarily due to a change in mix due to growth in Texas and Michigan, which have higher loss ratios than our average.

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



|                                                       |  |                             |   |  |      |  
|------------------------------------------------------ |  | --------------------------- | - |  | ---- | -
|                                                       |  | Three Months EndedMarch 31, |  
|                                                       |  | 2010                        |   |  | 2009 |  
|Loss ratio  current quarter                           |  | 76.6                        | % |  | 74.7 | %
|Adverse loss ratio development  prior period business |  |                            |   |  |     |  
|                                                       |  |                             |   |  |      |  
|Reported loss ratio                                    |  | 76.6                        | % |  | 74.7 | %
|                                                       |  |                             |   |  |      |  

Selling, General and Administrative Expenses. Another measurement of our performance that addresses
our overall efficiency is the level of selling, general and administrative expenses. We recognize that our customers are primarily motivated by low prices. As a result, we strive to keep our costs as low as possible to be able to keep our prices
affordable and thus to maximize our sales while still maintaining profitability. Our selling, general and administrative expenses include not only the cost of acquiring the insurance policies through our insurance carriers (the amortization of the
deferred acquisition costs) and managing our insurance carriers and the retail stores, but also the costs of the holding company. The largest component of selling, general and administrative expenses is personnel costs, including payroll, benefits
and accrued bonus expenses. Selling, general and administrative expenses increased $2.4 million, or 6.0%, compared with the prior year quarter. This increase was primarily related to a reallocation of expenses from loss adjustment expense to more
accurately reflect claim handling costs. If the new allocation methodology was in place in the first quarter of 2009, selling, general and administrative expenses would have been higher by $1.7 million.

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



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



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

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

During
2006, we developed a comprehensive implementation plan and supporting business case to consolidate and transform our primary business applications onto a new strategic platform. Through March 31, 2010, the new point-of-sale and policy
administration system was implemented in Illinois, Indiana, Michigan, Missouri, South Carolina and Texas. For the new policy administration system implementation, we plan to operate the legacy systems through the policies renewal dates when
they will be converted to the new system. This will result in additional operating expense until the legacy systems can be retired.

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



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##### Table of Contents

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



|                                                                                  |  |                             |         |   |      |   |         |  
|--------------------------------------------------------------------------------- |  | --------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                  |  | Three Months EndedMarch 31, |        
|                                                                                  |  | 2010                        |         |   | 2009 |  
|Amortization of deferred acquisition costs                                        |  | $                           | 20,279  |   |      | $ | 18,111  |  
|Other selling, general and administrative expenses                                |  |                             | 22,260  |   |      |   | 22,012  |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Total selling, general and administrative expenses                                |  | $                           | 42,539  |   |      | $ | 40,123  |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Total as a percentage of net premiums earned                                      |  |                             | 45.9    | % |      |   | 43.0    | %
|                                                                                  |  |                             |         |   |      |   |         |  
|Beginning deferred acquisition costs                                              |  | $                           | 24,230  |   |      | $ | 21,993  |  
|Additions                                                                         |  |                             | 24,994  |   |      |   | 21,925  |  
|Amortization                                                                      |  |                             | (20,279 | ) |      |   | (18,111 | )
|                                                                                  |  |                             |         |   |      |   |         |  
|Ending deferred acquisition costs                                                 |  | $                           | 28,945  |   |      | $ | 25,807  |  
|                                                                                  |  |                             |         |   |      |   |         |  
|Amortization of deferred acquisition costs as a percentage of net premiums earned |  |                             | 21.9    | % |      |   | 19.4    | %
|                                                                                  |  |                             |         |   |      |   |         |  

Depreciation and Amortization.Depreciation and amortization expense for the current quarter
was consistent with the same period in the prior year.

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

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

Loss on Interest Rate Swaps.Loss on interest rate swaps for the three months ended March 31, 2010 decreased $3.9 million, or
88.2%, compared with the same period in the prior year. The amendment of the senior credit facility in March 2009 resulted in the interest rate swaps becoming ineffective as cash flow hedges and are therefore carried at fair value. The loss relates
to the impact on the determination of fair value associated with the decline in short-term interest rates implied in the forward yield curve.

Interest Expense.Interest expense for the current quarter increased $2.0 million, or 47.8%, compared with the prior quarter. This
increase was due to higher interest rates on the senior secured credit facility and the amortization of debt discount of $1.7 million in the current quarter, partially offset by a decrease in the average debt outstanding.

Income Taxes.Income tax expense for the current quarter was $0.4 million as compared with income tax expense of $4.4
million for the same period in the prior year. The income tax expense for the three months ended March 31, 2010 was primarily due to an increase in the deferred tax liability related to goodwill and state tax expense.

