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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K/A

(Amendment No. 1 to Form 10-K)

(Mark One)

|  |  |                                                                                                                                       
|- |  | --------------------------------------------------------------------------------------------------------------------------------------
|x |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934

 For the fiscal year ended December 31, 2012
  Or
|  | 
| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES ACT OF 1934
For the transition period from              to         

Commission File Number: 000-50990

Tower Group, Inc.

(Exact name of registrant as specified in its charter)



| |  |                                                               |  |  |  |                                      |  | 
| |  | ------------------------------------------------------------- |  |  |  | ------------------------------------ |  | 
| |  | Delaware                                                      |  |  |  | 13-3894120                           |  | 
| |  | (State or other jurisdiction ofincorporation or organization) |  |  |  | (I.R.S. Employer Identification No.) |  | 
| |  | 120 Broadway, 31st FloorNew York, New York                    |  |  |  | 10271                                |  | 
| |  | (Address of principal executive offices)                      |  |  |  | (Zip Code)                           |  | 

(212) 655-2000



(Registrants telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:



| |  |                                         |  |  |  |                                           |  | 
| |  | --------------------------------------- |  |  |  | ----------------------------------------- |  | 
| |  | Title of each class                     |  |  |  | Name of each exchange on which registered |  | 
| |  | Common Stock, $0.01 par value per share |  |  |  | NASDAQ Global Select Market               |  | 

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check
mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of Securities

Act.    Yes   ̈    No  þ

Indicate by
check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the

Act.    Yes   ̈    No  þ

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  þ    No   ̈

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

Indicate by
check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.     ̈

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. (Check one):



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

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

The aggregate market value of the registrants common stock held by non-affiliates on June 30, 2012 (based on the closing price on the NASDAQ Global Select Market on such date) was $720,706,000.

As of March 8, 2013, the registrant had 38,379,597 shares of common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE:

Part III of this Form 10-K incorporates by reference certain information from the registrants definitive Proxy Statement with respect to the registrants 2013 Annual Meeting of
Shareholders, to be filed not later than 120 days after the close of the registrants fiscal year (the Proxy Statement).



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EXPLANATORY NOTE

This Amendment No. 1 (the Amendment) to our Annual Report on Form 10-K for the year ended December 31, 2012, which was filed with the Securities and Exchange Commission (the
SEC) on March 4, 2013 (the Form 10-K), is being filed to provide the conformed signature of PricewaterhouseCoopers LLP which was inadvertently omitted from the Report of Independent Registered Public Accounting Firm
which appears at page F-2 of the Consolidated Financial Statements in the Form 10-K. The Company obtained a manually-signed copy of the signed report of PricewaterhouseCoopers LLP on March 4, 2013 before filing its Form 10-K on
March 4, 2013.

No other changes have been made to the Form 10-K other than that described above. This Amendment does not
reflect subsequent events occurring after the original filing date of the Form 10-K or modify or update in any way disclosures made in the Form 10-K. Among other things, forward-looking statements made in the Form 10-K have not been
revised to reflect events that occurred or facts that became known to the Company after filing of the Form 10-K, and such forward-looking statements should be read in their historical context. Furthermore, this Form 10-K/A should be read
in conjunction with the Form 10-K and with the Companys filings with the SEC subsequent to the Form 10-K.



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TABLE OF CONTENTS



|                                                    |  |  |     | 
|--------------------------------------------------- |  |  | --- | 
|                                                    | 
|PART II                                             |  |  |     | 
|                                                    | 
|Item 8. Financial Statements And Supplementary Data |  |  | F-1 | 
|                                                    | 
|Item 9A. Controls And Procedures                    |  |  | 51  | 
|                                                    | 
|PART IV                                             |  |  | 53  | 
|                                                    | 
|Item 15. Exhibits, Financial Statement Schedules    |  |  | 53  | 



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Item 8. Financial Statements and Supplementary Data

Index to Consolidated Financial Statements



|                                                                                                                  |  |      |     | 
|----------------------------------------------------------------------------------------------------------------- |  | ---- | --- | 
|                                                                                                                  |  | Page |    
|                                                                                                                  | 
|Reports of Independent Registered Public Accounting Firm                                                          |  |      | F-2 | 
|Consolidated Balance Sheets as of December 31, 2012 and 2011                                                      |  |      | F-3 | 
|Consolidated Statements of Income and Comprehensive Income for the years ended December 
31, 2012, 2011, and 2010 |  |      | F-5 | 
|Consolidated Statements of Changes in Stockholders Equity for the years ended December 
31, 2012, 2011, and 2010 |  |      | F-6 | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2012, 2011, and
2010                       |  |      | F-7 | 
|Notes to Consolidated Financial Statements                                                                        |  |      | F-8 | 



F-1



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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of Tower Group, Inc,

In our opinion, the accompanying consolidated balance sheets as of December 31, 2012 and 2011 and the related consolidated statements of income and comprehensive income, changes in stockholders
equity, and cash flows for each of the three years in the period ended December 31, 2012 present fairly, in all material respects, the financial position of Tower Group, Inc. and its subsidiaries (the Company) at December 31,
2012 and 2011, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2012 in conformity with accounting principles generally accepted in the United States of America. In addition,
in our opinion, the financial statement schedules listed in the index appearing on page S-1 present fairly, in all material respects, the information set forth therein at December 31, 2012 and 2011, and for each of the years in the three year
period ended December 31, 2012 when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2012, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Companys management is responsible for these
financial statements and financial statement schedules, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in Managements
Report on Internal Control over Financial Reporting appearing under Item 9A. Our responsibility is to express opinions on these financial statements, on the financial statement schedules, and on the Companys internal control over
financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of the financial statements included
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement
presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and
operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our
opinions.

A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and
procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management
and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial
statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP

New York, New York

March 4, 2013



F-2



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Part I  FINANCIAL INFORMATION

Item 1. Financial Statements

Tower Group, Inc.

Consolidated Balance Sheets



|                                                                                                                                                         |  |              |           |  |      |   |           | 
|-------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | --------- |  | ---- | - | --------- | 
|                                                                                                                                                         |  | December 31, |          
|($ in thousands, except par value and share amounts)                                                                                                     |  | 2012         |           |  | 2011 |  
|                                                                                                                                                         | 
|Assets                                                                                                                                                   |  |              |           |  |      |   |           | 
|Investments - Tower                                                                                                                                      |  |              |           |  |      |   |           | 
|Available-for-sale investments, at fair value:                                                                                                           |  |              |           |  |      |   |           | 
|Fixed-maturity securities (amortized cost of $1,926,236 and $2,046,932)                                                                                  |  | $            | 2,065,148 |  |      | $ | 2,153,620 | 
|Equity securities (cost of $144,204 and $91,069)                                                                                                         |  |              | 140,695   |  |      |   | 87,479    | 
|Short-term investments (cost of $4,749 and $0)                                                                                                           |  |              | 4,750     |  |      |   | -         | 
|Other invested assets                                                                                                                                    |  |              | 57,786    |  |      |   | 44,347    | 
|Investments - Reciprocal Exchanges                                                                                                                       |  |              |           |  |      |   |           | 
|Available-for-sale investments, at fair value:                                                                                                           |  |              |           |  |      |   |           | 
|Fixed-maturity securities (amortized cost of $263,950 and $288,180)                                                                                      |  |              | 280,563   |  |      |   | 300,054   | 
|Equity securities (cost of $5,144 and $1,965)                                                                                                            |  |              | 5,563     |  |      |   | 1,866     | 
|                                                                                                                                                         | 
|Total investments                                                                                                                                        |  |              | 2,554,505 |  |      |   | 2,587,366 | 
|Cash and cash equivalents (includes $9,782 and $666 relating to Reciprocal Exchanges)                                                                    |  |              | 100,293   |  |      |   | 114,098   | 
|Investment income receivable (includes $2,610 and $2,978 relating to Reciprocal Exchanges)                                                               |  |              | 25,332    |  |      |   | 26,782    | 
|Investment in unconsolidated affiliate                                                                                                                   |  |              | 70,830    |  |      |   | -         | 
|Premiums receivable (includes $44,285 and $44,171 relating to Reciprocal Exchanges)                                                                      |  |              | 422,112   |  |      |   | 426,432   | 
|Reinsurance recoverable on paid losses (includes $682 and $5,670 relating to Reciprocal Exchanges)                                                       |  |              | 17,609    |  |      |   | 23,903    | 
|Reinsurance recoverable on unpaid losses (includes $52,389 and $11,253 relating to Reciprocal Exchanges)                                                 |  |              | 496,192   |  |      |   | 319,664   | 
|Prepaid reinsurance premiums (includes $17,803 and $14,685 relating to Reciprocal Exchanges)                                                             |  |              | 63,923    |  |      |   | 54,037    | 
|Deferred acquisition costs, net (includes $11,364 and $11,866 relating to Reciprocal Exchanges)                                                          |  |              | 180,941   |  |      |   | 168,858   | 
|Intangible assets (includes $6,854 and $4,839 relating to Reciprocal Exchanges)                                                                          |  |              | 106,768   |  |      |   | 114,920   | 
|Goodwill                                                                                                                                                 |  |              | 241,458   |  |      |   | 241,458   | 
|Funds held by reinsured companies                                                                                                                        |  |              | 137,545   |  |      |   | 69,755    | 
|Other assets (includes $2,042 and $2,685 relating to Reciprocal Exchanges)                                                                               |  |              | 331,506   |  |      |   | 306,295   | 
|                                                                                                                                                         | 
|Total assets                                                                                                                                             |  | $            | 4,749,014 |  |      | $ | 4,453,568 | 
|                                                                                                                                                         | 
|Liabilities                                                                                                                                              |  |              |           |  |      |   |           | 
|Loss and loss adjustment expenses (includes $135,791 and $136,274 relating to Reciprocal Exchanges)                                                      |  | $            | 1,895,073 |  |      | $ | 1,632,113 | 
|Unearned premium (includes $103,216 and $102,991 relating to Reciprocal Exchanges)                                                                       |  |              | 920,859   |  |      |   | 893,176   | 
|Reinsurance balances payable (includes $6,979 and $3,466 relating to Reciprocal Exchanges)                                                               |  |              | 40,569    |  |      |   | 20,794    | 
|Funds held under reinsurance agreements (includes $500 and $0 relating to Reciprocal Exchanges)                                                          |  |              | 98,581    |  |      |   | 96,726    | 
|Other liabilities (includes $21,054 and $10,035 relating to Reciprocal Exchanges)                                                                        |  |              | 292,239   |  |      |   | 289,394   | 
|Deferred income taxes (includes $19,818 and $18,906 relating to Reciprocal Exchanges)                                                                    |  |              | 36,464    |  |      |   | 33,285    | 
|Debt                                                                                                                                                     |  |              | 449,731   |  |      |   | 426,901   | 
|                                                                                                                                                         | 
|Total liabilities                                                                                                                                        |  |              | 3,733,516 |  |      |   | 3,392,389 | 
|Contingencies (Note 17)                                                                                                                                  |  |              | -         |  |      |   | -         | 
|Stockholders equity                                                                                                                                     |  |              |           |  |      |   |           | 
|Common stock ($0.01 par value; 100,000,000 shares authorized, 46,820,959 and 46,448,341 shares issued, and 38,405,837 and
39,221,102 shares outstanding) |  |              | 469       |  |      |   | 465       | 
|Treasury stock (8,415,122 and 7,227,239 shares)                                                                                                          |  |              | (181,435) |  |      |   | (158,185) | 
|Paid-in-capital                                                                                                                                          |  |              | 780,097   |  |      |   | 772,938   | 
|Accumulated other comprehensive income                                                                                                                   |  |              | 83,406    |  |      |   | 63,053    | 
|Retained earnings                                                                                                                                        |  |              | 298,299   |  |      |   | 355,528   | 
|                                                                                                                                                         | 
|Tower Group, Inc. stockholders equity                                                                                                                   |  |              | 980,836   |  |      |   | 1,033,799 | 
|                                                                                                                                                         | 
|Noncontrolling interests                                                                                                                                 |  |              | 34,662    |  |      |   | 27,380    | 
|                                                                                                                                                         | 
|Total stockholders equity                                                                                                                               |  |              | 1,015,498 |  |      |   | 1,061,179 | 
|                                                                                                                                                         | 
|Total liabilities and stockholders equity                                                                                                               |  | $            | 4,749,014 |  |      | $ | 4,453,568 | 
|                                                                                                                                                         | 

See accompanying notes to the consolidated financial statements.



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Tower Group, Inc.

Consolidated Statements of Operations



|                                                                          |  |                         |           |  |      |   |           |      |  |   |           | 
|------------------------------------------------------------------------- |  | ----------------------- | --------- |  | ---- | - | --------- | ---- |  | - | --------- | 
|                                                                          |  | Year Ended December 31, |          
|(in thousands, except per share amounts)                                  |  | 2012                    |           |  | 2011 |   |           | 2010 | 
|                                                                          | 
|Revenues                                                                  |  |                         |           |  |      |   |           |      |  |   |           | 
|Net premiums earned                                                       |  | $                       | 1,721,542 |  |      | $ | 1,593,850 |      |  | $ | 1,292,669 | 
|Ceding commission revenue                                                 |  |                         | 32,335    |  |      |   | 33,968    |      |  |   | 39,303    | 
|Insurance services revenue                                                |  |                         | 3,420     |  |      |   | 1,570     |      |  |   | 2,169     | 
|Policy billing fees                                                       |  |                         | 12,615    |  |      |   | 10,534    |      |  |   | 6,255     | 
|Net investment income                                                     |  |                         | 127,165   |  |      |   | 126,474   |      |  |   | 107,265   | 
|Net realized investment gains (losses):                                   |  |                         |           |  |      |   |           |      |  |   |           | 
|Other-than-temporary impairments                                          |  |                         | (9,919)   |  |      |   | (3,509)   |      |  |   | (14,930)  | 
|Portion of loss recognized in other comprehensive income                  |  |                         | 286       |  |      |   | 264       |      |  |   | 11,909    | 
|Other net realized investment gains                                       |  |                         | 35,109    |  |      |   | 12,639    |      |  |   | 17,674    | 
|                                                                          | 
|Total net realized investment gains (losses)                              |  |                         | 25,476    |  |      |   | 9,394     |      |  |   | 14,653    | 
|                                                                          | 
|Total revenues                                                            |  |                         | 1,922,553 |  |      |   | 1,775,790 |      |  |   | 1,462,314 | 
|Expenses                                                                  |  |                         |           |  |      |   |           |      |  |   |           | 
|Loss and loss adjustment expenses                                         |  |                         | 1,253,860 |  |      |   | 1,055,249 |      |  |   | 784,023   | 
|Direct and ceding commission expense                                      |  |                         | 359,710   |  |      |   | 309,826   |      |  |   | 267,872   | 
|Other operating expenses                                                  |  |                         | 316,645   |  |      |   | 280,447   |      |  |   | 231,381   | 
|Acquisition-related transaction costs                                     |  |                         | 9,229     |  |      |   | 360       |      |  |   | 2,369     | 
|Interest expense                                                          |  |                         | 32,630    |  |      |   | 34,290    |      |  |   | 24,223    | 
|                                                                          | 
|Total expenses                                                            |  |                         | 1,972,074 |  |      |   | 1,680,172 |      |  |   | 1,309,868 | 
|Other income (expense)                                                    |  |                         |           |  |      |   |           |      |  |   |           | 
|Equity in income (loss) of unconsolidated affiliate                       |  |                         | (2,534)   |  |      |   | -         |      |  |   | -         | 
|                                                                          | 
|Income (loss) before income taxes                                         |  |                         | (52,055)  |  |      |   | 95,618    |      |  |   | 152,446   | 
|Income tax expense (benefit)                                              |  |                         | (26,720)  |  |      |   | 24,142    |      |  |   | 52,168    | 
|                                                                          | 
|Net income (loss)                                                         |  | $                       | (25,335)  |  |      | $ | 71,476    |      |  | $ | 100,278   | 
|Less: Net income (loss) attributable to Noncontrolling interests          |  |                         | 2,819     |  |      |   | 10,995    |      |  |   | (6,078)   | 
|                                                                          | 
|Net income (loss) attributable to Tower Group, Inc.                       |  | $                       | (28,154)  |  |      | $ | 60,481    |      |  | $ | 106,356   | 
|                                                                          | 
|Earnings (loss) per share attributable to Tower Group, Inc. stockholders: |  |                         |           |  |      |   |           |      |  |   |           | 
|Basic                                                                     |  | $                       | (0.73)    |  |      | $ | 1.48      |      |  | $ | 2.45      | 
|Diluted                                                                   |  | $                       | (0.73)    |  |      | $ | 1.48      |      |  | $ | 2.44      | 
|                                                                          | 
|Weighted average common shares outstanding:                               |  |                         |           |  |      |   |           |      |  |   |           | 
|Basic                                                                     |  |                         | 38,795    |  |      |   | 40,833    |      |  |   | 43,462    | 
|Diluted                                                                   |  |                         | 38,795    |  |      |   | 40,931    |      |  |   | 43,648    | 
|                                                                          | 
|Dividends declared and paid per common share                              |  | $                       | 0.75      |  |      | $ | 0.69      |      |  | $ | 0.39      | 
|                                                                          | 

See accompanying notes to the consolidated financial statements.



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Tower Group, Inc.

Consolidated Statements of Comprehensive Income



|                                                                                           |  |                         |               |  |      |   |             |      |  |   |              | 
|------------------------------------------------------------------------------------------ |  | ----------------------- | ------------- |  | ---- | - | ----------- | ---- |  | - | ------------ | 
|                                                                                           |  | Year Ended December 31, |              
|(in thousands)                                                                             |  | 2012                    |               |  | 2011 |   |             | 2010 | 
|                                                                                           | 
|Net income (loss)                                                                          |  |                         | $    (25,335) |  |      |   | $    71,476 |      |  |   | $    100,278 | 
|Other comprehensive income (loss) before tax                                               |  |                         |               |  |      |   |             |      |  |   |              | 
|Gross unrealized investment holding gains arising during periods                           |  |                         | 63,326        |  |      |   | 50,851      |      |  |   | 45,912       | 
|Less: Reclassification adjustment for investment (gains) losses included in net income     |  |                         | (25,476)      |  |      |   | (9,394)     |      |  |   | (14,653)     | 
|Portion of other-than-temporary impairment losses recognized in other comprehensive income |  |                         | (286)         |  |      |   | (264)       |      |  |   | (11,909)     | 
|Cumulative translation adjustment                                                          |  |                         | 1,852         |  |      |   | -           |      |  |   | -            | 
|Deferred gain (loss) on cash flow hedge                                                    |  |                         | (2,422)       |  |      |   | (10,541)    |      |  |   | 3,223        | 
|                                                                                           | 
|Other comprehensive income (loss) before tax                                               |  |                         | 36,994        |  |      |   | 30,652      |      |  |   | 22,573       | 
|Income tax benefit (expense) related to items of other comprehensive income (loss):        |  |                         |               |  |      |   |             |      |  |   |              | 
|Unrealized investment holding gains (losses) arising during periods                        |  |                         | (22,896)      |  |      |   | (9,430)     |      |  |   | (14,081)     | 
|Reclassification adjustment for (gains) losses included in net income                      |  |                         | 8,917         |  |      |   | 1,742       |      |  |   | 4,494        | 
|Portion of other-than-temporary impairment losses recognized in other comprehensive income |  |                         | 100           |  |      |   | 49          |      |  |   | 3,652        | 
|Cumulative translation adjustment                                                          |  |                         | (648)         |  |      |   | -           |      |  |   | -            | 
|Deferred gain (loss) on cash flow hedge                                                    |  |                         | 571           |  |      |   | 1,955       |      |  |   | (988)        | 
|                                                                                           | 
|Other comprehensive income, net of income tax                                              |  |                         | 23,038        |  |      |   | 24,968      |      |  |   | 15,650       | 
|                                                                                           | 
|Comprehensive income (loss)                                                                |  | $                       | (2,297)       |  |      | $ | 96,444      |      |  | $ | 115,928      | 
|                                                                                           | 
|Less: Comprehensive income (loss) attributable to Noncontrolling interests                 |  |                         | 5,503         |  |      |   | 21,189      |      |  |   | (3,432)      | 
|                                                                                           | 
|Comprehensive income (loss) attributable to Tower Group, Inc.                              |  | $                       | (7,800)       |  |      | $ | 75,255      |      |  | $ | 119,360      | 
|                                                                                           | 

See accompanying notes to consolidated financial statements.



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Tower Group, Inc.

Consolidated Statements of Changes in Stockholders Equity



|                                                                                         |  |              |        |  |                |   |     |                 |  |   |                                            |   |  |                   |         |   |                          |   |        |                           |  |   |         |   |  |   |        |   |  |   |           |  
|---------------------------------------------------------------------------------------- |  | ------------ | ------ |  | -------------- | - | --- | --------------- |  | - | ------------------------------------------ | - |  | ----------------- | ------- | - | ------------------------ | - | ------ | ------------------------- |  | - | ------- | - |  | - | ------ | - |  | - | --------- | -
|                                                                                         |  | Common Stock |        |  | Treasury
Stock |   |     | Paid-in
Capital |  |   | AccumulatedOtherComprehensiveIncome (loss) |   |  | Retained
Earnings |         |   | Noncontrolling
Interests |   |        | TotalStockholders
Equity | 
|(in thousands)                                                                           |  | Shares       |        |  | Amount         |   |     |                 |  |   |                                            |  
|                                                                                         | 
|Balance at December 31, 2009                                                             |  |              | 45,092 |  |                |   | 451 |                 |  |   | (1,995                                     | ) |  |                   | 751,878 |   |                          |   | 35,275 |                           |  |   | 233,136 |   |  |   | -      |   |  |   | 1,018,745 |  
|Dividends declared                                                                       |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | -      |                           |  |   | (16,551 | ) |  |   | -      |   |  |   | (16,551   | )
|Stock based compensation                                                                 |  |              | 650    |  |                |   | 6   |                 |  |   | (1,750                                     | ) |  |                   | 10,276  |   |                          |   | -      |                           |  |   | -       |   |  |   | -      |   |  |   | 8,532     |  
|Repurchase of common stock                                                               |  |              | -      |  |                |   | -   |                 |  |   | (88,034                                    | ) |  |                   | -       |   |                          |   | -      |                           |  |   | -       |   |  |   | -      |   |  |   | (88,034   | )
|Reciprocal Exchanges equity on July 1, 2010, date of consolidation                      |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | -      |                           |  |   | -       |   |  |   | 7,622  |   |  |   | 7,622     |  
|Equity component of convertible senior notes issuance, net of income tax and issue costs |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | 7,055   |   |                          |   | -      |                           |  |   | -       |   |  |   | -      |   |  |   | 7,055     |  
|Convertible senior notes hedge transactions, net of tax                                  |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | (9,945  | ) |                          |   | -      |                           |  |   | -       |   |  |   | -      |   |  |   | (9,945    | )
|Warrants issued related to convertible senior notes issuance                             |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | 3,800   |   |                          |   | -      |                           |  |   | -       |   |  |   | -      |   |  |   | 3,800     |  
|Net income                                                                               |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | -      |                           |  |   | 106,356 |   |  |   | (6,078 | ) |  |   | 100,278   |  
|Other comprehensive income                                                               |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | 13,004 |                           |  |   | -       |   |  |   | 2,646  |   |  |   | 15,650    |  
|                                                                                         | 
|                                                                                         |  |              |        |  |                |   |     |                
|Balance at December 31, 2010                                                             |  |              | 45,742 |  |                | $ | 457 |                 |  | $ | (91,779                                    | ) |  | $                 | 763,064 |   |                          | $ | 48,279 |                           |  | $ | 322,941 |   |  | $ | 4,190  |   |  | $ | 1,047,152 |  
|                                                                                         | 
|Dividends declared                                                                       |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | -      |                           |  |   | (27,894 | ) |  |   | -      |   |  |   | (27,894   | )
|Stock based compensation                                                                 |  |              | 706    |  |                |   | 8   |                 |  |   | (1,834                                     | ) |  |                   | 10,657  |   |                          |   | -      |                           |  |   | -       |   |  |   | -      |   |  |   | 8,831     |  
|Deferred taxes on stock option activity                                                  |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | (783    | ) |                          |   | -      |                           |  |   | -       |   |  |   | -      |   |  |   | (783      | )
|Repurchase of common stock                                                               |  |              | -      |  |                |   | -   |                 |  |   | (64,572                                    | ) |  |                   | -       |   |                          |   | -      |                           |  |   | -       |   |  |   | -      |   |  |   | (64,572   | )
|Net income                                                                               |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | -      |                           |  |   | 60,481  |   |  |   | 10,995 |   |  |   | 71,476    |  
|Other comprehensive income                                                               |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | 14,774 |                           |  |   | -       |   |  |   | 10,194 |   |  |   | 24,968    |  
|Noncontrolling interest in acquired consolidated partnership                             |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | -      |                           |  |   | -       |   |  |   | 2,001  |   |  |   | 2,001     |  
|                                                                                         | 
|                                                                                         |  |              |        |  |                |   |     |                
|Balance at December 31, 2011                                                             |  |              | 46,448 |  |                | $ | 465 |                 |  | $ | (158,185                                   | ) |  | $                 | 772,938 |   |                          | $ | 63,053 |                           |  | $ | 355,528 |   |  | $ | 27,380 |   |  | $ | 1,061,179 |  
|                                                                                         | 
|Dividends declared                                                                       |  |              | -      |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | -      |                           |  |   | (29,075 | ) |  |   | -      |   |  |   | (29,075   | )
|Stock based compensation                                                                 |  |              | 373    |  |                |   | 4   |                 |  |   | (2,263                                     | ) |  |                   | 8,937   |   |                          |   | -      |                           |  |   | -       |   |  |   | -      |   |  |   | 6,678     |  
|Repurchase of common stock                                                               |  |              | -      |  |                |   | -   |                 |  |   | (20,987                                    | ) |  |                   | -       |   |                          |   | -      |                           |  |   | -       |   |  |   | -      |   |  |   | (20,987   | )
|Net income                                                                               |  |              |        |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | -      |                           |  |   | (28,154 | ) |  |   | 2,819  |   |  |   | (25,335   | )
|Transfer of assets to Reciprocal Exchanges                                               |  |              |        |  |                |   | -   |                 |  |   | -                                          |   |  |                   | (1,778  | ) |                          |   | -      |                           |  |   | -       |   |  |   | 1,778  |   |  |   | -         |  
|Other comprehensive income                                                               |  |              |        |  |                |   | -   |                 |  |   | -                                          |   |  |                   | -       |   |                          |   | 20,353 |                           |  |   | -       |   |  |   | 2,685  |   |  |   | 23,038    |  
|                                                                                         | 
|                                                                                         |  |              |        |  |                |   |     |                
|Balance at December 31, 2012                                                             |  |              | 46,821 |  |                | $ | 469 |                 |  | $ | (181,435                                   | ) |  | $                 | 780,097 |   |                          | $ | 83,406 |                           |  | $ | 298,299 |   |  | $ | 34,662 |   |  | $ | 1,015,498 |  
|                                                                                         | 

See accompanying notes to the consolidated financial statements.



F-6



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##### Table of Contents

Tower Group, Inc.

Consolidated Statements of Cash Flows



|                                                                                  |  |                         |             |  |      |   |             |      |  |   |             | 
|--------------------------------------------------------------------------------- |  | ----------------------- | ----------- |  | ---- | - | ----------- | ---- |  | - | ----------- | 
|                                                                                  |  | Year Ended December 31, |            
|($ in thousands)                                                                  |  | 2012                    |             |  | 2011 |   |             | 2010 | 
|                                                                                  | 
|Cash flows provided by (used in) operating activities:                            |  |                         |             |  |      |   |             |      |  |   |             | 
|Net income (loss)                                                                 |  | $                       | (25,335)    |  |      | $ | 71,476      |      |  | $ | 100,278     | 
|Adjustments to reconcile net income to net cash provided by (used in) operations: |  |                         |             |  |      |   |             |      |  |   |             | 
|Net realized investment (gains) losses                                            |  |                         | (25,476)    |  |      |   | (9,394)     |      |  |   | (14,653)    | 
|Depreciation and amortization                                                     |  |                         | 33,609      |  |      |   | 30,940      |      |  |   | 21,634      | 
|Amortization of bond premium or discount                                          |  |                         | 11,447      |  |      |   | 9,239       |      |  |   | 2,237       | 
|Amortization of restricted stock                                                  |  |                         | 8,247       |  |      |   | 10,292      |      |  |   | 8,694       | 
|Deferred income taxes                                                             |  |                         | (10,349)    |  |      |   | 16,145      |      |  |   | 61,352      | 
|Changes in operating assets and liabilities:                                      |  |                         |             |  |      |   |             |      |  |   |             | 
|Investment income receivable                                                      |  |                         | 1,450       |  |      |   | (2,912)     |      |  |   | (3,598)     | 
|Premiums receivable                                                               |  |                         | 4,320       |  |      |   | (20,232)    |      |  |   | 13,574      | 
|Reinsurance recoverable                                                           |  |                         | (170,234)   |  |      |   | (42,671)    |      |  |   | (30,621)    | 
|Prepaid reinsurance premiums                                                      |  |                         | (9,886)     |  |      |   | 23,590      |      |  |   | 45,024      | 
|Deferred acquisition costs, net                                                   |  |                         | (12,083)    |  |      |   | (4,735)     |      |  |   | 3,359       | 
|Funds held by reinsured companies                                                 |  |                         | (67,790)    |  |      |   | (66,176)    |      |  |   | (3,579)     | 
|Other assets                                                                      |  |                         | (37,301)    |  |      |   | 13,452      |      |  |   | (60,442)    | 
|Increase (decrease) in liabilities:                                               |  |                         |             |  |      |   |             |      |  |   |             | 
|Loss and loss adjustment expenses                                                 |  |                         | 262,960     |  |      |   | 21,692      |      |  |   | 76,166      | 
|Unearned premium                                                                  |  |                         | 27,683      |  |      |   | 21,150      |      |  |   | (23,269)    | 
|Reinsurance balances payable                                                      |  |                         | 19,775      |  |      |   | (14,243)    |      |  |   | (61,249)    | 
|Funds held under reinsurance agreements                                           |  |                         | 1,855       |  |      |   | 3,573       |      |  |   | 79,416      | 
|Other liabilities                                                                 |  |                         | 94,345      |  |      |   | 21,568      |      |  |   | (17,298)    | 
|                                                                                  | 
|Net cash flows provided by operations                                             |  |                         | 107,237     |  |      |   | 82,754      |      |  |   | 197,025     | 
|                                                                                  | 
|Cash flows provided by (used in) investing activities:                            |  |                         |             |  |      |   |             |      |  |   |             | 
|Net cash (used in) acquired from acquisitions                                     |  |                         | -           |  |      |   | 2,274       |      |  |   | (171,907)   | 
|Purchase of fixed assets                                                          |  |                         | (44,951)    |  |      |   | (53,568)    |      |  |   | (36,905)    | 
|Investment in unconsolidated affiliate                                            |  |                         | (71,512)    |  |      |   | -           |      |  |   | -           | 
|Purchase - fixed-maturity securities                                              |  |                         | (1,855,590) |  |      |   | (2,019,603) |      |  |   | (2,024,965) | 
|Purchase - equity securities                                                      |  |                         | (1,525,206) |  |      |   | (819,180)   |      |  |   | (96,439)    | 
|Short-term investments, net                                                       |  |                         | (4,750)     |  |      |   | 1,560       |      |  |   | 561,827     | 
|Purchase of other invested assets                                                 |  |                         | (13,440)    |  |      |   | (42,346)    |      |  |   | -           | 
|Sale of fixed-maturity securities                                                 |  |                         | 1,813,628   |  |      |   | 1,859,282   |      |  |   | 1,347,096   | 
|Maturity of fixed-maturity securities                                             |  |                         | 205,534     |  |      |   | 172,745     |      |  |   | 80,432      | 
|Sale - equity securities                                                          |  |                         | 1,442,225   |  |      |   | 793,886     |      |  |   | 80,746      | 
|Change in restricted cash                                                         |  |                         | (35,000)    |  |      |   | -           |      |  |   | -           | 
|                                                                                  | 
|Net cash flows provided by (used in) investing activities                         |  |                         | (89,062)    |  |      |   | (104,950)   |      |  |   | (260,115)   | 
|                                                                                  | 
|Cash flows provided by (used in) financing activities:                            |  |                         |             |  |      |   |             |      |  |   |             | 
|Proceeds from credit facility borrowings                                          |  |                         | 20,000      |  |      |   | 67,000      |      |  |   | 56,000      | 
|Repayment of credit facility borrowings                                           |  |                         | -           |  |      |   | (17,000)    |      |  |   | (56,000)    | 
|Proceeds from capital lease financing                                             |  |                         | -           |  |      |   | 39,839      |      |  |   | -           | 
|Proceeds from convertible senior notes                                            |  |                         | -           |  |      |   | -           |      |  |   | 145,634     | 
|Payments for convertible senior notes hedge                                       |  |                         | -           |  |      |   | -           |      |  |   | (15,300)    | 
|Proceeds from issuance of warrants                                                |  |                         | -           |  |      |   | -           |      |  |   | 3,800       | 
|Proceeds from share-based payment arrangements                                    |  |                         | 345         |  |      |   | 534         |      |  |   | 288         | 
|Treasury stock acquired-net employee share-based compensation                     |  |                         | (2,263)     |  |      |   | (1,834)     |      |  |   | (1,750)     | 
|Repurchase of Common Stock                                                        |  |                         | (20,987)    |  |      |   | (64,572)    |      |  |   | (88,034)    | 
|Dividends paid                                                                    |  |                         | (29,075)    |  |      |   | (27,894)    |      |  |   | (16,551)    | 
|                                                                                  | 
|Net cash flows provided by (used in) financing activities                         |  |                         | (31,980)    |  |      |   | (3,927)     |      |  |   | 28,087      | 
|                                                                                  | 
|Increase (decrease) in cash and cash equivalents                                  |  |                         | (13,805)    |  |      |   | (26,123)    |      |  |   | (35,003)    | 
|Cash and cash equivalents, beginning of period                                    |  |                         | 114,098     |  |      |   | 140,221     |      |  |   | 175,224     | 
|                                                                                  | 
|Cash and cash equivalents, end of period                                          |  | $                       | 100,293     |  |      | $ | 114,098     |      |  | $ | 140,221     | 
|                                                                                  | 
|Supplemental disclosures of cash flow information:                                |  |                         |             |  |      |   |             |      |  |   |             | 
|Cash paid for income taxes                                                        |  | $                       | -           |  |      | $ | 3,000       |      |  | $ | 29,000      | 
|Cash paid for interest                                                            |  |                         | 20,917      |  |      |   | 25,880      |      |  |   | 19,834      | 
|Schedule of non-cash investing and financing activities:                          |  |                         |             |  |      |   |             |      |  |   |             | 



F-7



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements

Note 1Nature of Business

Tower Group, Inc. (the Company or Tower) offers a broad range of commercial, specialty and personal specialty
property and casualty insurance products and services through its subsidiaries to businesses in various industries and to individuals. The Companys common stock is publicly traded on the NASDAQ Global Select Market under the symbol
TWGP.

The Company operates three business segments as follows:



| |  | Commercial Insurance (Commercial) Segment offers a broad range of standard and specialty commercial lines property and casualty insurance
products to businesses distributed through a network of retail and wholesale agents and program underwriting agents on both an admitted and non-admitted basis. This segment also includes assumed reinsurance;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Personal Insurance (Personal) Segment offers a broad range of personal lines property and casualty insurance products to individuals
distributed through a network of retail and wholesale agents; and
|- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Insurance Services (Services) Segment provides underwriting, claims and reinsurance brokerage services to insurance companies.
|- |  | --------------------------------------------------------------------------------------------------------------------------------

Note 2Accounting Policies and Basis of Presentation

Basis of Presentation

The accompanying consolidated financial statements include the accounts of Tower and its insurance subsidiaries, managing general agencies and management
companies. The consolidated financial statements also include the accounts of Adirondack Insurance Exchange, a New York reciprocal insurer, and New Jersey Skylands Insurance Association, a New Jersey reciprocal insurer (together, the
Reciprocal Exchanges). The Company does not own the Reciprocal Exchanges but manages them through its management companies.

The
accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). All inter-company accounts and transactions have been eliminated in
consolidation.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Intercompany transactions

In the first
quarter 2012, Tower transferred a licensed insurance subsidiary shell to the Reciprocal Exchanges and received cash for its statutory book value. At the date of the transfer, Towers GAAP carrying basis in this subsidiary exceeded the statutory
book value and the transfer resulted in a loss to Tower of $1.8 million. Since this was a non-recurring transaction between entities under common control, assets are transferred at historical book value. Any difference in the consideration paid and
the book value of the assets transferred is treated as an adjustment to equity. This transaction had no effect on consolidated stockholders equity.

Reclassifications

Certain reclassifications have been made to prior years financial
information to conform to the current year presentation.

Accounting Policies

Net Premiums Earned

The insurance policies issued or reinsured by the Company are
short-duration contracts. Accordingly, premium revenue, including direct business and reinsurance assumed, net of business ceded to reinsurers, is recognized on a pro-rata basis over the terms of the underlying policies. Unearned premiums represent
premium applicable to the unexpired risk of in-force insurance contracts at each balance sheet date. Prepaid reinsurance premiums represent the unexpired portion of reinsurance premiums on risks ceded and are earned consistent with premiums.
Mandatory reinstatement premiums are recognized and earned at the time a loss event occurs.



F-8



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Ceding Commission Revenue

Commissions on reinsurance premiums ceded are earned in a manner consistent with the recognition of the costs to acquire the underlying policies, generally on a pro-rata basis over the terms of the
policies reinsured. Certain reinsurance agreements contain provisions whereby the ceding commission rates vary based on the loss experience of the policies covered by the agreements. The Company records ceding commission revenue based on its current
estimate of losses on the reinsured policies subject to variable commission rates. The Company records adjustments to the ceding commission revenue in the period that changes in the estimated losses are determined.

Insurance Services Revenue

Direct
commission revenue from the Companys managing general underwriting services is recognized and earned as insurance policies are placed with the issuing companies of its managing general agencies. Fees relating to the provision of reinsurance
intermediary services are earned when the Companys insurance subsidiaries or the issuing companies of its managing general agencies cede premiums to reinsurers. Management fees earned by the management companies for services provided to the
Reciprocal Exchanges are reported as management fee income within the segment but are eliminated in consolidation.

Policy Billing Fees

Policy billing fees are earned on a pro-rata basis over the terms of the underlying policies. These fees include installment and other
fees related to billing and collections.

Loss and Loss Adjustment Expenses (LAE)

The liability for loss and LAE represents managements best estimate of the ultimate cost and expense of all reported and unreported losses that are
unpaid as of the balance sheet date. The liability for loss and LAE is recorded net of a tabular reserve discount for workers compensation and excess workers compensation claims in the amount of $8.4 million and $3.7 million at
December 31, 2012 and 2011, respectively. The 2012 discount relates to $381.6 million of total net reserves for workers compensation. The projection of future claims payments and reporting is based on an analysis of the Companys
historical experience, supplemented by analyses of industry loss data. Management believes that the liability for loss and LAE is adequate to cover the ultimate cost of losses and claims to date; however, because of the uncertainty from various
sources, including changes in reporting patterns, claims settlement patterns, judicial decisions, legislation, and economic conditions, actual loss experience may not conform to the assumptions used in determining the estimated amounts for such
liability at the balance sheet date. As adjustments to these estimates become necessary, such adjustments are reflected in expense for the period in which the estimates are changed.

Tower estimates reserves separately for losses, allocated loss adjustment expenses, and unallocated loss adjustment expenses. Allocated loss adjustment expenses (ALAE) refers to costs of
attorneys as well as miscellaneous costs such as investigators, witness fees and court costs attributable to specific claims that generally are in various stages of litigation. Unallocated loss adjustment expenses (ULAE) refers to costs
for administering claims that are not related to attorney fees and miscellaneous costs associated with litigated claims. Tower estimates the ALAE liability separately for claims that are defended by in-house attorneys, claims that are handled by
other attorneys that are not employees, and miscellaneous ALAE costs such as witness fees and court costs. Similarly, Tower estimates the ULAE liability separately for claims which are handled internally by our employees and for claims which are
handled by third party administrators.

The Company determines a fixed fee per in-house litigated claim for ALAE stemming from defense by
in-house attorneys and allocates to each of these litigated claims 50% of this fixed fee when litigation on a particular claim begins and 50% of the fee when the litigation is closed. The fee is determined actuarially based upon the projected number
of litigated claims and expected closing patterns at the beginning of each year as well as the projected budget for the Companys in-house attorneys, and these amounts are subject to adjustment each quarter based upon actual experience.

The Company determines a standard cost per claim for ULAE for each line of business that represents the ultimate average cost to administer
that claim. For property lines, 50% of this standard cost is recorded as paid ULAE when a claim is opened, and 50% of this standard cost is recorded as paid ULAE when a claim is closed. For casualty lines, 75% of this standard cost is recorded as
paid ULAE when a claim is opened, and 25% is recorded as paid ULAE when a claim is closed. The standard costs are determined actuarially and subject to adjustment each quarter. Calendar period costs for the claims function is recorded as paid ULAE
each quarter.



F-9



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Reinsurance

The Company uses reinsurance to limit its exposure to certain risks. Management has evaluated its reinsurance arrangements and determined that significant insurance risk is transferred to the reinsurers.
Reinsurance agreements have been determined to be short-duration prospective contracts and, accordingly, the costs of reinsurance are recognized over the life of the contracts in a manner consistent with the earning of premiums on the underlying
policies subject to the reinsurance contract.

Reinsurance recoverable represents managements best estimate of paid and unpaid loss and
LAE recoverable from reinsurers. Ceded losses recoverable are estimated using techniques and assumptions consistent with those used in estimating the liability for loss and LAE. These techniques and assumptions are continually reviewed and updated
with any resulting adjustments recorded in current earnings. Loss and LAE incurred as presented in the consolidated statement of income and comprehensive net income are net of reinsurance recoveries.

Management estimates uncollectible amounts receivable from reinsurers based on an assessment of a number of factors. The Company recorded no allowance
for uncollectible reinsurance at December 31, 2012 or 2011. The Company did not write-off balances from reinsurers during the three year period ended December 31, 2012.

Cash and Cash Equivalents

Cash consists of cash in banks, generally in operating
accounts. The Company maintains its cash balances at several financial institutions. Management monitors balances and believes they do not represent a significant credit risk to the Company.

The Company considers all highly liquid investments with original maturities of three months or less to be cash equivalents. Cash and cash equivalents are presented at cost, which approximates fair value.
Cash restricted as to use is included in Other Assets.

Investments

The Companys fixed-maturity and equity securities are classified as available-for-sale and carried at fair value. The Company may sell its available-for-sale securities in response to changes in
interest rates, risk/reward characteristics, liquidity needs or other factors.

Fair value for fixed-maturity securities and equity securities
is primarily based on quoted market prices or a matrix pricing using observable inputs, with limited exceptions as discussed in Note 7  Fair Value Measurements. Changes in unrealized gains and losses, net of tax effects, are
reported as a separate component of other comprehensive income while cumulative unrealized gains and losses are reported net of tax effects within accumulated other comprehensive income in stockholders equity. Realized gains and losses are
determined on the specific identification method. Investment income is recorded when earned and includes the amortization of premium and discount on investments.

The Company, along with its outside portfolio managers, regularly reviews its fixed-maturity and equity security portfolios to evaluate the necessity of recording impairment losses for
other-than-temporary declines in the fair value of investments. In evaluating potential impairment, management considers, among other criteria: (i) the overall financial condition of the issuer, (ii) the current fair value compared to
amortized cost or cost, as appropriate; (iii) the length of time the securitys fair value has been below amortized cost or cost; (iv) specific credit issues related to the issuer such as changes in credit rating, reduction or
elimination of dividends or non-payment of scheduled interest payments; (v) whether management intends to sell the security and, if not, whether it is not more likely than not that the Company will be required to sell the security before
recovery of its cost or amortized cost basis; (vi) specific cash flow estimations for fixed-maturity securities and (vii) current economic conditions. If an other-than-temporary-impairment (OTTI) loss is determined for a
fixed-maturity security (and management does not intend to sell the security or it is not more likely than not that the Company will be required to sell the security), the credit portion is recorded in the statement of income as net realized losses
on investments and the non-credit portion is recorded in accumulated other comprehensive income. The credit portion results in a permanent reduction of the cost basis of the underlying investment. OTTI losses on fixed-maturity securities management
has the intent to sell or it is more likely than not that the Company will be required to sell and on equity securities are reported in realized losses for the entire impairment.

The Companys other invested assets consist of investments in limited partnerships accounted for using the equity method of accounting, real estate and certain securities for which the Company has
elected the fair value option. In accounting for the partnerships, management uses the financial information provided by the general partners, which is on a three-month lag. As of December 31, 2012, the Company had future funding commitments of
$29.7 million to these limited partnerships. For securities in which the Company has elected the fair value option, interest and dividends are reported in net investment income with the remaining change in overall fair value reported in other net
realized investment gains (losses).



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Fair Value

GAAP establishes a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active
markets for identical assets or liabilities (Level 1) followed by similar but not identical assets or liabilities (Level 2) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within
different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets
in which the assets and liabilities are traded, including during periods of market disruption, and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when
available.

The Company primarily uses outside pricing services to assist in determining fair values. For investments in active markets, the
Company uses the quoted market prices provided by the outside pricing services to determine fair value. In circumstances where quoted market prices are unavailable, the pricing services utilize fair value estimates based upon other observable inputs
including matrix pricing, benchmark interest rates, market comparables and other relevant inputs.

As management is responsible for the
recorded fair values, the Company has processes in place to validate the market prices obtained from the outside pricing sources including, but not limited to, periodic evaluation of model pricing methodologies and analytical reviews of certain
prices. The Company also periodically performs back-testing of selected sales activity to determine whether there are any significant differences between the market price used to value the security prior to sale and the actual sale price.

Premiums Receivable

Premiums receivable represent amounts due from insureds and reinsureds for insurance coverage and are presented net of an allowance for doubtful accounts
of $5.5 million and $4.4 million at December 31, 2012 and 2011, respectively. The allowance for uncollectible amounts is based on an analysis of amounts receivable giving consideration to historical loss experience and current economic
conditions and reflects an amount that, in managements judgment, is adequate. Uncollectible premiums receivable of $4.8 million, $5.2 million and $1.8 million were written off in 2012, 2011 and 2010, respectively.

Deferred Acquisition Costs

Acquisition
costs represent the costs of writing business that vary with, and are primarily related to, the successful production of insurance business (principally commissions, premium taxes and certain underwriting costs). Policy acquisition costs are
deferred and recognized as expense as related premiums are earned. Deferred acquisition costs (DAC) presented in the balance sheet are net of deferred ceding commission revenue.

The value of business acquired (VOBA) is an intangible asset relating to the estimated fair value of the unexpired insurance policies acquired in a business combination. VOBA is determined at
the time of a business combination and is reported on the consolidated balance sheet with DAC and is amortized in proportion to the timing of the estimated underwriting profit associated with the in force policies acquired. The Company considers
anticipated investment income in determining the recoverability of these costs and believes they are fully recoverable. See Note 9  Deferred Acquisition Costs for additional information regarding deferred acquisition costs.

Goodwill and Intangible Assets

In business combinations, including the acquisition of a group of assets, the Company allocates the purchase price to the net tangible and intangible assets acquired based on their relative fair values.
Any portion of the purchase price in excess of this amount results in goodwill. Identifiable intangible assets with a finite useful life are amortized over the period that the asset is expected to contribute directly or indirectly to the future cash
flows of the Company. Intangible assets with an indefinite life and goodwill are not amortized and are subject to annual impairment testing at the reporting unit level. For purposes of goodwill impairment testing, the Company defined its two
segments, Commercial Insurance and Personal Insurance as reporting units. The Insurance Services segment does not carry goodwill.

To estimate
the fair value of its reporting units, the Company may utilize a combination of widely accepted valuation techniques including a stock price and market capitalization analysis, discounted cash flow calculations and peer company price to earnings
multiples analysis. The stock price and market capitalization analysis takes into consideration the quoted market price of the Companys outstanding common stock and includes a control premium, derived from historical insurance industry
acquisition activity, in determining the estimated fair value of the consolidated entity before allocating that fair value to individual reporting units. The discounted cash flow analysis utilizes long term assumptions for revenue growth, capital
growth, earnings projections including those used in the Companys strategic plan, and an appropriate discount rate. The peer company price to earnings multiples analysis takes into consideration the price earnings multiples of peer companies
for each reporting unit and estimated income from the Companys strategic plan.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



The Company conducted the required annual goodwill and intangible asset impairment testing as of
September 30 for 2012. Additionally, identifiable intangible assets and goodwill are tested for recoverability whenever events or changes in circumstances indicate that a carrying amount may not be recoverable. No impairment losses were
recognized in 2012, 2011 or 2010.

Other Assets

Towers other assets balances are comprised primarily of fixed assets, capitalized software development costs, restricted cash, receivables for securities sold, receivables for the participation in
involuntary pools and current tax receivables.

Fixed Assets

Furniture, leasehold improvements, computer equipment, and software, including internally developed software, are reported at cost less accumulated depreciation and amortization. Gross fixed assets were
$194.0 million and $176.4 million as of December 31, 2012 and 2011, respectively. Capitalized leases of $44.0 million and $41.0 million were included in this amount as at December 31, 2012 and 2011, respectively. Accumulated depreciation
and amortization of $54.7 million and $56.5 million were recorded as of December 31, 2012 and 2011, respectively. In 2012, the Company wrote off $21.5 million of fully depreciated fixed assets with no impact to net income. Depreciation and
amortization is provided using the straight-line method over the estimated useful lives of the assets. The Company estimates the useful life for computer equipment to be three years, computer software, three to seven years, furniture and other
equipment seven years and leasehold improvements is the term of the lease. Depreciation and amortization expense of $20.2 million, $22.0 million and $15.4 million were recorded for the years ended December 31, 2012, 2011 and 2010, respectively.
Fixed assets are recorded in Other Assets on the balance sheet.

Other liabilities

Towers other liabilities balances are comprised primarily of accrued operating expenses, payables for securities purchased, accrued boards, bureaus
and tax expenses, and capital lease obligations.

Variable Interest Entities

The Company consolidates the Reciprocal Exchanges as it has determined that these are variable interest entities and that the Company is the primary beneficiary. See Note 5  Variable Interest
Entities for more details.

Investment in unconsolidated affiliate

Although the Company owned less than 20% of the outstanding common stock of Canopius Group, Limited (CGL) at December 31, 2012, it recorded its investment in CGL under the equity method
of accounting as it was able to significantly influence the operating and financial policies and decisions of CGL.

Income Taxes

Pursuant to a written tax agreement (the Tax Sharing Agreement), each of the Towers subsidiaries is required to make
payments to Tower for federal income tax imposed on its taxable income in a manner consistent with filing a separate federal income tax return (but subject to certain limitations that are applied to the Tower consolidated group as a whole). The
Reciprocal Exchanges are not subject to the Tax Sharing Agreement but file separate tax returns annually.

Deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and for operating loss and tax credit carry forwards.
Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities
of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that all or some portion of the deferred tax asset will not be
realized.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Treasury Stock

The Company accounts for the treasury stock at the repurchase price as a reduction to stockholders equity as it does not currently intend to retire the treasury stock held at December 31, 2012.

Stock-based Compensation

The Company accounts for restricted stock shares and options awarded at fair value at the date awarded and compensation expense is recorded over the
requisite service period that has not been rendered. The Company amortizes awards with graded vesting on a straight-line basis over the requisite service period.

Assessments

Insurance related assessments are accrued in the period in which they have
been incurred. The Company is subject to a variety of assessments. Among such assessments are state guaranty funds and workers compensation second injury funds. State guaranty fund assessments are used by state insurance oversight boards to
cover losses of policyholders of insolvent insurance companies and for the operating expenses of such agencies. The Company uses estimates derived from state regulators and/or NAIC Tax and Assessments Guidelines.

Earnings per Share

The Company
measures earnings per share at two levels: basic earnings per share and diluted earnings per share. Basic earnings per share is calculated by dividing net income attributable to Tower common stockholders by the weighted average number of common
shares outstanding during the year. This weighted average number of shares includes unvested share-based awards that contain nonforfeitable rights to dividends or dividend equivalents whether paid or unpaid (participating securities).
Diluted earnings per share is calculated by dividing net income attributable to Tower common stockholders by the weighted average number of common shares outstanding during the year, as adjusted for the potentially dilutive effects of stock options,
warrants, unvested restricted stock and/or preferred stock that are not participating securities, unless such items are not dilutive.

Foreign currency

The Companys
reporting currency is the U.S. dollar. The Company holds an equity method investment in Canopius Group, Limited, which is denominated in British pounds sterling (GBP). The Company translates this investment to U.S. dollars at the
exchange rate in effect at the balance sheet date. Towers portion of changes in translation adjustment, based on its percentage ownership in this investment, is included as a component of accumulated other comprehensive income.

Statutory Accounting Principles

The
Companys insurance subsidiaries are required to prepare statutory basis financial statements in accordance with practices prescribed or permitted by the state or country in which they are domiciled. See Note 18  Statutory Financial
Information and Accounting Policies for more details.

Concentration and Credit Risk

Financial instruments that potentially subject the Company to concentration and credit risk are primarily cash and cash equivalents, investments,
interest rate swaps, premiums receivable and reinsurance recoverables. Investments are diversified through many industries and geographic regions through the use of money managers who employ different investment strategies. The Company limits the
amount of credit exposure with any one financial institution and believes that no significant concentration of credit risk exists with respect to cash and investments. The interest rate swap contracts contain credit support annex agreements with
collateral posting provisions which reduces counterparty non-performance risk. The premiums receivable balances are generally diversified due to the number of entities comprising the Companys distribution network and its customer base, which
is largely concentrated in the Northeast, Florida, Texas and California. To reduce credit risk, the Company performs ongoing evaluations of its distribution networks and customers financial condition. The Company also has receivables
from its reinsurers. Reinsurance contracts do not relieve the Company from its obligations to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company periodically evaluates the financial
condition of its reinsurers and, in certain cases, requires collateral from its reinsurers to minimize its exposure to significant losses from reinsurer insolvencies. As at December 31, 2012, the largest uncollateralized reinsurance recoverable
balance from any one reinsurer was $47.8 million representing 8.3% of the Companys total reinsurance recoverable balance. Managements policy is to review all outstanding receivables at period end as well as the bad debt write-offs
experienced in the past and establish an allowance for doubtful accounts, if deemed necessary.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Our largest agent accounted for 7.5%, 10% and 12%, respectively, of the insurance subsidiaries
premiums receivable balances at December 31, 2012, 2011 and 2010. Our largest agent accounted for 7%, 7% and 4% of the insurance subsidiaries direct premiums written in 2012, 2011 and 2010, respectively.

Accounting Pronouncements

Accounting guidance adopted in 2012

In
May 2011, the Financial Accounting Standards Board (FASB) issued new guidance concerning fair value measurement and disclosure. This new guidance requires additional disclosure about fair value measurements categorized as Level 3. This
guidance had no effect on the Companys financial position, results of operations or cash flows. The Companys fair value disclosures have been revised effective January 1, 2012 to comply with this guidance.

In June 2011 (and as amended in December 2011), the FASB issued new guidance concerning the presentation of comprehensive income. The Company adopted
this new guidance retrospectively on January 1, 2012 and now reports its comprehensive income in a separate consolidated financial statement immediately following the statement of operations.

In September 2011, the FASB issued amended guidance on testing goodwill for impairment. This guidance was intended to reduce the cost and complexity of
the annual goodwill impairment test by allowing an entity to utilize more qualitative factors. The Company considered this guidance in the performance of its goodwill impairment test in the fourth quarter as of September 30, 2012. See Note 8
 Goodwill and Intangible Assets for further discussion on goodwill impairment testing.

Accounting guidance not yet
effective

In July 2012, the FASB issued amended guidance on testing indefinite lived intangible assets for impairment. This guidance is
intended to reduce the cost and complexity of the annual impairment test by allowing an entity to utilize more qualitative factors. This guidance is effective for fiscal years beginning after September 15, 2012. This guidance will not affect
the Companys financial position, result of operations or cash flows.

Note 3Investment in Canopius Group Limited and Exercise of Merger Option

On August 20, 2012, Tower closed on its $74.9 million acquisition of a 10.7% stake in Canopius Group Limited (Canopius
Group), a privately owned Lloyds insurance holding company domiciled in Guernsey, Channel Islands. In connection with this acquisition, which was agreed to on April 25, 2012, Tower also entered into an agreement dated April 25,
2012 (the Master Transaction Agreement) under which Canopius Group committed to assist Tower with the establishment of a presence at Lloyds of London through a special purpose syndicate (SPS Transaction Right and Acquisition
Right), subject to required approvals and granted Tower an option (the Merger Option) to combine with Canopius Holdings Bermuda Limited (Canopius Bermuda). On July 30, 2012, Tower announced that it had exercised
the Merger Option and executed an Agreement and Plan of Merger (the Original Merger Agreement) with Canopius Bermuda pursuant to which a wholly-owned subsidiary of Canopius Bermuda will acquire all of Towers common stock. Under
applicable accounting principles Tower will be regarded as the acquiring entity. Tower paid Canopius Group a fee of $1,000,000 to exercise the Merger Option. On November 8, 2012, the Original Merger Agreement was amended by Amendment No. 1
to the Agreement and Plan of Merger to reflect changes to the merger consideration to be received by Tower stockholders (the Original Merger Agreement as so amended, the Merger Agreement).

Under the Merger Agreement, Tower stockholders will receive, in exchange for each share of Towers common stock, a certain number of Canopius
Bermuda common shares equal to a Stock Conversion Number (defined below). Canopius Group intends to sell its shares in Canopius Bermuda prior to the consummation of the merger in a private placement of those shares (the Canopius Secondary
Offering) to a group of yet-to-be-identified institutional third party investors (the Third Party Investors). The Stock Conversion Number will be equal the quotient obtained by dividing (x) the price per share of
Tower common stock at the market close on the date of the pricing of the Canopius Secondary Offering by (y) the Adjusted Canopius Bermuda Price Per Share (defined below).

The Adjusted Canopius Bermuda Price Per Share will be equal to the quotient obtained by dividing (i) the sum of (a) the Target TNAV Amount, which is the amount that Tower specifies
in a written notice delivered to Canopius Group prior to the signing date of the purchase and sale agreements for the Canopius Secondary Offering, as the target amount of the tangible net asset value of Canopius Bermuda as of the closing date of the
Canopius Secondary Offering, (b) the value of the retained business of Canopius Bermuda following its restructuring, (c) the aggregate amount of the placement fees received by the placement agents in connection with the Canopius Secondary
Offering and (d) the aggregate amount, expressed in dollars, equal to the absolute



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



value of the discount from the closing price of Towers common stock on the pricing date of the Canopius Secondary Offering, or on another reasonably current date (as agreed by Tower,
Canopius Bermuda and the Third Party Investors), that Tower, Canopius Bermuda and the Third Party Investors have agreed is necessary in order to effect the Canopius Secondary Offering, by (ii) the aggregate number of Canopius Bermuda common
shares sold in the Canopius Secondary Offering. Because neither the restructuring of Canopius Bermuda nor the Canopius Secondary Offering is likely to occur until the first quarter of 2013 at the earliest, no assurances can be given as to the Target
TNAV Amount or the Adjusted Canopius Bermuda Price Per Share. In determining the Target TNAV Amount, Tower will principally consider the amount of capital that it believes will be required to maintain its ratings and to operate the combined
business. Tower believes this capital amount to be between $150 million and $180 million.

Although the Merger Agreement contains no
conditions precedent to Towers obligations to consummate the merger, Tower will not proceed with the merger in the event that (1) the Canopius Secondary Offering cannot be effected, or can only be effected on terms that would make the
Stock Conversion Number, and therefore the merger, unattractive to Tower, (2) the Adjusted Canopius Bermuda Price Per Share declines to a point that the Third Party Investors would own 20% or less of the merged entitys fully diluted
capital stock immediately following the closing of the merger, (3) Tower stockholders and option holders, as well as holders of Towers convertible senior notes, would own less than 76% of the fully diluted capital stock of Tower Ltd.
immediately following the closing of the merger, (4) the parties to the Merger Agreement fail to obtain the necessary regulatory approvals on terms acceptable to Tower, (5) Towers stockholders fail to adopt the Merger Agreement and
approve the merger, (6) Towers Board of Directors determines that the transactions contemplated by the Merger Agreement are not favorable to Tower or its stockholders and (7) Tower has not received an opinion of a nationally
recognized law firm, in form and substance satisfactory to Tower, to the effect that the merger should not cause Tower Ltd. to be treated as a domestic corporation under Section 7874(b) of the Internal Revenue Code of 1986, as amended.

The consideration paid by Tower was allocated as follows based upon each of the acquired assets estimated fair values:



|                                            |  |   |        | 
|------------------------------------------- |  | - | ------ | 
|($ in thousands)                            |  |   |       
|                                            | 
|Investment in Unconsolidated Affiliate      |  | $ | 71,512 | 
|Merger Option                               |  |   | 484    | 
|SPS Transaction Right and Acquisition Right |  |   | 2,903  | 
|                                            | 
|Total                                       |  | $ | 74,899 | 
|                                            | 

Tower accounts for its 10.7% investment in Canopius Group using the equity method of accounting on a one quarter lag.
Management has concluded it exerts significant influence over Canopius Group due to the following: Tower has a board seat on Canopius Groups Board of Directors, Tower assumes approximately 6% of premiums written by Canopius Group, and Tower
has certain rights in accordance with the Merger Option and SPS Transaction Right and Acquisition Right to cause Canopius Group to assist Tower as defined in the Master Transaction Agreement. For the year ended December 31, 2012, Tower recorded
a reduction in its investment in Canopius Group by $0.7 million, of which $2.5 million is related to losses recorded in the statement of operations offset by a $1.8 million foreign currency translation adjustment which is recorded in other
comprehensive income.

The Merger Option and SPS Transaction Right and Acquisition Right are reported in Other assets in the
accompanying balance sheet at December 31, 2012.

Tower also participates in Canopius Groups reinsurance program. For the year
ended December 31, 2012, Tower had assumed earned premiums, losses and loss adjustment expenses and commission expense of $49.8 million, $32.3 million and $14.2 million, respectively, relating to business assumed from Canopius Group.

Note 4Acquisitions

NAV PAC Division of Navigators Group, Inc. (NAV PAC)

On January 14, 2011, Tower obtained the renewal rights to the middle market commercial package and commercial automobile business underwritten through the NAV PAC division of Navigators Group, Inc.
Tower pays Navigators Insurance Company a commission equal to 2% of the direct premiums written under this renewal rights arrangement. This business allowed us to expand our middle market commercial product offering into certain niche classes of
business. This renewal rights acquisition represents the ability to write future insurance business and does not include the acquisition of any assets or liabilities of NAV PAC. Accordingly, this transaction was not accounted for as a business
combination.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Acquisition of the Renewal Rights of AequiCap Program Administrators Inc. (AequiCap)

On November 2, 2010, Tower acquired the renewal rights to the commercial automobile liability and physical damage business of
AequiCap for $12 million (AequiCap II). The business subject to the agreement covers both trucking and taxi risks that are consistent with Towers current underwriting guidelines. The acquisition was accounted for as a business
combination under GAAP. The distribution network was the only identifiable asset acquired and had a fair value of $11.3 million. No liabilities were assumed. $0.7 million of goodwill was recorded as a result of this transaction.

Acquisition of the OneBeacon Personal Lines Division

On July 1, 2010, Tower completed the OBPL acquisition pursuant to a definitive agreement (the Agreement) dated February 2, 2010 by and among the Company and OneBeacon Insurance Group
(OneBeacon). This acquisition expanded Towers suite of personal lines insurance products to include private passenger automobile, homeowners, umbrella, and the signature package product, OneChoice CustomPac, which provides
customers with one policy for all of their homeowners, auto and umbrella needs.

Under the terms of the Agreement, the Company acquired
Massachusetts Homeland Insurance Company (MHIC), York Insurance Company of Maine (York) and two management companies (collectively the Stock Companies). The management companies are the attorneys-in-fact for the
Reciprocal Exchanges. Tower purchased $102 million principal of surplus notes issued by the Reciprocal Exchanges (the surplus notes). In addition, Tower also reinsured the personal lines business written by other subsidiaries of
OneBeacon not acquired by Tower. The total consideration paid for OBPL was $164.3 million.

Effective July 1, 2010, Tower entered
into transition service agreements with OneBeacon whereby OneBeacon will provide certain information technology and operational support to Tower until such time that these processes are migrated to Tower. Expenses incurred under such transition
service agreements were $20.3 million and $23.9 million for the years ended December 31, 2012 and 2011, respectively.

Tower
consolidated OBPL as of July 1, 2010 and the purchase consideration has been allocated to the assets acquired and liabilities assumed, including separately identified intangible assets, based on their fair values as of the close of the
acquisition, with the amounts exceeding the fair value recorded as goodwill. The goodwill consisted largely of the synergies and economies of scale expected from combining the operations of the Company and OBPL.

Direct costs of the acquisition are accounted for separately from the business combination and are expensed as incurred.

All goodwill associated with the OBPL acquisition has been allocated to the Personal Insurance segment.

Note 5Variable Interest Entities (VIEs)

Through its management companies, Tower is the attorney-in-fact for the Reciprocal Exchanges and has the ability to direct their
activities. The Reciprocal Exchanges are policyholder-owned insurance carriers organized as unincorporated associations. Each policyholder insured by the Reciprocal Exchanges shares risk with the other policyholders.

In the event of dissolution, policyholders would share any residual unassigned surplus in the same proportion as the amount of insurance purchased but
are not subject to assessment for any deficit in unassigned surplus of the Reciprocal Exchanges. Tower receives management fee income for the services provided to the Reciprocal Exchanges. The assets of the Reciprocal Exchanges can be used only to
settle the obligations of the Reciprocal Exchanges and general creditors to their liabilities have no recourse to Tower as the primary beneficiary.

In addition, Tower holds the surplus notes issued by the Reciprocal Exchanges when they were originally capitalized. The obligation to repay principal and interest on the surplus notes is subordinated to
the Reciprocal Exchanges other liabilities including obligations to policyholders and claimants for benefits under insurance policies. Principal and interest on the surplus notes are payable only with regulatory approval. The Company has no
ownership interest in the Reciprocal Exchanges.

The Company determined that each of the Reciprocal Exchanges qualifies as a VIE and that the
Company is the primary beneficiary as it has both the power to direct the activities of the Reciprocal Exchanges that most significantly impact their economic performance and the risk of economic loss through its ownership of the surplus notes.
Accordingly, the Company consolidates these Reciprocal Exchanges and eliminates all intercompany balances and transactions with Tower.