Our net deferred tax assets prior to recognition of valuation allowance were $22.9 million and $20.8 million at March 31,
2010 and December 31, 2009, respectively. In assessing the realizability of our deferred tax assets, we considered whether it was more likely than not that our deferred tax assets will be realized based upon all available evidence, including
scheduled reversal of deferred tax liabilities, historical operating results, projected future operating results, tax carry-back availability, and limitations pursuant to Section 382 of the Internal Revenue Code, among others. Based on this
assessment, we began recording a valuation allowance against deferred taxes in December 2009.



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LIQUIDITY AND CAPITAL RESOURCES

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

There are no restrictions on the payment of dividends by our non-insurance company subsidiaries other than state corporate laws regarding
solvency. As a result, our non-insurance company subsidiaries generate revenues, profits and net cash flows that are generally unrestricted as to their availability for the payment of dividends and we have and expect to continue to use those
revenues to service our corporate financial obligations, such as debt service and stockholder dividends. As of March 31, 2010, we had $1.9 million of cash and equivalents at the holding company level and $27.9 million of cash and cash
equivalents at our non-insurance company subsidiaries.

State insurance laws restrict the ability of our insurance company
subsidiaries to declare stockholder dividends. These subsidiaries may not make an extraordinary dividend until 30 days after the applicable commissioner of insurance has received notice of the intended dividend and has not objected in
such time or until the commissioner has approved the payment of the extraordinary dividend within the 30-day period. In most states, an extraordinary dividend is defined as any dividend or distribution of cash or other property whose fair market
value, together with that of other dividends and distributions made within the preceding 12 months, exceeds the greater of 10.0% of the insurance companys surplus as of the preceding year-end or the insurance companys net income for the
preceding year, in each case determined in accordance with statutory accounting practices. In addition, dividends may only be paid from unassigned earnings and an insurance companys remaining surplus must be both reasonable in relation to its
outstanding liabilities and adequate to its financial needs. As of March 31, 2010, our insurance companies could not pay ordinary dividends to us without prior regulatory approval due to a negative unassigned surplus position. However, as
mentioned previously, our nonregulated entities provide adequate cash flow to fund their own operations. In February 2009, we obtained approval from the New York Department of Insurance for one of our insurance subsidiaries to retire one million
shares of its stock for $2.9 million and approved payment of an extraordinary dividend for $0.1 million.

The National
Association of Insurance Commissioners model law for risk-based capital provides formulas to determine the amount of capital that an insurance company needs to ensure that it has an acceptable expectation of not becoming financially impaired.
At March 31, 2010, each of our insurance subsidiaries maintained a risk-based capital level that was in excess of an amount that would require any corrective actions on our part.

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

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

Senior secured credit facility. At March 31, 2010, we were in compliance with all of our financial and other covenants.



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

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

Interest rate risk.Our investment portfolio consists of investment-grade, fixed-income securities classified as
available-for-sale investment securities and auction-rate tax-exempt securities classified as trading. Accordingly, the primary market risk exposure to our debt securities is interest rate risk. In general, the fair market value of a portfolio of
fixed-income securities increases or decreases inversely with changes in market interest rates, while net investment income realized from future investments in fixed-income securities increases or decreases along with interest rates. In addition,
some of our fixed-income securities have call or prepayment options. This could subject us to reinvestment risk should interest rates fall and issuers call their securities and we reinvest at lower interest rates. We attempt to mitigate this
interest rate risk by investing in securities with varied maturity dates and by managing the duration of our investment portfolio to a defined range of less than three years. The fair value of our fixed-income securities as of March 31, 2010
was $192.4 million. The effective average duration of the portfolio as of March 31, 2010 was 1.45 years. If market interest rates increase 1.0%, our fixed-income investment portfolio would be expected to decline in market value by 1.45%, or
$2.8 million, representing the effective average duration multiplied by the change in market interest rates. Conversely, a 1.0% decline in interest rates would result in a 1.45%, or $2.8 million, increase in the market value of our fixed-income
investment portfolio.



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



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Derivative financial instruments are reported at fair value on the consolidated balance
sheet. Our current derivative instruments consist of two interest rate swaps with an aggregate notional amount of $90.0 million outstanding at March 31, 2010. One swap instrument has a notional amount outstanding of $50.0 million that requires
quarterly settlements whereby we pay a fixed rate of 4.993% and receive a three-month LIBOR rate. The second interest rate swap has a notional amount of $40.0 million outstanding, for which we pay a fixed rate of 3.031% and receive a three-month
LIBOR rate. The interest rate swaps were previously designated as hedges against the variability of cash flows associated with that portion of the senior secured credit facility.

Our notes payable are also subject to interest rate risk. The $30.9 million notes payable bear an initial interest rate of 7.545% until
March 15, 2010, at which time the securities adjust quarterly to the three-month LIBOR rate plus 3.60%. The interest rate as of March 31, 2010 was 3.86%. The $25.8 million notes payable bear an initial interest rate of 7.792% until
June 15, 2010, at which time they will adjust quarterly to the three-month LIBOR rate plus 3.55%. The interest rate as of March 31, 2010 was 7.79%. The $20.2 million notes payable bear an interest rate of the three-month LIBOR rate plus
3.95% not exceeding 12.50% through March 2010 with no limit thereafter. The interest rate as of March 31, 2010 was 4.21%.