For
the year ended December 31, 2012, the Reciprocal Exchanges recognized total revenues, total expenses and net income of $204.7 million, $201.9 million and $2.8 million, respectively. For the year ended December 31, 2011, the Reciprocal
Exchanges recognized total revenues, total expenses and net income of $209.8 million, $198.8 million and $11.0 million, respectively.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Note 6Investments

The cost or amortized cost and fair value of the Companys investments in fixed maturity and equity securities, gross unrealized
gains and losses, and other-than-temporary impairment losses as of December 31, 2012 and December 31, 2011 are summarized as follows:



|                                                            |  |                      |           |  |                      |   |         |                       |  |   |            |  |  |                          |           |  |  |   |         | 
|----------------------------------------------------------- |  | -------------------- | --------- |  | -------------------- | - | ------- | --------------------- |  | - | ---------- |  |  | ------------------------ | --------- |  |  | - | ------- | 
|($ in thousands)                                            |  | Cost orAmortizedCost |           |  | GrossUnrealizedGains |   |         | GrossUnrealizedLosses |  |   | Fair Value |  |  | UnrealizedOTTILosses (1) |          
|                                                            | 
|December 31, 2012                                           |  |                      |           |  |                      |   |         |                       |  |   |            |  |  |                          |           |  |  |   |         | 
|U.S. Treasury securities                                    |  | $                    | 183,462   |  |                      | $ | 1,500   |                       |  | $ | (13)       |  |  | $                        | 184,949   |  |  | $ | -       | 
|U.S. Agency securities                                      |  |                      | 98,502    |  |                      |   | 4,351   |                       |  |   | (76)       |  |  |                          | 102,777   |  |  |   | -       | 
|Municipal bonds                                             |  |                      | 633,373   |  |                      |   | 52,914  |                       |  |   | (244)      |  |  |                          | 686,043   |  |  |   | -       | 
|Corporate and other bonds                                   |  |                      |           |  |                      |   |         |                       |  |   |            |  |  |                          |           |  |  |   |         | 
|Finance                                                     |  |                      | 233,849   |  |                      |   | 21,293  |                       |  |   | (95)       |  |  |                          | 255,047   |  |  |   | -       | 
|Industrial                                                  |  |                      | 412,465   |  |                      |   | 26,556  |                       |  |   | (868)      |  |  |                          | 438,153   |  |  |   | -       | 
|Utilities                                                   |  |                      | 51,698    |  |                      |   | 2,958   |                       |  |   | (191)      |  |  |                          | 54,465    |  |  |   | -       | 
|Commercial mortgage-backed securities                       |  |                      | 211,819   |  |                      |   | 30,375  |                       |  |   | (141)      |  |  |                          | 242,053   |  |  |   | -       | 
|Residential mortgage-backed securities                      |  |                      |           |  |                      |   |         |                       |  |   |            |  |  |                          |           |  |  |   |         | 
|Agency backed securities                                    |  |                      | 283,652   |  |                      |   | 12,326  |                       |  |   | (262)      |  |  |                          | 295,716   |  |  |   | -       | 
|Non-agency backed securities                                |  |                      | 38,615    |  |                      |   | 3,575   |                       |  |   | (34)       |  |  |                          | 42,156    |  |  |   | (6)     | 
|Asset-backed securities                                     |  |                      | 42,751    |  |                      |   | 1,615   |                       |  |   | (14)       |  |  |                          | 44,352    |  |  |   | -       | 
|                                                            | 
|Total fixed-maturity securities                             |  |                      | 2,190,186 |  |                      |   | 157,463 |                       |  |   | (1,938)    |  |  |                          | 2,345,711 |  |  |   | (6)     | 
|Preferred stocks, principally financial sector              |  |                      | 31,272    |  |                      |   | 730     |                       |  |   | (481)      |  |  |                          | 31,521    |  |  |   | -       | 
|Common stocks, principally financial and industrial sectors |  |                      | 118,076   |  |                      |   | 953     |                       |  |   | (4,292)    |  |  |                          | 114,737   |  |  |   | -       | 
|Short-term investments                                      |  |                      | 4,749     |  |                      |   | 1       |                       |  |   | -          |  |  |                          | 4,750     |  |  |   | -       | 
|                                                            | 
|Total, December 31, 2012                                    |  | $                    | 2,344,283 |  |                      | $ | 159,147 |                       |  | $ | (6,711)    |  |  | $                        | 2,496,719 |  |  | $ | (6)     | 
|                                                            | 
|Tower                                                       |  | $                    | 2,075,189 |  |                      | $ | 141,614 |                       |  | $ | (6,210)    |  |  | $                        | 2,210,593 |  |  | $ | (6)     | 
|Reciprocal Exchanges                                        |  |                      | 269,094   |  |                      |   | 17,533  |                       |  |   | (501)      |  |  |                          | 286,126   |  |  |   | -       | 
|                                                            | 
|Total, December 31, 2012                                    |  | $                    | 2,344,283 |  |                      | $ | 159,147 |                       |  | $ | (6,711)    |  |  | $                        | 2,496,719 |  |  | $ | (6)     | 
|                                                            | 
|                                                            |  |                      |           |  |                     
|December 31, 2011                                           |  |                      |           |  |                      |   |         |                       |  |   |            |  |  |                          |           |  |  |   |         | 
|U.S. Treasury securities                                    |  | $                    | 154,430   |  |                      | $ | 1,725   |                       |  | $ | (13)       |  |  | $                        | 156,142   |  |  | $ | -       | 
|U.S. Agency securities                                      |  |                      | 114,411   |  |                      |   | 2,779   |                       |  |   | -          |  |  |                          | 117,190   |  |  |   | -       | 
|Municipal bonds                                             |  |                      | 688,192   |  |                      |   | 48,777  |                       |  |   | (255)      |  |  |                          | 736,714   |  |  |   | -       | 
|Corporate and other bonds                                   |  |                      |           |  |                      |   |         |                       |  |   |            |  |  |                          |           |  |  |   |         | 
|Finance                                                     |  |                      | 331,917   |  |                      |   | 9,201   |                       |  |   | (4,615)    |  |  |                          | 336,503   |  |  |   | -       | 
|Industrial                                                  |  |                      | 388,139   |  |                      |   | 22,198  |                       |  |   | (2,287)    |  |  |                          | 408,050   |  |  |   | -       | 
|Utilities                                                   |  |                      | 30,164    |  |                      |   | 3,067   |                       |  |   | (61)       |  |  |                          | 33,170    |  |  |   | -       | 
|Commercial mortgage-backed securities                       |  |                      | 232,877   |  |                      |   | 22,854  |                       |  |   | (2,564)    |  |  |                          | 253,167   |  |  |   | (483)   | 
|Residential mortgage-backed securities                      |  |                      |           |  |                      |   |         |                       |  |   |            |  |  |                          |           |  |  |   |         | 
|Agency backed securities                                    |  |                      | 304,876   |  |                      |   | 15,401  |                       |  |   | (1)        |  |  |                          | 320,276   |  |  |   | -       | 
|Non-agency backed securities                                |  |                      | 29,907    |  |                      |   | 2,603   |                       |  |   | (901)      |  |  |                          | 31,609    |  |  |   | (695)   | 
|Asset-backed securities                                     |  |                      | 60,199    |  |                      |   | 1,309   |                       |  |   | (655)      |  |  |                          | 60,853    |  |  |   | -       | 
|                                                            | 
|Total fixed-maturity securities                             |  |                      | 2,335,112 |  |                      |   | 129,914 |                       |  |   | (11,352)   |  |  |                          | 2,453,674 |  |  |   | (1,178) | 
|Preferred stocks, principally financial sector              |  |                      | 24,083    |  |                      |   | 317     |                       |  |   | (890)      |  |  |                          | 23,510    |  |  |   | -       | 
|Common stocks, principally industrial and financial sectors |  |                      | 68,951    |  |                      |   | 1,078   |                       |  |   | (4,194)    |  |  |                          | 65,835    |  |  |   | -       | 
|Short-term investments                                      |  |                      | -         |  |                      |   | -       |                       |  |   | -          |  |  |                          | -         |  |  |   | -       | 
|                                                            | 
|Total, December 31, 2011                                    |  | $                    | 2,428,146 |  |                      | $ | 131,309 |                       |  | $ | (16,436)   |  |  | $                        | 2,543,019 |  |  | $ | (1,178) | 
|                                                            | 
|Tower                                                       |  | $                    | 2,138,001 |  |                      | $ | 118,173 |                       |  | $ | (15,075)   |  |  | $                        | 2,241,099 |  |  | $ | (1,178) | 
|Reciprocal Exchanges                                        |  |                      | 290,145   |  |                      |   | 13,136  |                       |  |   | (1,361)    |  |  |                          | 301,920   |  |  |   | -       | 
|                                                            | 
|Total, December 31, 2011                                    |  | $                    | 2,428,146 |  |                      | $ | 131,309 |                       |  | $ | (16,436)   |  |  | $                        | 2,543,019 |  |  | $ | (1,178) | 
|                                                            | 

(1) Represents the gross unrealized loss on other-than-temporarily impaired securities recognized in accumulated other
comprehensive income (loss).



F-17



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



As at December 31, 2012 and 2011, U.S. Treasury Notes and other securities with carrying values of
$351.1 million and $226.8 million, respectively, were on deposit with various states to comply with the insurance laws in which the Company is licensed.

In addition, the Company had $481.5 million and $340.8 million of investments as of December 31, 2012 and 2011, respectively, held by counterparties as collateral or in trusts to support letter of
credit issued on Towers behalf, reinsurance liabilities on certain assumed reinsurance treaties, and collateral posted for certain leases.

Major categories of net investment income are summarized as follows:



|                                                             |  |                         |         |  |      |   |         |      |  |   |         | 
|------------------------------------------------------------ |  | ----------------------- | ------- |  | ---- | - | ------- | ---- |  | - | ------- | 
|                                                             |  | Year Ended December 31, |        
|($ in thousands)                                             |  | 2012                    |         |  | 2011 |   |         | 2010 | 
|                                                             | 
|Income                                                       |  |                         |         |  |      |   |         |      |  |   |         | 
|Fixed-maturity securities                                    |  | $                       | 96,056  |  |      | $ | 105,533 |      |  | $ | 103,921 | 
|Equity securities                                            |  |                         | 28,989  |  |      |   | 24,576  |      |  |   | 7,225   | 
|Cash and cash equivalents                                    |  |                         | 1,112   |  |      |   | 695     |      |  |   | 732     | 
|Other invested assets                                        |  |                         | 6,680   |  |      |   | 274     |      |  |   | -       | 
|Other                                                        |  |                         | 387     |  |      |   | 643     |      |  |   | 539     | 
|                                                             | 
|Total                                                        |  |                         | 133,224 |  |      |   | 131,721 |      |  |   | 112,417 | 
|Expenses                                                     |  |                         |         |  |      |   |         |      |  |   |         | 
|Investment expenses                                          |  |                         | (6,059) |  |      |   | (5,247) |      |  |   | (5,152) | 
|                                                             | 
|Net investment income                                        |  | $                       | 127,165 |  |      | $ | 126,474 |      |  | $ | 107,265 | 
|                                                             | 
|Tower                                                        |  |                         | 121,907 |  |      |   | 120,083 |      |  |   | 105,506 | 
|Reciprocal Exchanges                                         |  |                         | 12,575  |  |      |   | 12,846  |      |  |   | 5,118   | 
|Elimination of interest on Reciprocal Exchange surplus notes |  |                         | (7,317) |  |      |   | (6,455) |      |  |   | (3,359) | 
|                                                             | 
|Net investment income                                        |  | $                       | 127,165 |  |      | $ | 126,474 |      |  | $ | 107,265 | 
|                                                             | 

Proceeds from the sale of fixed-maturity securities were $1.8 billion, $2.0 billion and $1.4 billion for the
year ended December 31, 2012, 2011 and 2010, respectively. Proceeds from the sale of equity securities were $1.4 billion, $793.9 million and $80.7 million for the year ended December 31, 2012, 2011 and 2010, respectively.



F-18



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Gross realized gains, losses and impairment write-downs on investments are summarized as follows:



|                                                                    |  |                         |          |  |      |   |          |      |  |   |          | 
|------------------------------------------------------------------- |  | ----------------------- | -------- |  | ---- | - | -------- | ---- |  | - | -------- | 
|                                                                    |  | Year Ended December 31, |         
|($ in thousands)                                                    |  | 2012                    |          |  | 2011 |   |          | 2010 | 
|                                                                    | 
|Fixed-maturity securities                                           |  |                         |          |  |      |   |          |      |  |   |          | 
|Gross realized gains                                                |  | $                       | 59,319   |  |      | $ | 44,550   |      |  | $ | 31,587   | 
|Gross realized losses                                               |  |                         | (2,780)  |  |      |   | (11,101) |      |  |   | (11,388) | 
|                                                                    | 
|                                                                    |  |                         | 56,539   |  |      |   | 33,449   |      |  |   | 20,199   | 
|Equity securities                                                   |  |                         |          |  |      |   |          |      |  |   |          | 
|Gross realized gains                                                |  |                         | 13,090   |  |      |   | 8,328    |      |  |   | 482      | 
|Gross realized losses                                               |  |                         | (31,404) |  |      |   | (29,138) |      |  |   | (3,007)  | 
|                                                                    | 
|                                                                    |  |                         | (18,314) |  |      |   | (20,810) |      |  |   | (2,525)  | 
|Other (1)                                                           |  |                         |          |  |      |   |          |      |  |   |          | 
|Gross realized gains                                                |  |                         | 3,432    |  |      |   | -        |      |  |   | -        | 
|Gross realized losses                                               |  |                         | (6,548)  |  |      |   | -        |      |  |   | -        | 
|                                                                    | 
|                                                                    |  |                         | (3,116)  |  |      |   | -        |      |  |   | -        | 
|                                                                    | 
|Net realized gains on investments                                   |  |                         | 35,109   |  |      |   | 12,639   |      |  |   | 17,674   | 
|                                                                    | 
|Other-than-temporary impairment losses:                             |  |                         |          |  |      |   |          |      |  |   |          | 
|Fixed-maturity securities                                           |  |                         | (1,320)  |  |      |   | (580)    |      |  |   | (3,021)  | 
|Equity securities                                                   |  |                         | (8,313)  |  |      |   | (2,665)  |      |  |   | -        | 
|                                                                    | 
|Total other-than-temporary impairment losses recognized in earnings |  |                         | (9,633)  |  |      |   | (3,245)  |      |  |   | (3,021)  | 
|                                                                    | 
|Total net realized investment gains (losses)                        |  | $                       | 25,476   |  |      | $ | 9,394    |      |  | $ | 14,653   | 
|                                                                    | 
|Tower                                                               |  | $                       | 12,245   |  |      | $ | 6,980    |      |  | $ | 14,910   | 
|Reciprocal Exchanges                                                |  |                         | 13,231   |  |      |   | 2,414    |      |  |   | (257)    | 
|                                                                    | 
|Total net realized investment gains (losses)                        |  | $                       | 25,476   |  |      | $ | 9,394    |      |  | $ | 14,653   | 
|                                                                    | 

(1) Other gross realized
gains and losses consists primarily of debt and equity securities sold, not yet purchased, which are reported with Other liabilities.

Management may dispose of a particular security due to changes in facts and circumstances related to the invested asset that have arisen since the last analysis supporting managements determination
whether or not it intended to sell the security, and if not, whether it is more likely than not that the Company would be required to sell the security before recovery of its amortized cost basis.

Impairment Review

Management regularly
reviews the Companys fixed-maturity and equity security portfolios in accordance with its impairment policy to evaluate the necessity of recording impairment losses for OTTI. The determination of OTTI is a subjective process and different
judgments and assumptions could affect the timing of loss realization.

Management, in conjunction with its outside portfolio managers,
analyzes its non-agency residential mortgage-backed securities (RMBS) using default loss models based on the performance of the underlying loans. Performance metrics include delinquencies, defaults, foreclosures, anticipated cash flow
prepayments and cumulative losses incurred. The expected losses for a mortgage pool are compared to the break-even loss, which represents the point at which the Companys tranche begins to experience losses.

The commercial mortgage-backed securities (CMBS) holdings are evaluated using analytical techniques and various metrics including the level
of subordination, debt-service-coverage ratios, loan-to-value ratios, delinquencies, defaults and foreclosures.

For the non-structured
fixed-maturity securities (U.S. Treasury and Agency securities, municipal bonds, and certain corporate debt), unrealized losses are reviewed to determine whether full recovery of principal and interest will be received. The estimate of expected cash
flows is determined by projecting a recovery value and a recovery time frame and assessing whether further principal and interest will be received. The determination of recovery value incorporates an issuer valuation assumption utilizing one or a
combination of valuation methods as deemed appropriate by management. The present value of the cash flows is determined by applying the effective yield of the security at the date of acquisition (or the most recent implied rate used to accrete the
security if the implied rate has changed as a result of a previous impairment) and an estimated recovery time frame. For securities for which the issuer is financially troubled but not in bankruptcy, that time frame is generally longer. Included in
the present value calculation are expected principal and interest payments; however, for securities for which the issuer is classified as bankrupt or in default, the present value calculation assumes no interest payments and a single recovery
amount. In situations for which a present value of cash flows cannot be estimated, a write-down to fair value is recorded.



F-19



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



In estimating the recovery value, significant judgment is involved in the development of assumptions
relating to a number of factors related to the issuer including, but not limited to, revenue, margin and earnings projections, the likely market or liquidation values of assets, potential additional debt to be incurred pre- or post-
bankruptcy/restructuring, the ability to shift existing or new debt to different priority layers, the amount of restructuring/bankruptcy expenses, the size and priority of unfunded pension obligations, litigation or other contingent claims, the
treatment of intercompany claims and the likely outcome with respect to inter-creditor conflicts.

The evaluation of equity securities
includes managements intent and ability to hold the security to recovery. Management will record OTTI in those situations where it does not intend to hold the security to recovery or if the security is not expected to recover in value in the
near term.

The following table shows the amount of fixed-maturity and equity securities that were OTTI for the years ended December 31,
2012, 2011 and 2010. This resulted in recording impairment write-downs included in net realized investment gains (losses), and reduced the unrealized loss in other comprehensive net income:



|                                                                            |  |                         |         |  |      |   |         |      |  |   |          | 
|--------------------------------------------------------------------------- |  | ----------------------- | ------- |  | ---- | - | ------- | ---- |  | - | -------- | 
|                                                                            |  | Year Ended December 31, |        
|($ in thousands)                                                            |  | 2012                    |         |  | 2011 |   |         | 2010 | 
|                                                                            | 
|Municipal bonds                                                             |  | $                       | (113)   |  |      | $ | -       |      |  | $ | -        | 
|Corporate and other bonds                                                   |  |                         | (1,029) |  |      |   | -       |      |  |   | -        | 
|Commercial mortgage-backed securities                                       |  |                         | (430)   |  |      |   | (219)   |      |  |   | (6,987)  | 
|Residential mortgage-backed securities                                      |  |                         | (34)    |  |      |   | (235)   |      |  |   | (6,164)  | 
|Asset-backed securities                                                     |  |                         | -       |  |      |   | (391)   |      |  |   | (1,779)  | 
|Equities                                                                    |  |                         | (8,313) |  |      |   | (2,664) |      |  |   | -        | 
|                                                                            | 
|Other-than-temporary-impairments                                            |  |                         | (9,919) |  |      |   | (3,509) |      |  |   | (14,930) | 
|Portion of loss recognized in accumulated other comprehensive income (loss) |  |                         | 286     |  |      |   | 264     |      |  |   | 11,909   | 
|                                                                            | 
|Impairment losses recognized in earnings                                    |  | $                       | (9,633) |  |      | $ | (3,245) |      |  | $ | (3,021)  | 
|                                                                            | 
|Tower                                                                       |  | $                       | (9,919) |  |      | $ | (3,245) |      |  | $ | (3,021)  | 
|Reciprocal Exchanges                                                        |  |                         | 286     |  |      |   | -       |      |  |   | -        | 
|                                                                            | 
|Impairment losses recognized in earnings                                    |  | $                       | (9,633) |  |      | $ | (3,245) |      |  | $ | (3,021)  | 
|                                                                            | 

The following table provides a rollforward of the cumulative amount of credit related OTTI for securities still held
showing the amounts that have been included in earnings on a pretax basis for the years ended 2012 and 2011 (none of such OTTI was included within the Reciprocal Exchanges):



|                                                                                        |  |                         |         |  |      |   |         |      |  |   |          | 
|--------------------------------------------------------------------------------------- |  | ----------------------- | ------- |  | ---- | - | ------- | ---- |  | - | -------- | 
|                                                                                        |  | Year Ended December 31, |        
|($ in thousands)                                                                        |  | 2012                    |         |  | 2011 |   |         | 2010 | 
|                                                                                        | 
|Balance, January 1,                                                                     |  | $                       | 12,666  |  |      | $ | 18,075  |      |  | $ | 41,904   | 
|Additional credit losses recognized during the period, related to securities for which: |  |                         |         |  |      |   |         |      |  |   |          | 
|No OTTI has been previously recognized                                                  |  |                         | 1,259   |  |      |   | 44      |      |  |   | 707      | 
|OTTI has been previously recognized                                                     |  |                         | 61      |  |      |   | 537     |      |  |   | 2,314    | 
|Reductions due to:                                                                      |  |                         |         |  |      |   |         |      |  |   |          | 
|Securities sold during the period (realized)                                            |  |                         | (9,494) |  |      |   | (5,990) |      |  |   | (26,850) | 
|                                                                                        | 
|Balance, December 31,                                                                   |  | $                       | 4,492   |  |      | $ | 12,666  |      |  | $ | 18,075   | 
|                                                                                        | 

Unrealized Losses

There are 212 securities at December 31, 2012, including fixed maturities and equity securities, which account for the gross unrealized loss, none of which is deemed by management to be OTTI.
Temporary losses on corporate and other bonds result from purchases made in a lower interest rate environment or lower yield spread environment. In addition, there have been some ratings downgrades on certain of these securities. After analyzing the
credit quality, balance sheet strength and company outlook, management believes these securities will recover in value. The structured securities that had significant unrealized losses resulted primarily from declines in both residential and
commercial real estate prices. To the extent projected cash flows on structured securities change adversely, they would be considered OTTI, and an impairment loss would be recognized in the current period. Management considered all relevant factors,
including expected recoverability of cash flows, in assessing whether a loss was other-than-temporary. The Company does not intend to sell these fixed maturity securities, and it is not more likely than not that these securities will be sold before
recovering their cost basis.



F-20



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



For all fixed-maturity securities in an unrealized loss position at December 31, 2012, the Company
has received all contractual interest payments (and principal if applicable). Based on the continuing receipt of cash flow and the foregoing analyses, management expects continued timely payments of principal and interest and considers the losses to
be temporary.

The unrealized loss position associated with the fixed-maturity portfolio was $1.9 million as of December 31, 2012,
consisting primarily of corporate bonds and mortgage-backed securities of $1.6 million. The total fixed-maturity portfolio of gross unrealized losses included 182 securities which were, in aggregate, approximately 0.7% below amortized cost. Of the
182 fixed maturity investments identified, 31 have been in an unrealized loss position for more than 12 months. The total unrealized loss on these investments at December 31, 2012 was $0.3 million. Management does not consider these investments
to be other-than-temporarily impaired.

For common stocks, there were 23 securities in a loss position at December 31, 2012 totaling $4.3
million. Management evaluated the financial condition of the common stock issuers, the severity and duration of the impairment, and our ability and intent to hold to recovery and determined these securities are not OTTI. The evaluation consisted of
a detailed review, including but not limited to some or all of the following factors for each security: the current S&P rating, analysts reports, past earnings trends and analysts earnings expectations for the next 12 months,
liquidity, near-term financing risk, and whether the company was currently paying dividends on its equity securities. Management does not consider these investments to be other-than-temporarily impaired.



F-21



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



The following table presents information regarding invested assets that were in an unrealized loss
position at December 31, 2012 and December 31, 2011 by amount of time in a continuous unrealized loss position:



|                                       |  |                     |         |  |                     |   |         |       |  |   |            |  |  |            |      |   |            |   |         |  |  |   |         |  
|-------------------------------------- |  | ------------------- | ------- |  | ------------------- | - | ------- | ----- |  | - | ---------- |  |  | ---------- | ---- | - | ---------- | - | ------- |  |  | - | ------- | -
|                                       |  | Less than 12 Months |         |  | 12 Months or Longer |   |         | Total | 
|                                       |  | Fair                |         |  | Unrealized          |   |         | Fair  |  |   | Unrealized |  |  | Aggregate  |      |   | Unrealized |  
|($ in thousands)                       |  | Value               |         |  | Losses              |   |         | Value |  |   | Losses     |  |  | Fair Value |      |   | Losses     |  
|                                       | 
|December 31, 2012                      |  |                     |         |  |                     |   |         |       |  |   |            |  |  |            |      |   |            |   |         |  |  |   |         |  
|U.S. Treasury securities               |  | $                   | 44,347  |  |                     | $ | (13     | )     |  | $ | -          |  |  | $          | -    |   |            | $ | 44,347  |  |  | $ | (13     | )
|U.S. Agency securities                 |  |                     | 22,345  |  |                     |   | (76     | )     |  |   | -          |  |  |            | -    |   |            |   | 22,345  |  |  |   | (76     | )
|Municipal bonds                        |  |                     | 21,532  |  |                     |   | (235    | )     |  |   | 251        |  |  |            | (9   | ) |            |   | 21,783  |  |  |   | (244    | )
|Corporate and other bonds              |  |                     |         |  |                     |   |         |       |  |   |            |  |  |            |      |   |            |   |         |  |  |   |         |  
|Finance                                |  |                     | 17,853  |  |                     |   | (95     | )     |  |   | -          |  |  |            | -    |   |            |   | 17,853  |  |  |   | (95     | )
|Industrial                             |  |                     | 53,576  |  |                     |   | (667    | )     |  |   | 4,188      |  |  |            | (202 | ) |            |   | 57,764  |  |  |   | (869    | )
|Utilities                              |  |                     | 20,143  |  |                     |   | (191    | )     |  |   | 7          |  |  |            | -    |   |            |   | 20,150  |  |  |   | (191    | )
|Commercial mortgage-backed securities  |  |                     | 23,223  |  |                     |   | (141    | )     |  |   | 95         |  |  |            | -    |   |            |   | 23,318  |  |  |   | (141    | )
|Residential mortgage-backed securities |  |                     |         |  |                     |   |         |       |  |   |            |  |  |            |      |   |            |   |         |  |  |   |         |  
|Agency backed                          |  |                     | 59,009  |  |                     |   | (261    | )     |  |   | 25         |  |  |            | (1   | ) |            |   | 59,034  |  |  |   | (262    | )
|Non-agency backed                      |  |                     | 815     |  |                     |   | (6      | )     |  |   | 588        |  |  |            | (28  | ) |            |   | 1,403   |  |  |   | (34     | )
|Asset-backed securities                |  |                     | 1,499   |  |                     |   | (2      | )     |  |   | 4,232      |  |  |            | (11  | ) |            |   | 5,731   |  |  |   | (13     | )
|                                       | 
|Total fixed-maturity securities        |  |                     | 264,342 |  |                     |   | (1,687  | )     |  |   | 9,386      |  |  |            | (251 | ) |            |   | 273,728 |  |  |   | (1,938  | )
|Preferred stocks                       |  |                     | 9,716   |  |                     |   | (155    | )     |  |   | 5,724      |  |  |            | (326 | ) |            |   | 15,440  |  |  |   | (481    | )
|Common stocks                          |  |                     | 55,560  |  |                     |   | (4,292  | )     |  |   | -          |  |  |            | -    |   |            |   | 55,560  |  |  |   | (4,292  | )
|                                       | 
|Total, December 31, 2012               |  | $                   | 329,618 |  |                     | $ | (6,134  | )     |  | $ | 15,110     |  |  | $          | (577 | ) |            | $ | 344,728 |  |  | $ | (6,711  | )
|                                       | 
|Tower                                  |  | $                   | 271,609 |  |                     | $ | (5,732  | )     |  | $ | 13,338     |  |  | $          | (478 | ) |            | $ | 284,947 |  |  | $ | (6,210  | )
|Reciprocal Exchanges                   |  |                     | 58,009  |  |                     |   | (402    | )     |  |   | 1,772      |  |  |            | (99  | ) |            |   | 59,781  |  |  |   | (501    | )
|                                       | 
|Total, December 31, 2012               |  | $                   | 329,618 |  |                     | $ | (6,134  | )     |  | $ | 15,110     |  |  | $          | (577 | ) |            | $ | 344,728 |  |  | $ | (6,711  | )
|                                       | 
|December 31, 2011                      |  |                     |         |  |                     |   |         |       |  |   |            |  |  |            |      |   |            |   |         |  |  |   |         |  
|U.S. Treasury securities               |  | $                   | 92,001  |  |                     | $ | (13     | )     |  | $ | -          |  |  | $          | -    |   |            | $ | 92,001  |  |  | $ | (13     | )
|U.S. Agency securities                 |  |                     | -       |  |                     |   | -       |       |  |   | -          |  |  |            | -    |   |            |   | -       |  |  |   | -       |  
|Municipal bonds                        |  |                     | 13,449  |  |                     |   | (255    | )     |  |   | -          |  |  |            | -    |   |            |   | 13,449  |  |  |   | (255    | )
|Corporate and other bonds              |  |                     |         |  |                     |   |         |       |  |   |            |  |  |            |      |   |            |   |         |  |  |   |         |  
|Finance                                |  |                     | 138,986 |  |                     |   | (4,610  | )     |  |   | 251        |  |  |            | (5   | ) |            |   | 139,237 |  |  |   | (4,615  | )
|Industrial                             |  |                     | 57,357  |  |                     |   | (2,141  | )     |  |   | 3,519      |  |  |            | (146 | ) |            |   | 60,876  |  |  |   | (2,287  | )
|Utilities                              |  |                     | 1,902   |  |                     |   | (61     | )     |  |   | -          |  |  |            | -    |   |            |   | 1,902   |  |  |   | (61     | )
|Commercial mortgage-backed securities  |  |                     | 26,130  |  |                     |   | (2,564  | )     |  |   | -          |  |  |            | -    |   |            |   | 26,130  |  |  |   | (2,564  | )
|Residential mortgage-backed securities |  |                     |         |  |                     |   |         |       |  |   |            |  |  |            |      |   |            |   |         |  |  |   |         |  
|Agency backed                          |  |                     | 19      |  |                     |   | (1      | )     |  |   | 12         |  |  |            | -    |   |            |   | 31      |  |  |   | (1      | )
|Non-agency backed                      |  |                     | 13,294  |  |                     |   | (318    | )     |  |   | 4,609      |  |  |            | (583 | ) |            |   | 17,903  |  |  |   | (901    | )
|Asset-backed securities                |  |                     | 29,624  |  |                     |   | (647    | )     |  |   | 610        |  |  |            | (8   | ) |            |   | 30,234  |  |  |   | (655    | )
|                                       | 
|Total fixed-maturity securities        |  |                     | 372,762 |  |                     |   | (10,610 | )     |  |   | 9,001      |  |  |            | (742 | ) |            |   | 381,763 |  |  |   | (11,352 | )
|Preferred stocks                       |  |                     | 17,773  |  |                     |   | (644    | )     |  |   | 1,303      |  |  |            | (246 | ) |            |   | 19,076  |  |  |   | (890    | )
|Common stocks                          |  |                     | 44,132  |  |                     |   | (4,194  | )     |  |   | -          |  |  |            | -    |   |            |   | 44,132  |  |  |   | (4,194  | )
|                                       | 
|Total, December 31, 2011               |  | $                   | 434,667 |  |                     | $ | (15,448 | )     |  | $ | 10,304     |  |  | $          | (988 | ) |            | $ | 444,971 |  |  | $ | (16,436 | )
|                                       | 
|Tower                                  |  | $                   | 398,989 |  |                     | $ | (14,160 | )     |  | $ | 8,264      |  |  | $          | (915 | ) |            | $ | 407,253 |  |  | $ | (15,075 | )
|Reciprocal Exchanges                   |  |                     | 35,678  |  |                     |   | (1,288  | )     |  |   | 2,040      |  |  |            | (73  | ) |            |   | 37,718  |  |  |   | (1,361  | )
|                                       | 
|Total, December 31, 2011               |  | $                   | 434,667 |  |                     | $ | (15,448 | )     |  | $ | 10,304     |  |  | $          | (988 | ) |            | $ | 444,971 |  |  | $ | (16,436 | )
|                                       | 

Management evaluated the severity of the impairment in relation to the carrying values for the securities referred to
above and considered all relevant factors in assessing whether the loss was other-than-temporary. Management does not intend to sell its fixed-maturity securities, and it is not more likely than not that fixed maturity and equity securities will be
sold until there is a recovery of fair value to the original cost basis, which may be at maturity.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Fixed-Maturity InvestmentTime to Maturity

The following table shows the composition of the fixed-maturity portfolio by remaining time to maturity at December 31, 2012 and 2011. For
securities that are redeemable at the option of the issuer and have a market price that is greater than par value, the maturity used for the table below is the earliest redemption date. For securities that are redeemable at the option of the issuer
and have a market price that is less than par value, the maturity used for the table below is the final maturity date.



|                                     |  |               |           |  |                      |   |           |               |  |   |            |  |  |               |         |  |            |   |           |  |  |   |           | 
|------------------------------------ |  | ------------- | --------- |  | -------------------- | - | --------- | ------------- |  | - | ---------- |  |  | ------------- | ------- |  | ---------- | - | --------- |  |  | - | --------- | 
|                                     |  | Tower         |           |  | Reciprocal Exchanges |   |           | Total         | 
|($ in thousands)                     |  | AmortizedCost |           |  | Fair Value           |   |           | AmortizedCost |  |   | Fair Value |  |  | AmortizedCost |         |  | Fair Value |  
|                                     | 
|December 31, 2012                    |  |               |           |  |                      |   |           |               |  |   |            |  |  |               |         |  |            |   |           |  |  |   |           | 
|Remaining Time to Maturity           |  |               |           |  |                      |   |           |               |  |   |            |  |  |               |         |  |            |   |           |  |  |   |           | 
|Less than one year                   |  | $             | 30,082    |  |                      | $ | 30,614    |               |  | $ | 2,678      |  |  | $             | 2,715   |  |            | $ | 32,760    |  |  | $ | 33,329    | 
|One to five years                    |  |               | 489,939   |  |                      |   | 510,523   |               |  |   | 45,576     |  |  |               | 47,275  |  |            |   | 535,515   |  |  |   | 557,798   | 
|Five to ten years                    |  |               | 564,556   |  |                      |   | 607,711   |               |  |   | 76,480     |  |  |               | 80,009  |  |            |   | 641,036   |  |  |   | 687,720   | 
|More than 10 years                   |  |               | 346,410   |  |                      |   | 380,045   |               |  |   | 57,628     |  |  |               | 62,542  |  |            |   | 404,038   |  |  |   | 442,587   | 
|Mortgage and asset-backed securities |  |               | 495,249   |  |                      |   | 536,255   |               |  |   | 81,588     |  |  |               | 88,022  |  |            |   | 576,837   |  |  |   | 624,277   | 
|                                     | 
|Total                                |  | $             | 1,926,236 |  |                      | $ | 2,065,148 |               |  | $ | 263,950    |  |  | $             | 280,563 |  |            | $ | 2,190,186 |  |  | $ | 2,345,711 | 
|                                     | 
|December 31, 2011                    |  |               |           |  |                      |   |           |               |  |   |            |  |  |               |         |  |            |   |           |  |  |   |           | 
|Remaining Time to Maturity           |  |               |           |  |                      |   |           |               |  |   |            |  |  |               |         |  |            |   |           |  |  |   |           | 
|Less than one year                   |  | $             | 40,201    |  |                      | $ | 40,529    |               |  | $ | 44,238     |  |  | $             | 44,942  |  |            | $ | 84,439    |  |  | $ | 85,471    | 
|One to five years                    |  |               | 479,721   |  |                      |   | 491,904   |               |  |   | 81,566     |  |  |               | 83,743  |  |            |   | 561,287   |  |  |   | 575,647   | 
|Five to ten years                    |  |               | 563,830   |  |                      |   | 593,838   |               |  |   | 21,522     |  |  |               | 22,797  |  |            |   | 585,352   |  |  |   | 616,635   | 
|More than 10 years                   |  |               | 427,357   |  |                      |   | 458,536   |               |  |   | 48,818     |  |  |               | 51,480  |  |            |   | 476,175   |  |  |   | 510,016   | 
|Mortgage and asset-backed securities |  |               | 535,823   |  |                      |   | 568,813   |               |  |   | 92,036     |  |  |               | 97,092  |  |            |   | 627,859   |  |  |   | 665,905   | 
|                                     | 
|Total                                |  | $             | 2,046,932 |  |                      | $ | 2,153,620 |               |  | $ | 288,180    |  |  | $             | 300,054 |  |            | $ | 2,335,112 |  |  | $ | 2,453,674 | 
|                                     | 

Other Invested Assets

The following table shows the composition of the other invested assets as of December 31, 2012 and 2011:



|                                                |  |      |        |  |      |   |        | 
|----------------------------------------------- |  | ---- | ------ |  | ---- | - | ------ | 
|($ in thousands)                                |  | 2012 |        |  | 2011 |  
|                                                | 
|Limited partnerships, equity method             |  | $    | 23,864 |  |      | $ | 12,459 | 
|Real estate, amortized cost                     |  |      | 7,422  |  |      |   | 6,888  | 
|Securities reported under the fair value option |  |      | 25,000 |  |      |   | 25,000 | 
|Other                                           |  |      | 1,500  |  |      |   | -      | 
|                                                | 
|Total                                           |  | $    | 57,786 |  |      | $ | 44,347 | 
|                                                | 

In December 2011, the Company purchased two securities for which it elected the fair value option. This election was made
to simplify the accounting for these instruments which contain embedded derivatives and other features.

Note 7Fair Value Measurements

GAAP establishes a three-level hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. The fair
value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). If the inputs used to measure the assets or liabilities fall within
different levels of the hierarchy, the classification is based on the lowest level input that is significant to the fair value measurement of the asset or liability. Classification of assets and liabilities within the hierarchy considers the markets
in which the assets and liabilities are traded, including during periods of market disruption, and the reliability and transparency of the assumptions used to determine fair value. The hierarchy requires the use of observable market data when
available. The levels of the hierarchy are as follows:

Level 1 Inputs to the valuation methodology are quoted prices
(unadjusted) for identical assets or liabilities traded in active markets. Included are those equity securities that are traded on active exchanges, such as the NASDAQ Global Select Market.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Level 2 Inputs to the valuation methodology include quoted prices for similar assets or
liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability and market-corroborated inputs. Included are
investments in U.S. Treasury and Agency securities and, together with municipal bonds, corporate debt securities, commercial mortgages, residential mortgage-backed securities and asset-backed securities. Additionally, interest-rate swap contracts
utilize Level 2 inputs in deriving fair values.

Level 3 Inputs to the valuation methodology are unobservable in the market for
the asset or liability and are significant to the fair value measurement. Material assumptions and factors considered in pricing investment securities may include projected cash flows, collateral performance including delinquencies, defaults and
recoveries, and any market clearing activity or liquidity circumstances in the security or similar securities that may have occurred since the prior pricing period. Generally included in this valuation methodology are investments in certain
mortgage-backed and asset-backed securities and securities the Company is reporting under the fair value option.

The availability of
observable inputs varies and is affected by a wide variety of factors. When the valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires significantly more judgment. The
degree of judgment exercised by management in determining fair value is greatest for investments categorized as Level 3. For investments in this category, management considers prices and inputs that are current as of the measurement date. In periods
of market dislocation, as characterized by current market conditions, the ability to observe stable prices and inputs may be reduced for many instruments. This condition could cause a security to be reclassified between levels.



F-24



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



As at December 31, 2012 and 2011, the Companys financial instruments carried at fair value
are allocated among levels as follows:



|                                                   |  |         |         |  |         |   |           |         |  |   |        |  |  |   |           |  
|-------------------------------------------------- |  | ------- | ------- |  | ------- | - | --------- | ------- |  | - | ------ |  |  | - | --------- | -
|($ in thousands)                                   |  | Level 1 |         |  | Level 2 |   |           | Level 3 |  |   | Total  | 
|                                                   | 
|December 31, 2012                                  |  |         |         |  |         |   |           |         |  |   |        |  |  |   |           |  
|Fixed-maturity securities                          |  |         |         |  |         |   |           |         |  |   |        |  |  |   |           |  
|U.S. Treasury securities                           |  | $       | -       |  |         | $ | 184,949   |         |  | $ | -      |  |  | $ | 184,949   |  
|U.S. Agency securities                             |  |         | -       |  |         |   | 102,777   |         |  |   | -      |  |  |   | 102,777   |  
|Municipal bonds                                    |  |         | -       |  |         |   | 686,043   |         |  |   | -      |  |  |   | 686,043   |  
|Corporate and other bonds                          |  |         | -       |  |         |   | 747,665   |         |  |   | -      |  |  |   | 747,665   |  
|Commercial mortgage-backed securities              |  |         | -       |  |         |   | 242,053   |         |  |   | -      |  |  |   | 242,053   |  
|Residential mortgage-backed securities             |  |         | -       |  |         |   | -         |         |  |   | -      |  |  |   | -         |  
|Agency                                             |  |         | -       |  |         |   | 295,716   |         |  |   | -      |  |  |   | 295,716   |  
|Non-agency                                         |  |         | -       |  |         |   | 42,156    |         |  |   | -      |  |  |   | 42,156    |  
|Asset-backed securities                            |  |         | -       |  |         |   | 44,352    |         |  |   | -      |  |  |   | 44,352    |  
|                                                   | 
|Total fixed-maturities                             |  |         | -       |  |         |   | 2,345,711 |         |  |   | -      |  |  |   | 2,345,711 |  
|Equity securities                                  |  |         | 146,258 |  |         |   | -         |         |  |   | -      |  |  |   | 146,258   |  
|Short-term investments                             |  |         | -       |  |         |   | 4,750     |         |  |   | -      |  |  |   | 4,750     |  
|                                                   | 
|Total investments at fair value                    |  |         | 146,258 |  |         |   | 2,350,461 |         |  |   | -      |  |  |   | 2,496,719 |  
|Other invested assets (1)                          |  |         | -       |  |         |   | -         |         |  |   | 25,000 |  |  |   | 25,000    |  
|Other liabilities                                  |  |         | -       |  |         |   | -         |         |  |   | -      |  |  |   | -         |  
|Interest rate swap contracts                       |  |         | -       |  |         |   | (9,016    | )       |  |   | -      |  |  |   | (9,016    | )
|Debt and equity securities sold, not yet purchased |  |         | -       |  |         |   | (17,101   | )       |  |   | -      |  |  |   | (17,101   | )
|                                                   | 
|Total, December 31, 2012                           |  | $       | 146,258 |  |         | $ | 2,324,344 |         |  | $ | 25,000 |  |  | $ | 2,495,602 |  
|                                                   | 
|Tower                                              |  | $       | 140,695 |  |         | $ | 2,043,780 |         |  | $ | 25,000 |  |  | $ | 2,209,475 |  
|Reciprocal Exchanges                               |  |         | 5,563   |  |         |   | 280,564   |         |  |   | -      |  |  |   | 286,127   |  
|                                                   | 
|Total, December 31, 2012                           |  | $       | 146,258 |  |         | $ | 2,324,344 |         |  | $ | 25,000 |  |  | $ | 2,495,602 |  
|                                                   | 
|December 31, 2011                                  |  |         |         |  |         |   |           |         |  |   |        |  |  |   |           |  
|Fixed-maturity securities                          |  |         |         |  |         |   |           |         |  |   |        |  |  |   |           |  
|U.S. Treasury securities                           |  | $       | -       |  |         | $ | 156,142   |         |  | $ | -      |  |  | $ | 156,142   |  
|U.S. Agency securities                             |  |         | -       |  |         |   | 117,190   |         |  |   | -      |  |  |   | 117,190   |  
|Municipal bonds                                    |  |         | -       |  |         |   | 736,714   |         |  |   | -      |  |  |   | 736,714   |  
|Corporate and other bonds                          |  |         | -       |  |         |   | 777,723   |         |  |   | -      |  |  |   | 777,723   |  
|Commercial mortgage-backed securities              |  |         | -       |  |         |   | 253,167   |         |  |   | -      |  |  |   | 253,167   |  
|Residential mortgage-backed securities             |  |         | -       |  |         |   | -         |         |  |   | -      |  |  |   | -         |  
|Agency                                             |  |         | -       |  |         |   | 320,276   |         |  |   | -      |  |  |   | 320,276   |  
|Non-agency                                         |  |         | -       |  |         |   | 31,609    |         |  |   | -      |  |  |   | 31,609    |  
|Asset-backed securities                            |  |         | -       |  |         |   | 60,853    |         |  |   | -      |  |  |   | 60,853    |  
|                                                   | 
|Total fixed-maturities                             |  |         | -       |  |         |   | 2,453,674 |         |  |   | -      |  |  |   | 2,453,674 |  
|Equity securities                                  |  |         | 89,345  |  |         |   | -         |         |  |   | -      |  |  |   | 89,345    |  
|Short-term investments                             |  |         | -       |  |         |   | -         |         |  |   | -      |  |  |   | -         |  
|                                                   | 
|Total investments                                  |  |         | 89,345  |  |         |   | 2,453,674 |         |  |   | -      |  |  |   | 2,543,019 |  
|Other invested assets (2)                          |  |         | -       |  |         |   | -         |         |  |   | 25,000 |  |  |   | 25,000    |  
|Other liabilities                                  |  |         | -       |  |         |   | -         |         |  |   | -      |  |  |   | -         |  
|Interest rate swap contracts                       |  |         | -       |  |         |   | (7,384    | )       |  |   | -      |  |  |   | (7,384    | )
|                                                   | 
|Total, December 31, 2011                           |  | $       | 89,345  |  |         | $ | 2,446,290 |         |  | $ | 25,000 |  |  | $ | 2,560,635 |  
|                                                   | 
|Tower                                              |  | $       | 87,479  |  |         | $ | 2,146,236 |         |  | $ | 25,000 |  |  | $ | 2,258,715 |  
|Reciprocal Exchanges                               |  |         | 1,866   |  |         |   | 300,054   |         |  |   | -      |  |  |   | 301,920   |  
|                                                   | 
|Total, December 31, 2011                           |  | $       | 89,345  |  |         | $ | 2,446,290 |         |  | $ | 25,000 |  |  | $ | 2,560,635 |  
|                                                   | 

(1) $25.0 million of the $57.8 million Other invested assets reported on the consolidated balance sheet at
December 31, 2012 is reported at fair value. The remaining $32.8 million of Other invested assets is reported under the equity method of accounting or at amortized cost.

(2) $25.0 million of the $44.3 million Other invested assets reported on the consolidated balance sheet at December 31, 2011 is reported at fair value. The remaining $19.3 million of Other invested
assets is reported under the equity method of accounting or at amortized cost.

As of December 31, 2012, substantially all of the
investment portfolio recorded at fair value was priced based upon quoted market prices or other observable inputs. For investments in active markets, we used the quoted market prices provided by the outside pricing services to determine fair value.
In circumstances where quoted market prices were unavailable, we used fair



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



value estimates based upon other observable inputs including matrix pricing, benchmark interest rates, market comparables and other relevant inputs. When observable inputs were adjusted to
reflect managements best estimate of fair value, such fair value measurements are considered a lower level measurement in the GAAP fair value hierarchy.

Our process to validate the market prices obtained from the outside pricing sources includes, but is not limited to, periodic evaluation of model pricing methodologies and analytical reviews of certain
prices. We also periodically perform testing of the market to determine trading activity, or lack of trading activity, as well as market prices. Several securities sold during the quarter were back-tested (i.e., the sales price is
compared to the previous month end reported market price to determine reasonableness of the reported market price). If management believes that the price provided from the pricing source is distressed, management will use a valuation method that
reflects an orderly transaction between market participants, generally a discounted cash flow method that incorporates relevant interest rate, risk and liquidity factors.

The ability to observe stable prices and inputs may be reduced for highly-customized and illiquid instruments which had been the case for certain non-agency residential and commercial mortgage-backed
securities and asset-backed securities in previous periods.

Substantially all of the portfolio valuations at December 31, 2012
classified as Level 1 or Level 2 in the above table is priced by utilizing the services of several independent pricing services that provide the Company with a price quote for each security. There were no adjustments made to the prices obtained from
the independent pricing sources and dealers on securities classified as Level 1 or Level 2.

In 2012, there were no transfers of investments
between Level 1 and Level 2 or between Level 2 and Level 3.

The fair values of the interest rate swaps were derived by using an industry
standard swap valuation model with market based inputs for swaps having similar characteristics.

The fair values of the debt and equity
securities sold, not yet purchased were derived by using quoted prices for similar securities in active markets. These instruments resulted in net realized gains (losses) of $(2.1) million for the year ended December 31, 2012.

In December 2011, the Company purchased two securities that are reported in other invested assets and have been classified as Level 3 of the fair value
hierarchy. Management utilizes a discounted cash flow analysis to derive the fair values. For one security, which matures in 2015 and whose cash flows are supported by underlying short-term loans, the significant unobservable inputs include the
underlying short-term loans probability of default and loss severity, and a discount for the securitys lack of marketability. Increases in the probability of default and loss severity assumptions (which generally move directionally with
each other) would have the effect of decreasing the fair value of this security. The Company obtains credit ratings on the underlying short-term loans quarterly and considers these ratings when updating its assumptions. The second security is an
equity instrument which entitles the Company to residual interests of a finite life special purpose vehicle. The significant unobservable inputs include the estimated losses to be incurred by the vehicle and the equity instruments lack of
marketability. The Company obtains quarterly financial data from the vehicle and evaluates the estimated incurred loss figure. An increase in the vehicles estimated incurred losses would have the effect of decreasing the instruments fair
value.

Management is responsible for the determination of the value of the investments carried at fair value and the supporting methodologies
and assumptions. Management has reviewed the pricing techniques and methodologies of the independent pricing sources and believes that their policies adequately consider market activity, either based on specific transactions for the issue valued or
based on modeling of securities with similar credit quality, duration, yield and structure that were recently traded. Management monitors security-specific valuation trends and discusses material changes or the absence of expected changes with the
portfolio managers to understand the underlying factors and inputs and to validate the reasonableness of pricing. Management also back-tests the prices on numerous sales of securities during the year to validate the previous pricing provided as well
as utilizes other pricing sources to validate the pricing provided by our primary provider of the majority of the non-U.S. Treasury securities and non-agency securities included in Level 2.

There were no changes in Level 3 assets measured at fair value for the years ended December 31, 2012 and 2011.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



The following table summarizes changes in Level 3 assets measured at fair value for the year ended
December 31, 2012 and 2011 for Tower (the Reciprocal Exchanges have no Level 3 assets):



|                                              |  |                         |        |  |      |   |        |      |  |   |        |  
|--------------------------------------------- |  | ----------------------- | ------ |  | ---- | - | ------ | ---- |  | - | ------ | -
|                                              |  | Year Ended December 31, |       
|($ in thousands)                              |  | 2012                    |        |  | 2011 |   |        | 2010 | 
|                                              | 
|Beginning balance, January 1                  |  | $                       | 25,000 |  |      | $ | 2,058  |      |  | $ | 13,595 |  
|Total gains (losses)-realized / unrealized    |  |                         |        |  |      |   |        |      |  |   |        |  
|Included in net income                        |  |                         | -      |  |      |   | (1,067 | )    |  |   | (32    | )
|Included in other comprehensive income (loss) |  |                         | -      |  |      |   | -      |      |  |   | (6,229 | )
|Purchases, issuances and settlements          |  |                         | -      |  |      |   | 25,000 |      |  |   | -      |  
|Net transfers into (out of) Level 3           |  |                         | -      |  |      |   | (991   | )    |  |   | (5,276 | )
|                                              | 
|Ending balance, December 31,                  |  | $                       | 25,000 |  |      | $ | 25,000 |      |  | $ | 2,058  |  
|                                              | 

Note 8Goodwill and Intangible Assets

Goodwill

Goodwill
is calculated as the excess of purchase price over the net fair value of assets acquired. See Note 4  Acquisitions for information regarding the calculation of goodwill related to the recent acquisitions. The following is a summary
of goodwill by reporting units:



|                                     |  |                     |         |   |                   |   |        |       |  |   |         |  
|------------------------------------ |  | ------------------- | ------- | - | ----------------- | - | ------ | ----- |  | - | ------- | -
|($ in thousands)                     |  | CommercialInsurance |         |   | PersonalInsurance |   |        | Total | 
|                                     | 
|Balance, January 1, 2011 as reported |  | $                   | 189,121 |   |                   | $ | 56,427 |       |  | $ | 245,548 |  
|Adjustments (a)                      |  |                     | (3,203  | ) |                   |   | (887   | )     |  |   | (4,090  | )
|                                     | 
|Balance, January 1, as adjusted      |  |                     | 185,918 |   |                   |   | 55,540 |       |  |   | 241,458 |  
|Adjustments                          |  |                     | -       |   |                   |   | -      |       |  |   | -       |  
|                                     | 
|Balance, January 1, 2012             |  |                     | 185,918 |   |                   |   | 55,540 |       |  |   | 241,458 |  
|Adjustments                          |  |                     | -       |   |                   |   | -      |       |  |   | -       |  
|                                     | 
|Total, December 31, 2012             |  | $                   | 185,918 |   |                   | $ | 55,540 |       |  | $ | 241,458 |  
|                                     | 

(a) In 2012, the Company identified deferred tax assets that should have been recorded in purchase accounting for certain
acquisitions. The Company increased deferred tax assets by $4,090 and reduced goodwill to properly report 2010 and prior items as of the earliest period presented.

Goodwill impairment testing

The Company performs an impairment test for each of our
reporting units with goodwill annually or whenever events or circumstances indicate that the value of goodwill may be impaired. In performing Step 1 of the impairment test, management compared the fair value of the reporting units to their carrying
value including goodwill. If the carrying value including goodwill were to exceed the fair value of a reporting unit, Step 2 of the test would be performed. Step 2 of the impairment test requires the carrying value of goodwill to be reduced to its
fair value, if lower, as of the test date. For Step 1 of the test, the Company estimated the reporting units fair value using an average of five standard valuation techniques, which include a market multiples based on (i) book value;
(ii) tangible book value; (ii) estimates of projected results for 2013 and 2014; and, (iv) a valuation technique using discounted cash flows (DCF) to be generated by the reporting unit, which include a terminal value.

The market multiples techniques are based on book value; tangible book value; and estimates of projected future results were derived from
selected guideline companies, which write products similar to those issued by us and are of comparable size, and were adjusted for the return on equity and the return on tangible equity. The DCF valuation and market multiples are based on projected
future results involve a number of estimates that require broad assumptions and significant judgment by management regarding future performance. The key assumptions used in these methods are as follows:



|                          |  |                      |  |                   
|------------------------- |  | -------------------- |  | ------------------
|                          |  | Commercial Insurance |  | Personal Insurance
|                         
|Discounting interest rate |  | 10%                  |  | 10%               
|Growth rate  near term   |  | 8-14%                |  | 10-23%            
|Terminal growth rate      |  | 3%                   |  | 3%                
|Combined ratio(*)         |  | 94%-98%              |  | 94%-98%           

* In the determination of the terminal value we considered a combined ratio of 94% as reasonable for Commercial Insurance
and Personal Insurance.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



The Company also compared the aggregate fair value of the reporting units to Towers overall market
capitalization. The aggregate fair value of the reporting units exceeded Towers book value by 1% and market capitalization by 42%; management believes that the implied premium of the aggregate fair value over market capitalization is a
reasonable valuation for an acquisition control premium (the price in excess of a stocks market price that investors would typically pay to gain control of an entity).

For the Commercial Insurance reporting unit, the Company determined in Step 1 that the reporting units fair value was less than its carrying value, primarily driven by the overall market
capitalization. Accordingly, recoverability was evaluated assuming fair value was allocated to assets and liabilities as if the reporting unit had been acquired in a business combination. In Step 2, the implied value of the Commercial Insurance
reporting units goodwill was greater than its goodwill carrying value by $5 million considering an acquisition control premium of 42%; therefore, goodwill was not impaired and no write-down was required; however, the Step 1 comparison
indicates a greater risk of future impairment for this reporting units goodwill.

For the Personal Insurance reporting unit, management
determined in Step 1 that the reporting units fair value was in excess of its carrying value by 9% or $21 million considering an acquisition control premium of 42%; and therefore goodwill was not impaired.

In November and December 2012, Towers market capitalization was negatively impacted by what management believes was the uncertainty about the
results of Superstorm Sandy coupled with the uncertainty as to the timing of the merger with Canopius: therefore, despite a temporary decline in the Companys share price, management determined that there were no events or material changes in
circumstances that indicated that a material change in the fair value of the Companys reporting units had occurred.

Subsequent goodwill
assessments could result in impairment due to the impact of a volatile financial market on earnings, discount assumptions, liquidity and market capitalization, as well as our assessment of segment organization upon the completion of the proposed
merger with the Canopius Bermuda Operations. Management will continue to monitor its goodwill for possible future impairments.

Intangible
Assets

Intangible assets consist of finite and indefinite life assets. Finite life intangible assets include customer relationships and
trademarks. Insurance company licenses and management contracts are considered indefinite life intangible assets subject to annual impairment testing.

The components of intangible assets and their useful lives, accumulated amortization, and net carrying value as of December 31, 2012 and 2011 are as follows:



|                       |  |                    |  |                     |         |  |                         |   |         |                   |  |   |                     |  |  |                         |         |  |                   |   |         |   |  |   |         | 
|---------------------- |  | ------------------ |  | ------------------- | ------- |  | ----------------------- | - | ------- | ----------------- |  | - | ------------------- |  |  | ----------------------- | ------- |  | ----------------- | - | ------- | - |  | - | ------- | 
|                       |  |                    |  | December 31, 2012   |         |  | December 31, 2011       |  
|($ in thousands)       |  | UsefulLife(in-yrs) |  | GrossCarryingAmount |         |  | AccumulatedAmortization |   |         | NetCarryingAmount |  |   | GrossCarryingAmount |  |  | AccumulatedAmortization |         |  | NetCarryingAmount |  
|                       | 
|Insurance licenses     |  | -                  |  | $                   | 19,003  |  |                         | $ | -       |                   |  | $ | 19,003              |  |  | $                       | 19,003  |  |                   | $ | -       |   |  | $ | 19,003  | 
|Management contracts   |  | -                  |  |                     | 54,600  |  |                         |   | -       |                   |  |   | 54,600              |  |  |                         | 54,600  |  |                   |   | -       |   |  |   | 54,600  | 
|Customer relationships |  | 10-25              |  |                     | 57,890  |  |                         |   | (26,754 | )                 |  |   | 31,136              |  |  |                         | 57,890  |  |                   |   | (19,427 | ) |  |   | 38,463  | 
|Trademarks             |  | 5                  |  |                     | 5,290   |  |                         |   | (3,261  | )                 |  |   | 2,029               |  |  |                         | 5,290   |  |                   |   | (2,436  | ) |  |   | 2,854   | 
|                       | 
|Total                  |  |                    |  | $                   | 136,783 |  |                         | $ | (30,015 | )                 |  | $ | 106,768             |  |  | $                       | 136,783 |  |                   | $ | (21,863 | ) |  | $ | 114,920 | 
|                       | 
|Tower                  |  |                    |  | $                   | 128,283 |  |                         | $ | (28,369 | )                 |  | $ | 99,914              |  |  | $                       | 130,883 |  |                   | $ | (20,802 | ) |  | $ | 110,081 | 
|Reciprocal Exchanges   |  |                    |  |                     | 8,500   |  |                         |   | (1,646  | )                 |  |   | 6,854               |  |  |                         | 5,900   |  |                   |   | (1,061  | ) |  |   | 4,839   | 
|                       | 
|Total                  |  |                    |  | $                   | 136,783 |  |                         | $ | (30,015 | )                 |  | $ | 106,768             |  |  | $                       | 136,783 |  |                   | $ | (21,863 | ) |  | $ | 114,920 | 
|                       | 



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



The activity in the components of intangible assets for the years ended December 31, 2012 and 2011
consisted of intangible assets acquired from business combinations and amortization expense as shown in the table below:



|                           |  |                   |        |  |                     |   |        |                       |  |   |            |   |  |       |       |   |  |   |         |  
|-------------------------- |  | ----------------- | ------ |  | ------------------- | - | ------ | --------------------- |  | - | ---------- | - |  | ----- | ----- | - |  | - | ------- | -
|($ in thousands)           |  | InsuranceLicenses |        |  | ManagementContracts |   |        | CustomerRelationships |  |   | Trademarks |   |  | Total |      
|                           | 
|Balance, January 1, 2011   |  | $                 | 19,003 |  |                     | $ | 54,600 |                       |  | $ | 46,492     |   |  | $     | 3,725 |   |  | $ | 123,820 |  
|Additions                  |  |                   | -      |  |                     |   | -      |                       |  |   | -          |   |  |       | -     |   |  |   | -       |  
|Deductions (a)             |  |                   | -      |  |                     |   | -      |                       |  |   | (8,029     | ) |  |       | (871  | ) |  |   | (8,900  | )
|                           | 
|Balance, December 31, 2011 |  | $                 | 19,003 |  |                     | $ | 54,600 |                       |  | $ | 38,463     |   |  | $     | 2,854 |   |  | $ | 114,920 |  
|                           | 
|Tower                      |  | $                 | 18,603 |  |                     | $ | 54,600 |                       |  | $ | 35,594     |   |  | $     | 1,284 |   |  | $ | 110,081 |  
|Reciprocal Exchanges       |  |                   | 400    |  |                     |   | -      |                       |  |   | 2,869      |   |  |       | 1,570 |   |  |   | 4,839   |  
|                           | 
|Total, December 31, 2011   |  | $                 | 19,003 |  |                     | $ | 54,600 |                       |  | $ | 38,463     |   |  | $     | 2,854 |   |  | $ | 114,920 |  
|                           | 
|Additions                  |  |                   | -      |  |                     |   | -      |                       |  |   | -          |   |  |       | -     |   |  |   | -       |  
|Deductions (a)             |  |                   | -      |  |                     |   | -      |                       |  |   | (7,327     | ) |  |       | (825  | ) |  |   | (8,152  | )
|                           | 
|Balance, December 31, 2012 |  | $                 | 19,003 |  |                     | $ | 54,600 |                       |  | $ | 31,136     |   |  | $     | 2,029 |   |  | $ | 106,768 |  
|                           | 
|Tower                      |  | $                 | 16,003 |  |                     | $ | 54,600 |                       |  | $ | 28,600     |   |  | $     | 711   |   |  | $ | 99,914  |  
|Reciprocal Exchanges (b)   |  |                   | 3,000  |  |                     |   | -      |                       |  |   | 2,536      |   |  |       | 1,318 |   |  |   | 6,854   |  
|                           | 
|Total, December 31, 2012   |  | $                 | 19,003 |  |                     | $ | 54,600 |                       |  | $ | 31,136     |   |  | $     | 2,029 |   |  | $ | 106,768 |  
|                           | 

(a) Amortization

(b) In 2012, Tower transferred a licensed insurance subsidiary shell to the Reciprocal Exchanges, as discussed in Note 2-Accounting Policies and Basis of
Presentation. This resulted in classifying $2.6 million insurance licenses out of Tower and into the Reciprocal Exchange.

Intangible asset
impairment testing and amortization

The Company performs an analysis annually as of September 30 to identify potential impairment of
intangible assets with both definite and indefinite lives and measures the amount of any impairment loss that may need to be recognized. Intangible asset impairment testing requires an evaluation of the estimated fair value of each identified
intangible asset to its carrying value. An impairment charge could be recorded if the estimated fair value is less than the carrying amount of the intangible asset. No impairments have been identified in the years ended December 31, 2012, 2011
and 2010.

The Company recorded amortization expense related to intangible assets with definite lives of $8.2 million, $8.9 million and
$6.6 million in the years ended December 31, 2012, 2011 and 2010, respectively. The estimated amortization expense associated with these intangible assets for each of the next five years is:



|                 |  |       |       |  |                     |   |     |       |  |   |       | 
|---------------- |  | ----- | ----- |  | ------------------- | - | --- | ----- |  | - | ----- | 
|($ in thousands) |  | Tower |       |  | ReciprocalExchanges |   |     | Total | 
|                 | 
|2013             |  | $     | 6,791 |  |                     | $ | 517 |       |  | $ | 7,308 | 
|2014             |  |       | 2,804 |  |                     |   | 466 |       |  |   | 3,270 | 
|2015             |  |       | 2,253 |  |                     |   | 405 |       |  |   | 2,658 | 
|2016             |  |       | 1,932 |  |                     |   | 354 |       |  |   | 2,286 | 
|2017             |  |       | 1,716 |  |                     |   | 311 |       |  |   | 2,027 | 



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Note 9Deferred Acquisition Costs (DAC)

Acquisition costs incurred and policy-related ceding commission revenue are deferred and amortized to income on property and casualty
business for the year ended December 31, 2012, 2011 and 2010 as follows:



|                                                                          |  |                         |          |   |                     |   |         |       |  |   |          |   |  |                     |          |   |       |   |         |       |  |   |                     |   |  |       |          |   |  |   |         |   |  |   |          |  
|------------------------------------------------------------------------- |  | ----------------------- | -------- | - | ------------------- | - | ------- | ----- |  | - | -------- | - |  | ------------------- | -------- | - | ----- | - | ------- | ----- |  | - | ------------------- | - |  | ----- | -------- | - |  | - | ------- | - |  | - | -------- | -
|                                                                          |  | Year Ended December 31, |         
|                                                                          |  | 2012                    |          |   | 2011                |   |         | 2010  | 
|($ in thousands)                                                          |  | Tower                   |          |   | ReciprocalExchanges |   |         | Total |  |   | Tower    |   |  | ReciprocalExchanges |          |   | Total |   |         | Tower |  |   | ReciprocalExchanges |   |  | Total |         
|                                                                          | 
|Deferred acquisition costs, net, January 1                                |  | $                       | 156,992  |   |                     | $ | 11,866  |       |  | $ | 168,858  |   |  | $                   | 145,917  |   |       | $ | 18,206  |       |  | $ | 164,123             |   |  | $     | 126,307  |   |  | $ | -       |   |  | $ | 126,307  |  
|Acquisition date value of business acquired (VOBA) of acquired entities |  |                         | -        |   |                     |   | -       |       |  |   | -        |   |  |                     | -        |   |       |   | -       |       |  |   | -                   |   |  |       | 23,492   |   |  |   | 17,301  |   |  |   | 40,793   |  
|Cost incurred and deferred:                                               |  |                         |          |   |                     |   |         |       |  |   |          |   |  |                     |          |   |       |   |         |       |  |   |                     |   |  |       |          |   |  |   |         |   |  |   |          |  
|Commissions and brokerage                                                 |  |                         | 298,444  |   |                     |   | 31,266  |       |  |   | 329,710  |   |  |                     | 279,699  |   |       |   | 31,837  |       |  |   | 311,536             |   |  |       | 240,428  |   |  |   | 20,465  |   |  |   | 260,893  |  
|Other underwriting and acquisition costs                                  |  |                         | 68,238   |   |                     |   | 7,467   |       |  |   | 75,705   |   |  |                     | 64,416   |   |       |   | 5,896   |       |  |   | 70,312              |   |  |       | 87,715   |   |  |   | 13,500  |   |  |   | 101,215  |  
|Ceding commission revenue                                                 |  |                         | (25,052  | ) |                     |   | (15,878 | )     |  |   | (40,930  | ) |  |                     | (20,082  | ) |       |   | (11,446 | )     |  |   | (31,528             | ) |  |       | (32,526  | ) |  |   | (7,232  | ) |  |   | (39,758  | )
|                                                                          | 
|Net costs incurred and deferred                                           |  |                         | 341,630  |   |                     |   | 22,855  |       |  |   | 364,485  |   |  |                     | 324,033  |   |       |   | 26,287  |       |  |   | 350,320             |   |  |       | 295,617  |   |  |   | 26,733  |   |  |   | 322,350  |  
|Amortization                                                              |  |                         | (329,045 | ) |                     |   | (23,357 | )     |  |   | (352,402 | ) |  |                     | (312,958 | ) |       |   | (32,627 | )     |  |   | (345,585            | ) |  |       | (299,499 | ) |  |   | (25,828 | ) |  |   | (325,327 | )
|                                                                          | 
|Deferred acquisition costs, net, December 31,                             |  | $                       | 169,577  |   |                     | $ | 11,364  |       |  | $ | 180,941  |   |  | $                   | 156,992  |   |       | $ | 11,866  |       |  | $ | 168,858             |   |  | $     | 145,917  |   |  | $ | 18,206  |   |  | $ | 164,123  |  
|                                                                          | 

Note 10Reinsurance

The Company utilizes various excess of loss, quota share and catastrophe reinsurance programs to limit its exposure to a maximum loss
on any one risk.

Under the terms of the excess of loss programs in 2012, Tower was at risk of loss for $5.0 million on property, $3.5 million
on workers compensation and $2.5 million on umbrella. The Company then had reinsurance coverage up to $30 million for property, $60 million for workers compensation, and $5 million for umbrella. In addition, the Company
also had clash coverage in effect for 2012 for a limit of $5 million in excess of $5 million which applies to the aggregate liability for liability losses from multiple insureds involved in the same occurrence.

Towers 2012 quota share reinsurance cedes 35.5% of the homeowners business written by the companies obtained in the OBPL transaction. This coverage
has a $288 million per occurrence cap.

The Company also purchases property catastrophe reinsurance on an excess of loss basis above a
specified retention to protect itself from an accumulation of losses resulting from a catastrophic event. At the July 1, 2012 renewal of its property catastrophe program, the Company maintained a retention of $75 million per catastrophe, had
100% catastrophe protection for the next $75 million of loss above the $75 million, 70% catastrophe protection for the next $75 million of loss over $150 million and 100% catastrophe protection for the next $700 million of loss in excess of $225
million.