Credit risk.An additional exposure to our fixed-income securities portfolio is credit risk. We attempt to manage our
credit risk by investing only in investment-grade securities and limiting our exposure to a single issuer. At March 31, 2010, our fixed-income investments were invested in the following: U.S. Treasury and government agencies securities 14.1%,
corporate debt securities 39.9%, residential mortgage-backed securities 2.3% and states and political subdivisions securities 43.7%.

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



|                          |  |               |         |   |                  |   |         |  
|------------------------- |  | ------------- | ------- | - | ---------------- | - | ------- | -
|                          |  | March 31,2010 |         |   | December 31,2009 |  
|Total invested assets     |  | $             | 192,439 |   |                  | $ | 251,072 |  
|Tax-equivalent book yield |  |               | 3.40    | % |                  |   | 4.00    | %
|Average duration in years |  |               | 1.45    |   |                  |   | 1.50    |  
|Average S&P rating        |  |               | AA-     |   |                  |   | AA-     |  

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

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



|                                                         |  |               |        |                  |   |       
|-------------------------------------------------------- |  | ------------- | ------ | ---------------- | - | ------
|                                                         |  | March 31,2010 |        | December 31,2009
|Michigan Catastrophic Claims Association                 |  | $             | 21,310 |                  | $ | 18,452
|Vesta Insurance Group                                    |  |               | 14,721 |                  |   | 14,691
|Quota-share reinsurer for Louisiana and Alabama business |  |               | 3,061  |                  |   | 3,955 
|Other                                                    |  |               | 4,845  |                  |   | 4,984 
|                                                         |  |               |        |                  |   |       
|Total reinsurance receivable                             |  | $             | 43,937 |                  | $ | 42,082
|                                                         |  |               |        |                  |   |       

Under the reinsurance agreement with Vesta Insurance
Group (VIG), including primarily Vesta Fire Insurance Corporation (VFIC), Affirmative Insurance Company (AIC) had the right, under certain circumstances, to require VFIC to provide a letter of credit or establish a trust account to collateralize the
gross amount due AIC and Insura Property and Casualty Insurance Company from VFIC under the reinsurance agreement. Accordingly, AIC, Insura and VFIC entered into a Security Fund Agreement effective September 1, 2004. On August 30, 2005,
AIC received a letter from VFICs President that irrevocably confirmed VFICs duty and obligation under the Security Fund Agreement to provide security sufficient to satisfy VFICs gross obligations under the reinsurance agreement
(the VFIC Trust). At March 31, 2010, the VFIC Trust held $17.6 million (after cumulative withdrawals of $7.6 million through March 31, 2010), consisting of $12.7 million of a U.S. Treasury money market account and $4.9 million of corporate
bonds rated BBB or higher, to collateralize the $14.7 million net recoverable from VFIC.

At March 31, 2010, $11.1
million was included in reserves for losses and loss adjustment expenses that represented the amounts owed by AIC and Insura under reinsurance agreements with the VIG affiliated companies, including Hawaiian Insurance and



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Guaranty Company, Ltd (Hawaiian). Affirmative established a trust account to collateralize this payable, which currently holds $20.7 million in securities (the AIC Trust). The Special Deputy
Receiver (SDR) in Texas or the SDR in Hawaii drew down the AIC Trust $0.4 million through March 2010, and the Special Deputy Receiver in Hawaii had cumulative withdrawals from the AIC Trust of $1.7 million through March 2010.

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



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

The Companys management performed an evaluation under the supervision and with the participation of the Companys principal
executive officer and the principal financial officer, and completed an evaluation of the effectiveness of the design and operation of the Companys disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e)),
as adopted by the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934, as amended (the Exchange Act) as of March 31, 2010. Disclosure controls and procedures are the controls and other procedures that are designed
to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms. Disclosure controls
and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management,
including the principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures.

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

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

Subsequently, during 2010, we implemented enhancements to our internal controls over financial reporting to ensure proper presentation
and review of the income tax provision. We believe the controls have been effective during the period.

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

PART II  OTHER INFORMATION



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

See
Note 10 of Notes to Consolidated Financial Statements, Legal and Regulatory Proceedings.



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

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



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

31.1    Certification of Kevin R. Callahan, Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002

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

32.1    Certification of Kevin R. Callahan, Chief Executive Officer,
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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



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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 10, 2010 |  |     |  |                                                     
|                   |  |     |  | /s/ Michael J. McClure                              
|                   |  | By: |  | Michael J. McClure                                  
|                   |  |     |  | Executive Vice President and Chief Financial Officer
|                   |  |     |  | (and in his capacity as Principal Financial Officer)



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