In 2012 Tower purchased an Original Insured Market Loss Warranty basis, whereby the Company can recover up to the limit of the
contract for its ultimate net loss arising from the windstorm peril in the Northeast in an event where the insured market loss exceeds a specified threshold.

In 2011, Tower was at risk of loss for the first $5.0 million on property, $2.5 million on workers compensation and $2.5 million on umbrella. The Company then had reinsurance coverage up to
$30 million for property, $50 million for workers compensation, and $5 million for umbrella. In addition, the Company also had clash coverage in effect for 2012 for a limit of $5 million in excess of
$5 million which applies to the aggregate liability for liability losses from multiple insureds involved in the same occurrence. The property catastrophe program renewed on July 1, 2011 had a retention of $75 million per catastrophe, had
60% catastrophe protection for the next $50 million of loss above the $75 million, and 100% percent catastrophe protection for the next $775 million of loss in excess of $125 million.

The Company maintains funds held liabilities under the liability quota share reinsurance agreements written in 2010 and prior years and is required to credit interest to the reinsurers with annual
effective yields ranging from 2.5% to 4.0% on the monthly balance in the funds held liability accounts. The amounts credited for 2012, 2011 and 2010 were $3.9 million, $3.6 million and $2.7 million, respectively, and have been recorded as
interest expense.

The Reciprocal Exchanges are not party to the reinsurance agreements discussed above, except for the homeowners quota share
treaty whereby they cede 35.5% of homeowners business written. The Reciprocal Exchanges were covered under this treaty in 2012, 2011 and 2010. The Reciprocal Exchanges are also protected under a property catastrophe reinsurance cover placed on an
excess of loss basis. In 2012, 2011 and 2010, this coverage was for 100% of $150 million in excess of a $10 million retention.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Impact of Reinsurance on Premiums

The table below shows direct, assumed and ceded premiums for the years ended December 31, 2012, 2011 and 2010:



|                            |  |        |           |   |         |   |         |       |  |   |         |   |  |   |           |  
|--------------------------- |  | ------ | --------- | - | ------- | - | ------- | ----- |  | - | ------- | - |  | - | --------- | -
|($ in thousands)            |  | Direct |           |   | Assumed |   |         | Ceded |  |   | Net     |  
|                            | 
|2012                        |  |        |           |   |         |   |         |       |  |   |         |   |  |   |           |  
|Premiums written            |  | $      | 1,755,157 |   |         | $ | 215,915 |       |  | $ | 231,691 |   |  | $ | 1,739,382 |  
|Change in unearned premiums |  |        | 3,647     |   |         |   | (31,370 | )     |  |   | (9,884  | ) |  |   | (17,840   | )
|                            | 
|Premiums earned             |  | $      | 1,758,804 |   |         | $ | 184,545 |       |  | $ | 221,807 |   |  | $ | 1,721,542 |  
|                            | 
|2011                        |  |        |           |   |         |   |         |       |  |   |         |   |  |   |           |  
|Premiums written            |  | $      | 1,692,282 |   |         | $ | 118,642 |       |  | $ | 172,333 |   |  | $ | 1,638,591 |  
|Change in unearned premiums |  |        | (8,262    | ) |         |   | (12,890 | )     |  |   | 23,589  |   |  |   | (44,741   | )
|                            | 
|Premiums earned             |  | $      | 1,684,020 |   |         | $ | 105,752 |       |  | $ | 195,922 |   |  | $ | 1,593,850 |  
|                            | 
|2010                        |  |        |           |   |         |   |         |       |  |   |         |   |  |   |           |  
|Premiums written            |  | $      | 1,432,177 |   |         | $ | 64,194  |       |  | $ | 182,307 |   |  | $ | 1,314,064 |  
|Change in unearned premiums |  |        | (2,927    | ) |         |   | 26,195  |       |  |   | 44,663  |   |  |   | (21,395   | )
|                            | 
|Premiums earned             |  | $      | 1,429,250 |   |         | $ | 90,389  |       |  | $ | 226,970 |   |  | $ | 1,292,669 |  
|                            | 

Reinsurance Balances

As of December 31, 2012 and 2011, the Company had $532.6 million and $314.0 million, respectively, of reinsurance recoverables with reinsurers rated A- or higher by A.M. Best. These represented 92.2%
and 91.0%, respectively, of the Companys total reinsurance recoverables as of those dates. As of December 31, 2012 and 2011, the largest reinsurance recoverable balance with any one reinsurer was approximately 8.3% and 9.1% of the
Companys stockholders equity.

The Company did not record any modifications of its reinsurance recoverables on paid or unpaid
losses in the years ended December 31, 2012, 2011 or 2010. The Company recorded no allowance for credit losses on its reinsurance recoverables on paid or unpaid losses as of December 31, 2012 or 2011. The Company did not consider that any
of its undisputed reinsurance recoverables on paid or unpaid losses as of years ended December 31, 2012 and 2011 to be past due. As discussed in Note 17  Contingencies, certain reinsurance agreements are subject to legal
proceedings.

Under certain reinsurance agreements, collateral and letters of credit (collateral) are held to secure performance
of reinsurers in meeting their obligations. The amount of such collateral was $189.6 million and $161.9 million at December 31, 2012 and 2011, respectively. The collateral we hold does not apply to our entire outstanding reinsurance
recoverable. Rather, collateral is provided on an individual basis. For each individual reinsurer, the collateral held may exceed or fall below the total outstanding recoverable from that individual reinsurer.

Ceding Commission Revenue

The
Company earns ceding commission revenue under certain quota share reinsurance agreements. In addition, the commission revenue earned on prior reinsurance agreements continue to be adjusted based on a sliding scale of commission rates and ultimate
treaty year loss ratios on the policies reinsured under each of these agreements. The sliding scale includes minimum and maximum commission rates in relation to specified ultimate loss ratios. The commission rate and ceding commissions earned
increase when the estimated ultimate loss ratio decreases, and conversely, the commission rate and ceding commissions earned decrease when the estimated ultimate loss ratio increases.

The estimated ultimate loss ratios are the Companys best estimate based on facts and circumstances known at the end of each period that losses are estimated. The estimation process is complex and
involves the use of informed estimates, judgments and actuarial methodologies relative to future claims severity and frequency, the length of time for losses to develop to their ultimate level, possible changes in law and other external factors. The
same uncertainties associated with estimating loss and loss adjustment expense reserves affect the estimates of ceding commissions earned. The Company monitors and adjusts the ultimate loss ratio on a quarterly basis to determine the effect on the
commission rate and ceding commissions earned. The decrease in estimated ceding commission income relating to prior years recorded in 2012, 2011 and 2010 was $4.5 million, $0.1 million and $2.2 million, respectively.



F-31



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Note 11Loss and Loss Adjustment Expense

The components of the liability for loss and LAE expenses and related reinsurance recoverables for the years ended December 31,
2012 and 2011 are as follows:



|                           |  |                |           |  |                        |   |         |                |  |   |                        |  |  |                |        |  |                        |   |           |  |  |   |         | 
|-------------------------- |  | -------------- | --------- |  | ---------------------- | - | ------- | -------------- |  | - | ---------------------- |  |  | -------------- | ------ |  | ---------------------- | - | --------- |  |  | - | ------- | 
|                           |  | Tower          |           |  | Reciprocal Exchanges   |   |         | Total          | 
|($ in thousands)           |  | GrossLiability |           |  | ReinsuranceRecoverable |   |         | GrossLiability |  |   | ReinsuranceRecoverable |  |  | GrossLiability |        |  | ReinsuranceRecoverable |  
|                           | 
|December 31, 2012          |  |                |           |  |                        |   |         |                |  |   |                        |  |  |                |        |  |                        |   |           |  |  |   |         | 
|Case-basis reserves        |  | $              | 913,411   |  |                        | $ | 79,911  |                |  | $ | 63,465                 |  |  | $              | 10,160 |  |                        | $ | 976,876   |  |  | $ | 90,071  | 
|IBNR reserves              |  |                | 845,871   |  |                        |   | 363,892 |                |  |   | 72,326                 |  |  |                | 42,229 |  |                        |   | 918,197   |  |  |   | 406,121 | 
|Recoverable on paid losses |  |                | -         |  |                        |   | 16,927  |                |  |   | -                      |  |  |                | 682    |  |                        |   | -         |  |  |   | 17,609  | 
|                           | 
|Total, December 31, 2012   |  | $              | 1,759,282 |  |                        | $ | 460,730 |                |  | $ | 135,791                |  |  | $              | 53,071 |  |                        | $ | 1,895,073 |  |  | $ | 513,801 | 
|                           | 
|December 31, 2011          |  |                |           |  |                        |   |         |                |  |   |                        |  |  |                |        |  |                        |   |           |  |  |   |         | 
|Case-basis reserves        |  | $              | 766,275   |  |                        | $ | 135,686 |                |  | $ | 82,203                 |  |  | $              | 7,916  |  |                        | $ | 848,478   |  |  | $ | 143,602 | 
|IBNR reserves              |  |                | 729,564   |  |                        |   | 172,725 |                |  |   | 54,071                 |  |  |                | 3,337  |  |                        |   | 783,635   |  |  |   | 176,062 | 
|Recoverable on paid losses |  |                | -         |  |                        |   | 18,233  |                |  |   | -                      |  |  |                | 5,670  |  |                        |   | -         |  |  |   | 23,903  | 
|                           | 
|Total, December 31, 2011   |  | $              | 1,495,839 |  |                        | $ | 326,644 |                |  | $ | 136,274                |  |  | $              | 16,923 |  |                        | $ | 1,632,113 |  |  | $ | 343,567 | 
|                           | 

The following tables provide a reconciliation of the beginning and ending consolidated balances for unpaid losses and LAE
for the years ended December 31, 2012, 2011 and 2010:



|                                                  |  |                         |           |   |                     |   |         |       |  |   |           |   |  |                     |           |   |       |   |         |   |  |   |           |  
|------------------------------------------------- |  | ----------------------- | --------- | - | ------------------- | - | ------- | ----- |  | - | --------- | - |  | ------------------- | --------- | - | ----- | - | ------- | - |  | - | --------- | -
|                                                  |  | Year Ended December 31, |          
|                                                  |  | 2012                    |           |   | 2011                |  
|($ in thousands)                                  |  | Tower                   |           |   | ReciprocalExchanges |   |         | Total |  |   | Tower     |   |  | ReciprocalExchanges |           |   | Total |  
|                                                  | 
|Balance at January 1,                             |  | $                       | 1,495,839 |   |                     | $ | 136,274 |       |  | $ | 1,632,113 |   |  | $                   | 1,439,106 |   |       | $ | 171,315 |   |  | $ | 1,610,421 |  
|Less reinsurance recoverables on unpaid losses    |  |                         | (308,411  | ) |                     |   | (11,253 | )     |  |   | (319,664  | ) |  |                     | (271,298  | ) |       |   | (11,384 | ) |  |   | (282,682  | )
|                                                  | 
|                                                  |  |                         | 1,187,428 |   |                     |   | 125,021 |       |  |   | 1,312,449 |   |  |                     | 1,167,808 |   |       |   | 159,931 |   |  |   | 1,327,739 |  
|Net reserves, at fair value, of acquired entities |  |                         | -         |   |                     |   | -       |       |  |   | -         |   |  |                     | -         |   |       |   | -       |   |  |   | -         |  
|Incurred related to:                              |  |                         |           |   |                     |   |         |       |  |   |           |   |  |                     |           |   |       |   |         |   |  |   |           |  
|Current year                                      |  |                         | 1,066,411 |   |                     |   | 118,099 |       |  |   | 1,184,510 |   |  |                     | 933,791   |   |       |   | 142,254 |   |  |   | 1,076,045 |  
|Prior years unfavorable/(favorable) development   |  |                         | 78,231    |   |                     |   | (8,881  | )     |  |   | 69,350    |   |  |                     | 17,039    |   |       |   | (37,835 | ) |  |   | (20,796   | )
|                                                  | 
|Total incurred                                    |  |                         | 1,144,642 |   |                     |   | 109,218 |       |  |   | 1,253,860 |   |  |                     | 950,830   |   |       |   | 104,419 |   |  |   | 1,055,249 |  
|Paid related to:                                  |  |                         |           |   |                     |   |         |       |  |   |           |   |  |                     |           |   |       |   |         |   |  |   |           |  
|Current year                                      |  |                         | 431,437   |   |                     |   | 98,682  |       |  |   | 530,119   |   |  |                     | 337,268   |   |       |   | 59,078  |   |  |   | 396,346   |  
|Prior years                                       |  |                         | 585,154   |   |                     |   | 52,155  |       |  |   | 637,309   |   |  |                     | 593,942   |   |       |   | 80,251  |   |  |   | 674,193   |  
|                                                  | 
|Total paid                                        |  |                         | 1,016,591 |   |                     |   | 150,837 |       |  |   | 1,167,428 |   |  |                     | 931,210   |   |       |   | 139,329 |   |  |   | 1,070,539 |  
|                                                  | 
|Net balance at end of period                      |  |                         | 1,315,479 |   |                     |   | 83,402  |       |  |   | 1,398,881 |   |  |                     | 1,187,428 |   |       |   | 125,021 |   |  |   | 1,312,449 |  
|Add reinsurance recoverables on unpaid losses     |  |                         | 443,803   |   |                     |   | 52,389  |       |  |   | 496,192   |   |  |                     | 308,411   |   |       |   | 11,253  |   |  |   | 319,664   |  
|                                                  | 
|Balance at December 31,                           |  | $                       | 1,759,282 |   |                     | $ | 135,791 |       |  | $ | 1,895,073 |   |  | $                   | 1,495,839 |   |       | $ | 136,274 |   |  | $ | 1,632,113 |  
|                                                  | 



|                                                  |  |       |           |   |                     |   |         |       |  |   |           |  
|------------------------------------------------- |  | ----- | --------- | - | ------------------- | - | ------- | ----- |  | - | --------- | -
|                                                  |  | 2010  |          
|($ in thousands)                                  |  | Tower |           |   | ReciprocalExchanges |   |         | Total | 
|                                                  | 
|Balance at January 1,                             |  | $     | 1,131,989 |   |                     | $ | -       |       |  | $ | 1,131,989 |  
|Less reinsurance recoverables on unpaid losses    |  |       | (199,687  | ) |                     |   | -       |       |  |   | (199,687  | )
|                                                  | 
|                                                  |  |       | 932,302   |   |                     |   | -       |       |  |   | 932,302   |  
|Net reserves, at fair value, of acquired entities |  |       | 193,484   |   |                     |   | 158,652 |       |  |   | 352,136   |  
|Incurred related to:                              |  |       |           |   |                     |   |         |       |  |   |           |  
|Current year                                      |  |       | 724,254   |   |                     |   | 72,059  |       |  |   | 796,313   |  
|Prior years unfavorable/(favorable) development   |  |       | (2,433    | ) |                     |   | (9,857  | )     |  |   | (12,290   | )
|                                                  | 
|Total incurred                                    |  |       | 721,821   |   |                     |   | 62,202  |       |  |   | 784,023   |  
|Paid related to:                                  |  |       |           |   |                     |   |         |       |  |   |           |  
|Current year                                      |  |       | 278,859   |   |                     |   | 46,276  |       |  |   | 325,135   |  
|Prior years                                       |  |       | 400,940   |   |                     |   | 14,647  |       |  |   | 415,587   |  
|                                                  | 
|Total paid                                        |  |       | 679,799   |   |                     |   | 60,923  |       |  |   | 740,722   |  
|                                                  | 
|Net balance at end of period                      |  |       | 1,167,808 |   |                     |   | 159,931 |       |  |   | 1,327,739 |  
|Add reinsurance recoverables on unpaid losses     |  |       | 271,298   |   |                     |   | 11,384  |       |  |   | 282,682   |  
|                                                  | 
|Balance at December 31,                           |  | $     | 1,439,106 |   |                     | $ | 171,315 |       |  | $ | 1,610,421 |  
|                                                  | 



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Incurred losses and LAE for the year ended December 31, 2012 attributable to insured events of
prior years increased by $69.3 million. Excluding the Reciprocal Exchanges the incurred losses and LAE increased by $78.2 million.

The
consolidated net loss ratio, which includes the Reciprocal Exchanges, was 72.8% and 66.2% for the years ended December 31, 2012 and 2011, respectively. Excluding the Reciprocal Exchanges, the net loss ratio was 73.5% and 67.6% for the years
ended December 31, 2012 and 2011, respectively. The Reciprocal Exchanges net loss ratio was 66.7% and 55.8% for the years ended December 31, 2012 and 2011, respectively.

Excluding the Reciprocal Exchanges, the 2012 net loss and loss adjustment expenses included $101.0 million from claims related to Superstorm Sandy.

Excluding the Reciprocal Exchanges, there was net adverse loss development of $78.2 million for the year ended December 31, 2012 comprised of
adverse development in Personal Insurance of $4.0 million and adverse development in Commercial Insurance of $74.2 million.

The net adverse
development in Commercial Insurance included $52.1 million in workers compensation, $20.8 million in commercial automobile liability and $1.3 million in other lines. The net adverse development in Personal Insurance was comprised mainly of $4.6
million for homeowners, $1.2 million for other liability, and $5.4 million for other lines, partially offset by $7.2 million for amortization of reserves risk premium, principally relating to reserves acquired in the OBPL transaction.

For the Reciprocal Exchanges, the favorable development was $8.9 million, comprised of favorable development of $3.1 million for homeowners, $1.6 million
for private passenger automobile liability, $1.7 million for other lines, and $2.5 million for amortization of reserves risk premium.

Prior
year development is based upon numerous estimates by line of business and accident year. No additional premiums or return premiums have been accrued as a result of the prior year effects, although we recorded changes in ceding commissions on
reinsurance treaties for which the ceding commissions depend in part on loss experience. The Companys management continually monitors claims activity to assess the appropriateness of carried case and incurred but not reported
(IBNR) reserves, giving consideration to Company and industry trends.

Incurred losses and LAE for the years ended
December 31, 2012 and 2011 included reductions in loss and loss expense reserves pertaining to the amortization of the reserve risk premium on loss reserves recorded in connection with the Companys acquisitions in prior years. Excluding
the Reciprocal Exchanges these reductions in loss reserves were $7.2 million and $3.7 million, respectively, for 2012 and 2011. The Reciprocal Exchanges had reductions in loss reserves of $2.5 million and $1.2 million, respectively, for
2012 and 2011.

Loss and loss adjustment expense reserves.The reserving process for loss and LAE reserves provides
managements best estimate at a particular point in time of the ultimate unpaid cost of all losses and LAE incurred, including settlement and administration of losses, and is based on facts and circumstances then known and including losses that
have been incurred but not yet reported. The process includes using actuarial methodologies to assist in establishing these estimates, judgments relative to estimates of future claims severity and frequency, the length of time before losses will
develop to their ultimate level and the possible changes in the law and other external factors that are often beyond our control. There are various actuarial methods that are appropriate for the different lines of business, and our actuaries
use of a particular method or weighting of methods depends in part on the maturity of each accident year by line of business, the limits of liability covered under the policies, the presence or absence of large claims in the experience, and other
considerations. In general, the various actuarial methods can be grouped into three categories: loss ratio projection, loss development methods, and the Bornhuetter-Ferguson (B-F) method. For the most recent accident year, and especially
for liability lines of business, the actuarial method given the most weight is usually the loss ratio method, since the percentage of ultimate claims reported to date is expected to be low and the immature reported claims experience is not a
reliable indicator of ultimate losses for that accident year. For property lines of business for the most recent accident year, the B-F method is usually given the most weight, because experience typically shows that there is a small percentage of
claims reported in the subsequent period due to normal lags in reporting and processing of claims in these lines of business that can be relatively reliably estimated as a percentage of premiums, which is reflected in the B-F method. For each line



F-33



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



of business, the actuarial reserving method usually given the most weight shifts from the loss ratio projection to the B-F method to the incurred loss projection as each accident year matures.
These methods are described in BusinessLoss and Loss Adjustment Expense Reserves.

This process helps management set carried
loss reserves based upon the actuaries best estimates, using estimates made by segment, product or line of business, territory, and accident year. The actuaries also separately estimate loss reserves from LAE reserves and within LAE reserves
estimates are made for defense and cost containment expenses or Allocated Loss Adjustment Expenses (ALAE) and for other claims adjusting expenses or Unallocated Loss Adjustment Expenses (ULAE). The amount of loss and LAE
reserves for reported claims is based primarily upon a case-by-case evaluation of coverage, liability, injury severity, and any other information considered pertinent to estimating the exposure presented by the claim. The amounts of loss and LAE
reserves for unreported claims are determined using historical information by line of business as adjusted to current conditions. Due to the inherent uncertainty associated with the reserving process, the ultimate liability may differ, perhaps
substantially, from the original estimate. Such estimates are regularly reviewed and updated, and any resulting adjustments are included in the current years results. Reserves are closely monitored and are recomputed periodically using the
most recent information on reported claims and a variety of statistical techniques. Specifically, on at least a quarterly basis, we review, by line of business, existing reserves, new claims, changes to existing case reserves and paid losses with
respect to the current and prior years. See BusinessLoss and Loss Adjustment Expense Reserves for additional information regarding our loss and LAE reserves.

We segregate our data for estimating loss reserves. The property lines include Fire and Allied Lines, Homeowners-property, Commercial Multi-peril Property, Multi-Family Dwellings, Inland Marine and
Automobile Physical Damage. The casualty lines include Homeowners-liability, Commercial Multi-peril Liability, Other Liability, Workers Compensation, Commercial Automobile Liability, and Personal Automobile Liability. Commercial Insurance
segment reserves are estimated separately from Personal Insurance segment reserves. For the Commercial Insurance segment we analyze reserves by line of business and, where appropriate, we further segregate the data for analysis purposes between
small, middle and large policies sizes and by state or region. We also analyze various producers business separately where the volume of business from those producers is considered significant and the characteristics of the business from those
particular producers are perceived to be different. Within the Personal Insurance segment, we estimate loss and loss expenses reserves separately for the Reciprocal Exchanges, which we manage, and for our owned companies. We utilize line of business
breakdowns and, where appropriate, analyze results separately by state.

Two key assumptions that materially impact the estimate of loss
reserves are the loss ratio estimate for the current accident year and the loss development factor selections for all accident years. The loss ratio estimate for the current accident year is selected after reviewing historical accident year loss
ratios adjusted for rate and price changes, trend, mix of business, and other factors. In addition, as the year matures and, depending upon the line of business, we utilize B-F methods or loss development methods for the current accident year.

In most cases, our data are sufficiently credible to determine loss development factors utilizing our own data. In some cases, we supplement
our own loss development experience with industry data and utilize historical loss development experience for particular books of business, programs or treaties obtained from our sources. The loss development factors are reviewed at least annually,
and whenever there is a significant change in the underlying business. Each quarter we test the loss development by analyzing actual emerging claims compared to expected development.

Because of the nature of the business historically written, the Companys management believes that the Company has limited exposure to environmental claim liabilities.

We estimate ALAE reserves separately for claims that are defended by in-house attorneys, claims that are handled by other attorneys that are not
employees, and miscellaneous ALAE costs such as investigators, witness fees and court costs.

For claims that are defended by in-house
attorneys, we estimate the defense cost per claim, and we attribute to each of these claims a fixed fee for defense work. We allocate to each of these litigated claims 50% of the fixed fee when litigation on a particular claim begins and 50% of the
fee when the litigation is closed. The fee is determined actuarially based upon the projected number of litigated claims and expected closing patterns at the beginning of each year as well as the projected budget for our in-house attorneys, and
these amounts are calibrated to reimburse our in-house legal department for all of their costs.

ULAE for claims that are handled in-house by
our claims adjusters utilize a similar process to that described above for ALAE. We determine fixed fees per claim by line of business, and assign these costs to line of business and accident year. For property lines, 50% of the fixed fee is
attributed to claims when a claim is opened and 50% is attributed to claims when they are closed. For casualty lines, 75% of the fixed fee is attributed to the claim when a claim is opened and 25% is attributed to the claims when the claim is
closed. The IBNR portion of ULAE for these claims is based upon 50% of the fixed fee per claims for in-house ULAE multiplied by the number of claims open and by 100% of the fixed fee multiplied by the estimated number of claims to be reported for
prior accident dates.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



For some types of claims and for some programs where we utilize third-party administrators
(TPA) to adjust claims, we pay them fees which are included in ULAE. In some cases, we arrange for fixed percentages of premiums earned to be the fee for claims administration, and in other cases we arrange for fixed fees per claim or
hourly charges for ULAE services. The reserves for ULAE for these situations is estimated based upon the particular arrangement for these types of claims by product or program.

Note 12Stockholders Equity

Shares of Common Stock Issued

For the years ended December 31, 2012 and 2011, 0 and 34,612 new common shares, respectively, were issued as the result of employee stock option exercises and 372,618 and 654,180 new common shares,
for the same periods, respectively, were issued as the result of restricted stock grants.

For the years ended December 31, 2012 and
2011, 103,599 and 78,732 shares, respectively, of common stock were purchased from employees in connection with the vesting of restricted stock issued under the 2004 Long Term Equity Compensation Plan (the Plan). The shares were
withheld at the direction of employees as permitted under the Plan in order to pay the expected amount of tax liability owed by the employees from the vesting of those shares. In addition, for the years ended December 31, 2012 and 2011, 25,166
and 18,841 shares, respectively, of common stock were surrendered as a result of restricted stock forfeitures.

Share Repurchase
Program

The Board of Directors of Tower approved a $100 million share repurchase program on March 3, 2011. This authorization is in
addition to the $100 million share repurchase program approved on February 26, 2010. Purchases under both programs can be made from time to time in the open market or in privately negotiated transactions in accordance with applicable laws and
regulations. The new share repurchase program will expire on March 4, 2013. In the year ended December 31, 2012, 1.1 million shares of common stock were purchased under these programs at an aggregate consideration of $21.0 million. In
the year ended December 31, 2011, 2.9 million shares were purchased under these programs at an aggregate consideration of $64.6 million. As of December 31, 2012, the original $100 million share purchase program had been fully utilized
and $26.4 million remained available for future share repurchases under the new program.

Dividends Declared

Dividends on common stock of $29.1 million, $27.9 million and $16.6 million for the years ended December 31, 2012, 2011 and 2010,
respectively, were declared and paid.

On January 30, 2013, the Board of Directors approved a quarterly dividend of $0.1875 per share
payable on February 28, 2013 to stockholders of record as of February 14, 2013.

Note 13Debt

The Companys borrowings consisted of the following at December 31, 2012 and 2011:



|                         |  |                   |         |  |                   |   |         |                |  |   |            |  |  |   |         | 
|------------------------ |  | ----------------- | ------- |  | ----------------- | - | ------- | -------------- |  | - | ---------- |  |  | - | ------- | 
|                         |  | December 31, 2012 |         |  | December 31, 2011 |  
|($ in thousands)         |  | Carrying Value    |         |  | Fair Value        |   |         | Carrying Value |  |   | Fair Value | 
|                         | 
|Credit facility          |  | $                 | 70,000  |  |                   | $ | 70,000  |                |  | $ | 50,000     |  |  | $ | 50,000  | 
|Convertible senior notes |  |                   | 144,673 |  |                   |   | 152,063 |                |  |   | 141,843    |  |  |   | 150,743 | 
|Subordinated debentures  |  |                   | 235,058 |  |                   |   | 232,678 |                |  |   | 235,058    |  |  |   | 234,550 | 
|                         | 
|Total                    |  | $                 | 449,731 |  |                   | $ | 454,741 |                |  | $ | 426,901    |  |  | $ | 435,293 | 
|                         | 

The fair value of the convertible senior notes are determined utilizing recent transaction prices for these securities
between third-party market participants and the fair value of the subordinated debentures are based on discounted cash flow analysis. The significant inputs used for fair value are considered Level 2 in the fair value hierarchy.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Aggregate Scheduled Maturities and Interest Expense

Aggregate scheduled maturities of the Companys borrowings at December 31, 2012 are:



|                 |  |   |         |    
|---------------- |  | - | ------- | ---
|($ in thousands) |  |   |        
|                 | 
|2013             |  | $ | 70,000  |    
|2014             |  |   | 150,000 | (a)
|2033             |  |   | 20,620  |    
|2034             |  |   | 25,775  |    
|2035             |  |   | 13,403  |    
|2036             |  |   | 123,713 |    
|2037             |  |   | 51,547  |    
|                 | 
|                 |  | $ | 455,058 |    
|                 | 

(a) Amount reflected in balance sheet for convertible senior notes is net of unamortized original issue discount of $5.3
million

Total interest expense incurred, including interest expense on the funds held liabilities disclosed in Note 10 
Reinsurance, was $32.6 million, $34.3 million and $24.2 million for the years ended December 31, 2012, 2011 and 2010, respectively.

Subordinated Debentures

The Company and its wholly-owned subsidiaries have issued trust
preferred securities through wholly-owned Delaware statutory business trusts. The trusts use the proceeds of the sale of the trust preferred securities and common securities that the Company acquired from the trusts to purchase junior subordinated
debentures from the Company with terms that match the terms of the trust preferred securities. Interest on the junior subordinated debentures and the trust preferred securities is payable quarterly. In some cases, the interest rate is fixed for an
initial period of five years after issuance and then floats with changes in the London Interbank Offered Rate (LIBOR) and in other cases the interest rate floats with LIBOR without any initial fixed-rate period. The principal terms,
before any effects of interest rate swaps, of the outstanding trust preferred securities, including those which were assumed by the Company through acquisitions, are summarized in the following table:



|                           |  |                                           |  |                |  |                                                     |  |                                                                                    |  |                                                |     |  |                                                             |   |       | 
|-------------------------- |  | ----------------------------------------- |  | -------------- |  | --------------------------------------------------- |  | ---------------------------------------------------------------------------------- |  | ---------------------------------------------- | --- |  | ----------------------------------------------------------- | - | ----- | 
|($ in millions)
Issue Date |  | Issuer                                    |  | Maturity Date  |  | Early Redemption                                    |  | Interest Rate                                                                      |  | Amount ofInvestmentin CommonSecuritiesof Trust |     |  | PrincipalAmount ofJuniorSubordinatedDebentureIssued toTrust |  
|                           | 
|May 2003                   |  | Tower Group Statutory Trust I             |  | May 2033       |  | At our option at par on or after May 15, 2008       |  | Three-month LIBOR plus 410 basis points                                            |  | $                                              | 0.3 |  |                                                             | $ | 10.3  | 
|                           | 
|September 2003             |  | Tower Group Statutory Trust II            |  | September 2033 |  | At our option at par on or after September 30, 2008 |  | Three-month LIBOR plus 400 basis points                                            |  | $                                              | 0.3 |  |                                                             | $ | 10.3  | 
|                           | 
|May 2004                   |  | Preserver Capital Trust I                 |  | May 2034       |  | At our option at par on or after May 24, 2009       |  | Three-month LIBOR plus 425 basis points                                            |  | $                                              | 0.4 |  |                                                             | $ | 12.4  | 
|                           | 
|December 2004              |  | Tower Group Statutory Trust III           |  | December 2034  |  | At our option at par on or after December 15, 2009  |  | Three-month LIBOR plus 340 basis points                                            |  | $                                              | 0.4 |  |                                                             | $ | 13.4  | 
|                           | 
|December 2004              |  | Tower Group Statutory Trust IV            |  | March 2035     |  | At our option at par on or after March 15, 2010     |  | Three-month LIBOR plus 340 basis points                                            |  | $                                              | 0.4 |  |                                                             | $ | 13.4  | 
|                           | 
|March 2006                 |  | Tower Group Statutory Trust V             |  | April 2036     |  | At our option at par on or after April 7, 2011      |  | Three-month LIBOR plus 330 basis points                                            |  | $                                              | 0.6 |  |                                                             | $ | 20.6  | 
|                           | 
|January 2007               |  | Tower Group Statutory Trust VI            |  | March 2037     |  | At our option at par on or after March 15, 2012     |  | 8.16% until March 14, 2012; three-month LIBOR plus 300 basis points thereafter     |  | $                                              | 0.6 |  |                                                             | $ | 20.6  | 
|                           | 
|September 2007             |  | CastlePoint Bermuda Capital Trust I       |  | December 2037  |  | At our option at par on or after December 15, 2012  |  | 8.39% until December 14, 2012; three-month LIBOR plus 350 basis points thereafter. |  | $                                              | 0.9 |  |                                                             | $ | 30.9  | 
|                           | 
|December 2006              |  | CastlePoint Management Statutory Trust II |  | December 2036  |  | At our option at par on or after December 15, 2011  |  | Three-month LIBOR plus 350 basis points                                            |  | $                                              | 1.6 |  |                                                             | $ | 51.6  | 
|                           | 
|December 2006              |  | CastlePoint Management Statutory Trust I  |  | December 2036  |  | At our option at par on or after December 15, 2011  |  | Three-month LIBOR plus 350 basis points                                            |  | $                                              | 1.6 |  |                                                             | $ | 51.6  | 
|                           | 
|Total                      |  |                                           |  |                |  |                                                     |  |                                                                                    |  | $                                              | 7.1 |  |                                                             | $ | 235.1 | 
|                           | 



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Interest Rate Swaps

In October 2010, the Company entered into interest rate swap contracts (the Swaps) with $190 million notional value to manage interest costs and cash flows associated with the floating rate
subordinated debentures. The Swaps have terms of five years. The majority of the Swaps is forward starting and become effective when the respective subordinated debentures change from fixed to floating rates and convert the subordinated debentures
to fixed rates ranging from 5.1% to 5.9%. As of December 31, 2012 and 2011, the Swaps had a fair value of $9.0 million and $7.4 million, respectively, in a liability position and are reported in Other Liabilities.

The Company has designated and accounts for the Swaps as cash flow hedges. The Swaps are considered to have no ineffectiveness and changes in their fair
values will be recorded in Accumulated Other Comprehensive Income (AOCI), net of tax. For the years ended December 31, 2012, 2011 and 2010, $1.6 million, $0.4 million and $18,000, respectively, was reclassified from AOCI to interest
expense for the effects of the hedges. As of December 31, 2012 and 2011, the Company had collateral on deposit with the counterparty amounting to $9.1 million and $7.0 million, respectively, pursuant to its Credit Support Annex.

Credit Facility

On February 15,
2012, the Company amended its $125.0 million credit facility by increasing borrowing capacity up to $150 million, extending the maturity date to February 15, 2016, and resetting borrowing fees to more favorable current market terms. The credit
facility is used for general corporate purposes. The original credit facility was entered into on May 14, 2010 and had an expiration date of May 14, 2013.

On November 26, 2012, the Company further amended its credit facility whereby the lenders provided consent to the proposed merger of the Company with a subsidiary of Canopius Holdings Bermuda Limited
that the Company expects to consummate (see Note 3-Investment in Canopius Group Limited and Exercise of Merger Option). The second amendment also increases the Companys maximum revolving commitment by $70 million to $220 million
upon the effectiveness of the Merger and the satisfaction of certain other conditions set forth in the Second Amendment.

The credit facility
contains customary covenants for facilities of this type, including restrictions on indebtedness and liens, limitations on mergers, dividends and the sale of assets, and requirements to maintain certain consolidated net worth, debt to capitalization
ratios, minimum risk-based capital and minimum statutory surplus. The credit facility also provides for customary events of default, including failure to pay principal when due, failure to pay interest or fees within three days after becoming due,
failure to comply with covenants, any representation or warranty made by the Company being false in any material respect, default under certain other indebtedness, certain insolvency or receivership events affecting the Company and its material
subsidiaries, the occurrence of certain material judgments, or a change in control of the Company, and upon an event of default the administrative agent (subject to the consent of the requisite percentage of the lenders) may immediately terminate
the obligations to make loans and to issue letters of credit, declare the Companys obligations under the credit facility to become immediately due and payable, and require the Company to deposit in a collateral account cash collateral with a
value equal to the then outstanding amount of the aggregate face amount of any outstanding letters of credit. The Company was in compliance with or has obtained waivers for all covenants under the credit facility at December 31, 2012.

Fees payable by the Company under the credit facility include a fee on the daily unused portion of each letter of credit, a letter of credit
fronting fee with respect to each fronted letter of credit and a commitment fee.

The Company had $70.0 million and $50.0 million outstanding
as of December 31, 2012 and 2011, respectively. The weighted average interest rate on the amount outstanding as of December 31, 2012 and 2011 was 2.0% and 3.5%, respectively.

Convertible Senior Notes

In September 2010, the Company issued $150.0 million principal
amount of 5.0% convertible senior notes (the Notes), which mature on September 15, 2014. Interest on the Notes is payable semi-annually in arrears on March 15 and September 15 of each year, commencing March 15, 2011.
Holders may convert their Notes into cash or common shares, at the Companys option, at any time on or after March 15, 2014 or earlier under certain circumstances determined by: (i) the market price of the Companys stock,
(ii) the trading price of the Notes, or (iii) the occurrence of specified corporate transactions. Upon conversion, the Company intends to settle its obligation either entirely or partially in cash.

The adjusted conversion rate at December 31, 2012 is 37.1689 shares of common stock per $1,000 principal amount of the Notes (equivalent to a
conversion price of $26.90 per share), subject to further adjustment upon the occurrence of certain events,



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



including the following: if Tower issues shares of common stock as a dividend or distribution on shares of the common stock , or if Tower effects a share split or share combination; if Tower
issues to all or substantially all holders of common stock any rights, options or warrants entitling them, for a period of not more than 45 calendar days after the announcement date of such issuance, to subscribe for or purchase shares of the common
stock at a price per share that is less than the average of the last reported sales price of the common stock for the ten consecutive trading day period ending on the date of announcement of such issuance; if Tower distributes shares of its capital
stock, other indebtedness, other assets or property of Tower or rights, options or warrants to acquire capital stock or other securities of Tower, to all or substantially all holders of capital stock; if any cash dividend or distribution is made to
all or substantially all holders of the common stock, other than a regular quarterly cash dividend that does not exceed $0.125 per share; if Tower makes a payment in respect of a tender offer or exchange offer for common stock, and the cash and
value of any other consideration included in the payment per share of common stock exceeds the last reported sale price of the common stock on the trading day next succeeding the last day on which the tenders or exchange may be made. In February
2013, the conversion rate was adjusted to 37.2895, equivalent to a conversion price of $26.82 per share.

Additionally, in the event of a
fundamental change, the holders may require the Company to repurchase the Notes for a cash price equal to 100% of the principal plus any accrued and unpaid interest.

The proceeds from the issuance of the Notes were allocated to the liability component and the embedded conversion option, or equity component. The equity component was reported as an adjustment to
paid-in-capital, net of tax, and is reflected as an original issue discount (OID). The OID of $11.5 million and $5.0 million of deferred origination costs relating to the liability component are being amortized into interest expense over
the term of the Notes. After considering the contractual interest payments and amortization of the original issue discount, the Notes effective interest rate is 7.2%. Transaction costs of $0.4 million associated with the equity component were
netted with the equity component in paid-in-capital. Interest expense, including amortization of deferred origination costs, recognized on the Notes was $11.6 million for the year ended December 31, 2012.

The following table shows the amounts recorded for the Notes as of December 31, 2012 and 2011:



|                             |  |              |         |  |      |   |         | 
|---------------------------- |  | ------------ | ------- |  | ---- | - | ------- | 
|                             |  | December 31, |        
|($ in thousands)             |  | 2012         |         |  | 2011 |  
|                             | 
|Liability component          |  |              |         |  |      |   |         | 
|Outstanding principal        |  | $            | 150,000 |  |      | $ | 150,000 | 
|Unamortized OID              |  |              | (5,327) |  |      |   | (8,157) | 
|                             | 
|Liability component          |  |              | 144,673 |  |      |   | 141,843 | 
|                             | 
|Equity component, net of tax |  | $            | 7,469   |  |      | $ | 7,469   | 
|                             | 

To the extent the market value per share of the Companys common stock exceeds the conversion price, the Company
will use the treasury stock method in calculating the dilutive effect on earnings per share.

Convertible Senior Notes Hedge
and Warrant Transactions

In connection with the offering of the Notes, the Company also entered into convertible senior notes hedge
transactions (the Note Hedges or purchased call options) and warrant transactions (the Warrants) with respect to its common stock with financial institutions. The Note Hedges and Warrants are intended generally to
reduce the potential dilution of the Companys common stock and to offset potential cash payments in excess of the principal of the Notes upon conversion. The Note Hedges and Warrants are separate transactions, entered into by the Company with
the financial institutions, and are not part of the terms of the Notes.

In September 2010, the Company paid $15.3 million for the Note Hedges
which cover 5.5 million shares of common stock at a strike price of $26.90 per share at December 31, 2012, subject to anti-dilution provisions, and are exercisable upon conversion of the Notes. The Note Hedges have been accounted for as an
adjustment to the Companys paid-in-capital, net of deferred taxes.

In September 2010, the Company received $3.8 million for Warrants
sold to the financial institutions. The Warrants provide for the acquisition of 5.5 million shares of common stock at a strike price of $32.71 per share at December 31, 2012, subject to anti-dilution adjustments. The Warrants have been
accounted for as an adjustment to the Companys paid-in-capital.

To the extent the Companys common stock price is above $26.90 but
below the Warrant strike price of $32.71, there is no dilutive effect to common stockholders equity because the Note Hedge offsets any shares to be issued under the Notes. If the market value per share of the Companys common stock
exceeds the strike price of the Warrants, the Warrants will have a dilutive effect on the Companys net income per share.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Note 14Stock Based Compensation

2008 Long-Term Equity Compensation Plan (2008 LTEP)

In 2008, the Companys Board of Directors adopted and its stockholders approved the 2008 LTEP, which amended and revised the 2004 Long-Term Equity Compensation Plan.

The 2008 LTEP provides for the granting of non-qualified stock options, incentive stock options (within the meaning of Section 422 of the Code),
stock appreciation rights (SARs), restricted stock and restricted stock unit awards, performance shares and other cash or share-based awards. The maximum amount of share-based awards authorized is 2,325,446 of which 230,943 are available
for future grants as of December 31, 2012.

2013 Long-Term Incentive Plan (2013 LTIP)

The Compensation Committee of the Board of Directors has established, beginning in 2013 and subject to stockholder approval, a new Long Term Incentive
Plan (the 2013 LTIP), to replace the Companys existing 2008 Long Term Equity Compensation Plan.

Shares and Options
Granted

The following table provides information with respect to the stock options and shares of the Companys common stock issued
(i) to the Companys employees under the 2004 LTEP and (ii) to employees and directors of companies acquired by the Company in exchange for the options and shares owned by such employees and directors in such companies at the time of
acquisition.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



|                                                                                         |  |                         |         |  |      |  |         |      |  |  |         | 
|---------------------------------------------------------------------------------------- |  | ----------------------- | ------- |  | ---- |  | ------- | ---- |  |  | ------- | 
|                                                                                         |  | Year Ended December 31, |        
|                                                                                         |  | 2012                    |         |  | 2011 |  |         | 2010 | 
|                                                                                         | 
|Granted under the Plan (excludes shares and options issued with respect to acquisitions) |  |                         |         |  |      |  |         |      |  |  |         | 
|Restricted stock                                                                         |  |                         | 372,618 |  |      |  | 654,180 |      |  |  | 355,539 | 
|Stock options, at fair value                                                             |  |                         | -       |  |      |  | -       |      |  |  | -       | 
|                                                                                         | 
|                                                                                         |  |                         | 372,618 |  |      |  | 654,180 |      |  |  | 355,539 | 
|Issued restricted stock and stock options from acquisitions                              |  |                         | -       |  |      |  | -       |      |  |  | -       | 
|                                                                                         | 
|Total                                                                                    |  |                         | 372,618 |  |      |  | 654,180 |      |  |  | 355,539 | 
|                                                                                         | 

Restricted Stock

The following table provides an analysis of restricted stock activity for the years ended December 31, 2012, 2011 and 2010:



|                          |  |                         |           |  |            |   |       |           |  |  |            |  |  |           |       |  |            |  |           |  |  |   |       | 
|------------------------- |  | ----------------------- | --------- |  | ---------- | - | ----- | --------- |  |  | ---------- |  |  | --------- | ----- |  | ---------- |  | --------- |  |  | - | ----- | 
|                          |  | Year Ended December 31, |          
|                          |  | 2012                    |           |  | 2011       |   |       | 2010      | 
|                          | 
|                          |  |                         |           |  | Weighted   |   |       |           |  |  | Weighted   |  |  |           |       |  | Weighted   | 
|                          |  |                         |           |  | Average    |   |       |           |  |  | Average    |  |  |           |       |  | Average    | 
|                          |  | Number of               |           |  | Grant Date |   |       | Number of |  |  | Grant Date |  |  | Number of |       |  | Grant Date | 
|                          |  | Shares                  |           |  | Fair Value |   |       | Shares    |  |  | Fair Value |  |  | Shares    |       |  | Fair Value | 
|                          | 
|Outstanding, January 1    |  |                         | 988,607   |  |            | $ | 23.44 |           |  |  | 591,675    |  |  | $         | 23.10 |  |            |  | 474,023   |  |  | $ | 24.64 | 
|Granted                   |  |                         | 372,618   |  |            |   | 22.40 |           |  |  | 654,180    |  |  |           | 23.80 |  |            |  | 355,539   |  |  |   | 21.84 | 
|Vested                    |  |                         | (439,410) |  |            |   | 23.72 |           |  |  | (238,407)  |  |  |           | 23.55 |  |            |  | (209,054) |  |  |   | 24.44 | 
|Forfeitures               |  |                         | (25,166)  |  |            |   | 23.44 |           |  |  | (18,841)   |  |  |           | 23.61 |  |            |  | (28,833)  |  |  |   | 23.20 | 
|                          | 
|Outstanding, December 31, |  |                         | 896,649   |  |            | $ | 23.09 |           |  |  | 988,607    |  |  | $         | 23.44 |  |            |  | 591,675   |  |  | $ | 23.10 | 
|                          | 

Stock Options

The following table provides an analysis of stock option activity for the years ended December 31, 2012, 2011 and 2010:



|                            |  |                         |         |  |          |   |       |           |  |  |          |  |  |           |       |  |          |  |           |  |  |   |       | 
|--------------------------- |  | ----------------------- | ------- |  | -------- | - | ----- | --------- |  |  | -------- |  |  | --------- | ----- |  | -------- |  | --------- |  |  | - | ----- | 
|                            |  | Year Ended December 31, |        
|                            |  | 2012                    |         |  | 2011     |   |       | 2010      | 
|                            | 
|                            |  |                         |         |  | Average  |   |       |           |  |  | Average  |  |  |           |       |  | Average  | 
|                            |  | Number of               |         |  | Exercise |   |       | Number of |  |  | Exercise |  |  | Number of |       |  | Exercise | 
|                            |  | Shares                  |         |  | Price    |   |       | Shares    |  |  | Price    |  |  | Shares    |       |  | Price    | 
|                            | 
|Outstanding, January 1      |  |                         | 855,530 |  |          | $ | 20.14 |           |  |  | 917,155  |  |  | $         | 20.01 |  |          |  | 1,387,019 |  |  | $ | 19.62 | 
|Exercised                   |  |                         | -       |  |          |   | -     |           |  |  | (34,612) |  |  |           | 10.74 |  |          |  | (242,169) |  |  |   | 6.64  | 
|Forfeitures and expirations |  |                         | -       |  |          |   | -     |           |  |  | (27,013) |  |  |           | 27.59 |  |          |  | (227,695) |  |  |   | 31.88 | 
|                            | 
|Outstanding, December 31    |  |                         | 855,530 |  |          | $ | 20.14 |           |  |  | 855,530  |  |  | $         | 20.14 |  |          |  | 917,155   |  |  | $ | 20.01 | 
|                            | 
|Exercisable, December 31    |  |                         | 855,530 |  |          | $ | 20.14 |           |  |  | 855,530  |  |  | $         | 20.14 |  |          |  | 861,941   |  |  | $ | 20.09 | 
|                            | 

All options outstanding as of December 31, 2012 are fully exercisable as shown on the following table:



|                         |  |                     |         |  |                     |  |     |          |  |   |           |  |  |          |         |  |  |   |       | 
|------------------------ |  | ------------------- | ------- |  | ------------------- |  | --- | -------- |  | - | --------- |  |  | -------- | ------- |  |  | - | ----- | 
|                         |  | Options Outstanding |         |  | Options Exercisable | 
|                         |  |                     |         |  | Average             |  |     |          |  |   |           |  |  |          |        
|                         |  |                     |         |  | Remaining           |  |     | Average  |  |   |           |  |  | Average  |        
|                         |  | Number of           |         |  | Contractual         |  |     | Exercise |  |   | Number of |  |  | Exercise |        
|Range of Exercise Prices |  | Shares              |         |  | Life (Years)        |  |     | Price    |  |   | Shares    |  |  | Price    |        
|                         | 
|$10.01 - $20.00          |  |                     | 687,410 |  |                     |  | 3.6 |          |  | $ | 18.50     |  |  |          | 687,410 |  |  | $ | 18.50 | 
|$20.01 - $30.00          |  |                     | 166,254 |  |                     |  | 5.1 |          |  |   | 26.78     |  |  |          | 166,254 |  |  |   | 26.78 | 
|$30.01 - $40.00          |  |                     | 1,866   |  |                     |  | 2.1 |          |  |   | 34.39     |  |  |          | 1,866   |  |  |   | 34.39 | 
|                         | 
|Total Options            |  |                     | 855,530 |  |                     |  | 3.9 |          |  | $ | 20.14     |  |  |          | 855,530 |  |  | $ | 20.14 | 
|                         | 



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



The fair value of the options granted to replace the CastlePoint options was estimated using the
Black-Scholes pricing model as of February 5, 2009, the date of conversion from CastlePoint stock options to the Companys stock options, with the following weighted average assumptions: risk free interest rate of 1.46% to 1.83%, dividend
yield of 0.8%, volatility factors of the expected market price of the Companys common stock of 43.8% to 45.3%, and a weighted-average expected life of the options of 3.3 to 5.3 years.

The fair value of the options granted to replace the SUA options was estimated using the Black-Scholes pricing model as of November 13, 2009, the
date of conversion from SUA stock options to the Companys stock options, with the following weighted average assumptions: risk free interest rate of 1.66%, dividend yield of 1.2%, volatility factors of the expected market price of the
Companys common stock of 43.8%, and a weighted-average expected life of the options of 1.4 years.

The fair value measurement
objective of the relevant GAAP guidance is achieved using the Black-Scholes model as the model (a) is applied in a manner consistent with the fair value measurement objective and other requirements of GAAP, (b) is based on established
principles of financial economic theory and generally applied in that field and (c) reflects all substantive characteristics of the instrument.

Stock Based Compensation Expense

The following table provides an analysis of stock based
compensation expense for the years ended December 31, 2012, 2011 and 2010:



|                                                  |  |                         |        |  |      |   |        |      |  |   |        | 
|------------------------------------------------- |  | ----------------------- | ------ |  | ---- | - | ------ | ---- |  | - | ------ | 
|                                                  |  | Year Ended December 31, |       
|($ in thousands)                                  |  | 2012                    |        |  | 2011 |   |        | 2010 | 
|                                                  | 
|Restricted stock                                  |  |                         |        |  |      |   |        |      |  |   |        | 
|Expense, net of tax                               |  | $                       | 6,043  |  |      | $ | 6,126  |      |  | $ | 3,792  | 
|Value of shares vested                            |  |                         | 9,485  |  |      |   | 5,622  |      |  |   | 4,673  | 
|Value of unvested shares                          |  |                         | 15,967 |  |      |   | 19,940 |      |  |   | 15,147 | 
|Stock options                                     |  |                         |        |  |      |   |        |      |  |   |        | 
|Expense, net of tax                               |  |                         | -      |  |      |   | 105    |      |  |   | 293    | 
|Intrinsic value of outstanding options            |  |                         | 1,149  |  |      |   | 1,150  |      |  |   | 5,408  | 
|Intrinsic value of vested outstanding options     |  |                         | 1,149  |  |      |   | 1,150  |      |  |   | 5,025  | 
|Unrecognized compensation expense                 |  |                         |        |  |      |   |        |      |  |   |        | 
|Non-vested stock options, net of tax              |  |                         | -      |  |      |   | -      |      |  |   | 105    | 
|Unvested restricted stock, net of tax             |  |                         | 8,262  |  |      |   | 9,617  |      |  |   | 6,097  | 
|Weighted average years expense will be recognized |  |                         | 2.1    |  |      |   | 2.3    |      |  |   | 3.1    | 

Note 15Income Taxes

The Company files a consolidated Federal income tax return. The Reciprocal Exchanges are not included in the Companys
consolidated tax return as the Company does not have an ownership interest in the Reciprocal Exchanges, and they are not a part of the consolidated tax sharing agreement.

The provision for Federal, state and local income taxes consist of the following components for the years ended December 31, 2012, 2011 and 2010:



|                                                |  |                         |          |  |            |   |         |       |  |   |          |  |  |            |        |  |       |   |       |       |  |   |            |  |  |       |         |  |  |   |         |  |  |   |          | 
|----------------------------------------------- |  | ----------------------- | -------- |  | ---------- | - | ------- | ----- |  | - | -------- |  |  | ---------- | ------ |  | ----- | - | ----- | ----- |  | - | ---------- |  |  | ----- | ------- |  |  | - | ------- |  |  | - | -------- | 
|                                                |  | Year ended December 31, |         
|                                                |  | 2012                    |          |  | 2011       |   |         | 2010  | 
|                                                |  |                         |          |  | Reciprocal |   |         |       |  |   |          |  |  | Reciprocal |        |  |       |   |       |       |  |   | Reciprocal |  |  |       |        
|($ in thousands)                                |  | Tower                   |          |  | Exchanges  |   |         | Total |  |   | Tower    |  |  | Exchanges  |        |  | Total |   |       | Tower |  |   | Exchanges  |  |  | Total |        
|                                                | 
|Current Federal income tax expense (benefit)    |  | $                       | (16,855) |  |            | $ | 284     |       |  | $ | (16,571) |  |  | $          | 6,744  |  |       | $ | 1,510 |       |  | $ | 8,254      |  |  | $     | (8,096) |  |  | $ | (2,380) |  |  | $ | (10,476) | 
|Current state income tax expense (benefit)      |  |                         | 200      |  |            |   | -       |       |  |   | 200      |  |  |            | (257)  |  |       |   | -     |       |  |   | (257)      |  |  |       | 1,292   |  |  |   | -       |  |  |   | 1,292    | 
|Deferred Federal and state income tax (benefit) |  |                         | (7,828)  |  |            |   | (2,521) |       |  |   | (10,349) |  |  |            | 14,473 |  |       |   | 1,672 |       |  |   | 16,145     |  |  |       | 60,435  |  |  |   | 917     |  |  |   | 61,352   | 
|                                                | 
|Provision for income taxes                      |  | $                       | (24,483) |  |            | $ | (2,237) |       |  | $ | (26,720) |  |  | $          | 20,960 |  |       | $ | 3,182 |       |  | $ | 24,142     |  |  | $     | 53,631  |  |  | $ | (1,463) |  |  | $ | 52,168   | 
|                                                | 

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 provided benefits from 100%
accelerated depreciation of fixed assets. As a result, the Companys current Federal income tax benefit for the year ended December 31, 2011 includes a refund from prior year overpayments and benefits from the 100% acceleration of
depreciation of



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



fixed assets placed in service after September 8, 2010 as allowed by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010. This 100% acceleration provision
expired on December 31, 2011, and the Company is back to a 50% acceleration of depreciation of fixed assets.

Deferred tax assets and
liabilities are determined using the enacted tax rates applicable to the period the temporary differences are expected to be recovered. Accordingly, the current period income tax provision can be affected by the enactment of new tax rates. The net
deferred income taxes on the balance sheet reflect temporary differences between the carrying amounts of the assets and liabilities for financial reporting purposes and income tax purposes. Significant components of the consolidated deferred tax
assets and liabilities are as follows:



|                                                                          |  |              |          |  |            |   |          |       |  |   |          |  |  |            |          |  |       |   |          |  |  |   |          | 
|------------------------------------------------------------------------- |  | ------------ | -------- |  | ---------- | - | -------- | ----- |  | - | -------- |  |  | ---------- | -------- |  | ----- | - | -------- |  |  | - | -------- | 
|                                                                          |  | December 31, |         
|                                                                          |  | 2012         |          |  | 2011       |  
|                                                                          |  |              |          |  | Reciprocal |   |          |       |  |   |          |  |  | Reciprocal |          |  |       |  
|($ in thousands)                                                          |  | Tower        |          |  | Exchanges  |   |          | Total |  |   | Tower    |  |  | Exchanges  |          |  | Total |  
|                                                                          | 
|Deferred tax assets:                                                      |  |              |          |  |            |   |          |       |  |   |          |  |  |            |          |  |       |   |          |  |  |   |          | 
|Claims reserve discount                                                   |  | $            | 43,283   |  |            | $ | 1,747    |       |  | $ | 45,030   |  |  | $          | 41,058   |  |       | $ | 2,691    |  |  | $ | 43,749   | 
|Unearned premium                                                          |  |              | 55,134   |  |            |   | 5,928    |       |  |   | 61,062   |  |  |            | 53,337   |  |       |   | 6,139    |  |  |   | 59,476   | 
|Equity compensation plans                                                 |  |              | 6,072    |  |            |   | -        |       |  |   | 6,072    |  |  |            | 5,806    |  |       |   | -        |  |  |   | 5,806    | 
|Investment impairments                                                    |  |              | 2,316    |  |            |   | 15       |       |  |   | 2,331    |  |  |            | 3,754    |  |       |   | 78       |  |  |   | 3,832    | 
|Net operating loss carryforwards                                          |  |              | 20,964   |  |            |   | 4,731    |       |  |   | 25,695   |  |  |            | 16,312   |  |       |   | 2,729    |  |  |   | 19,041   | 
|Convertible senior note and note hedge OID                                |  |              | 618      |  |            |   | -        |       |  |   | 618      |  |  |            | 1,333    |  |       |   | -        |  |  |   | 1,333    | 
|AMT credits                                                               |  |              | 6,575    |  |            |   | 508      |       |  |   | 7,083    |  |  |            | 197      |  |       |   | -        |  |  |   | 197      | 
|Fair value of interest rate swap                                          |  |              | 3,155    |  |            |   | -        |       |  |   | 3,155    |  |  |            | 2,584    |  |       |   | -        |  |  |   | 2,584    | 
|Bad debt reserves                                                         |  |              | 1,943    |  |            |   | 22       |       |  |   | 1,965    |  |  |            | 1,346    |  |       |   | 21       |  |  |   | 1,367    | 
|Deferred rent                                                             |  |              | 1,905    |  |            |   | -        |       |  |   | 1,905    |  |  |            | 74       |  |       |   | -        |  |  |   | 74       | 
|Merger Option, SPS Transaction Right and Acquisition Right                |  |              | 3,710    |  |            |   | -        |       |  |   | 3,710    |  |  |            | -        |  |       |   | -        |  |  |   | -        | 
|Other                                                                     |  |              | 1,489    |  |            |   | 993      |       |  |   | 2,482    |  |  |            | 423      |  |       |   | 1,071    |  |  |   | 1,494    | 
|                                                                          | 
|Total gross deferred tax assets                                           |  |              | 147,164  |  |            |   | 13,944   |       |  |   | 161,108  |  |  |            | 126,224  |  |       |   | 12,729   |  |  |   | 138,953  | 
|Less: valuation allowance                                                 |  |              | 1,896    |  |            |   | 4,726    |       |  |   | 6,622    |  |  |            | 1,896    |  |       |   | 5,065    |  |  |   | 6,961    | 
|                                                                          | 
|Total deferred tax assets                                                 |  |              | 145,268  |  |            |   | 9,218    |       |  |   | 154,486  |  |  |            | 124,328  |  |       |   | 7,664    |  |  |   | 131,992  | 
|                                                                          | 
|Deferred tax liabilities:                                                 |  |              |          |  |            |   |          |       |  |   |          |  |  |            |          |  |       |   |          |  |  |   |          | 
|Deferred acquisition costs net of deferred ceding commission revenue      |  |              | 59,387   |  |            |   | 3,864    |       |  |   | 63,251   |  |  |            | 54,947   |  |       |   | 4,034    |  |  |   | 58,981   | 
|Depreciation and amortization                                             |  |              | 44,919   |  |            |   | 2,357    |       |  |   | 47,276   |  |  |            | 41,058   |  |       |   | 789      |  |  |   | 41,847   | 
|Net unrealized appreciation of securities and deferred intercompany gains |  |              | 47,303   |  |            |   | 5,791    |       |  |   | 53,094   |  |  |            | 36,085   |  |       |   | 4,003    |  |  |   | 40,088   | 
|Accrual of bond discount                                                  |  |              | 5,034    |  |            |   | -        |       |  |   | 5,034    |  |  |            | 5,537    |  |       |   | -        |  |  |   | 5,537    | 
|Surplus notes                                                             |  |              | 1,800    |  |            |   | 17,024   |       |  |   | 18,824   |  |  |            | 1,080    |  |       |   | 17,744   |  |  |   | 18,824   | 
|Unconsolidated affiliate                                                  |  |              | 3,471    |  |            |   | -        |       |  |   | 3,471    |  |  |            | -        |  |       |   | -        |  |  |   | -        | 
|Other                                                                     |  |              | -        |  |            |   | -        |       |  |   | -        |  |  |            | -        |  |       |   | -        |  |  |   | -        | 
|                                                                          | 
|Total deferred tax liabilities                                            |  |              | 161,914  |  |            |   | 29,036   |       |  |   | 190,950  |  |  |            | 138,707  |  |       |   | 26,570   |  |  |   | 165,277  | 
|                                                                          | 
|Net deferred income tax asset (liability)                                 |  | $            | (16,646) |  |            | $ | (19,818) |       |  | $ | (36,464) |  |  | $          | (14,379) |  |       | $ | (18,906) |  |  | $ | (33,285) | 
|                                                                          | 

In assessing the valuation of deferred tax assets, the Company considers whether it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible.

Preserver Group, Inc. (PGI), acquired by the Company in 2007 and CastlePoint , acquired in 2009, have net operating tax loss
carryforwards (NOLs). Section 382 of the Internal Revenue Code (Section 382) limits ability of a corporation to offset income using NOLs generated prior to a change in ownership. We will perform a
Section 382 limitation calculation if require based on the change of ownership resulting from the anticipated merger with Canopius. The Company expects the NOLs will be used in the future, subject to change of ownership limitations pursuant to
Section 382. As of December 31, 2012, the Tower NOL totaled $58.0 million related. This included PGI and CastlePoint NOLs as follows: $33.4 million and $7.1 million, respectively. In addition, the Reciprocal Exchanges have
NOLs of $13.9 million. Additionally, Tower and the Reciprocal Exchanges have an AMT credit that can be carried over indefinitely.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Section 382 imposes annual limitations on a corporations ability to utilize its NOLs if it
experiences an ownership change. As a result of the acquisitions, PGI and CastlePoints NOLs are subject to annual limitations of $2.8 million and $11.1 million, respectively. Any unused annual limitation may be carried
over to later years. The NOLs will expire in years 2019 through 2029.

Additionally, Tower and the Reciprocal Exchanges have an AMT credit of
$6.5 million and $0.5 million, respectively, that can be carried over indefinitely.

The Company believes it is more likely than not that the
results of future operations will generate sufficient taxable income to realize the deferred tax assets, including the NOLs, except for those associated with the Reciprocal Exchanges. The Company has recorded a valuation allowance of
$4.7 million and $5.1 million at December 31, 2012 and 2011, respectively, to reflect the amount of the Reciprocal Exchanges deferred taxes that may not be realized.

As of December 31, 2012 and 2011, the Company had no material uncertain tax positions and no adjustments to liabilities or operations were required.

The Internal Revenue Service performed an audit of The Companys 2006 and 2007 tax years and closed these audits in 2011 with no changes.
Additionally, in 2011 the IRS performed an audit of CastlePoint and subsidiarys federal income tax return for the period ended February 2009 and closed this audit with no changes. CastlePoints federal excise tax for the 2009 and 2010 tax
years were examined by the IRS in 2012. This audit was closed in 2012 with no changes. One of the Reciprocal Exchanges is currently under an IRS excise tax examination for the 2011 tax year. We expect to close this examination in 2013 with no
changes.

The provision for Federal income taxes incurred is different from that which would be obtained by applying the Federal income tax
rate to net income before taxes. The items causing this difference at the consolidated level are as follows:



|                                          |  |                         |          |  |            |   |         |       |  |   |          |  |  |            |         |  |       |   |         |       |  |   |            |  |  |       |         |  |  |   |         |  |  |   |         | 
|----------------------------------------- |  | ----------------------- | -------- |  | ---------- | - | ------- | ----- |  | - | -------- |  |  | ---------- | ------- |  | ----- | - | ------- | ----- |  | - | ---------- |  |  | ----- | ------- |  |  | - | ------- |  |  | - | ------- | 
|                                          |  | Year Ended December 31, |         
|                                          |  | 2012                    |          |  | 2011       |   |         | 2010  | 
|                                          |  |                         |          |  | Reciprocal |   |         |       |  |   |          |  |  | Reciprocal |         |  |       |   |         |       |  |   | Reciprocal |  |  |       |        
|($ in thousands)                          |  | Tower                   |          |  | Exchanges  |   |         | Total |  |   | Tower    |  |  | Exchanges  |         |  | Total |   |         | Tower |  |   | Exchanges  |  |  | Total |        
|                                          | 
|Federal income tax expense at             |  |                         |          |  |            |   |         |       |  |   |          |  |  |            |         |  |       |   |         |       |  |   |            |  |  |       |         |  |  |   |         |  |  |   |         | 
|U.S. statutory rate                       |  | $                       | (18,423) |  |            | $ | 198     |       |  | $ | (18,225) |  |  | $          | 28,309  |  |       | $ | 4,820   |       |  | $ | 33,129     |  |  | $     | 55,763  |  |  | $ | (2,519) |  |  | $ | 53,244  | 
|Tax exempt interest                       |  |                         | (7,374)  |  |            |   | (901)   |       |  |   | (8,275)  |  |  |            | (6,823) |  |       |   | (418)   |       |  |   | (7,241)    |  |  |       | (4,685) |  |  |   | (193)   |  |  |   | (4,878) | 
|State income taxes net of Federal benefit |  |                         | 130      |  |            |   | -       |       |  |   | 130      |  |  |            | 488     |  |       |   | -       |       |  |   | 488        |  |  |       | 840     |  |  |   | -       |  |  |   | 840     | 
|Acquisition-related transaction costs     |  |                         | 2,261    |  |            |   | -       |       |  |   | 2,261    |  |  |            | 100     |  |       |   | -       |       |  |   | 100        |  |  |       | 655     |  |  |   | -       |  |  |   | 655     | 
|Prior period adjustment                   |  |                         | (1,065)  |  |            |   | (471)   |       |  |   | (1,536)  |  |  |            | -       |  |       |   | -       |       |  |   | -          |  |  |       | -       |  |  |   | -       |  |  |   | -       | 
|Valuation Allowance                       |  |                         | -        |  |            |   | (1,072) |       |  |   | (1,072)  |  |  |            | -       |  |       |   | (1,757) |       |  |   | (1,757)    |  |  |       | -       |  |  |   | 1,059   |  |  |   | 1,059   | 
|Other                                     |  |                         | (12)     |  |            |   | 9       |       |  |   | (3)      |  |  |            | (1,114) |  |       |   | 537     |       |  |   | (577)      |  |  |       | 1,058   |  |  |   | 190     |  |  |   | 1,248   | 
|                                          | 
|Provision for income taxes                |  | $                       | (24,483) |  |            | $ | (2,237) |       |  | $ | (26,720) |  |  | $          | 20,960  |  |       | $ | 3,182   |       |  | $ | 24,142     |  |  | $     | 53,631  |  |  | $ | (1,463) |  |  | $ | 52,168  | 
|                                          | 

Note 16Employee Benefit Plans

The Company maintains a defined contribution Employee Pretax Savings Plan (401(k) Plan) for its employees. The Company matches
50% of each participants contribution up to 8% of the participants eligible contribution. The Company incurred $3.5 million, $3.2 million, and $2.7 million of expense in 2012, 2011 and 2010, respectively, related to the 401(k) Plan.

Supplemental Executive Retirement Plan (SERP)

The SERP is a non-qualified defined contribution plan effective as of January 1, 2009 that is intended to enhance retirement benefits for the Companys most senior executives and certain other
key employees. Eligibility to participate in the SERP generally requires three years of prior employment with the Company for Executive Vice Presidents and Senior Vice Presidents and between five and 10 years of prior employment with the Company for
other key employees. In 2012, all of the Named Executive Officers, as well as certain other key executives selected at the discretion of the Compensation Committee, participated in the SERP. Subject to the approval of the Compensation Committee, the
Company may make annual contributions to the SERP on behalf of each participant. The SERP is not a defined benefit plan and such target benefit level cannot be guaranteed. For all participants, the amount of the annual contribution is presently
equal to 5.0% of their annual cash compensation. Company contributions for each participant remain unvested until such participant has completed 10 years of service with the Company, and vest in full upon completion of 10 years of service. The
Compensation Committee has discretion to terminate the SERP at any time or to adjust upward or downward the level of the Companys contribution each year.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Note 17Contingencies

Legal Proceedings

On May 28, 2009, Munich Reinsurance America, Inc. (Munich) commenced an action against Tower Insurance Company of New York (TICNY), a wholly-owned subsidiary of Tower
Group, Inc., in the United States District Court for the District of New Jersey seeking, inter alia, to recover $6.1 million under various retrocessional contracts pursuant to which TICNY reinsures Munich. On June 22, 2009, TICNY filed its
answer, in which it, inter alia, asserted two separate counterclaims seeking to recover $2.8 million under various reinsurance contracts pursuant to which Munich reinsures TICNY. (A separate action commenced by Munich
against TICNY on June 17, 2009 in the United States District Court for the District of New Jersey seeking a declaratory judgment that Munich is entitled to access to TICNYs books and records pertaining to various quota share
agreements, to which TICNY filed its answer on July 7, 2009, was subsequently dismissed pursuant to the stipulation of the parties on March 17, 2010). On July 15, 2011, TICNY paid $3.3 million to Munich to resolve a portion of
the dispute. On December 22, 2011, the court granted partial summary judgment with respect to certain of the claims and defenses in the litigation. On March 23, 2012, the Court ruled that Munich was entitled to approximately $168,000 from
TICNY in pre-judgment interest on the amount of $3.3 million that TICNY had paid to Munich on July 15, 2011, which was expensed in the first quarter of 2012. Trial was scheduled for October 15, 2012, but during the third quarter of 2012,
the parties have reached a settlement of the action for $2.9 million after-tax which is included as a charge in other operating expenses. On October 9, 2012, the Court entered an order dismissing certain claims with prejudice and other
claims without prejudice.

On May 12, 2010, Mirabilis Ventures, Inc. (Mirabilis) commenced an action against Specialty
Underwriters Alliance Insurance Co. (SUA, now known as CastlePoint National Insurance Company (CNIC), a subsidiary of Tower Group, Inc.) and Universal Reinsurance Co., Ltd., an unrelated entity, in the United States
District Court for the Middle District of Florida. The Complaint is based upon a Workers Compensation/Employers Liability policy issued by SUA to AEM, Inc. (AEM), to whose legal rights Mirabilis is alleged to have succeeded
as a result of the Chapter 11 bankruptcy of AEM. The Complaint, which includes claims against SUA for breach of contract and breach of the duty of good faith, alleges that SUA failed to properly audit AEMs operations to determine
AEMs workers compensation exposure for two policy years, in order to compute the premium owed by AEM, such that SUA owes Mirabilis the principal sum of $3.4 million for one policy year and $0.6 million for the other policy
year, plus interest and costs. On July 30, 2010, CNIC answered the Complaint and asserted nine separate counterclaims, to which Mirabilis responded on September 3, 2010. Since that time, Mirabilis has filed an amended complaint that failed
to add any defenses against Mirabilis, and CNIC subsequently filed a motion for summary judgment on all of Mirabilis claims. On March 15, 2012, Mirabilis and CNIC entered into a settlement agreement and mutual release, pursuant to which
Mirabilis agreed to withdraw all of its claims against CNIC and CNIC agreed to withdraw its counterclaims against Mirabilis. Neither party was required to pay any money under the terms of the settlement. On March 20, 2012, the Court ordered
dismissal of the case. On March 26, 2012, CNIC filed a stipulation of final order and the case was dismissed with prejudice and terminated.

Leases

The Company has various lease agreements for office space, furniture and
equipment. The terms of the office space lease agreements provide for annual rental increases and certain lease incentives including initial free rent periods and cash allowances for leasehold improvements.

The Company amortizes scheduled annual rental increases and lease incentives ratably over the term of the lease. The Companys future minimum lease
payments are as follows:



|                 |  |           |        |  |         |   |        |       |  |   |         | 
|---------------- |  | --------- | ------ |  | ------- | - | ------ | ----- |  | - | ------- | 
|                 |  | Operating |        |  | Capital |   |        |       | 
|($ in thousands) |  | Leases    |        |  | Leases  |   |        | Total | 
|                 | 
|2013             |  | $         | 9,654  |  |         | $ | 9,466  |       |  | $ | 19,120  | 
|2014             |  |           | 10,278 |  |         |   | 11,022 |       |  |   | 21,300  | 
|2015             |  |           | 10,167 |  |         |   | 15,865 |       |  |   | 26,032  | 
|2016             |  |           | 9,981  |  |         |   | 1,533  |       |  |   | 11,514  | 
|2017             |  |           | 8,926  |  |         |   | 1,671  |       |  |   | 10,597  | 
|Thereafter       |  |           | 32,904 |  |         |   | 54     |       |  |   | 32,958  | 
|                 | 
|                 |  | $         | 81,910 |  |         | $ | 39,611 |       |  | $ | 121,521 | 
|                 | 

Total rental expense was $9.7 million, $11.1 million and $10.0 million in 2012, 2011 and 2010, respectively.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Assessments

Towers insurance subsidiaries are also required to participate in various mandatory insurance facilities or in funding mandatory pools, which are generally designed to provide insurance coverage for
consumers who are unable to obtain insurance in the voluntary insurance market. The insurance subsidiaries are subject to assessments in New York, Florida, New Jersey, Georgia, California and other states for various purposes, including the
provision of funds necessary to fund the operations of the New York Insurance Department and the New York Property/Casualty Insurance Security Fund, which pays covered claims under certain policies provided by impaired, insolvent or failed insurance
companies and various funds administered by the New York Workers Compensation Board, which pays covered claims under certain policies provided by impaired, insolvent or failed insurance companies.

The Company paid $4.8 million, $5.1 million and $4.8 million in 2012, 2011 and 2010, respectively, for its proportional share of the operating expenses
of the New York Insurance Department. Property casualty insurance company insolvencies or failures may result in additional security fund assessments to the Company at some future date. At this time the Company is unable to estimate the possible
amounts, if any, of such assessments. Accordingly, the Company is unable to determine the impact, if any; such assessments may have on financial position or results of operations of the Company. The Company is permitted to assess premium surcharges
on workers compensation policies that are based on statutorily enacted rates. Actual assessments have resulted in differences to the original estimates based on permitted surcharges of $0 million, $1.1 million and $4.1 million in 2012,
2011 and 2010, respectively. The Company estimates its liability for future assessments based on actual written premiums and historical rates and available information. As of December 31, 2012, the liability for the various workers
compensation funds, which includes amounts assessed on workers compensation policies, was $7.5 million. This amount is expected to be paid over an eighteen month period ending June 30, 2013. As of December 31, 2011, the liability for
the various workers compensation funds was $8.2 million.

Note 18Statutory Financial Information and Accounting Policies

United States

For
regulatory purposes, the Companys insurance subsidiaries, excluding CastlePoint Reinsurance Company, Ltd. (CastlePoint Re) which, as discussed below, is Bermuda domiciled, prepare their statutory basis financial statements in
accordance with practices prescribed or permitted by the state they are domiciled in (statutory basis or SAP). The more significant SAP variances from GAAP are as follows:



| |  | Policy acquisition costs are charged to operations in the year such costs are incurred, rather than being deferred and amortized as premiums are earned
over the terms of the policies.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Ceding commission revenues are earned when ceded premiums are written except for ceding commission revenues in excess of anticipated acquisition costs,
which are deferred and amortized as ceded premiums are earned. GAAP requires that all ceding commission revenues be earned as the underlying ceded premiums are earned over the term of the reinsurance agreements.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Certain assets including certain receivables, a portion of the net deferred tax asset, prepaid expenses and furniture and equipment are not admitted.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Investments in fixed-maturity securities are valued at NAIC value for statutory financial purposes, which is primarily amortized cost. GAAP requires
investments in fixed-maturity securities classified as available for sale, to be reported at fair value.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Loss and LAE reserves are reported net of ceded reinsurance within the statutory basis financial statements. GAAP requires the reserve and reinsurance
amounts to be shown gross.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | For SAP purposes, changes in deferred income taxes relating to temporary differences between net income for financial reporting purposes and taxable
income are recognized as a separate component of gains and losses in surplus rather than included in income tax expense or benefit as required under GAAP.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

State insurance laws restrict the ability of our insurance subsidiaries to declare dividends. State insurance regulators require insurance companies to maintain specified levels of statutory capital and
surplus. Generally, dividends may only be paid out of earned surplus, and the amount of an insurers surplus following payment of any dividends must be reasonable in relation to the insurers outstanding liabilities and adequate to meet
its financial needs. Further, prior approval of the insurance department of its state of domicile is required before any of our insurance subsidiaries can declare and pay an extraordinary dividend to the Company.



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



For the years ended December 31, 2012, 2011 and 2010, the Companys insurance subsidiaries had
SAP net income (loss) of $(29.6), $52.0 million and $76.0 million, respectively. At December 31, 2012 and 2011 the Companys insurance subsidiaries had reported SAP surplus as regards policyholders of $619.9 million and
$686.8 million, respectively, as filed with the insurance regulators.

The Companys insurance subsidiaries paid $14.0 million,
$35.0 million and $4.7 million in dividends and or return of capital to Tower in 2012, 2011 and 2010, respectively. As of December 31, 2012, the maximum distribution that Towers insurance subsidiaries could pay without prior
regulatory approval was $33.5 million and the maximum return of capital available from CastlePoint Re without Bermuda regulatory permission was $43.0 million.

Bermuda

CastlePoint Re is registered as a Class 3 reinsurer under The Insurance Act 1978
(Bermuda), amendments thereto and related regulations (the Insurance Act). Under the Insurance Act, CastlePoint Re is required to prepare Statutory Financial Statements and to file a Statutory Financial Return. The Insurance Act also
requires CastlePoint Re to maintain minimum share capital and surplus, and it has met these requirements as of December 31, 2012.

CastlePoint Re is also subject to dividend limitations imposed by Bermuda. Under the Companies Act 1981 of Bermuda, as amended (the Companies
Act), we may declare or pay a dividend out of distributable reserves only if we have reasonable grounds for believing that we are, or would after the payment, be able to pay our liabilities as they become due and if the realizable value of our
assets would thereby not be less than the aggregate of our liabilities and issued share capital and share premium accounts.

For the year
ended December 31, 2012, CastlePoint Re had statutory net income of $0.9 million and at December 31, 2012, had statutory surplus of $277.0 million.

For Bermuda registered companies, there are some differences between financial statements prepared in accordance with GAAP and those prepared on a statutory basis. Certain assets are non-admitted under
Bermuda regulations. Accordingly, for Bermuda statutory reporting, deferred policy acquisition costs have been fully expensed to income and prepaid expenses and fixed assets have been removed from the statutory balance sheet.

Note 19Fair Value of Financial Instruments

GAAP guidance requires all entities to disclose the fair value of financial instruments, both assets and liabilities recognized and
not recognized in the balance sheet, for which it is practicable to estimate fair value. The Company uses the following methods and assumptions in estimating its fair value disclosures for financial instruments:

Fixed maturity and equity securities: Fair value disclosures for investments are included in Note 7Fair Value
Measurements.

Other invested assets: The fair value of securities which are reported under the fair value option are
included in Note 7Fair Value Measurements.

Premiums receivable and reinsurance recoverable: The carrying values
reported in the accompanying balance sheets for these financial instruments approximate their fair values.

Debt: Fair value
disclosures for debt are included in Note 13Debt. The Company uses a discounted cash flow model to fair value the subordinated debentures. Market quotes are used to fair value the senior convertible notes.

Reinsurance balances payable and funds held under reinsurance contracts: The carrying value reported in the balance sheet for these
financial instruments approximates fair value.

Note 20Earnings (loss) per Share

Undistributed net earnings (loss) (net income less dividends declared during the period) are allocated to both common stock and
unvested share-based payment awards (unvested restricted stock). Because the common shareholders and unvested restricted



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Tower Group, Inc.

Notes to Consolidated Financial Statements



stock holders share in dividends on a 1:1 basis, the earnings per share on undistributed earnings is equivalent. Undistributed earnings are allocated to all outstanding share-based payment
awards, including those for which the requisite service period is not expected to be rendered.

The following table shows the computation of
the earnings per share:



|                                                                     |  |                         |         |   |      |   |        |      |  |   |         | 
|-------------------------------------------------------------------- |  | ----------------------- | ------- | - | ---- | - | ------ | ---- |  | - | ------- | 
|                                                                     |  | Year Ended December 31, |        
|(in thousands, except per share amounts)                             |  | 2012                    |         |   | 2011 |   |        | 2010 | 
|                                                                     | 
|Numerator                                                            |  |                         |         |   |      |   |        |      |  |   |         | 
|Net income (loss) attributable to Tower Group, Inc.                  |  | $                       | (28,154 | ) |      | $ | 60,481 |      |  | $ | 106,356 | 
|                                                                     | 
|Denominator                                                          |  |                         |         |   |      |   |        |      |  |   |         | 
|Weighted average common shares outstanding                           |  |                         | 38,795  |   |      |   | 40,833 |      |  |   | 43,462  | 
|Effect of dilutive securities:                                       |  |                         |         |   |      |   |        |      |  |   |         | 
|Stock options                                                        |  |                         | -       |   |      |   | 94     |      |  |   | 174     | 
|Other                                                                |  |                         | -       |   |      |   | 4      |      |  |   | 12      | 
|                                                                     | 
|Weighted average common and potential dilutive shares outstanding    |  |                         | 38,795  |   |      |   | 40,931 |      |  |   | 43,648  | 
|                                                                     | 
|Earnings (loss) per share attributable to Tower stockholdersbasic   |  |                         |         |   |      |   |        |      |  |   |         | 
|Common stock:                                                        |  |                         |         |   |      |   |        |      |  |   |         | 
|Distributed earnings                                                 |  | $                       | 0.75    |   |      | $ | 0.69   |      |  | $ | 0.39    | 
|Undistributed earnings                                               |  |                         | (1.48   | ) |      |   | 0.79   |      |  |   | 2.06    | 
|                                                                     | 
|Total                                                                |  |                         | (0.73   | ) |      |   | 1.48   |      |  |   | 2.45    | 
|                                                                     | 
|Earnings (loss) per share attributable to Tower stockholdersdiluted |  | $                       | (0.73   | ) |      | $ | 1.48   |      |  | $ | 2.44    | 
|                                                                     | 



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



The computation of diluted earnings (loss) per share excludes outstanding options and other common stock
equivalents in periods where inclusion of such potential common stock instruments would be anti-dilutive. For the years ended December 31, 2012, 2011 and 2010, 0, 166,700 and 193,000, respectively, options and other common stock equivalents to
purchase Tower shares were excluded from the computation of diluted earnings (loss) per share because the exercise price of the options was greater than the average market price.

Note 21Segment Information

The Personal Insurance segment includes revenues and expenses associated with the Reciprocal Exchanges, including fees paid to Tower
for underwriting, claims, investment management and other services provided pursuant to management services agreements with the Reciprocal Exchanges. The Insurance Services segment reports revenues earned by Tower from the Reciprocal Exchanges as
management fee income, which is calculated as a percentage of the Reciprocal Exchanges gross written premiums. The effects of these management services agreements between Tower and the Reciprocal Exchanges are eliminated in consolidation to
derive consolidated net income. However, the management fee income is reported in net income attributable to Tower Group, Inc. and included in basic and diluted earnings per share.

Segment performance is evaluated based on segment profit, which excludes investment income, realized gains and losses, interest expense, income taxes and incidental corporate expenses. Assets, other than
intangible assets and goodwill, are not allocated to segments because investments and assets other than intangible assets and goodwill are considered in total by management for decision-making purposes.



F-48



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



Business segments results are as follows:



|                                            |  |                         |           |   |      |   |           |      |  |   |         |  
|------------------------------------------- |  | ----------------------- | --------- | - | ---- | - | --------- | ---- |  | - | ------- | -
|                                            |  | Year Ended December 31, |          
|($ in thousands)                            |  | 2012                    |           |   | 2011 |   |           | 2010 | 
|                                            | 
|Commercial Insurance Segment                |  |                         |           |   |      |   |           |      |  |   |         |  
|Revenues                                    |  |                         |           |   |      |   |           |      |  |   |         |  
|Premiums earned                             |  | $                       | 1,224,303 |   |      | $ | 1,087,911 |      |  | $ | 941,015 |  
|Ceding commission revenue                   |  |                         | 7,702     |   |      |   | 14,786    |      |  |   | 33,247  |  
|Policy billing fees                         |  |                         | 5,467     |   |      |   | 4,345     |      |  |   | 2,742   |  
|                                            | 
|Total revenues                              |  |                         | 1,237,472 |   |      |   | 1,107,042 |      |  |   | 977,004 |  
|                                            | 
|Expenses                                    |  |                         |           |   |      |   |           |      |  |   |         |  
|Loss and loss adjustment expenses           |  |                         | 902,784   |   |      |   | 736,474   |      |  |   | 589,322 |  
|Underwriting expenses                       |  |                         | 432,660   |   |      |   | 361,890   |      |  |   | 347,497 |  
|                                            | 
|Total expenses                              |  |                         | 1,335,444 |   |      |   | 1,098,364 |      |  |   | 936,819 |  
|                                            | 
|Underwriting profit (loss)                  |  | $                       | (97,972   | ) |      | $ | 8,678     |      |  | $ | 40,185  |  
|                                            | 
|                                            |  |                         |          
|Personal Insurance Segment                  |  |                         |           |   |      |   |           |      |  |   |         |  
|Revenues                                    |  |                         |           |   |      |   |           |      |  |   |         |  
|Premiums earned                             |  | $                       | 497,239   |   |      | $ | 505,939   |      |  | $ | 351,654 |  
|Ceding commission revenue                   |  |                         | 24,633    |   |      |   | 19,182    |      |  |   | 6,056   |  
|Policy billing fees                         |  |                         | 7,148     |   |      |   | 6,189     |      |  |   | 3,513   |  
|                                            | 
|Total revenues                              |  |                         | 529,020   |   |      |   | 531,310   |      |  |   | 361,223 |  
|                                            | 
|Expenses                                    |  |                         |           |   |      |   |           |      |  |   |         |  
|Loss and loss adjustment expenses           |  |                         | 351,076   |   |      |   | 318,775   |      |  |   | 194,701 |  
|Underwriting expenses                       |  |                         | 238,548   |   |      |   | 226,836   |      |  |   | 159,573 |  
|                                            | 
|Total expenses                              |  |                         | 589,624   |   |      |   | 545,611   |      |  |   | 354,274 |  
|                                            | 
|Underwriting profit (loss)                  |  | $                       | (60,604   | ) |      | $ | (14,301   | )    |  | $ | 6,949   |  
|                                            | 
|Tower                                       |  | $                       | (42,060   | ) |      | $ | (19,681   | )    |  | $ | 16,177  |  
|Reciprocal Exchanges                        |  |                         | (18,544   | ) |      |   | 5,380     |      |  |   | (9,228  | )
|                                            | 
|Total underwriting profit (loss)            |  | $                       | (60,604   | ) |      | $ | (14,301   | )    |  | $ | 6,949   |  
|                                            | 
|                                            |  |                         |          
|Insurance Services Segment                  |  |                         |           |   |      |   |           |      |  |   |         |  
|Revenues                                    |  |                         |           |   |      |   |           |      |  |   |         |  
|Management fee income                       |  | $                       | 30,150    |   |      | $ | 29,303    |      |  | $ | 17,752  |  
|Other revenue                               |  |                         | 3,420     |   |      |   | 1,570     |      |  |   | 2,171   |  
|                                            | 
|Total revenues                              |  |                         | 33,570    |   |      |   | 30,873    |      |  |   | 19,923  |  
|                                            | 
|Expenses                                    |  |                         |           |   |      |   |           |      |  |   |         |  
|Direct commission expense paid to producers |  |                         |           |   |      |   |           |      |  |   |         |  
|Other expenses                              |  |                         | 23,695    |   |      |   | 19,331    |      |  |   | 5,760   |  
|                                            | 
|Total expenses                              |  |                         | 23,695    |   |      |   | 19,331    |      |  |   | 5,760   |  
|                                            | 
|Insurance services pretax income            |  | $                       | 9,875     |   |      | $ | 11,542    |      |  | $ | 14,163  |  
|                                            | 



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##### Table of Contents

Tower Group, Inc.

Notes to Consolidated Financial Statements



The following table reconciles revenue by segment to consolidated revenues:



|                                                                                       |  |                         |           |  |      |   |           |      |  |   |           | 
|-------------------------------------------------------------------------------------- |  | ----------------------- | --------- |  | ---- | - | --------- | ---- |  | - | --------- | 
|                                                                                       |  | Year Ended December 31, |          
|($ in thousands)                                                                       |  | 2012                    |           |  | 2011 |   |           | 2010 | 
|                                                                                       | 
|Commercial insurance segment                                                           |  | $                       | 1,237,472 |  |      | $ | 1,107,042 |      |  | $ | 977,004   | 
|Personal insurance segment                                                             |  |                         | 529,020   |  |      |   | 531,310   |      |  |   | 361,223   | 
|Insurance services segment                                                             |  |                         | 33,570    |  |      |   | 30,873    |      |  |   | 19,923    | 
|                                                                                       | 
|Total segment revenues                                                                 |  |                         | 1,800,062 |  |      |   | 1,669,225 |      |  |   | 1,358,150 | 
|Elimination of management fee income                                                   |  |                         | (30,150)  |  |      |   | (29,303)  |      |  |   | (17,754)  | 
|Net investment income                                                                  |  |                         | 127,165   |  |      |   | 126,474   |      |  |   | 107,265   | 
|Net realized gains (losses) on investments, including other-than-temporary impairments |  |                         | 25,476    |  |      |   | 9,394     |      |  |   | 14,653    | 
|                                                                                       | 
|Consolidated revenues                                                                  |  | $                       | 1,922,553 |  |      | $ | 1,775,790 |      |  | $ | 1,462,314 | 
|                                                                                       | 

The following table reconciles the results of the Companys individual segments to consolidated income before income
taxes:



|                                                                              |  |                         |          |  |      |   |          |      |  |   |          | 
|----------------------------------------------------------------------------- |  | ----------------------- | -------- |  | ---- | - | -------- | ---- |  | - | -------- | 
|                                                                              |  | Year Ended December 31, |         
|($ in thousands)                                                              |  | 2012                    |          |  | 2011 |   |          | 2010 | 
|                                                                              | 
|Commercial insurance segment underwriting profit (loss)                       |  | $                       | (97,972) |  |      | $ | 8,678    |      |  | $ | 40,185   | 
|Personal insurance segment underwriting profit (loss)                         |  |                         | (60,604) |  |      |   | (14,301) |      |  |   | 6,949    | 
|Insurance services segment pretax income                                      |  |                         | 9,875    |  |      |   | 11,542   |      |  |   | 14,163   | 
|Net investment income                                                         |  |                         | 127,165  |  |      |   | 126,474  |      |  |   | 107,265  | 
|Net realized gains on investments, including other-than-temporary impairments |  |                         | 25,476   |  |      |   | 9,394    |      |  |   | 14,653   | 
|Corporate expenses                                                            |  |                         | (11,602) |  |      |   | (11,519) |      |  |   | (4,177)  | 
|Acquisition-related transaction costs                                         |  |                         | (9,229)  |  |      |   | (360)    |      |  |   | (2,369)  | 
|Interest expense                                                              |  |                         | (32,630) |  |      |   | (34,290) |      |  |   | (24,223) | 
|Other income (expense)                                                        |  |                         | (2,534)  |  |      |   | -        |      |  |   | -        | 
|                                                                              | 
|Income (loss) before income taxes                                             |  | $                       | (52,055) |  |      | $ | 95,618   |      |  | $ | 152,446  | 
|                                                                              | 

Note 22Unaudited Quarterly Financial Information

The following table presents the unaudited quarterly financial information for the Company:



|                                                                |  |       |         |  |        |   |         |       |  |   |         |  |  |       |         |   |  |   |           |  
|--------------------------------------------------------------- |  | ----- | ------- |  | ------ | - | ------- | ----- |  | - | ------- |  |  | ----- | ------- | - |  | - | --------- | -
|                                                                |  | 2012  |        
|($ in thousands, except per share amounts)                      |  | First |         |  | Second |   |         | Third |  |   | Fourth  |  |  | Total |        
|                                                                | 
|Revenues                                                        |  | $     | 466,223 |  |        | $ | 506,392 |       |  | $ | 474,891 |  |  | $     | 475,047 |   |  | $ | 1,922,553 |  
|Net Income (loss) attributable to Tower Group, Inc.             |  |       | 19,166  |  |        |   | (16,809 | )     |  |   | 21,629  |  |  |       | (52,140 | ) |  |   | (28,154   | )
|Net income (loss) per share attributable to Tower stockholders: |  |       |         |  |        |   |         |       |  |   |         |  |  |       |         |   |  |   |           |  
|Basic(1)                                                        |  | $     | 0.49    |  |        | $ | (0.43   | )     |  | $ | 0.56    |  |  | $     | (1.36   | ) |  | $ | (0.73     | )
|Diluted(1)                                                      |  | $     | 0.49    |  |        | $ | (0.43   | )     |  | $ | 0.56    |  |  | $     | (1.36   | ) |  | $ | (0.73     | )



|                                                                 |  |       |         |  |        |   |         |       |  |   |         |   |  |       |         |  |  |   |           | 
|---------------------------------------------------------------- |  | ----- | ------- |  | ------ | - | ------- | ----- |  | - | ------- | - |  | ----- | ------- |  |  | - | --------- | 
|                                                                 |  | 2011  |        
|                                                                 |  | First |         |  | Second |   |         | Third |  |   | Fourth  |   |  | Total |        
|                                                                 | 
|Revenues                                                         |  | $     | 430,719 |  |        | $ | 434,855 |       |  | $ | 455,295 |   |  | $     | 454,921 |  |  | $ | 1,775,790 | 
|Net Income (loss) attributable to Tower Group, Inc.              |  |       | 26,521  |  |        |   | 24,407  |       |  |   | (15,733 | ) |  |       | 25,286  |  |  |   | 60,481    | 
|Net income (loss)) per share attributable to Tower stockholders: |  |       |         |  |        |   |         |       |  |   |         |   |  |       |         |  |  |   |           | 
|Basic(1)                                                         |  | $     | 0.63    |  |        | $ | 0.59    |       |  | $ | (0.39   | ) |  | $     | 0.64    |  |  | $ | 1.48      | 
|Diluted(1)                                                       |  | $     | 0.63    |  |        | $ | 0.59    |       |  | $ | (0.39   | ) |  | $     | 0.64    |  |  | $ | 1.48      | 

(1) Since the
weighted-average shares for the quarters are calculated independently of the weighted-average shares for the year, quarterly earnings per share may not total to annual earnings per share.



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##### Table of Contents

Item 9A. Controls and Procedures

(a) Disclosure Controls and Procedures

The Companys principal executive officer and its principal financial officer, based on their evaluation of the Companys disclosure controls and procedures (as defined in Exchange Act
Rule 13a-15(e)), concluded that the Companys disclosure controls and procedures were effective for the purposes set forth in the definition thereof in Exchange Act Rule 13a-15(e) as of December 31, 2012.

(b) Managements Report on Internal Control over Financial Reporting

The management of Tower Group, Inc. and its subsidiaries is responsible for establishing and maintaining adequate internal control over financial reporting for Tower as defined in Rule 13a-15(f)
under the Securities Exchange Act of 1934.

Our internal control over financial reporting is a process designed by or under the supervision of
our principal executive and principal financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. Our internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of
assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures are being made
only in accordance with authorizations of management and the directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Companys assets
that could have a material effect on our financial statements.

Because of its inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree or compliance with the
policies or procedures may deteriorate.

Management has assessed its internal controls over financial reporting as of December 31, 2012
in relation to criteria for effective internal control over financial reporting described in Internal ControlIntegrated Framework Issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment
under those criteria, Towers management concluded that its internal control over financial reporting was effective as of December 31, 2012.

(c) Attestation report of the Companys registered public accounting firm

PricewaterhouseCoopers LLP, an independent registered public accounting firm, which audited and reported on the consolidated financial statements
contained in this Form 10-K, has issued its written attestation report on the Companys internal control over financial reporting which appears on page F-2 of this report.

(d) Remediation Steps to Address the Material weakness

Management previously
reported a material weakness in the Companys internal control over financial reporting, related to recording an out of period income tax adjustment arising from the Castlepoint Inc. acquisition, in Amendment No. 1 on Form 10-Q/A for the
quarterly period ended March 31, 2012 (filed on January 16, 2013), Amendment No. 1 on Form 10-Q/A for the quarterly period ended June 30, 2012 (filed on January 16, 2013) and most recently in Amendment No. 1 on Form
10-Q/A for the quarterly period ended September 30, 2012 (filed on January 17, 2013). A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable
possibility that a material misstatement of the Companys annual or interim financial statements will not be prevented or detected on a timely basis.

The Company made the following changes to its internal controls over financial reporting to remediate the material weakness reported most recently in Amendment No. 1 on Form 10-Q/A for the quarter
ended September 30, 2012:



| | 1. | The Company formalized its cross-functional communications and holds quarterly meetings to identify transactions that may have a tax impact. Senior management has
formalized its role in the oversight of the reporting of deferred taxes on business combinations.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



51



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##### Table of Contents

| | 2. | The Company instituted a more rigorous approach to addressing deferred tax accounting matters in business combinations and the related tax impact on purchase price
allocation, opening GAAP balance sheet and subsequent adjustments to those items. A more robust analysis process has been implemented which includes the involvement of the Chief Accounting Officer, in consultation with external tax specialists to
review the new accounting basis as a result of business combination accounting.
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

The company completed the documentation and
testing of the corrective processes described above and, as of December 31, 2012, has concluded that the steps taken have remediated the material weakness related to accounting for income taxes previously disclosed in Amendment No. 1 to
the Companys 2012 Forms 10-Q/As.

(e) Changes in internal control over financial reporting

Other than the items mentioned above to remediate the material weakness, there were no other changes in the Companys internal control over
financial reporting that occurred during the quarter ended December 31, 2012 that has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.



52



---

##### Table of Contents

PART IV

Item 15. Exhibits, Financial Statement Schedules



|   |  |     |  |                                                                                                                                                      
|-- |  | --- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------
|   |  |    
|A. |  | (1) |  | The financial statements and notes to financial statements are filed as part of this report in Item 8. Financial Statements and Supplementary
Data.
|   |  |    
|   |  | (2) |  | The financial statement schedules are listed in the Index to Consolidated Financial Statement Schedules.                                             
|   |  |    
|   |  | (3) |  | The exhibits are listed in the Index to Exhibits                                                                                                     

The following entire exhibits are included:



Exhibit 21.1

Subsidiaries of Tower Group, Inc.Exhibit 23.1

Consent of PricewaterhouseCoopers LLPExhibit 31.1

Certification of CEO to Section 302(a)Exhibit 31.2

Certification of CFO to Section 302(a)Exhibit 32

Certification of CEO and CFO to Section 906


The following exhibits are filed electronically herewith:



EX-101

INSTANCE DOCUMENTEX-101

SCHEMA DOCUMENTEX-101

CALCULATION LINKBASE DOCUMENTEX-101

LABELS LINKBASE DOCUMENTEX-101

PRESENTATION LINKBASE DOCUMENTEX-101

DEFINITION LINKBASE DOCUMENT




53



---

##### Table of Contents

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) 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.



|                     |  |                   |  |                                                                            
|-------------------- |  | ----------------- |  | ---------------------------------------------------------------------------
|                     |  | Tower Group, Inc.
|                     |  | Registrant       
|                     |  |                  
|Date: March 12, 2013 |  |                   |  | /s/ Michael H. Lee                                                         
|                     |  |                   |  | Michael H. Lee Chairman of the
Board, President and Chief Executive Officer

Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons on
behalf of the registrant and in the capacities indicated.



|                                                       |  |                                                                                                               |  |               
|------------------------------------------------------ |  | ------------------------------------------------------------------------------------------------------------- |  | --------------
|Signature                                              |  | Title                                                                                                         |  | Date          
|                                                       |  |                                                                                                              
|/s/    MICHAEL H. LEE
Michael H. Lee                   |  | Chairman of the Board, President and Chief Executive Officer (Principal Executive Officer)                    |  | March 12, 2013
|                                                       |  |                                                                                                              
|/s/    WILLIAM E. HITSELBERGER
William E. Hitselberger |  | Executive Vice President, Chief Financial Officer (Principal Financial Officer, Principal Accounting Officer) |  | March 12, 2013
|                                                       |  |                                                                                                              
|/s/    CHARLES A. BRYAN
Charles A. Bryan               |  | Director                                                                                                      |  | March 4, 2013 
|                                                       |  |                                                                                                              
|/s/    WILLIAM W. FOX, JR.
William W. Fox, Jr.         |  | Director                                                                                                      |  | March 4, 2013 
|                                                       |  |                                                                                                              
|/s/    WILLIAM A. ROBBIE
William A. Robbie             |  | Director                                                                                                      |  | March 4, 2013 
|                                                       |  |                                                                                                              
|/s/    STEVEN W. SCHUSTER
Steven W. Schuster           |  | Director                                                                                                      |  | March 4, 2013 
|                                                       |  |                                                                                                              
|/s/    ROBERT S. SMITH
Robert S. Smith                 |  | Director                                                                                                      |  | March 4, 2013 
|                                                       |  |                                                                                                              
|/s/    JAN R. VAN GORDER
Jan R. Van Gorder             |  | Director                                                                                                      |  | March 4, 2013 
|                                                       |  |                                                                                                              
|/s/    AUSTIN P. YOUNG, III
Austin P. Young, III       |  | Director                                                                                                      |  | March 4, 2013 



54



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##### Table of Contents

Tower Group, Inc.

Index to Financial Statement Schedules



|          |  |                                                                                                                |  |      
|--------- |  | -------------------------------------------------------------------------------------------------------------- |  | -----
|Schedules |  |                                                                                                                |  | Pages
|          |  |                                                                                                               
|I         |  | Summary of Investmentsother than investments in related parties                                               |  | S-2  
|II        |  | Condensed Financial Information of the Registrant as of and for the years ended December 31, 2012 and 2011     |  | S-3  
|III       |  | Supplementary Insurance Information for the years ended December 31, 2012, 2011, and 2010                      |  | S-8  
|IV        |  | Reinsurance for the years ended December 31, 2012, 2011, and 2010                                              |  | S-9  
|V         |  | Valuation and Qualifying Accounts for the years ended December 31, 2012, 2011, and 2010                        |  | S-10 
|VI        |  | Supplemental Information Concerning Insurance Operations for the years ended December 31, 2012, 2011, and 2010 |  | S-11 



S-1



---

##### Table of Contents

Tower Group, Inc.

Schedule ISummary of InvestmentsOther Than Investments in Related Parties



|                                                                     |  |                   |           |  |           |   |           |                                 |  |   |           | 
|-------------------------------------------------------------------- |  | ----------------- | --------- |  | --------- | - | --------- | ------------------------------- |  | - | --------- | 
|                                                                     |  | December 31, 2012 |          
|($ in thousands)                                                     |  | Cost              |           |  | FairValue |   |           | AmountReflected onBalance Sheet | 
|                                                                     | 
|Fixed maturities:                                                    |  |                   |           |  |           |   |           |                                 |  |   |           | 
|Available for sale:                                                  |  |                   |           |  |           |   |           |                                 |  |   |           | 
|U.S. Treasury securities and obligations of U.S. Government agencies |  | $                 | 281,964   |  |           | $ | 287,726   |                                 |  | $ | 287,726   | 
|Corporate securities                                                 |  |                   | 698,012   |  |           |   | 747,665   |                                 |  |   | 747,665   | 
|Mortgage-backed securities                                           |  |                   | 576,837   |  |           |   | 624,277   |                                 |  |   | 624,277   | 
|Municipal securities                                                 |  |                   | 633,373   |  |           |   | 686,043   |                                 |  |   | 686,043   | 
|                                                                     | 
|Total fixed maturities                                               |  |                   | 2,190,186 |  |           |   | 2,345,711 |                                 |  |   | 2,345,711 | 
|Preferred stocks                                                     |  |                   | 31,272    |  |           |   | 31,521    |                                 |  |   | 31,521    | 
|Common stock:                                                        |  |                   |           |  |           |   |           |                                 |  |   |           | 
|Public utilities, industrial and other                               |  |                   | 118,076   |  |           |   | 114,737   |                                 |  |   | 114,737   | 
|                                                                     | 
|Total equities                                                       |  |                   | 149,348   |  |           |   | 146,258   |                                 |  |   | 146,258   | 
|                                                                     | 
|Short-term investments                                               |  |                   | 4,749     |  |           |   | 4,750     |                                 |  |   | 4,750     | 
|                                                                     | 
|Other invested assets                                                |  |                   | 57,786    |  |           |   | 57,786    |                                 |  |   | 57,786    | 
|                                                                     | 
|Total investments                                                    |  | $                 | 2,402,069 |  |           | $ | 2,554,505 |                                 |  | $ | 2,554,505 | 
|                                                                     | 



|                                                                     |  |                   |           |  |           |   |           |                                 |  |   |           | 
|-------------------------------------------------------------------- |  | ----------------- | --------- |  | --------- | - | --------- | ------------------------------- |  | - | --------- | 
|                                                                     |  | December 31, 2011 |          
|($ in thousands)                                                     |  | Cost              |           |  | FairValue |   |           | AmountReflected onBalance Sheet | 
|                                                                     | 
|Fixed maturities:                                                    |  |                   |           |  |           |   |           |                                 |  |   |           | 
|Available for sale:                                                  |  |                   |           |  |           |   |           |                                 |  |   |           | 
|U.S. Treasury securities and obligations of U.S. Government agencies |  | $                 | 268,841   |  |           | $ | 273,332   |                                 |  | $ | 273,332   | 
|Corporate securities                                                 |  |                   | 750,220   |  |           |   | 777,723   |                                 |  |   | 777,723   | 
|Mortgage-backed securities                                           |  |                   | 627,859   |  |           |   | 665,905   |                                 |  |   | 665,905   | 
|Municipal securities                                                 |  |                   | 688,192   |  |           |   | 736,714   |                                 |  |   | 736,714   | 
|                                                                     | 
|Total fixed maturities                                               |  |                   | 2,335,112 |  |           |   | 2,453,674 |                                 |  |   | 2,453,674 | 
|Preferred stocks                                                     |  |                   | 24,083    |  |           |   | 23,510    |                                 |  |   | 23,510    | 
|Common stock:                                                        |  |                   |           |  |           |   |           |                                 |  |   |           | 
|Public utilities, industrial and other                               |  |                   | 68,951    |  |           |   | 65,835    |                                 |  |   | 65,835    | 
|                                                                     | 
|Total equities                                                       |  |                   | 93,034    |  |           |   | 89,345    |                                 |  |   | 89,345    | 
|                                                                     | 
|Other invested assets                                                |  |                   | 44,347    |  |           |   | 44,347    |                                 |  |   | 44,347    | 
|                                                                     | 
|Total investments                                                    |  | $                 | 2,472,493 |  |           | $ | 2,587,366 |                                 |  | $ | 2,587,366 | 
|                                                                     | 



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##### Table of Contents

Tower Group, Inc.

Schedule IICondensed Financial Information of the Registrant

Condensed Balance
Sheets



|                                                                                                   |  |              |           |  |      |   |           | 
|-------------------------------------------------------------------------------------------------- |  | ------------ | --------- |  | ---- | - | --------- | 
|                                                                                                   |  | December 31, |          
|($ in thousands)                                                                                   |  | 2012         |           |  | 2011 |  
|                                                                                                   | 
|Assets                                                                                             |  |              |           |  |      |   |           | 
|Fixed-maturity securities, available-for-sale, at fair value (amortized cost of $7,656 and $5,938) |  | $            | 8,121     |  |      | $ | 5,937     | 
|Equity securities, available-for-sale, at fair value (cost of $0 and $9,649)                       |  |              | -         |  |      |   | 9,960     | 
|Other invested assets                                                                              |  |              | 2,045     |  |      |   | 10,458    | 
|Cash and cash equivalents                                                                          |  |              | 17,130    |  |      |   | 12,882    | 
|Investment in subsidiaries                                                                         |  |              | 1,282,278 |  |      |   | 1,271,266 | 
|Investment in unconsolidated affiliate                                                             |  |              | 70,830    |  |      |   | -         | 
|Deferred income taxes                                                                              |  |              | 15,879    |  |      |   | 2,714     | 
|Investment in statutory business trusts, equity method                                             |  |              | 2,664     |  |      |   | 2,664     | 
|Due from affiliate                                                                                 |  |              | -         |  |      |   | 1,231     | 
|Other assets                                                                                       |  |              | 69,172    |  |      |   | 46,100    | 
|                                                                                                   | 
|Total assets                                                                                       |  | $            | 1,468,119 |  |      | $ | 1,363,212 | 
|                                                                                                   | 
|Liabilities                                                                                        |  |              |           |  |      |   |           | 
|Accounts payable and accrued expenses                                                              |  | $            | 25,622    |  |      | $ | 16,293    | 
|Due to affiliates                                                                                  |  |              | 75,823    |  |      |   | 27,542    | 
|Deferred rent liability                                                                            |  |              | 4,537     |  |      |   | 5,071     | 
|Federal and state income taxes payable                                                             |  |              | 0         |  |      |   | 0         | 
|Debt                                                                                               |  |              | 381,301   |  |      |   | 280,507   | 
|                                                                                                   | 
|Total liabilities                                                                                  |  |              | 487,283   |  |      |   | 329,413   | 
|                                                                                                   | 
|Stockholders equity                                                                               |  |              | 980,836   |  |      |   | 1,033,799 | 
|                                                                                                   | 
|Total liabilities and stockholders equity                                                         |  | $            | 1,468,119 |  |      | $ | 1,363,212 | 
|                                                                                                   | 

The condensed financial information should be read in conjunction with the notes to the condensed financial
information of the registrant and the consolidated financial statements and the notes thereto.



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##### Table of Contents

Tower Group, Inc.

Schedule IICondensed Financial Information of the Registrant

Condensed Statements of Income



|                                                        |  |                         |           |  |      |   |         |      |  |   |         | 
|------------------------------------------------------- |  | ----------------------- | --------- |  | ---- | - | ------- | ---- |  | - | ------- | 
|                                                        |  | Year Ended December 31, |          
|($ in thousands)                                        |  | 2012                    |           |  | 2011 |   |         | 2010 | 
|                                                        | 
|Revenues                                                |  |                         |           |  |      |   |         |      |  |   |         | 
|Net realized gains (losses) on investments              |  | $                       | (1,570)   |  |      | $ | (264)   |      |  | $ | 201     | 
|Investment income                                       |  |                         | 815       |  |      |   | 1,394   |      |  |   | 1,000   | 
|Equity in net earnings of subsidiaries                  |  |                         | 890       |  |      |   | 77,727  |      |  |   | 120,675 | 
|                                                        | 
|Total revenues                                          |  |                         | 135       |  |      |   | 78,857  |      |  |   | 121,876 | 
|Expenses                                                |  |                         |           |  |      |   |         |      |  |   |         | 
|Other operating expenses                                |  |                         | 11,754    |  |      |   | 10,067  |      |  |   | 2,891   | 
|Interest expense                                        |  |                         | 18,782    |  |      |   | 17,843  |      |  |   | 9,685   | 
|                                                        | 
|Total expenses                                          |  |                         | 30,536    |  |      |   | 27,910  |      |  |   | 12,576  | 
|Other Income                                            |  |                         |           |  |      |   |         |      |  |   |         | 
|Equity income in unconsolidated affiliate               |  |                         | (2,534)   |  |      |   | -       |      |  |   | -       | 
|Gain on investment in acquired unconsolidated affiliate |  |                         | -         |  |      |   | -       |      |  |   | -       | 
|Acquisition related transaction costs                   |  |                         | (  9,229) |  |      |   | (360)   |      |  |   | (2,369) | 
|                                                        | 
|Income before income taxes                              |  |                         | (42,164)  |  |      |   | 50,587  |      |  |   | 106,931 | 
|Provision/(benefit) for income taxes                    |  |                         | (14,010)  |  |      |   | (9,894) |      |  |   | 575     | 
|                                                        | 
|Net income                                              |  | $                       | (28,154)  |  |      | $ | 60,481  |      |  | $ | 106,356 | 
|                                                        | 

The condensed financial information should be read in conjunction with the notes to the condensed financial information of the
registrant and the consolidated financial statements and the notes thereto.



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##### Table of Contents

Tower Group, Inc.

Schedule IICondensed Financial Information of the Registrant

Condensed Statements of Comprehensive Income



|                                                                                            |  |                         |          |  |      |   |          |      |  |   |          | 
|------------------------------------------------------------------------------------------- |  | ----------------------- | -------- |  | ---- | - | -------- | ---- |  | - | -------- | 
|                                                                                            |  | Year Ended December 31, |         
|($ in thousands)                                                                            |  | 2012                    |          |  | 2011 |   |          | 2010 | 
|                                                                                            | 
|Net income (loss)                                                                           |  | $                       | (28,154) |  |      | $ | 60,481   |      |  | $ | 106,356  | 
|Other comprehensive income (loss) before tax, includes Registrant and consolidated entities |  |                         |          |  |      |   |          |      |  |   |          | 
|Gross unrealized investment holding gains (losses) arising during the period                |  |                         | 63,325   |  |      |   | 50,851   |      |  |   | 45,912   | 
|Less: reclassification adjustment for (gains) losses included in net income                 |  |                         | (25,475) |  |      |   | (9,394)  |      |  |   | (14,653) | 
|Portion of other-than-temporary impairment losses included in net income                    |  |                         | (286)    |  |      |   | (264)    |      |  |   | (11,909) | 
|Cumulative translation adjustment                                                           |  |                         | 1,852    |  |      |   | -        |      |  |   | -        | 
|Deferred gain (loss) on cash flow hedge                                                     |  |                         | (2,422)  |  |      |   | (10,541) |      |  |   | 3,223    | 
|                                                                                            | 
|Other comprehensive income (loss) before tax                                                |  |                         | 36,994   |  |      |   | 30,652   |      |  |   | 22,573   | 
|Income tax (expense) benefit related to items of other comprehensive income                 |  |                         |          |  |      |   |          |      |  |   |          | 
|Unrealized investment holdings gains (losses) arising during periods                        |  |                         | (22,896) |  |      |   | (9,430)  |      |  |   | (14,081) | 
|Reclassification adjustment for (gains) losses included in net income                       |  |                         | 8,917    |  |      |   | 1,742    |      |  |   | 4,494    | 
|Portion of other-than-temporary impairment losses recognized in other comprehensive income  |  |                         | 100      |  |      |   | 49       |      |  |   | 3,652    | 
|Cumulative translation adjustment                                                           |  |                         | (648)    |  |      |   | -        |      |  |   | -        | 
|Deferred gain (loss) on cash flow hedge                                                     |  |                         | 571      |  |      |   | 1,955    |      |  |   | (988)    | 
|                                                                                            | 
|Other comprehensive income (loss) net of tax                                                |  |                         | 23,038   |  |      |   | 24,968   |      |  |   | 15,650   | 
|Less amount attributable to Reciprocal Exchanges                                            |  |                         | 2,684    |  |      |   | 10,194   |      |  |   | 2,646    | 
|                                                                                            | 
|Comprehensive income (loss)                                                                 |  | $                       | (7,800)  |  |      | $ | 75,255   |      |  | $ | 119,360  | 
|                                                                                            | 

The condensed financial information should be read in conjunction with the notes to the condensed financial
information of the registrant and the consolidated financial statements and the notes thereto. These condensed statements of comprehensive income were prepared using investments and other financial instruments held by the Registrant and its
consolidated entities.



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##### Table of Contents

Tower Group, Inc.

Schedule IICondensed Financial Information of the Registrant

Condensed Statements of Cash Flows



|                                                                                  |  |                         |          |  |      |   |          |      |  |   |           | 
|--------------------------------------------------------------------------------- |  | ----------------------- | -------- |  | ---- | - | -------- | ---- |  | - | --------- | 
|                                                                                  |  | Year Ended December 31, |         
|($ in thousands)                                                                  |  | 2012                    |          |  | 2011 |   |          | 2010 | 
|                                                                                  | 
|Cash flows provided by (used in) operating activities:                            |  |                         |          |  |      |   |          |      |  |   |           | 
|Net income                                                                        |  | $                       | (28,154) |  |      | $ | 60,481   |      |  | $ | 106,356   | 
|Adjustments to reconcile net income to net cash provided by (used) in operations: |  |                         |          |  |      |   |          |      |  |   |           | 
|(Gain) loss on sale of investments                                                |  |                         | 1,570    |  |      |   | 264      |      |  |   | (201)     | 
|Dividends received from consolidated subsidiaries                                 |  |                         | 22,954   |  |      |   | 55,400   |      |  |   | 12,200    | 
|Equity in undistributed net income of subsidiaries                                |  |                         | (2,928)  |  |      |   | (78,235) |      |  |   | (119,293) | 
|Depreciation and amortization                                                     |  |                         | 4,388    |  |      |   | 3,362    |      |  |   | 1,627     | 
|Amortization of debt issuance costs                                               |  |                         | 2,830    |  |      |   | 2,635    |      |  |   | 711       | 
|Amortization of restricted stock                                                  |  |                         | 9,283    |  |      |   | 10,292   |      |  |   | 8,694     | 
|Deferred income tax                                                               |  |                         | (13,165) |  |      |   | (3,836)  |      |  |   | 6,032     | 
|Excess tax benefits from share-based payment arrangements                         |  |                         | (345)    |  |      |   | (162)    |      |  |   | 1,302     | 
|Change in operating assets and liabilities                                        |  |                         |          |  |      |   |          |      |  |   |           | 
|Change in carrying value of unconsolidated affiliate                              |  |                         | 682      |  |      |   | -        |      |  |   | -         | 
|Investment income receivable                                                      |  |                         | -        |  |      |   | 173      |      |  |   | (315)     | 
|Federal and state income tax recoverable                                          |  |                         | (18,409) |  |      |   | 15,998   |      |  |   | (8,817)   | 
|Other assets                                                                      |  |                         | (20,639) |  |      |   | (16,763) |      |  |   | (14,482)  | 
|Accounts payable and accrued expenses                                             |  |                         | 57,610   |  |      |   | 6,089    |      |  |   | 158       | 
|Deferred rent                                                                     |  |                         | (534)    |  |      |   | (581)    |      |  |   | (380)     | 
|                                                                                  | 
|Net cash flows provided by operations                                             |  |                         | 15,143   |  |      |   | 55,117   |      |  |   | (6,408)   | 
|Cash flows provided by (used in) investing activities:                            |  |                         |          |  |      |   |          |      |  |   |           | 
|Investment in unconsolidated affiliate                                            |  |                         | (71,512) |  |      |   | -        |      |  |   | -         | 
|Acquisition of AequiCap II                                                        |  |                         | -        |  |      |   | -        |      |  |   | (12,000)  | 
|Sale or maturityfixed-maturity securities                                        |  |                         | 3,947    |  |      |   | 58,367   |      |  |   | 65,292    | 
|Purchasefixed-maturity securities                                                |  |                         | (6,117)  |  |      |   | (46,848) |      |  |   | (90,200)  | 
|Purchaseequity securities                                                        |  |                         | -        |  |      |   | (4,224)  |      |  |   | -         | 
|Net change in other invested assets                                               |  |                         | 8,413    |  |      |   | (10,458) |      |  |   | -         | 
|Saleequity securities                                                            |  |                         | 8,390    |  |      |   | 1,304    |      |  |   | -         | 
|                                                                                  | 
|Net cash flows used in investing activities                                       |  |                         | (56,879) |  |      |   | (1,859)  |      |  |   | (36,908)  | 
|Cash flows provided by (used in) financing activities:                            |  |                         |          |  |      |   |          |      |  |   |           | 
|Proceeds from credit facility borrowings                                          |  |                         | 20,000   |  |      |   | 67,000   |      |  |   | 56,000    | 
|Repayment of credit facility borrowings                                           |  |                         | -        |  |      |   | (17,000) |      |  |   | (56,000)  | 
|Proceeds from convertible senior notes                                            |  |                         | -        |  |      |   | -        |      |  |   | 145,634   | 
|Proceeds from intercompany borrowings                                             |  |                         | 77,968   |  |      |   | -        |      |  |   | -         | 
|Payment for convertible senior notes hedge                                        |  |                         | -        |  |      |   | -        |      |  |   | (15,300)  | 
|Proceeds from issuance of warrants                                                |  |                         | -        |  |      |   | -        |      |  |   | 3,800     | 
|Exercise of stock options and warrants                                            |  |                         | (2,263)  |  |      |   | 373      |      |  |   | 1,590     | 
|Excess tax benefits from share-based payment arrangements                         |  |                         | 345      |  |      |   | 161      |      |  |   | (1,302)   | 
|Treasury stock acquired-net employee share-based compensation                     |  |                         | (4)      |  |      |   | (1,834)  |      |  |   | (1,750)   | 
|Repurchase of common stock                                                        |  |                         | (20,987) |  |      |   | (64,572) |      |  |   | (88,034)  | 
|Dividends paid                                                                    |  |                         | (29,075) |  |      |   | (27,894) |      |  |   | (16,551)  | 
|                                                                                  | 
|Net cash flows provided by (used in) financing activities                         |  |                         | 45,984   |  |      |   | (43,766) |      |  |   | 28,087    | 
|                                                                                  | 
|Increase (decrease) in cash and cash equivalents                                  |  |                         | 4,248    |  |      |   | 9,492    |      |  |   | (15,229)  | 
|Cash and cash equivalents, beginning of year                                      |  |                         | 12,882   |  |      |   | 3,390    |      |  |   | 18,619    | 
|                                                                                  | 
|Cash and cash equivalents, end of year                                            |  | $                       | 17,130   |  |      | $ | 12,882   |      |  | $ | 3,390     | 
|                                                                                  | 

The condensed financial information should be read in conjunction with the notes to the condensed financial information of the
registrant and the consolidated financial statements and the notes thereto.



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##### Table of Contents

Tower Group, Inc.

Schedule II  Condensed Financial Information of the Registrant

Notes to Condensed Financial Information

The accompanying condensed financial statements of Tower Group, Inc. (parent company) should be read in conjunction with the consolidated financial statements and notes thereto of Tower Group, Inc.

Note 1  Debt

The information relating to debt is incorporated by reference from Note 13  Debt in the consolidated financial
statements.

Note 2  Income Taxes

Tower Group, Inc. files a consolidated Federal income tax return. The Reciprocal Exchanges are not included in Tower Group, Incs
consolidated tax return as it does not have an ownership interest in the Reciprocal Exchanges, and they are not a part of the consolidated tax sharing agreement. The Federal income tax provision represents an allocation under the consolidated tax
sharing agreement.

Note 3  Reclassifications

Certain reclassifications have been made to prior years financial information to conform to the current year presentation.



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##### Table of Contents

Tower Group, Inc.

Schedule IIISupplementary Insurance Information



|                     |  |                                                                |         |  |                                                    |   |           |                       |  |   |                   |  |  |                                 |           |  |                    |   |           |                   |  |   |                    |   |  |   |         |  |  |   |           | 
|-------------------- |  | -------------------------------------------------------------- | ------- |  | -------------------------------------------------- | - | --------- | --------------------- |  | - | ----------------- |  |  | ------------------------------- | --------- |  | ------------------ | - | --------- | ----------------- |  | - | ------------------ | - |  | - | ------- |  |  | - | --------- | 
|($ in thousands)     |  | DeferredAcquisitionCost, Net ofDeferredCedingCommissionRevenue |         |  | Gross Future PolicyBenefits,Losses andLossExpenses |   |           | GrossUnearnedPremiums |  |   | NetEarnedPremiums |  |  | Benefits,Losses andLossExpenses |           |  | Amortizationof DAC |   |           | OperatingExpenses |  |   | NetPremiumsWritten |  
|                     | 
|2012                 |  |                                                                |         |  |                                                    |   |           |                       |  |   |                   |  |  |                                 |           |  |                    |   |           |                   |  |   |                    |   |  |   |         |  |  |   |           | 
|Commercial Insurance |  | $                                                              | 128,909 |  |                                                    | $ | 1,465,595 |                       |  | $ | 594,560           |  |  | $                               | 1,224,303 |  |                    | $ | 902,784   |                   |  | $ | (249,781           | ) |  | $ | 184,180 |  |  | $ | 1,225,625 | 
|Personal Insurance   |  |                                                                | 52,032  |  |                                                    |   | 429,478   |                       |  |   | 326,299           |  |  |                                 | 497,239   |  |                    |   | 351,076   |                   |  |   | (102,612           | ) |  |   | 127,318 |  |  |   | 513,757   | 
|                     | 
|Total                |  | $                                                              | 180,941 |  |                                                    | $ | 1,895,073 |                       |  | $ | 920,859           |  |  | $                               | 1,721,542 |  |                    | $ | 1,253,860 |                   |  | $ | (352,393           | ) |  | $ | 311,498 |  |  | $ | 1,739,382 | 
|                     | 
|2011                 |  |                                                                |         |  |                                                    |   |           |                       |  |   |                   |  |  |                                 |           |  |                    |   |           |                   |  |   |                    |   |  |   |         |  |  |   |           | 
|Commercial Insurance |  | $                                                              | 120,655 |  |                                                    | $ | 1,218,681 |                       |  | $ | 588,436           |  |  | $                               | 1,087,911 |  |                    | $ | 736,474   |                   |  | $ | (242,412           | ) |  | $ | 153,277 |  |  | $ | 1,152,299 | 
|Personal Insurance   |  |                                                                | 48,203  |  |                                                    |   | 413,432   |                       |  |   | 304,740           |  |  |                                 | 505,939   |  |                    |   | 318,775   |                   |  |   | (103,173           | ) |  |   | 125,866 |  |  |   | 486,292   | 
|                     | 
|Total                |  | $                                                              | 168,858 |  |                                                    | $ | 1,632,113 |                       |  | $ | 893,176           |  |  | $                               | 1,593,850 |  |                    | $ | 1,055,249 |                   |  | $ | (345,585           | ) |  | $ | 279,143 |  |  | $ | 1,638,591 | 
|                     | 
|2010                 |  |                                                                |         |  |                                                    |   |           |                       |  |   |                   |  |  |                                 |           |  |                    |   |           |                   |  |   |                    |   |  |   |         |  |  |   |           | 
|Commercial Insurance |  | $                                                              | 131,966 |  |                                                    | $ | 1,197,065 |                       |  | $ | 541,809           |  |  | $                               | 941,015   |  |                    | $ | 589,322   |                   |  | $ | (283,949           | ) |  | $ | 155,569 |  |  | $ | 987,260   | 
|Personal Insurance   |  |                                                                | 32,157  |  |                                                    |   | 413,356   |                       |  |   | 330,217           |  |  |                                 | 351,654   |  |                    |   | 194,701   |                   |  |   | (41,378            | ) |  |   | 84,501  |  |  |   | 326,804   | 
|                     | 
|Total                |  | $                                                              | 164,123 |  |                                                    | $ | 1,610,421 |                       |  | $ | 872,026           |  |  | $                               | 1,292,669 |  |                    | $ | 784,023   |                   |  | $ | (325,327           | ) |  | $ | 240,070 |  |  | $ | 1,314,064 | 
|                     | 



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##### Table of Contents

Tower Group , Inc.

Schedule IVReinsurance



|                                |  |             |           |  |                        |   |         |                             |  |   |            |  |  |                                  |           |  |  |  |       | 
|------------------------------- |  | ----------- | --------- |  | ---------------------- | - | ------- | --------------------------- |  | - | ---------- |  |  | -------------------------------- | --------- |  |  |  | ----- | 
|($ in thousands)                |  | GrossAmount |           |  | Ceded toOtherCompanies |   |         | Assumed from OtherCompanies |  |   | Net Amount |  |  | Percentageof AmountAssumedto Net |          
|                                | 
|Year ended December 31, 2012    |  |             |           |  |                        |   |         |                             |  |   |            |  |  |                                  |           |  |  |  |       | 
|Premiums                        |  |             |           |  |                        |   |         |                             |  |   |            |  |  |                                  |           |  |  |  |       | 
|Property and casualty insurance |  | $           | 1,758,804 |  |                        | $ | 221,807 |                             |  | $ | 184,545    |  |  | $                                | 1,721,542 |  |  |  | 10.7% | 
|Accident and health insurance   |  |             | -         |  |                        |   | -       |                             |  |   | -          |  |  |                                  | -         |  |  |  | -     | 
|                                | 
|Total Premiums                  |  | $           | 1,758,804 |  |                        | $ | 221,807 |                             |  | $ | 184,545    |  |  | $                                | 1,721,542 |  |  |  | 10.7% | 
|                                | 
|Year ended December 31, 2011    |  |             |           |  |                        |   |         |                             |  |   |            |  |  |                                  |           |  |  |  |       | 
|Premiums                        |  |             |           |  |                        |   |         |                             |  |   |            |  |  |                                  |           |  |  |  |       | 
|Property and casualty insurance |  | $           | 1,684,020 |  |                        | $ | 195,922 |                             |  | $ | 105,752    |  |  | $                                | 1,593,850 |  |  |  | 6.6%  | 
|Accident and health insurance   |  |             | -         |  |                        |   | -       |                             |  |   | -          |  |  |                                  | -         |  |  |  | -     | 
|                                | 
|Total Premiums                  |  | $           | 1,684,020 |  |                        | $ | 195,922 |                             |  | $ | 105,752    |  |  | $                                | 1,593,850 |  |  |  | 6.6%  | 
|                                | 
|Year ended December 31, 2010    |  |             |           |  |                        |   |         |                             |  |   |            |  |  |                                  |           |  |  |  |       | 
|Premiums                        |  |             |           |  |                        |   |         |                             |  |   |            |  |  |                                  |           |  |  |  |       | 
|Property and casualty insurance |  | $           | 1,429,250 |  |                        | $ | 226,970 |                             |  | $ | 90,389     |  |  | $                                | 1,292,669 |  |  |  | 7.0%  | 
|Accident and health insurance   |  |             | -         |  |                        |   | -       |                             |  |   | -          |  |  |                                  | -         |  |  |  | -     | 
|                                | 
|Total Premiums                  |  | $           | 1,429,250 |  |                        | $ | 226,970 |                             |  | $ | 90,389     |  |  | $                                | 1,292,669 |  |  |  | 7.0%  | 
|                                | 



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##### Table of Contents

Tower Group, Inc.

Schedule VValuation and Qualifying Accounts



|                             |  |                            |        |  |           |   |       |           |  |   |                      |   |  |   |        | 
|---------------------------- |  | -------------------------- | ------ |  | --------- | - | ----- | --------- |  | - | -------------------- | - |  | - | ------ | 
|($ in thousands)             |  | Balance,Beginningof Period |        |  | Additions |   |       | Deletions |  |   | Balance,End ofPeriod |  
|                             | 
|Year ended December 31, 2012 |  |                            |        |  |           |   |       |           |  |   |                      |   |  |   |        | 
|Premiums receivable          |  | $                          | 4,383  |  |           | $ | 5,916 |           |  | $ | (4,790               | ) |  | $ | 5,509  | 
|Deferred income taxes, net   |  |                            | 6,961  |  |           |   | -     |           |  |   | (339                 | ) |  |   | 6,622  | 
|                             | 
|Year ended December 31, 2011 |  |                            |        |  |           |   |       |           |  |   |                      |   |  |   |        | 
|Premiums receivable          |  |                            | 2,119  |  |           |   | 5,269 |           |  |   | (3,005               | ) |  |   | 4,383  | 
|Deferred income taxes, net   |  |                            | 11,824 |  |           |   | -     |           |  |   | (4,863               | ) |  |   | 6,961  | 
|                             | 
|Year ended December 31, 2010 |  |                            |        |  |           |   |       |           |  |   |                      |   |  |   |        | 
|Premiums receivable          |  |                            | 1,272  |  |           |   | 3,735 |           |  |   | (2,888               | ) |  |   | 2,119  | 
|Deferred income taxes, net   |  |                            | 1,896  |  |           |   | 9,928 |           |  |   | -                    |   |  |   | 11,824 | 
|                             | 



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##### Table of Contents

Tower Group, Inc.

Schedule VISupplemental Information Concerning Insurance Operations



|                                    |  |             |         |  |            |   |           |             |  |   |          |  |  |         |         |  |            |   |           |                                                               |  |   |             |   |  |              |           |  |             |   |         |          |  |   |          |   |  |   |           |  |  |   |           | 
|----------------------------------- |  | ----------- | ------- |  | ---------- | - | --------- | ----------- |  | - | -------- |  |  | ------- | ------- |  | ---------- | - | --------- | ------------------------------------------------------------- |  | - | ----------- | - |  | ------------ | --------- |  | ----------- | - | ------- | -------- |  | - | -------- | - |  | - | --------- |  |  | - | --------- | 
|                                    |  |             |         |  | Reserves   |   |           |             |  |   |          |  |  |         |         |  |            |   |           | Claims and Claims
Adjustment Expenses Incurred and Related to |  |   |             |   |  |              |           |  |             |  
|                                    |  |             |         |  | For Unpaid |   |           |             |  |   |          |  |  |         |         |  |            |   |           |                                                               |  |   |             |   |  |              |           | 
|                                    |  |             |         |  | Claims and |   |           |             |  |   |          |  |  |         |         |  |            |   |           |                                                               |  |   | Prior Year* |   |  |              |           |  | Paid Claims |   |         |          | 
|                                    |  | Deferred    |         |  | Claim      |   |           |             |  |   |          |  |  |         |         |  | Net        |   |           |                                                               |  |   | Includes    |   |  | Amortization |           |  | and Claim   |   |         | Net      | 
|                                    |  | Acquisition |         |  | Adjustment |   |           | Discount on |  |   | Unearned |  |  | Earned  |         |  | Investment |   |           | Current                                                       |  |   | PXRE        |   |  | of           |           |  | Adjustment  |   |         | Premiums | 
|$ in thousands)                     |  | Cost        |         |  | Expenses   |   |           | Reserves    |  |   | Premium  |  |  | Premium |         |  | Income     |   |           | Year                                                          |  |   | Commutation |   |  | DAC          |           |  | Expenses    |   |         | Written  | 
|                                    | 
|2012                                |  |             |         |  |            |   |           |             |  |   |          |  |  |         |         |  |            |   |           |                                                               |  |   |             |   |  |              |           |  |             |   |         |          |  |   |          |   |  |   |           |  |  |   |           | 
|Consolidated Insurance Subsidiaries |  | $           | 180,941 |  |            | $ | 1,895,073 |             |  | $ | 8,354    |  |  | $       | 920,859 |  |            | $ | 1,721,542 |                                                               |  | $ | (6,059      | ) |  | $            | 1,184,510 |  |             | $ | 69,350  |          |  | $ | (352,402 | ) |  | $ | 1,167,428 |  |  | $ | 1,739,382 | 
|2011                                |  |             |         |  |            |   |           |             |  |   |          |  |  |         |         |  |            |   |           |                                                               |  |   |             |   |  |              |           |  |             |   |         |          |  |   |          |   |  |   |           |  |  |   |           | 
|Consolidated Insurance Subsidiaries |  |             | 168,858 |  |            |   | 1,632,113 |             |  |   | 3,674    |  |  |         | 893,176 |  |            |   | 1,593,850 |                                                               |  |   | 126,474     |   |  |              | 1,076,045 |  |             |   | (20,796 | )        |  |   | (345,585 | ) |  |   | 1,070,539 |  |  |   | 1,638,591 | 
|2010                                |  |             |         |  |            |   |           |             |  |   |          |  |  |         |         |  |            |   |           |                                                               |  |   |             |   |  |              |           |  |             |   |         |          |  |   |          |   |  |   |           |  |  |   |           | 
|Consolidated Insurance Subsidiaries |  |             | 164,123 |  |            |   | 1,610,421 |             |  |   | 3,674    |  |  |         | 872,026 |  |            |   | 1,292,669 |                                                               |  |   | 107,265     |   |  |              | 796,313   |  |             |   | (12,290 | )        |  |   | (325,327 | ) |  |   | 740,722   |  |  |   | 1,314,064 | 
|                                    | 



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